The USDA’s milk production report for December surprised us and sparked some interesting discussion in a recent mass balance and charting meeting. We thought it made sense to pull back the curtain and share some of that discussion on the podcast.

What does the USDA revision of cow numbers tell us? Should we worry about falling Texas cow numbers with cheese plants coming online this year?

Director of Global Strategy Don Street talks through his expectations for Q1 milk production in the wake of recent numbers, which leads to some back-and-forth about the adverse economics facing producers now.

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Don: All right. Do you want to get rolling?

T3: Yeah, let’s go ahead and get rolling.

Don: Okay. I’ve struggled to come up with a title. I finally settled on, Once You Count the Cows Before the Barn Door is Opened, which I realize doesn’t make any sense. But USDA is having some difficulties on cows. So, November production was revised lower by three-tenths of a percent. And to do that, USDA reduced cow numbers by 9000 head, kind of spread over a whole bunch of states.

Nobody more than 2000 down a couple, or even a 1000 or 2000 up. And milk per cow was down 0.2%. So, given where margins are, not much excitement on pushing cows to really produce more milk. December, production was reported as up 0.9. Again, this is 24 states. I was at 1.7. So clearly, an overshoot because I was two-tenths of a percent off on number of cows at the end of the day. And then about again, a half percent off on milk per cow.

So, even though December of ’21 was weaker on milk production, it didn’t translate into a bump in December. The other interesting thing to note is that USDA dropped the herd 5000 head in Texas in December. And we continue, well, we, me, continue to think that Texas cow numbers have to go up. But there again, counting cows is more of an art than a science, apparently.

All of this leads to thinking the milk supply will be more limited going into ’23. So, we’re at the end of January tomorrow. We’ll have January milk numbers in three weeks after that. But my projections now, down to 1.7. I think at one time, I even threw out the number it could be up 2.5 in January. That just simply isn’t going to happen with the downward pressure on milk per cow. Stated differently, the lack of growth in milk per cow.

Q1 2023, I’m now at up 1.1%. I think originally when we first started to look at this, I was at just over two. So, this is much less surplus milk in Q1 than I was expecting. And the next step from that is looking at Q2, not a lot of change. I think we’re going to be stuck for some months in about 1% overall growth in milk production, probably for the first-half of the year. January continuing to be the exception because it was down so heavily.

There will be a little bit of a bounce just from the math of that reality. If you assume, and this is where we ended 2022, 24 states, 8,918,000 cows, and just hold that steady for the whole year. You can see in January we’re up a half percent less than February. And then we’re just kind of even with the prior year, a tenth percent up down a little bit, up barely. So, without more cows coming into the system, all the growth after February is going to be dependent on milk per cow. And we already know that’s pretty minimal.

So, earlier this month, because of the delay in Christmas, we did talk about that you could expect 100,000 cows added to the herd for the two plants that are coming online in Q1 and Q2. If you actually had a 100,000 cows coming in, then your growth in number of cows would contribute much more significantly to overall milk production growth. I think at best, this is probably half of this number. So, I think even with that expansion, with depressed margins, non-aggressive feeding of cows, we’re going to be in a milk production environment where we’re kind of 1% up.

Just to review quickly, the plants that are coming online, that’s where you get 98,000 more cows. Quick word on components. This is unchanged from early January because of the USDA reporting cycle. So, nothing new here. But just that genetically butter fat is really getting the push. Nonfat solids less so. But protein somewhere in between the two.

So, I continue to be amused, if nothing else, by the fact that lactose content in milk, it continues to decline. When we go to the classes, I don’t think there’s any real surprises here. We’re updated for 11 months of data in ’22. Class I continues to shrink 2.4% for the year. I still think 2% annual declines is what we’re going to have until we don’t. Maybe a little more, maybe a little less. In the soft products’ category of Class II, I don’t think any real change here.

Cottage cheese down a little, sour cream up a little. Hard ice cream is maybe the surprise. It started the year down almost 10% on production, which I’m assuming is a reflection of demand and orders from stores, and it ends the year down only 1%. That is a real victory in the ice cream space. Class III, total cheese continues to be up. November was up one six, one seven for the year-to-date. I think the biggest change we’re seeing is that American types are becoming more of the growth piece of cheese, and Italian types are not as much of the growth.

They’re still ahead year-to-date, but slowing a bit in their growth rate. Butter was finally up in November. I’d been asking where the heck is all the butter? And it showed up in November. And I’m going to guess that we’ll see strong production in December when those results are published the first week of March. I wanted to try to look at a couple of different things, exports and stocks. So, when you look at exports, cheese exports were pretty healthy from a ’22 perspective over ’21, up about 12% year-to-date as well as in the month. Butter fat up strongly year-to-date.

