Milk Production Enters Slow Growth Phase - Will Milk Prices Rebound?

As we approach the midpoint of the 2003 calendar year it is time to take stock of where we are milk price-wise and where we are likely to go in the last seven months remaining for 2003.

The roller coaster that we know as the U.S. dairy market

As we look back at the dairy markets over the last four years, 1999 through 2002, we certainly can recall those familiar opening lines from Charles Dicken's Tale of Two Cities:

It was the best of times, it was the worst of times,
It was the spring of hope, it was the winter of despair.

As a recap on the "spring of hope" and the "winter of despair", recall that milk supply and demand were in tight balance as 1999 came to a close, with National Agricultural Statistical Service, USDA reporting the average All Milk Price at $14.35 and gross income from the sale of milk at a near peak of $23.3 billion dollars. Times were indeed, good! The performance for 2000 lived up to the billing of the worst of times. Milk production grew by 2.98% responding to high prices and cash inflow. However, as often happens with farm production, and dairy is not the exception, rapid production growth outpaces growth in commercial demand. Commercial disappearance, as measured by fat equivalence, grew by 2.54% for 2000 over 1999. By the end of 2000, this imbalance between production and use had sent the all milk price declining by 13.6% and gross income from the sale of milk declining by 11% to 20.8 billion dollars.

As 2001 began, it appeared that more despair was on the way! This was not to be, however, as difficult weather created harsh production conditions, and milk per cow struggled to keep up with the trend, and finally posted a significant reversal of direction and declined by 0.4% for the year. Even with demand now showing real weakness, this was enough to push the average value of the All Milk Price back up by 21.4% and send gross cash income from the sale of milk soaring to $24.9 billion dollars. It was the best of times once again!

As is the case for the US dairy, all of that cash income flowing onto the farms was put to good use by producing more milk. With the weather back to more normal conditions for most of 2002, production picked up again, cow numbers increased, yields went up, and US milk production posted a 2.5% gain over 2001. What happened to milk price? You guessed it! The average All Milk Price declined again. This time it fell by a staggering 19.5%. The annual average All Milk Price in 2001 was $15.05, and by the end of 2002, it had declined to $12.11! My, how the winter of despair had returned!

Why such a large decline in the milk price from 2001 to 2002? The answer to this rests squarely on the recognition that with weak consumer demand across the board, there is too much milk production taking place to support the higher prices we experienced in 1999 ($14.35) and 2001($15.05). Commercial disappearance grew by only 0.3% in 2001 and 0.5% in 2002! In addition, and this is a big factor for the future milk price outlook, we are starting each new production year with an ever increasing inventory of unsold dairy products - butter, cheese, and nonfat dry milk.

On a fat equivalent basis, commercial inventories increased by 11% in 2001 and by 2.95% in 2002. On a solids-equivalent basis, inventories held by the Commodity Credit Corporation also increased by 284% in 2001 and 50.4% in 2002, primarily as skim milk powder. This is the explanation for why a 2.98% increase in production from 1999 to 2000 resulted in a 13.5% price fall and a smaller, 2.5% increase in production from 2001 to 2002 resulted in a 19.5% price fall.

Dairy product inventories flatten milk prices

A seasonal pattern occurs for butter stocks to production ratio (BSPR). Stocks tend to rise during the first half of the year as cream is flush and butter production is full throttle. In the second half of the year, when cream is less available, stocks are drawn down relative to butter production. High milk price years need high butter prices. This is a fact! High butter prices require a moderate to low BSPR. In 2003, the BSPR is running at least two times higher than we would normally expect this time of the year. In fact, we are carrying inventories of butter that we would not expect to see until the peak in the June - August period. This strongly suggests that we will not see wholesale butter price move above the $1.10 to $1.20 range this year, unless something happens to soak up a significant quantity of this butter in commercial storage.

As with butter but not as obvious, a seasonal pattern occurs for the cheese stocks to production ratio (CSPR). Stocks relative to production tend to rise during the November to February months, and then again during the March to July period. In the second half of the year, when farm level protein tests fall, the cheese industry pulls from stocks to satisfy demand and stocks are drawn down relative to cheese production. Just as we discussed for butter, high milk price years need high cheese prices. And as with butter, higher cheese prices require a moderate to low CSPR. In 2003, the CSPR is running at 4 percentage points higher than we would normally expect this time of the year. While this is higher than we would like to see at this time of the year, this is not nearly as significant as the BSPR. With a pickup in commercial demand, we can anticipate a real rise in the wholesale cheese price. How high can the cheese price rise? Without a return to robust consumer demand, I do not expect to see the reported National Agriculture Statistics Service (NASS) monthly average wholesale cheese price to move above the $1.20 to $1.35 range for the remainder of 2003. In my opinion, the cash cheese price rally posted on the Chicago Mercantile Exchange on the opening days of July is not sustainable as a long-term price level.

