Milk and Dairy Product Production Climbs - What's Down the Road for Milk Prices?

Dr. Cameron Thraen, Milk Marketing Specialist, The Ohio State University, Additional milk marketing information by Dr. Thraen

As we enter the fall of the 2005 calendar year, it is time to take stock of where we are with milk prices and where we are likely to go in the next 15 months. In this column, I will review the trends observed in the cash markets for dairy commodities; take a look at the relationship of butter and cheese inventories to high and low milk prices; and finally stick my neck out and provide a forecast for the remainder of 2005 and for 2006. Let's get to it!

Cheese Market

After peaking at $1.73/lb in the last week of January 2005, the Chicago Mercantile Exchange (CME) average cheese price has followed a general downward trend through mid-August. Over the last 10 weeks, the CME cash cheese market has traded in a narrow band between $1.45 and $1.55/lb. The last week of October and the first week of November witnessed a fundamental adjustment in the cheese market. The CME cash cheese price fell into the mid $1.30's/lb - levels not seen since February of 2004. The last time CME cash price for cheese #40 blocks traded below this level was back on June 27, 2003 with a close of $1.275/lb. The Dairy Market News reports that cheese markets are weak and may remain so over the next couple of months. Look for the cheese price to remain low for sometime to come. My crystal ball has the National Agricultural Statistics Service cheese price dipping into the $1.28 to $1.30/lb range by March 2006. Higher cheese production costs as a result of soaring energy costs have severely squeezed cheese to milk margins and made life difficult for the cheese industry. For an in-depth look at the relationship between Federal Order formula pricing and cheese processing margins, check out the "Federal Order Product Price Formulas and Cheesemaker Margins" by Jesse and Gould at http://aae.wisc.edu/future/ under 'publications'.

Butter Market

The CME butter market has followed a different path, peaking only recently at $1.72/lb during the third week of September. However, in the last three weeks, the CME butter market has also lost steam and has slid down to $1.48/lb on the CME cash market. The new cash-settled butter futures trading on the CME suggests butter prices in the $1.45 to $1.50/lb range through May 2006. My forecast suggests that butter prices will rebound and trade in the $1.59/lb range, sliding toward $1.52/lb by the end of 2006. If not, be prepared for a substantial drop in milk prices this spring!

Skim Powder and Whey Markets

The powder markets have been on an upward trend through all of 2005. Nonfat dry milk, benefiting greatly from a very tight world market for skim powder, has increased steadily from a low of $0.88/lb to the current price of $0.97/lb. The whey market has moved in lockstep with the skim powder market, rising from a low of $0.24/lb to the current high of $0.30/lb. This matches the high reached during May 2004!

So, what we have here is a reversal of the roles typically played for these key dairy commodities. The butter and cheese markets are showing signs of weakness, while the powder derivative markets are showing signs of strength. This signals a growing imbalance in the all important domestic market for milk and dairy products, with available supply out-pacing commercial demand and an imbalance in the derivative protein market with commercial demand out-stripping available supplies.

Implications for the Class I Mover

With the cheese price showing the greatest sign of trading lower and butter and powder prices remaining strong, it is possible that we could see a return of the Class IV price as the Class I mover sometime around mid-January of 2006! The last time the advanced Class IV skim price functioned as the Advanced Class I mover was back in February 2002. This is not good news. The Advanced Class IV skim becomes the mover whenever the cheese market is weak, and this generally is associated with lower butter prices and low farm milk prices. Recall the milk prices at the farm level received during 2002 through July of 2003. The Class III price averaged only $10.33/cwt during this period. Let's hope that we are not headed too far in that direction!

Dairy Product Inventories Can Flatten Milk Prices

I have included three charts: one for Butter, one for Cheese, and a dairy commodity price forecast chart at the end of this article. The Butter and Cheese charts show the relationship between product inventories, production, and high or low milk prices. In each chart, I have plotted the ratio of dairy product stocks to dairy product production by month, averaged for the three high price years (1999, 2001, and 2004), the three low price years (2000, 2002, and 2003). The price forecast chart is shown directly below these two charts.

