Consequences of the drought, demand and shortages


Market analyst Sarina Sharp, of Dairy Business News, joins The Milk Check crew to talk about the lacking rain in the West, labor shortages and demand expectations for the second half of the year.

While the drought won’t drastically affect overall milk production, it will put Western dairy producers in a bind as feed prices and hauling rates increase. California producers also have to weigh the rising cost of scarce labor.

The crew also discusses issues like the accuracy of Class III price forecasts and how freight uncertainties continue to challenge exporting efforts.

T3: Welcome, everybody. Today’s June 10th. And welcome to our June podcast recording. Today, we have a special guest and great friend, Sarina Sharp, who is the market analyst for The Daily Dairy Report. She also writes the Jacoby Weekly Market Report. And we spend a lot of time, you know, talking to Sarina about markets and getting her insight and what she thinks, and we thought it would be a great time to have her join us today.

One of the things that we’ve been reading a lot about, I woke up this morning and I read an article in “The Wall Street Journal” about the Western drought and how low Lake Mead is. It’s like the lowest it’s been since 1933, I believe. And it made me wonder how much this drought was going to affect the dairy industry.

So I think my first question for you, Sarina, and I know my dad has a bunch of questions for you, but how serious should the dairy industry be taking this drought that everybody’s talking about?

Sarina: Well, like most weather issues, it’s gonna be localized, but it will also have a national and an international impact. The thing to remember is that the drought is severe in the West and it will impact feed costs for dairy producers in the West, there are certainly some key dairy states there. But we’ve actually had really good rains in the Southern Plains, including in some large dairy states like Texas.

And then we have had good rains up until a few weeks ago in most of the Corn Belt. The Northern Plains are very dry as well. And it is just starting to get dry to an extent that it’s a concern for farmers in Iowa, which has obviously a very big corn state. And then in the Northern tier of the Corn Belt, so Minnesota, Wisconsin, Michigan. Those latter three, those are not where you get your big, big crops. Minnesota is a very significant corn state, but Michigan much less so.

So the weather impact on feed prices, I think right now is actually less significant than the demand impact on feed prices. We just had the USDA crop report today and they estimate that we will use more than 15 billion bushels of corn in the current crop year, which ends September 1. That’s by far a record high. We are planting a lot of corn acres this year, but feed costs are going up because of demand.

Getting back to the drought and its impact on dairy producers and to milk production, we will see feed costs rise because of the drought, but I don’t think that the immediate impact will be less milk production. In fact, in the Southwest where a lot of cows are on dry lot pens, they’re very comfortable. The heat would be a greater concern for their immediate impact on milk yield.

T2: Sarina, this is Ted. You know, for 50 years, we’ve been hearing about droughts in Western California, low water supplies, and the effect that it has on a dairy and feed for dairy and so on. So you have to almost excuse us for not being very concerned, but is there a real concern this time as opposed to the other times we’ve seen the reservoirs in California and in the Sierras go down a little bit at this time of the year and everybody has their heart in their throat?

Sarina: So this is a very significant drought. We’ve seen severe back-to-back drought in California as recently as I think four years ago, but the impact on farmland is gonna be more significant this time around because California has enacted a long-term water management plan called SGMA. They divide the state into water districts and every five years, those districts have to report on their progress in conserving water. And if they do not meet their targets, then the state will pass down some more heavy-handed you have to take these steps in order to meet your targets.

So there are agricultural producers in California who are fallowing land because they have lower access to water than they did in the past, even than they did in the past during drought years. So water allocations have gone down as a result of this long-term water management and the acreage that is gonna be fallowed is primarily feed for livestock and especially dairy cows. Forage production in California will be down as a result of this drought. They’ll preserve the water for the higher value cash crops. The fruit and nut trees, the vineyards, the vegetable crops that they can sell to people rather than growing haylage and corn silage.

So those California dairy producers are going to have to import more of their feed. And today, there’s a trucking shortage and they’re gonna have to haul it from greater distances because of drought throughout the West. So it’s not going to mean that dairy cows in California will go hungry, but dairy producers in California and throughout the West will have to pay a significant markup on their feeds. So when you look at July corn futures that almost $7 per bushel, that actually understates the cost of cash feed for dairy producers in the West.

T2: So what’s the timeline of this? I mean, is it short now or are we intending it to be short come August through September, and then how long will it last?

Sarina: So I don’t think that we can say we’ll be short of milk by any means just because we have so many cows and some of those cows have been added on very modern facilities, which accommodate greater milk yields. And we always see improvement in milk yields year over year. However, I think that these higher feed costs are starting to bite.

So, usually, there’s a six-month lag between when on-farm economics turn bad and they have to be sustained for six months negative margins, and then we will see a decline in milk production. But these high feed costs that are not accompanied by super high milk prices, do force dairy producers to take a critical look at their ration. And I do know of dairy producers who are scaling things back in their ration to cut costs, and that’s probably gonna come at the expense of some milk production. So higher feed costs are trimming milk production growth at the margins, but with the number of cows that we have, I expect we’ll have plenty of milk.