A little good news please

From the latest USDA Milk Production report, it does appear that the prolonged financial pain of the past year is beginning to show as a reduced rate of growth in cow numbers, yield per cow, and US milk production. Couple this with weekly numbers from the USDA Federal Inspected Livestock Slaughter - Dairy Cattle report, which indicates that dairy cow slaughter is continuing to run an average of 10 to 11% ahead of last year at this time. If this continues, I expect that we have turned the corner on milk production growth and can expect to see much slower growth on a percentage basis over the next year. If the past is a guide, it will take 3 to 5 quarters of reduced milk output growth with the last couple of those showing a negative rate of growth over the year earlier period for the supply and demand balance to become tight enough for the All Milk Price to show a sustained and substantial increase. When this happens, you can expect to see a $1.50 to $2.00 increase in the monthly value of the All Milk Price by year end.

Let's take a look at what is ahead for market prices in the last half of 2003 and the first part of 2004

Until we get a better balance between the inventory of dairy products and commercial disappearance, you should look for the current wholesale price levels of Grade AA butter and Cheddar cheese to remain lethargic for the remainder of 2003 and the first quarter of 2004. The 2003 forecast, June through December, for dairy commodity prices (butter, nonfat dry milk, cheese, and whey), given by quarter, is shown in Table 1. These forecast prices translate into the average milk check value shown in Table 2. The producer differential and the gross milk check price are applicable to producers in the Mideast Federal Milk Marketing Order 33, Cleveland base zone. Milk component pay prices, given the 2003 forecast dairy product prices, will be quite moderate, which will be good news for processors of dairy products facing weak consumer demand and not so good news for dairy producers. Class prices in the remaining months of 2003 will not be as robust as they were in 2002 (Table 3).

Table 1. Forecast dairy commodity wholesale prices ($/lb), 2002 and 2003..

Table 2. Forecast milk component pay prices and Class III price, 2003.

*MILC = Milk Income Loss Compensation

Table 3. Forecast class prices 2003 with comparisons for 1999 through 2002.

Projected MILC payment rates

Now that we have the complete suite of price forecasts for FY2003, we can calculate the implied payment rates under the MILC program (Table 4). In doing this, keep in mind that these are only estimates of the rates and will change as new market and production information becomes available. Remember MILC payment rates increase as the Class III and/or Class IV advanced mover prices decline. A higher MILC payment rate is not what is desired as it lifts only some boats, while across the board strength in all milk prices raises all of the dairy boats.

Table 4. The FY2003 forecast Milk Income Loss Compensation (MILC) payment rate ($/cwt) by month.

Winding up

It is hard to be up-beat and rosy with quarterly average prices that look, at this point, not to be much better than 2000 or 2002. It is fair to ask what could alter my dairy product and milk price forecasts for 2003. Ignoring the unpredictable element of weather, there are really three economic factors at this point. One factor on the production side and two factors on the demand side.

First, higher feed costs and extremely unfavorable margins over feed costs are beginning to show up in reduced rate of growth in production per cow and in milk cow numbers. This must continue and grow in strength over the remainder of the year. For those of you who like to follow the numbers, early signs of better prices will be USDA reported cow numbers running 0.5 to 1% below year earlier levels, accompanied by output per cow coming in at 0.5 to 1.5% below year earlier levels. This is what is required to adequately slow the rate of growth in milk production and dairy product inventory and could push wholesale market prices and milk prices higher.

Second, the current slow recovery in the general US economy must continue to gain momentum. We are now headed toward the traditional peak consumer demand months for dairy products, and we need a real strong growth to get consumers back into the buying mood. If this happens, we could see consumer demand gain in strength, indicated by more rapidly declining inventories of butter and cheese. We could see prices for butter and cheese rise above those in this forecast and would be welcome news indeed for dairy producers.

Third, the current low wholesale price will slowly be reflected in prices in the supermarkets, pizza parlors, and sub-shops. Low prices do perform the function of making dairy products a better value for the dollar and this increases consumer demand that eats away at excessive inventories. Slowly, yes - but it does happen, and this will get market supply back into a better balance with consumer demand. Remember, it was just the right kind of poor weather that rescued milk prices and dairy farm revenue in 2001 from the lows of 2000, perhaps it will do so again in the remaining months of 2003!