January market report: The problem with soaring EU milk production

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Have you heard? Dairy markets in the U.S. are weak.

There are plenty of reasons why, but it’s partly due to a decision made almost three years ago several thousand miles away. That’s when the European Commission decided to lift milk production quotas that had been in place for member states since 1984.

When the decision to scrap the quotas was made in 2015, the Commission cited concerns that there wouldn’t be enough supply to meet the demands of a growing population.

With production controls out of the way, it was assumed that farmers would add to their herds and kick production into high gear. It wasn’t clear how much more milk would flood the market, but Europe is the largest milkshed in the world. There was bound to be an impact.

Key market barometers

 

Indeed, the impact is significant. EU milk delivery data show member states brought 6.1% more milk to market in November 2017 than in November 2016. Total year-over-year production was up 1.7%.

That’s despite a dairy cow census published last fall showing herds actually got smaller in the EU between spring 2016 and spring 2017. The population decrease was sharpest in Germany, home to the most dairy cows in the EU and highest-producing member of the bloc.

In any case, increased EU milk production would put downward pressure on American prices anyway, but it’s especially problematic since we’re dealing with a milk surplus of our own.

Recall our November market report, which described uncommonly high and still-rising nonfat dry milk inventories in the U.S. at a time of year when those levels traditionally draw down. We reported at the time that there were 296 million pounds of NFDM in storage this past July.

It’s the natural reflex to convert to powder in times of milk surplus, and it’s still happening: New data show inventories shot further upward to nearly 321 million pounds by September before drawing back down to just over 301 million pounds in November.

Meanwhile, prices remain in the basement they headed toward last June. Right now, NFDM prices are sitting just below $0.69 per pound. That’s compared to last year’s high water mark of $1.0289 per pound, recorded in the third week of January. That drop-off is amplified in Class IV milk prices when you consider that nine pounds of every hundredweight of raw milk can be converted to NFDM. A $0.34 per pound decline in the NFDM price translates to a decrease in Class IV milk value of around $3.06 per cwt.

Powder prices have never been this low, and we’ve never had this much in stock in the U.S. And we don’t foresee any scenario in the next few months where prices don’t stay depressed and stockpiles don’t keep piling up.

Other markets are faring just as poorly. For example, 2017 cheddar block prices hit their highest point early that February ($1.7475) before settling into a range between $1.50 and the low $1.70s. Then, a steep slide starting in November sent prices down into the range where they remain today: the upper $1.40s to mid $1.50s.

Cheddar barrels also took a late-2017 plunge. After bouncing around roughly between $1.60 and $1.72 during the autumn months, the bottom fell out in mid-December. Prices dipped as low as $1.2855 in mid-January.

End of year cold storage data showed a 7% increase in natural cheese stocks in warehouses compared to the end of 2016.

What needs to happen?

The cure for low prices is low prices. Right now, small American dairies are in survival mode. There will be casualties. Herds will be sold off —either for beef or to a stronger (read: bigger) dairy operation— and some farmers will leave the business.

What will emerge?

For one thing, we expect lower milk production better aligned with demand. For another, we’ll see a generally stronger, more resilient industry that’s shed its weakest links and is better positioned to survive in a world market where production is outpacing demand pretty much anywhere you look.

Unfortunately, the path toward stronger markets in the long term is paved with short-term hurt.