It Could Be Awhile Before Cow Numbers Rebound
The U.S. dairy cow herd has been in decline since January 2018, when the USDA Milk Production report pegged the national herd at 9.438 million head. As of July 2019, that number had fallen to 9.310 million head, a reduction of nearly 130,000 animals.
The drop in cow numbers has been the primary driver behind stagnant year-over-year milk production growth, as production per cow has not improved enough to keep up with the lower cow numbers. Coincidentally, milk prices have risen considerably since early summer. How long those prices remain robust will depend on how long cow numbers stay low.
When comparing the contraction of the U.S. dairy herd to other periods in time when the size of the national herd dropped, this contraction has been much longer than those other periods but not as severe, says Nate Donnay, director of dairy market insight with INTL FCStone.
“The big contractions in the past happened when the gross margin was in the $6 to $8 range,” Donnay says. “In 2018 the lowest we saw was a $9 margin and we’ve been above $10 for all of 2019.”
Gross margins are mostly impacted by feed costs, and Donnay suggests that if this recent contraction is being caused by distress on the farm than something other than feed costs must be the culprit.
According to California cost of production data, which Donnay says until the move to the federal order system was the best publicly available cost of production data, labor costs are the second largest expense on the dairy and those costs have been going up. According to the Atlanta Federal Reserve, earnings for workers paid hourly have grown at an average rate of 3.1% during the past 2 ½ years. If labor costs are $1.85/cwt, that increase would put costs at $2.03/cwt, only an 18 cent increase.
The next largest expense is herd replacement, which is the cost of a replacement minus the revenue from a culled cow. Replacement costs are actually down due to a 30% drop in heifer prices.
“Let’s be aggressive and put labor costs at 30 cents per cwt higher and replacement costs steady, and all other costs at 35 cents/cwt higher over the past two years,” Donnay says. “You can reasonably argue that costs-other-than-feed are up 65 cents but that is far from the $1 to $2 increase that would be needed to argue that the decline in cow numbers in 2018/19 has been driven by financial stress at the farm level.”
The mass exodus in dairies, Donnay says, is because farms that would have shut down in 2015 through 2017 were able to build financial buffers through record high milk prices and margins in 2014 that carried them through lean years. Those dairy farmers were probably hoping those record high prices would be coming back, Donnay says, and when those milk prices didn’t return the financial buffer went away and those dairies went out of business. That exodus was likely accelerated by margins that were weak in the first half of 2018, he says.
“I think the way we are going to be able to test the higher-cost versus delayed-farm-exit theories is to see how quickly the dairy herd starts to rebuild from the 2018/2019 decline,” Donnay says. Most of the delayed-exit dairies are out of the system, he says, and producers should start seeing a normal margin-to-cow relationship again. If a substantial increase in costs does occur, a steady to lower herd size will continue even if gross margins are at levels that would normally trigger herd expansion.
“Right now the models say the herd should have bottomed out in August and it will grow by and average of 2,600 head per month through June of next year,” Donnay says.