An expensive game of musical chairs for milk


The T.C. Jacoby team got together to talk about a two-part phenomenon that we’re expecting to wrinkle the dairy markets over the course of the next year or two.

2023 through ’25, plant capacity expansions total 9% of all milk production. But heifers are short, milk production was flat in 2023 and we expect it to be flat (or close to it) in 2024. So who will be left out, short on milk? Or will dairies pull off a production miracle?

Director of Milk Marketing Greg Scheer, “Semi-retired member of the board” Don Street, Dairy Ingredients Vice President Josh White and Dairy Ingredients Sales Associate Tristan Suellentrop join Ted and his dad to speculate on how these issues will resolve over 2024 and 2025.

From high level discussions of price and premiums to granular conversation about regional dynamics and potential changes to the direction of milk flow in the U.S., the team covered a lot of ground in 20-ish minutes.

Give it a listen, and let us know what you think.

T3: Welcome everybody to this month’s edition of The Milk Check. Today, I am joined by Greg Scheer, our director of milk marketing, Don Street, longtime dairy trader and industry veteran, Josh White, head of our whey and dairy ingredients group, my dad, another industry veteran, and then Tristan Suellentrop, who is part of Josh White’s team and also part of our marketing.

So today we are going to try to answer a very interesting question, which is is the dairy industry about to embark on a very expensive game of musical chairs? Let me tell you what I’m thinking.

Two seemingly unrelated issues are starting to feed through the dairy industry. The first one is the fact that we’ve got a heifer supply shortage because since the pandemic, beef prices have been so strong that people have been breeding dairy cows to beef cows because the value of a beef calf has been a lot higher than the value of a dairy calf. This has created a heifer shortage where we just don’t have enough heifers entering the milk supply right now, and it’s going to be very, very difficult for the US dairy industry to expand milk production because we don’t have the heifers to do so.

And think of it this way, if you make the decision today to breed to have a beef calf, you’ve got nine months of pregnancy, then you’ve got over two years of growth before that heifer can enter the milk supply, which means you have almost three years before you can change the dynamic that has already started. And everybody we’re talking to today says dairy farmers, most of them, many of them are still breeding for beef calves and so this heifer supply shortage is not going away anytime soon. So that’s one side of the coin.

On the other side of the coin, there is a lot of plant expansion going on right now. In fact so much that since the beginning of 2023 through 2025, that three year period, we are building enough additional plant capacity to equal about 9% of the total milk production in the United States. And given the fact that we’re already done with 2023 and milk production was basically flat in 2023, it’s hard for me to imagine, given the heifer shortage, that we’re going to be able to increase milk production by 4.5% a year over the next two years. In fact, our experts, and we’ll let them talk about it, are saying that we think ’24 is going to be flat as well. So what’s going to happen? All these new plants, how are we going to fill them? Where’s the milk going to come from when we aren’t going to have the additional cows to fill these plants?

I’ll tell you what, Don, I’ll start with you. What do you think is going to happen? How are we going to deal with this issue?

Don: First of all, one can always count on delays in plant construction so that the time arising gets pushed back a bit. It never fails, right? So maybe that takes a bit off of the leading edge, but it doesn’t really answer the question.

I think if profitability is there for the dairy producers that you could see a recovery in milk per cow, and that can give you, let’s say 1% year-on-year. And we’ve been more or less flat to very, very low on any increases in milk per cow. So that’s one spot it could come from. The other way to expand the herd is simply keep cows longer. And you probably, in a rotational sense, actually get better milk production out of a fourth or fifth lactation cow than you do a fresh heifer. So maybe that’s part of an answer. And then finally, it’s just survival of the fittest on the plant side and do all the old plants keep producing. So three thoughts.

T3: Greg, what do you think?

Greg: Well, I do think the US milk producer is very resilient and they find a way. If there’s plant capacity, they’ll find a way to keep that cow longer to continue to improve the feed and the rations. And then like Don was saying, maybe some of the older plants have to close and then it’s just the more efficient ones are the ones that stay open. So we’re not actually adding that much plant capacity. We are adding plant capacity, but some of the old plants will maybe have to shut down or retool. So I’m under the impression that you can’t count out the US dairy producer, even with the lack of heifers that they’ll find a way to produce some milk.