T2: That’s sort of my impression also, and with a six-month lag, then, in order for us to see any major bites, it almost puts it out to October, November, right?

Sarina: You are. At least with the future of those paying right now, we probably won’t be seeing $7 corn at harvest, but December corn futures are $6.15 today. So that’s still a historically high feed price and soybean meal is up towards $400 per ton. There are no cheap feeds out there, no cheap byproducts, and the forage is getting very tight.

T3: But it sounds like one thing that will not be an issue, the cows themselves will get enough water. Isn’t that safe to say?

Sarina: Yes, dairy producers will prioritize cow care. It’s going to be more expensive than it would have been in a normal year.

T3: So if California enacts allocations, obviously, the cities will get the water they need for the people. The farmers will get the water they need for their livestock. And so the first outside of whether it’s the golf courses or the people’s lawns, it’s the crops themselves and the irrigated crops that will start feeling the brunt of it first.

Sarina: That’s correct. So California is enacting allocations in most of the state. It depends on the water district, but most of the key crop areas are under sort of rein in your water use. But that’s going to come down to the individual farmers. Some farmers have historic water rights to groundwater like water that just runs through the canals, they can pump off of that. What’s gonna be limited is irrigation. So it’s gonna be a farmer by farmer, field by field basis, whether or not it’s going to be limited, but farmers will choose to prioritize using water for those high-value crops.

T3: OK.

T2: Interesting.

Sarina: And keeping your cows watered is not irrigation so there’s no limits on that.

T3: Got it.

T2: So the almonds are gonna get preference over alfalfa from the sound of it, right?

Sarina: Yes. Economically they will. And because you can let your alfalfa go, you know, not water it for a year and then just plant something new the next year but your trees are a long-term investment.

T3: Do we know, is there a correlation between how severe a drought is and temperature?

Sarina: I would guess that there is a correlation. The U.S. Weather Service is calling for above-normal temperatures in the Western United States and the Eastern United States and somewhat normal in the Central, I believe. And then a normal rainfall this year actually in the Corn Belt, but lower than normal rainfall in the West.

T2: Got it. How long are we gonna see 3% milk increases under this kind of a scenario, Sarina?

Sarina: Our 3% milk increases are compared to April and May of 2020, which were obviously unusual years with severe supply management restrictions in a lot of places due to the pandemic. In some areas, those supply management restrictions are still in place, but there’s not as much threat of dumped milk.

We’ve expanded processing capacity and we’ve somewhat normalized our supply chain. So, the year-over-year comparisons are gonna get a little bit tougher. I don’t think that we should necessarily expect 3% growth every month going forward, but given the number of cows we have, I think we should still expect significant year-over-year growth for a while.

T2: By significant, you’re probably talking 2.5%, right?

Sarina: Yeah. Two percent, 2.5%, I think would be pretty safe.

T2: But do you think that the numbers that we’re getting with regard to demand and consumption are actually accurate? It looks like exports are very strong and really strong in fact, but I’m sort of suspecting that we’re understating consumption a little bit.

Sarina: I have been concerned that particularly when we look at cheese and butter consumption that we might be double counting a little bit of the demand as restaurants are restocking, and as retailers have a hard time anticipating how long they can expect people to shop more at grocery stores and less at restaurants.

So I think that we’ve truly moved this cheese and butter away from the processor and into sort of the middleman, either a restaurant or the grocery store, but not truly turned every pound of those cheese and butter sales into consumption.

But those sales have been strong for long enough that I’m a little less concerned about that than I was a couple of months ago. I do think that’s probably still going on to some extent, but we’ve had enough time where that should even out a little bit. It does seem like both domestic and export demand are quite good.

T2: So you think the numbers that we’re getting with regard to demand are probably pretty accurate?

Sarina: I think, well, the export numbers are quite accurate. And then I think the domestic demand numbers are accurate in terms of stocks moving out of processors’ hands and into retailers and restaurants, but some of that might be a little bit of pipeline restocking. And we’ve seen quite a bit of fresh cheese come to the CME this week and last week. So there’s still plenty around even with that big demand.

T3: And that’s what we’re seeing as well, dad, it’s just in the last, I’d say two to three weeks, the cheese market, in particular, seems to have gotten a little weaker. And some of that I think is just seasonally, but some of it is I think the pipelines become filled and now it’s just a matter of seeing where we go from here.

T2: Well, if we look at the international pricing, we ought to be really in a position to really blow through the exports.

