September 2, 2016

The Worst is Over, Cows to Cap Rally

Top Story  |   |  By: Mary Ledman

The worst appears to be over for U.S. dairy producers. The June All-Milk price posted a modest 30¢ increase to $14.80 per cwt. The July California 4b price increased $1.64 to $14.67 per cwt, and the July Class III price jumped $2.20 to $15.24. Together, with an additional 72¢ increase in the California 4a price and a $1.07 gain in the July Class IV price, the July All-Milk price is expected to exceed $16.25—a new high for 2016.

Escalating Cheddar block and barrel cheese prices are propelling milk prices higher. As of Aug. 4, CME spot Cheddar block and barrel cheese prices closed at $1.76 per pound and $1.86 per pound, respectively. Both block and barrel prices are at new highs for the year. Barrel cheese continues to trade at an unprecedented premium to blocks. The weekly average barrel cheese price has exceeded the weekly average block price since April 22. The higher barrel price is supportive to Class III futures prices because 3¢ is added to the National Dairy Products Sales Report (NDPSR) barrel price to derive the monthly average NDPSR cheese price, which is used in the Class III price formula.

Historically, USDA allowed a 3¢ lower make allowance for barrel cheese compared to block cheese that was purchased under the now-retired support price program. Nevertheless, when USDA adopted the current pricing formulas in 2000, a single make allowance for block and barrel cheese was incorporated into the Class III price calculation. To offset the higher make allowance, 3¢ was added to the NDPSR barrel cheese price. As a result, the higher barrel price, in tandem with the 3¢ make allowance adjustment, has elevated the Class III price. In contrast,the California 4b price is derived from only the monthly average CME Cheddar block price and has not increased at the same magnitude as the Class III price. Current futures peg the August Class III price near $17 per cwt, the highest level since December 2014.

Strong domestic demand for cheese and butter has prevented U.S. farm-level milk prices from falling by the same magnitude as experienced by Oceania and European milk producers. Tighter margins and, in some areas, poor climate conditions have resulted in decreased year-over-year (YOY) output in Oceania and a significant slowdown in milk production growth in the European Union. Australian milk production for the year ending July 1, 2017, is expected to fall 3%. Fonterra is also forecasting a 3% reduction in milk production for the 2016/17 season.

By comparison, U.S. milk production increased 1.5% in June. Compared to last year, YOY growth was stronger than the two preceding months. U.S. dairy producers added 1,000 cows in June, bringing the national herd to 9.33 million head, up 5,000 cows from last year and 6,000 head shy of December 2008’s peak of 9.33 million. U.S. dairy producers have ample cows and replacements to respond to rapidly rising milk prices, which will likely cap how high those milk prices can climb.