T3: Josh, what do you think?

Josh: It’s a complicated question, and it’s so much easier to talk about the supply side because we’re so unsure of what the demand climate looks like today. So if we focus just on the supply side of this, I’m pretty sure that a lot of it can be solved in the margins in terms of how milk moves around, how milk’s traded. But I’m fairly convinced that we’re entering a new cycle with a change in our traditional milk movement paths throughout the US and that milk may move differently over the next several years than the traditional flow of milk that we’re used to.

T3: So how’s it going to change? What do you think is going to happen differently?

Josh: Yeah, I think it’s dangerous to try to predict it specifically, but there’s a few things that over the course of the last growth cycle, the last at least 10 years, a lot of the growth that we’ve seen has been in Texas, in the Upper Midwest and the growth in production has been in those areas. And as we know, that’s a cheese-dominated area. But when you think about trading some of the components, product historically liked to flow East. That Texas market has put on a lot of capacity to manage that additional milk. Where was the surplus milk out of that market going to prior years and are they a surplus market anymore or are they potentially even a deficit market?

So I think it would be ignorant of me to try to anticipate exactly how it’ll change, but it feels like it is changing and it’s moving in different directions. And we may see pockets or periods of time where milk could flow directionally differently than we thought before. And very generically milk would flow from West to East at different points in times with the big obstacle of the Rocky Mountains blocking some of that. Do we see scenarios or different movements now where you actually could see periods where milk flows South or West? I don’t know.

T3: With beef prices as high as they are, Don, there seems to be a lot of incentive for dairy farmers to continue to call cows because we still have really high beef prices, really high live cattle prices. And most dairy farmers aren’t out there saying, “Hey, we’re making a lot of money right now,” which tells me that the economic incentive is not there right now for them to keep the cows in the herd.

Don: I would not argue with that point at all. If the financial incentives are there, then you would have an inducement to keep cows longer. But I would guess at today’s prices, even with falling corn prices, that that’s not the case. The profitability per cow is minimal at best, if not negative. So the easier answer or the most expedient cash flow answer is to send her to slaughter.

T3: And if that’s going to happen, that means there’s some plants out there they’re going to be losing milk to fill the new plants.

Don: Yes.

T3: Is there any region of the country that will be better off than others, do we know? Greg, you probably understand where the milk is long and short better than anybody.

Greg: Well, that’s a good question because producers are going to look at where do they have land, where do they have feed? So that’s why we’ve grown in the Upper Midwest. That’s why we’ve grown in West Texas. So those are still going to be key growth areas, but with the new plants in other areas of the country, we’re going to have to figure out how to move that milk. And so as transportation has become so much more expensive, that becomes a much more daunting figure to move milk around.

T3: A lot of the plant expansion’s happening in the Southwest, so West Texas. And I think that if there’s one place where I think it’s going to be difficult, even though there has been a lot of dairy farm expansion in the area, my sense is there’s nowhere near enough expansion there coming down the pike to fill the number of new plants that are being added to the area. In the fall, a lot of milk in the Southwest tends to get shipped into the Southeast. Is that going to stop? And if so, where’s that milk going to come from that goes into places like Florida and Georgia?

Greg: Yeah, that’s the key. In the first half of the year, it’ll be fine, but when production’s down in the fall and schools start up and we have the big rush on milk, where is that milk going to come from? It’s going to have to come from… Maybe it’ll stair-step some, but it’s going to have to pull from the Northeast and the Mideast. Maybe some Mideast milk gets pulled to the Southeast and Midwest milk comes around to the Mideast to fill in. I mean, that’s likely going to have to happen.

T3: That makes sense. Dad, what do you think?

Ted Jr: Well, the first question with regard to the heifer supply, heifers are short. But the last time we looked at that, I think we decided that the heifer supply is sufficient to hold us even given a normal slaughter rate, given the dairy farmer’s pension for looking at cash flow first. Probably what will happen is that the slaughter rate will go down in order for him to produce additional milk, looking at his feed and so on and how to keep the cost down and all that.

