Q&A: Milking the Market

The dairy industry is affected by many unique factors, including regulation like the Farm Bill. Food Manufacturing spoke with Bill Brooks of FCStone about the state of the dairy industry and what issues should be top-of-mind for dairy processors.

This article originally appeared in the November/December print issue of Food Manufacturing.

Interview with Bill Brooks, Economist, FCStone, LLC

Food Manufacturing spoke with Bill Brooks of FCStone about the state of the dairy industry and what issues should be top-of-mind for dairy processors.

Q: What factors play a key role in dairy prices in the U.S.?

A: On the demand side, the domestic market is still the main driver of U.S. milk production. But international sales are a growing segment and continue to gain in importance, especially in the dried dairy protein area. Increased demand from international markets is pushing milk prices higher due to an increase in NFDM prices that is filtering through the milk price system. Slow growing domestic demand for cheese and butter is helping support milk prices, but not adding the value that dried proteins are.
On the supply side, dairy producers have been facing increased costs for most of their inputs. Due to drought and U.S. energy policy, U.S. dairy producers have been under the most pressure from increased feed costs that typically are going to make up around 50 percent of their costs. That figure increased substantially in 2011 and 2012. Lower feed costs over the next 4-6 months will help dairy producers increase milk production, improve cash flow and increase their equity in their operations.

Q: Whether or not the Farm Bill is passed seems to be a large issue for the dairy industry. How will the sector be impacted if the bill is passed, or if it does not pass?

A: If the bill is passed, dairy producers will have a brand new program implemented to provide a safety net. Both sides of Congress have passed a margin insurance program to replace the handful of current programs that provide a low safety net to dairy producers. So if a Farm Bill is agreed upon, the margin insurance program most likely will be included. The difference is in a market stabilization program that the Senate has included in their version that the House does not have. The stabilization program will have to be determined in the conference committee on the Farm Bill. If a Farm Bill is not passed, federal law will revert back to the permanent legislation from the 1930s and 1940s. For dairy, that would be a return to parity pricing that could move the support price for milk from a current equivalent of $9.80 to a level in the upper $30s. A milk price in the upper $30s will not be beneficial for anyone, as dairy producers will produce more milk at a price for which hardly any consumer will pay. This would lead to large excess inventories of butter, cheese and NFDM that USDA will be required by law to purchase. Market prices will not immediately rise to the new price support level, but just the thought of milk prices that high causes heartburn for most in the industry.

Q: How is strong demand from developing countries impacting the dairy industry?

A: Over the past few years it has helped offset slow to declining demand in developed countries that have not had the same economic growth. The developing countries' demand has helped keep dairy commodity prices higher than what they would have been by offsetting relatively strong milk production levels in the major milk shed of the world. In the U.S., the U.S. Dairy Export Council is reporting that through July 2013, year-to-date exports of total milk solids have amounted to 15.1 percent of total milk production during the same period. In 2012, the percentage was 13.5 percent. Dried dairy proteins have been the biggest beneficiary, with over 50 percent of the 2013 production of NFDM/SMP, Dry Sweet Whey, and Lactose moving into export channels. Fonterra, the largest dairy cooperative in New Zealand, is forecasting a record milk price for milk produced during the 2013-14 milk production season on the basis of strong international demand.

A: Consumer tastes are always changing. What are the latest preferences in dairy, and how is this shaping the industry?

A: Greek yogurt has been the fastest growing segment of the industry the past couple of years. The high protein product is appealing to a wide segment of the domestic market. We know that the rapid rates of growth in this category will not be sustainable, but where the category plateaus remains to be seen. One side effect of the demand for higher levels of protein onto Greek yogurt has been a need to handle the remaining butterfat, and so far there has not been enough demand to offset the excess butterfat that has been going into butter production, resulting in heavy inventories and lower than expected
prices this year.

Q: What key issues should dairy producers keep an eye on in the coming months?

A: The Farm Bill is at the forefront for dairy producers at the moment. Both sides of Congress have passed large changes to the Dairy Section of the Farm Bill which will replace the current Dairy Price Support Program and Milk Income Loss Contract program with a margin insurance program. The Senate version has passed the Dairy Security Act that contains a market stabilization section that forces participating dairy producers to reduce milk production during times of low margins. The House of Representatives has passed the Dairy Freedom Act that does not contain any provisions that would reduce milk production. Secondarily, there is the price of feed inputs, which has had a large impact dairy producer profitability over the past few years. Feed costs will be impacted, not only by the Farm Bill, but also potential changes in energy policy. Weather conditions in the U.S., South America, New Zealand and Australia require constant monitoring with regards to impacts on feed inputs and competing milk supplies that also service the international markets.

Q: What do you see in store for the dairy industry in the next few years?

A: The industry will continue to grow, but the number of dairy producers in the U.S. will continue to decline. It is not a given that the number of processors will also decline as more and more smaller companies are starting to process milk to take advantage of the current local, know- your-food trend that probably will continue for a few more years. There will continue to be opportunities in the export market as more and more consumers climb up the economic ladder and naturally move over to a more animal-based diet. The opportunities will be difficult to acquire as other exporting countries are ramping up their production sectors to take advantage of the expect growth. Importing countries are also working to supply more of their own needs. Given the relatively stable production levels in the U.S., the U.S. dairy industry should continue to have a place at the table to fill international needs. But the continued evolution of the U.S. dairy industry will need to be looked upon as a reliable supplier of the dairy products in demand by international customers.

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