I don’t really understand that given so much of the year that we spent over $3 a pound, and clearly, the most expensive butter in the world. So, I’m assuming that means some of our good co-op friends sold under market, which is typically what happens. The big jump in November was shipments to Canada. So, that must have been holiday demand in the short fat market in Canada, given the milk production scheme that they run there.

And nonfat and skim, down year-to-date, down a little bit in November, which without Mexico, this number would’ve been down a lot. But Mexico’s been very strong to offset weakness in Southeast Asia and China. And then finally, to look at stocks. So, cheese production’s up, exports are up, stocks are unchanged. That can only mean that the domestic consumption disappearance side of the market is doing pretty well. Butter fat production is down. Exports are up, and stocks are still up. But pricing seems to follow its own path relative to butter fat.

And nonfat, we had production down, exports down, stocks up, which to me, just continues to point to the very lethargic domestic market demand for dried protein at the 35, 36% level. So, I think all these numbers make sense in their own way for each of these three broad categories. And probably means we’ll see nonfat stocks continue to creep up for the time being. That’s the last slide. Any questions?

T3: Don, these stocks are end of December stocks?

Don: They would be for cheese and butter fat. They’re end of November for nonfat.

T3: Okay.

Joe: Don, regarding your comment on exports, the butter exports, you hit the nail on the head with Canada. That’s been the largest export customer pretty much all of last year, and looks to be a pretty large customer this year as well because they are just net short fat in general. For the other side of the picture, there was a lot of deals that were made in late of 2021 before the market ran away for 2022 shipments that had to be honored that were sold well under where it should have been sold at.

Josh: Just to make sure I understand, if it’s comparables, or what’s driving it. So, we had this milk production that was significantly under expectations for December, right. And then we’re expecting a pretty healthy bounce back to kind of the previous predictions, but just tempered a little bit. Is that more of comparable driven? Was there an anomaly last December? Or, do we think it’s the cows that just were yanked out of the herd sort of suddenly? Why is the trend kind of coming down and then moving back up again as opposed to that kind of steady climb and then steady decline of year-to-year growth?

Don: Year ago comparables were pretty erratic in terms of milk per cow. The cow numbers at a year ago were growing. So, it is milk per cow that is jumping around. And I think these are national numbers. So, the regional factors feeding into this are a bit all over the place. Base programs, margins, weather, potentially in certain parts of the country, although I can’t pinpoint that from memory. I think it’s more base programs, and margin, and feeding management by the producers.

Josh: If we think about the vulnerability in our predictions right now, like the California rain situation, could that have any influence do we think on our January predictions? And then number two, is there any concerns that feeding practices are starting to shift a little bit, and that that milk per cow growth rate we may have actually found a short-term high, and we might start to come off that?

Don: I think California was pretty wet in December, or flooded, or lots of rainfall. And any mud impact was baked into those numbers. So, California was actually up a little bit in milk per cow in December. So, will there be a negative impact in January? Have to be cumulative of trudging in mud for 60 days instead of 30, but I’m going to say maybe not. It will be flat on cow numbers in California. I don’t think we’ll see a big surprise out of California.

Don: So, where does all this leave us? If I can try to sum this up, we should be up on powder production. I would say low 1, 2, 3%. Where in a normal world, I think you could argue for a bottom on nonfat pricing, and maybe a bounce back, is all going to be limited by texture production of milk and dried solids in Europe. That’s really going to drive the pricing. And I think it’s going to do more to drive our pricing than the production side of the equation would suggest.

Gus: Don, and I know that the last time I challenged you, Don, I was horribly wrong. So, I’m getting that out there right now. But I’m going to challenge you again, that I really struggle to believe, is this model, if I’m looking at it correctly, showing that you suspect a 1.6% average increase over the course of the next few months?

Don: No. January I think will be the peak of production in 2023. And at this point, I’m going to hang my hat on 1.7. But I think the full quarter is up about just over 1%. And I think Q2 is going to be up about 1%.

Gus: Are we expecting the milk price to go up dramatically to influence something of this? I’m thinking that 0.9 is the top until prices rebound.

T3: Gus, I think it has nothing to do with what’s going on with the current trend in milk production and everything to do with what it did last year, because it was dropping into January last year. So, you’re measuring against the biggest weakness in January, and then it starts to strengthen from there.

Don: This January play is nothing but a reaction to a pullback in January of ’22.

Gus: Okay.

Don: Okay?

Josh: We’re now predicting cow numbers still to grow some.

Don: I struggle with that, Josh, because I think there should be more cows.

Gus: Don, haven’t we had some pretty strong calling in the recent weeks that are published?

