The Troubling Implications of a Shrinking Basis
If low milk prices aren’t enough to worry about in the short-term, shrinking basis across the Northeast and Midwest are enough to give dairy farmers long-term chronic fatigue syndrome.
Technically, basis is defined as the difference between the all-milk price and standard uniform price in a Federal Order. This difference, the amount of premium (or basis), is paid by processors to attract milk to their dairy plants.
Even as milk prices have fluctuated based on changing market conditions, the Midwest has generally enjoyed a very strong basis. Milk plants were running at less than capacity, and they bid for milk with premiums for butterfat, protein, milk quality, subsidized (or free) hauling and volume. For years, it wasn’t uncommon for the basis in the Midwest to be $1/cwt for just about everyone and even $2 or more for large producers delivering a tanker load of milk each day.
But as dairy expansions continued and processing plants were filled up, the need to bid for milk has evaporated. Michigan’s rapid expansion, producing six million pounds more milk per day than it can process, has meant milk has spilled over into Wisconsin. This cheap, distressed milk has meant there is rarely any excess room in cheese vats.
As a result, basis in the Midwest has shrunk to 20¢ to 30¢/cwt, calculates Marin Bozic, a University of Minnesota dairy economist. He spoke this week at the Minnesota Milk Producers Association annual meeting. (Michigan’s basis, by the way, is a negative $1.50, and has been for the past three years.)
There are both short- and long-term consequences to this phenomenon. The short-term effect is that milk prices are just that much less. And when there’s a glut of milk both nationally and world-wide, the lack of basis simply means even lower net milk prices.
Dairy farmers are used to these short-term glitches. Nobody likes them, but everyone knows eventually prices will rebound. Having sufficient working capital and continuous, prudent risk management generally is enough for farms to weather these short-term price valleys.
More concerning, however, is the long-term effects of a weak basis. “How do you hedge against a constant decline in prices?” Bozic rhetorically asks.
This change in the economic dairy landscape has long-term consequences for the region. For the last 20 or 30 years, dairy farmers here could assume two things: 1) They would always have a market for their milk, and 2) they’d always have a higher price.
Moving forward, dairy farmers in the Midwest will have to question both assumptions. Any dairy expansion budgets will have to be based first on finding a market for the milk, and then using Class III prices to make those budgets cash flow. Bozic says, and I think he’s right, this can only lead to further consolidation of dairy farms.
In the last decade, we’ve been losing three to five percent of dairy farms annually. Most of these have been last generation farms, typically with less than 100 cows. Moving forward, the attrition rate will accelerate. Those most vulnerable could be in the 200- to 800-cow range. These dairies are already stretched thin on labor and overhead costs, and often don’t have the economies of scale or specialization to compete with the larger dairies.
The next wave of change in the dairy industry is about to wash over us. Are you ready?