July market report: Tariffs are NOT the biggest problem with U.S. dairy

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This spring we were optimistic that the dairy industry would begin climbing out of the bearish period that marked late 2017 and early 2018. Over the last two months, we were pleased to see some numbers justifying the optimism.

For instance, dairy exports from January to May were the best we’ve seen in a while. Hot temperatures this spring and summer have resulted in less of a milk surplus during peak production season. According to the USDA, milk production increased just 0.6% in April, 0.8% in May and 1.3% in June.

The USDA’s July milk production report stated that milk production for the April – June quarter was up only 0.8% on average, well below the traditional 1.5% to 2% increase in production that closely follows the normal annual growth in population.

Proposed new tariffs on U.S.-made dairy products have been the hot topic in the industry for almost two months. And while trade matters take up all the bandwidth, we’re watching something more unsettling behind those headlines.

It looks like domestic demand for dairy products is weakening. That trend bodes far worse over the long term than temporary trade squabbles.

Cold storage reports point to a problem

Unemployment is about as low as it ever gets. Wage growth appears to be picking up. The most recent GDP report showed 4.1% growth in the economy. These signs all have traditionally pointed to increased consumer demand for dairy products.

Meanwhile, we assumed that lower-than-normal milk production increases would spur drawdowns of stockpiled supplies so that domestic demand would be met and market prices make modest gains. But the last few months of USDA cold storage reports show that drawdown isn’t happening.

In March, natural cheese stocks were up 1% from the previous month and up 5% from March 2017. There was 1.327 billion pounds in cold storage at the end of March, the most since the USDA began keeping those records in 1917.

In April, natural cheese stocks rose 2% over the previous month and up 3% over April 2017. The 1.346 billion pounds of natural cheese stockpiled at the end of April set another record.

In May, natural cheese stocks were up 3% over the previous month and up 6% from May 2017. A total of 1.385 billion pounds of natural cheese was stockpiled at the end of May.

Natural cheese stocks in June rose 1% over the previous month and 6% over June 2017. There were 1.392 billion pounds of natural cheese in cold storage at the end of June.

Month after month of stunted milk production should not coincide with month after month of increases in warehoused cheese.

Pinpointing possible causes

We can point to a few broad reasons why demand might be slipping:

• Fluid milk consumption has steadily dropped for decades. It’s not breaking news, but it bears mentioning.
• Ersatz “milk” products have rapidly gained in popularity, possibly speeding up the decline in fluid milk demand by converting some previously-loyal milk drinkers.
• Once the darling of the dairy industry, yogurt sales have plateaued.
• Dietary habits are changing. Simply put, drinking milk or eating other dairy products accounts for less caloric intake in today’s consumers compared to previous generations.

But there’s likely more nuance to the problem than simply saying “Fewer people want to buy dairy products.” Weakened demand for dairy doesn’t happen in a vacuum.

For instance, NAFTA renegotiations may play a role. Prior to the introduction of Canada’s Class 7 milk class, dairies in Wisconsin, Michigan and New York could rely on steady export business to meet needs across the border. Now, subsidies paid to Canadian producers prevent Americans from competing in that market.

While markets can disappear at the stroke of a pen, milk production can’t. The milk has to go somewhere. We think cheese plants have picked up the slack, which could partly explain why cold storage facilities are swollen with cheese when economic signs indicate they shouldn’t be.

Another bit of nuance has to do with consumer buying habits. While we acknowledge that people are buying less dairy than they used to, we should also examine the decisions made by consumers who still choose dairy products.

The grocery business is focusing its efforts on Millennials. These powerful buyers often seek out specialty products from smaller local or regional sources. Two words: Whole Foods.

A consequence is that the dairy products these consumers do buy don’t come from the classic food production giants like Nabisco or Kraft—producers on whose data the USDA relies to compile the reports we cited above when we declared there was a demand problem.

It’s not that we’re backtracking on our claim that demand is weakening. We’re convinced that it is. But understanding market movements is more complicated now that the data we use to help ferret out problems is less reliable.

Can we reverse the trend?

We do believe there’s an opportunity to move the demand needle in the right direction —if rather slowly— over time. That opportunity lies in the Farm Bill, which includes provisions that allow for forward pricing of Class I milk.

Specifically, we think the restaurant sector will gradually begin incorporating fluid milk in more of their recipes if they can secure fixed prices forward in time. They’ve so far avoided this owing to milk’s greater price volatility compared to other food items. But if they’re able to treat milk like they do other items, it won’t be long before new menu items emerge that could cause milk demand to begin moving back in the right direction.

As of this writing, the bill remains in conference committee as the House and Senate work to reconcile their respective versions of the legislation.

We discuss the Farm Bill in more detail on our podcast.