I do believe that they’ll continue to produce additional milk. I don’t think we’ll see new dairymen getting into the business, but if someone wants to sell out at this rate, I think other dairymen will snap them up immediately to fill their barns. So I’m not particularly concerned about there not being enough milk. All it means, as far as we’re concerned, is that when someone needs an extra load, he’s going to have to pay for it. This is the traditional solution to long and short supplies in the dairy industry, which we have seen for the last 60 years. So I don’t think that’s necessarily a big issue.

The bigger issue in my mind is the overproduction of cheese. And given that cheddar cheese has become the base commodity that drives dairy pricing and given the fact that cheddar cheese is probably going to be overproduced to the point where we’re going to have to put it in the export market no matter what, I guess it’s hard to visualize how this affects everything, but the base price will stay down, but the market for milk will gravitate towards higher premiums to people who can pay for it, which are specialty cheese manufacturers, Class I manufacturers who need the milk. And I point out at this point that Class I’s decline seems to be leveling off a little bit.

T3: Sounds like what you’re saying is dairy farmers should be happy about the fact that maybe the days of milk discounted by $10 cwt just to get it moved in the second quarter in the spring, those days may be over.

Ted Jr: You’re right. It’s a good way to sum it up. But we may be back to where we were 20 years ago in that regard. So Greg, you got the ball. When we look at a milk shortage up at all these specialty cheese plants up in the upper Midwest, it’s up to you to make sure that they get it no matter what.

Greg: Well, we’re going to have to have good haulers and hopefully diesel fuel prices don’t explode because the cost to move milk has grown so much. But like you said earlier, Ted, they’ll have to pay for it if they need additional milk. They’ll just have to help pay for that transportation to get it to the right area.

Ted Jr: Well, to put things in a little bit of perspective, not that we are trying to support this, but how low did the discount go when milk was long? I guess I don’t want to even mention the number. But how high can the premium go when milk is short if someone needs the load to cover orders? I think that’s probably where we’re heading. And I think the base price given the supply of cheddar will probably remain somewhat suppressed.

Don: So Ted and Ted, I have a question, which is everything that Ted just said would suggest Class IV prices will be higher than Class III prices. Can cheese plants then no longer standardize protein to fat but standardize fat to protein so that you have more cream moving to a higher value? It’s not good for plant efficiency, I would say, but is that a possible work through?

Ted Jr: The way I would look at it, keep it simple, if the Class IV price is $2 cwt higher than the Class III, the first thing that will happen is you’re not going to move it anywhere unless you’re at least $2 plus premium FOB the seller, whether it’s the seller’s dairy or whether it’s this plant, probably the seller’s dairy these days. So you’re looking then adding the hauling cost onto that. And quite frankly, you’re probably looking at some pretty big numbers to get milk delivered, which benefits the sellers probably at the expense of Class IV making Class IV that much more dear.

T3: I agree with my dad. This is kind of how I would imagine it. What’s been going on, Don, to your point, is a lot of skim condensed and skim UF milk has been moving from, let’s call it Class IV plants or UF condensing facilities into cheese plants to standardize to the higher fat levels of today’s milk. But those plants are going to really struggle to be incentivized to do that because that milk is a lot more valuable being turned into Class IV than it is into Class III.

Ted Jr: Correct.

T3: And so they’ll keep it, which means now the cheese plants that are just taking in the milk off the farm, at much higher fat levels than 10, 15 years ago, are going to have to spin off that extra fat and then sell it in the form of cream.

The process is going to invert because of the shortage of milk. You’re going to have a much tighter skim condensed market. You’re going to have a much tighter skim UF market. And I’m going to say you’re going to actually still have a tighter cream market, but for a very different reason. And that’s because so much of this additional plant expansion is cheese expansion. And we’re going to end up with a flat to only slightly higher milk production. You’re ultimately going to have taken milk away from Class IV plants in order to get there. And now that’s going to shorten the butter fat supply in the Class IV space. And that extra cream is still going to be in higher demand. It’s just going to be coming from different places than it did a year or two before. It’s going to be coming from a cheese plant instead of a butter powder plant.