T3: I will say something that I’ve brought up a few times in the last couple of months and that’s that we’ve got export opportunities that we are turning down because we can’t get the freight worked out. I was just talking to one of our traders today about an opportunity to ship some cheese to a customer and they need it by August, and we’re probably gonna have to pass on the sale because we’re not going to be able to get the cheese there in time. There’s just no way.

Sarina: So, Ted, does the United States lose that business, or our competitors would have similar shipping issues as well? So does the buyer just have to not accept delivery by August?

T3: So I would say this, let’s say it depends on what part of the world you’re in. If it’s Asia, you could be losing the business to New Zealand, possibly. If it’s the Middle East, you could be losing the business to Europe. And so, in those cases, the answer would be yes, because they’re probably able to get the product there a little bit quicker than we are.

But in some cases, Mexico might be a good example. Mexico’s freight costs have gone up, but the availability is still there. We can still get the product to Mexico. It’s really containers, it’s ocean freight to Asia, ocean freight to the Middle East that really is where the biggest problem has been.

And everything’s just delayed. Everything’s more expensive and everything’s delayed. And lately, the big issue has been there’s a lot of concern now. COVID rates in China are going up again and it’s particularly bad around one of the ports in Southern China. And if that port has to close down because of COVID, that’s just gonna delay everything even further. That’s where the problems are.

T2: So what do you think the second half of the year is gonna bring, Sarina? What’s your feel for the Class III prices as I guess the best barometer?

Sarina: I think that say, the whole second half, I think those prices are a little rich right now. I’m particularly looking at October at $18.88 and November at $18.81. Those prices just seem high given the expansion in cheese production capacity. The fact that we are starting to see fresh cheese pile up a little bit, and just the sheer number of cows we have in the United States.

On the other hand, we have price cheese at a level where we should be gaining some export business and we saw excellent exports in April. Net cheese exports in April were the second-highest on record. So we do have a bit of a release valve there, but if those exports start to dry up for any reason, I think that Class III futures are probably a little too high.

T2: Given the price juxtaposition that we have, it’s hard to see the exports suddenly grinding to a halt.

Sarina: True. And the cheese that we’re selling via export today isn’t going to move for a couple of months. So maybe I’m talking myself in circles on September and October Class III. But $18, almost $19 milk still seems a little high, you know, we export roughly 5% of our cheese so we could boost those exports considerably and still have too much cheese.

T2: We’re torn by the same conflict basically, or a conundrum is that we’re looking at basically flush level production increases. And we’re looking at all the problems with the supply and demand because of heat, because of transportation and how that affects pricing, and so on. It’s really very difficult to try to project how this thing is gonna go.

I guess my own feeling is that yeah, $19 might be a little rich, but on the other end historically, $19 is a pretty good price even in the face of inflation. So that’s probably gonna continue to pull a lot of milk out of the woodwork.

T3: I will say this though, dad, I agree with Sarina. I think the prices may be a little bit too high, but I don’t think there’s near as much downside as there normally would be with supply getting as long as I think it could get in the second half of this year.

But one thing I do think is really true is that the costs have gone up everywhere. There are problems with staffing and hiring the people that whether it’s a cheese plant or its dairy farm need to run at full capacity. There’s some serious issues in the industry right now about that. Calling costs have gone way up, and so there’s so many places where costs have gone up that I think you’re gonna have higher prices that aren’t necessarily gonna feel that high because you’ve lost so much of that profit margin into places where you normally haven’t historically.

T2: Yeah. There’s no question. That’s correct. I guess we’ll have to see.

T3: I think so. Anna, you’ve been pretty quiet. Do you have any questions?

Anna: Well, I was about to chime in because you started to hit on something that I wanted to ask about and if this is out of your wheelhouse, that’s fine, but I wanted to get, Sarina, take on labor, especially.

Sarina: Labor is going to be a bigger issue on the West Coast right now than anywhere else, simply because both California and Washington have recently passed both minimum wage increases and some pretty strict overtime rules that make it hard for dairy producers to run 12-hour shifts, for example, which is often a milking shift.

So they have to pay a lot more for overtime than they did in the past, and it’s mandated to kick in, I think right after eight hours. And so that’s raised labor costs considerably. And then, of course, there’s the question of the availability of labor. There is certainly a mismatch in the United States of skills to positions and that’s creating a lot of headaches in a lot of industries.

I would say for agriculture, the fact that immigration has gotten a little more friendly provides some people that dairy producers are also competing with local warehouses. They are short of truckers. They are competing in the Southwest with the energy industry. There’s a lot of lower-skilled entry-level positions available. So I think the solution to labor is gonna be the same as the solution to everything else. And it’s you’re going to have to pay more in order to make sure you get what you need.

T3: I would have to agree with that. Anybody else have any other questions?

T2: No, I think we’ve done quite a bit of damage. Sarina, we very much appreciate your participation.

Sarina: Thanks very much for having me.

T3: Sarina, for me as well, thank you so much for joining us. We really appreciate it.

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