August market report: Butter might be the bright spot—again

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It’s strange how much can change over the course of a year and yet we end up almost where we started. Consider the dairy industry’s roller coaster ride over the last year:

In the middle of last summer, the industry was abuzz over a butterfat shortage in Europe that resulted in an uncharacteristic summertime rally in the U.S. Then, deep summer doldrums set in. By winter, we were occupied by the threat of no more NAFTA and concerned about soaring milk production on the other side of the Atlantic.

And when a months-long stagnant spell saw payments to dairy farmers dip too low for anyone’s comfort, we stated that prices couldn’t go anywhere but up because there was no bad news left.

Fluid milk prices have improved over this spring and summer thanks to a weaker spring flush across the country. But the international trade situation has deteriorated further, and there’s a fundamental problem with domestic demand for dairy products.

Here we are again at the end of a summer, back to talking about a butterfat shortage in Europe.

Cream, butter and bad weather in Europe

Cream multiples were stronger in early August than they have been in the last few years. It indicates demand in that sector is strong, which we expect to remain true for several weeks. What’s more, cream and butter are also in short supply in Europe. They had similar shortages a year ago, but this time it’s because the continent has had trash weather all year and is currently in the grips of a heat wave so unprecedented it earned its own Wikipedia entry.

These facts set some good things in motion over both the long and short terms—good, that is, if you’re sitting on cream or butterfat.

First, the long term. We observe that butter consumption grows around 2% a year (which is almost triple the U.S. population growth rate). Churns in the U.S. therefore must boost their output by 2% annually to meet this demand. What’s more, as dietary habits change and healthy eaters recognize butterfat is good fat, consumption growth rates may surge still higher as butter displaces other, less healthy fats.

Now, the short term. The situation in the E.U. has caused some serious stress in a couple of ways. Cows get uncomfortable in high heat. Hot weather is nothing new in the U.S., where we’ve developed cooling systems that keep cows happy. Those systems are less prevalent in the E.U., where temperatures rarely climb high enough to warrant the expense. The feed situation is precarious, too. This weather pattern puts extreme pressure on current and future feeding needs regardless of whether cows are grazed or stall-fed. Things won’t suddenly improve overnight even if the weather does.

What it means for us

Butter demand surges for the holidays in Europe just like it does here, so there’s bound to be another shortage. The question now is whether European buyers will turn to the U.S. to meet their demands or just choose to go without.

It’s an interesting dynamic:

• American-style butter is made with 80% butterfat. European buyers would need to be in short enough supply that they’d be willing to purchase that formula and alter their processes away from the 82% butterfat product that’s standard for them.
• They’d also need to be ready to pay the premium to ship American butter to European ports. Supplies would need to get really short in the E.U. before buyers choose to make that move.
• It could become easier for European butter buyers to meet their obligations with U.S.-made butter if production here continues growing. Simply put, the chances for a butter rally are good as long as the weather stays bad in Europe and stays good here.

Then there’s the cream situation. We do expect the current high demand to drop off late this year, but not before it draws some butterfat away from the churn to keep pace. We believe these market dynamics will send cream and butterfat prices steadily upward. Impending holiday demand for each will be amplified by the effects of the weather woes in Europe.

What’s interesting is our expectation that prices will climb “steadily upward,” which we normally don’t see in butter markets. Butter prices usually spike upward in the fall rather than slowly creep. That’s the weird thing with dairy markets lately: Even traditional volatility itself is unpredictable.