July 14, 2017

Unprecedented Chasm Between Barrel and Block Cheese

 |  By: Fran Howard

CME block and barrel cheese prices have been diverging for months, and that pushed the monthly block-barrel price spread to a record high of 20 cents in June. Aside from making block production more attractive to manufacturers, the wide spread creates more risk for both manufacturers and producers.

“There are two potential explanations for the weaker barrel market,” says Mary Ledman, dairy economist with the Daily Dairy Report and president of Keough Ledman Associates Inc., Libertyville, Ill.  “First, there has been greater substitution of natural cheese for processed cheese on sandwiches in some restaurants. And second, additional barrel cheese manufacturing capacity has come online.”

Barrel cheese also continues to dominate the CME spot cheese market. “Clearly more barrel cheese is being sold at the CME cash market this year than last year,” Ledman says. “Approximately 228 loads—about 9.7 million pounds of barrel cheese—exchanged hands this June compared to only 63 loads in June 2016.”

From January 1 through July 12 of this year, Ledman notes that over 320 loads of block cheese have traded at the CME compared to more than 870 loads of barrel cheese, suggesting that there is significantly more barrel cheese seeking a market than block cheese. On July 12, CME block cheese closed at $1.63/lb. and barrel cheese ended the session at $1.4375, leaving the price spread at a very wide 19.25 cents.

“The large chasm between block and barrel cheese prices is unprecedented,” notes Ledman. “Historically, the annual block-barrel price spread has averaged between less than a penny to less than a nickel, but occasionally, daily and monthly block-barrel price spreads have exceeded a dime.”

For the first time ever, the monthly block-barrel price spread topped 20.5¢ in June 2017. “Ironically, the June 2016 block-barrel price spread was negative, and barrel cheese traded at a 2.97-cent premium to block cheese. In fact, the spread was negative for the first three quarters of 2016.”

By September 2016, however, Ledman notes that the monthly average block-barrel price spread widened to over 7 cents and the gap continued to escalate into the third quarter of 2017. Reduced barrel cheese plant capacity contributed to the barrel cheese premium in 2016. However, additional barrel cheese capacity came online later in 2016, and since then, the barrel cheese market has been at a larger-than-normal discount to the block market.

“Larger year-over-year growth in U.S. milk production is also contributing to greater barrel cheese production,” says Ledman. “Record-high milk production resulted in virtually all manufacturing plants operating at capacity during the spring flush. Barrel cheese production absorbed a large percent of the surplus milk, which end users sold on the spot cheese market rather than through contract sales. While the block-barrel price spread is large, its better than dumping milk.”

In the meantime, the wide spread increases the basis risk for producers and processors using hedge programs, she adds.

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