Don: One week we did. If you look at the 12-week average, it’s one or two-tenths of a percent up on slaughter. So, it is up.

T3: But 0.1 0.2% means basically flat.

Gus: Yeah, but-

Don: It’s not a lot.

Gus: But recently published, which is what, two weeks ago now? Am I right?

Don: One week. But that was a screw, I mean, that was just the jacking around of slaughterhouse schedules for New Year’s holiday causing that.

Gus: Okay.

Don: I think. I don’t think it’s anything more than that.

Gus: Believe me, if I were Greg right now, I know he would say milk is extremely long. And he doesn’t see any contraction yet. But if you talk to producers, they are really struggling. And they get extremely frustrated when you tell them that the market is bearish.

Don: I appreciate that. But it’s the age old question of everybody’s losing money, so who quits first? Well, typically, producers would wait for someone else to quit first. Right?

Gus: The only thing I would say, and I struggle here because the last time I went down this road, dad, I was wrong. So, but what dairymen are facing today is more adverse than what they’ve faced in almost a decade. Their breakeven price and the actual milk price has more disparity than what we’ve seen in quite some time. I don’t think that if we have… What we’ve seen over the last eight years or so is not the same as what we’re seeing right now, is my point.

We’re going to have a real hard time. And I know that dairymen might have some money in the coffers at the moment. So, that’s why I slow to make any stern forecast. But I do believe they’re going to lose a lot of money in the next few months, predicated on what they’re facing feed-wise and milk price-wise. And utility-wise, and all that good stuff.

T3: Gus, are you having any conversations with any of your producers right now about their plans to sell all their cows and get out of business?

Gus: Well, the producers usually don’t approach us first on those type of discussions, Ted. That’s discussions with their bank. I think there’s other producers who are clearly conveying that they’re going to lose a lot of money, and are scratching their head as to how to deal with it right now.

I would say if those conversations happen, we’re probably a couple months away from them. But I don’t think you’re going to see them increase first. I think you’re going to see them start to cut cows, and start to figure out other ways to get around this, and then deal with it down the road.

T3: I think one thing that’s important to notice is let’s assume milk production trend-wise is flat for the foreseeable future, which is more or less the way Don is modeling it. You’re going to see the numbers kind of go through the path that Don’s predicting, not because of what milk production is doing now, but because of what it’s measuring against last year. And so, it’s going to look like milk productions up, when in reality it was just down that much last year.

Gus: I see your point, Ted. And I agree with that. That’s plausible perspective that we need to consider as well.

T3: The second thing I’d say is once some dairy farmers start having the conversation about, “Okay, I’m going out of business,” it’s still going to be three to six months before they actually go out of business because they’re going to have to get in line to sell their cows.

Gus: Well, I’m not suggesting that, I mean, we probably will see a number of the weaker producers go out of business. But that’s not really what I’m getting at. I’m getting at just beef prices are still strong enough right now where if you’re struggling and you need some immediate revenue, you’re going to call. And I think we’ve already seen that trend start.

Again, I just think it’s a very plausible scenario over the next few months. Not necessarily are you going to see waves of bankruptcy, although I think you’ll see some. You’ll see even large producers say, “You know what? Looks like we’re going to lose this much more. Let’s get a little bit more revenue, and call a bit more aggressively this month,” or what have you. I think that’s just going to come into play in the near-term.

T3: I agree with that. I think it is too. But I think there’s going to be a lot of talking about how bad things are before we actually start seeing the numbers show milk production actually starting to go down because of it.

Gus: It’s just gotten to that point where a lot of dairymen are showing a lot of frustration for a lot of things.

T3: The flip side of it is, as we talk about these numbers, the thing that really strikes me is, right now, I think we’re still underestimating how bad demand is. Because when you talk about how long things are, and the numbers we’re seeing show up like this, and we’re revising them down, and yet, we’re still talking about how long milk is, that just tells me that demand is right now not good. And I think that’s the real issue we’ve got at the moment.

Don: Well, I was going to throw out to this. That I think Gus is onto something in that you really get heavy slaughter of cows, fewer cows in the herd. And you get into the second-half of the year, or even 12 months from now, and at a certain point, you’re going to get a rebound in Asian demand, which is principally protein, but okay, cheese as well. And you’re going to have an increasing demand corresponding with the shrinking production base. Then you’re going to get a real price response. And let’s just say it’s January 1, right, of 2024, something like that. You can see this starting to set itself up for that.

Gus: I agree, Don. I think what we’re looking at in probably underestimating is a little bit more aggressive downtrend in the near-term, but certainly, we have the wherewithal. I don’t want to act like our heifer supplies are abundant. But they’re better than they have been. And we could rebound relatively quickly in the second-half of the year.