There’s another dynamic that’s going to be very interesting. Traditionally, when we talk about depooling, we’re usually depooling Class III milk from the order, but this time around we’re going to be depooling Class IV milk. And I wonder over a long period of time the dollars are going to add up in terms of that dynamic. It’s going to be interesting to see how that plays out because it’s a different set of people who usually end up with the benefit. I think it’s already started.

Greg: And that spread is very wide right now.

T3: Where I’m going with that comment is some of these co-ops that have a butter powder plant, geez, it seems to me they’re going to be more likely to say, “I want to keep that milk,” than sell it to some of their local cheese makers. I wonder how much of that is going to happen in ways that we just haven’t experienced before because we’ve been around long enough that we tend to just immediately make the assumption that cheese plants get all the milk they need. But I wonder if this time around that’s not going to happen.

Josh: There’s a lot of moving parts to that, but I think right now you’re talking about a very wide Class III/IV spread. And to be clear, we’re doing that in a firm butter market, but a not so robust powder market because international demand hasn’t been very strong. So a couple things that we have to consider is what happens if the international demand returns and they need product. We’re already talking about the milk gap between III and IV in a weak demand for global skim solids. The rest of the world isn’t poised to respond either to milk production growth signals. We are clearly the market that can respond the quickest. And all of that being said, when a new plant starts, I’m not convinced anyone’s going to short them of their milk because part of that startup plan is to make sure that plant has the milk. And to Greg’s point earlier, who’s left wanting?

T3: It’s going to get interesting.

Ted Jr: Another side to the coin is the corn price. The corn price is what? Mid $4 range right now? Low $4? I sort of lost track of it.

T3: $4.40, roughly.

Ted Jr: Yeah. So that’ll also make it a little bit easier to produce a little bit more milk and keep the barn full.

Josh: Beginning when is probably the biggest question. And Ted, I think you brought that point up before too. How much at this price is available to be put up and how much has already been put up at a higher price?

T3: You’re talking corn.

Josh: Just feed. Feed cost.

Ted Jr: Yeah, good question.

T3: Well, I think that’s a good point. If this corn price, soy prices, just call it dairy feed prices in general stay low and maybe get lower between now and the fall, you may have dairy farmers looking at late fall ’24 into ’25 expanding because now all of a sudden the math works because feed prices are low enough and who knows what beef prices will do between now and then.

Josh: Greg brought up a great point, every time don’t bet against the US dairymen to figure out how to make more milk.

Ted Jr: That’s right.

Josh: Proven to do a pretty tremendous job in the past, but the things that have been mentioned, the availability of the animals to do that, the competitive market for those animals and how we can do that by retaining, maybe you can already expect that dairy slaughter rates are just going to be tremendously down through the majority of 2024. And the real question for me is what is the earliest we can see a reversal in the US milk production direction? What is the soonest we can see a supply response at this moment? And given heifer availability, given the decisions to put on large dairies and to build new ones, that model is a little bit different and it is going to take a little bit of time.

Ted Jr: I agree.

Don: I always like to remind people to be aware of what we don’t know, and it’s always a lot, right? We keep peeling the onion back month by month as we get more data and understanding of the markets, but things can always surprise you.

Tristan: What about how Jersey cows have been added to the herd year over year because they produce a pound of milk components at a lower cost compared to other major breeds. To what scale does this counteract the lack of heifers versus the added plant capacity in the US?

Don: Let me take the first stab at that, Tristan. We’ve seen and now for several years fat components of milk increasing at 2% a year ago over the prior year and 1% this year. So it’s fairly significant to where total solids in milk are well over 13% at this point. So that is just like producing more of five-year-ago milk, right? It’s just more solids to process. And genetically, if we have a lower level of heifers entering the herd, it will slow that progression a bit, but it certainly won’t stop it because it’s already present. So those cows will keep producing until they exit the herd at a higher solids level. And I would further guess that the heifers coming in are more reflective of crosses between Jersey and Holstein or just pure Jerseys to where that trend will continue.

T3: Anything else on anybody’s mind on this topic that you think we need to address?

Ted Jr: I think we’ve had a good discussion.

T3: Sounds good.

Ted Jr: No, I don’t think so.

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