The first chart on the left shows the Butter stocks to production ratio (BSPR) and where we are sitting at the present time. The seasonal pattern is obvious. Stocks tend to rise during the first half of the year as cream is flush and butter production is in full throttle. In the second half of the year, when cream is less available, stocks are drawn down relative to butter production. What is also apparent and very important for our outlook on the butter price is the relative position of each of the charted lines. High milk price years need high butter prices. High butter prices have been associated with a moderate to low BSPR. Now look at where we are sitting in 2005. The BSPR is 1.64 to 1. This is higher than we have observed this time of the year for the 'high-price' years but much lower than that observed during the 'low-price' years. This suggests that we will not see wholesale butter price move below $1.40/lb in the coming months unless something happens to limit commercial demand or further advance milk production.

The second chart on the right shows the Cheese stocks to production ratio (CSPR) and where we are sitting at the present time. As with butter, the seasonal pattern is there but not as obvious. Stocks relative to production tend to rise during November through February, 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. Higher average cheese prices require a moderate to low CSPR. Now look at where we are sitting in 2005. At a ratio of 1.06 to 1, the CSPR is running below what we would normally expect this time of the year and indeed what we have experienced during high price years. With continuing strong commercial demand, we can anticipate that the wholesale cheese price will not decline much below $1.30/lb. While this seems low when viewed in the light of the past 18 months, remember that the last time we experienced a strong surge in milk production, cheese price retreated to support levels of $1.10 to $1.15/lb and stayed there for many months. The third chart directly below the Butter and Cheese charts shows what can happen to the class III milk price IF demand weakens and production stays strong going into the spring of 2006. Relative to the last couple of years, this is a very pessimistic outcome. The class III milk price declines over the next six months into the upper $11/cwt range. I remind you that spring-time, Class III prices in the $11.75 to $12.20/cwt range were much more typical of the long-run averages than are the $14.00 to $20.00/cwt prices that we have seen in the past two years.

Let's Take a Look at What is Ahead for Milk Prices

With milk cow numbers increasing, dairy slaughter low, and the specter of energy prices siphoning disposable income from the consumer pocketbook, we can anticipate a drop in milk prices over the next 15 months. However, if we can keep a balance between commodity stocks and production, the decline will be gradual and not wrenching. My long-term forecast for the last quarter of 2005 and for all of 2006 is based on this assumption and shown in Table 1 and Table 2. These forecast prices translate into a Class III milk price of $14.07/cwt for 2005 and $13.71/cwt for 2006. For those producers who participate in the Federal Order 33 pricing program, you can add an additional $0.30 to $.40/cwt to this price to arrive at an estimate of their mailbox price. For 2005, this gives us a price of $14.37 to $14.47/cwt and for 2006 a range of $14.01 to $14.10/cwt. It remains to be seen what impact the Cooperative Working Together (CWT) program will have on these forecasts. Recall that the program is set to remove 65,644 cows over the next couple of months. According to National Milk Producers Federation, this represents a production capacity of 1.2 billion pounds of milk annual rate. Perhaps, more important at this point is the export subsidy program. The trigger price for cheese and butter is $1.40 and $1.30/lb, respectively. Let's hope that these measures are not needed in the coming months. I strongly suspect they will be put into action as we move into 2006.

Table 1. Forecast component and Class III price, 2005.

Table 2. Forecast component and Class III price, 2006.

For a complete update on current market conditions, futures, and options markets, and policy issues of importance to Ohio and Federal Order 33 producers go to my web site, Ohio Dairy Web 2004, and click on Cam's Price Outlook.

Charts 1, 2, and 3. Total U.S. butter and cheese stocks production ratios and dairy commodity price forecast, November through April 2006.