The dairy industry has been worried since the Mexican government placed tariffs on U.S.-made cheeses in early June.
Ted, T3 and Anna welcome Yara Morales to The Milk Check. Yara, who is Director of Sales for Latin America and Mexico, shares valuable expertise on how the new tariffs will affect markets on both sides of the border.
Also, Ted, T3 and Anna discuss their expectations for milk prices this fall.
Anna: Welcome to “The Milk Check,” a podcast from T.C. Jacoby & Company where we share market insights and analysis with dairy farmers in mind. Today is June 14th, and we have Ted and T3 as usual. Today we need to talk about NAFTA and tariffs to Mexico. So, we’ve brought in Yara Morales, our Director of Sales from Mexico and Latin America. So, let’s get right into it. Ted, why don’t you start us off?
Ted: The question that we need to resolve or address is how this will affect milk pricing, if it will affect it at all. I would expect that NAFTA will be terminated. I guess from the dairy industry standpoint, yes, you don’t wanna throw out the baby with the bath water, and, yes, the trade agreement is very important, but it does need to be renegotiated, it does need to have dispute reconciliation put into it, particularly that. And I think the dairy industry will survive very nicely under this scenario with possibly temporary disruptions in pricing, which in my view will probably not be that major.
T3: I think more specific to what’s going on today, and this plays into the temporary disruption that we’re talking about. The Trump administration increased the tariffs, the steel tariffs to include allies, so it included Canada and Mexico and Europe, and in response, the various nations implemented some of their own tariffs. I think the one that’s been in the news the last couple of weeks has been cheese. It was included in some of the tariffs that Mexico have added. NAFTA when it was implemented in ’94 over that five-year period, it basically brought U.S. cheese tariffs to Mexico to virtually zero. The new tariffs that will be implemented as a response to the Trump administration’s steel tariffs are gonna be approximately 25%. The immediate reaction to most of the people that we’ve talked to is that, “Oh my God, that’s a huge price increase. That’s gonna have a major effect on our exports to Mexico.” I think there is some important background knowledge that needs to be had about that. And the first is this. Cheese tariffs and Yara… We have Yara Morales with us today. Yara is our Director of Sales for Latin America and Mexico. And so, Yara, correct me if I’m wrong here.
Yara: Yeah, absolutely. Yeah.
T3: But cheese tariffs coming out of Europe are primarily already at about 25%.
Yara: Yeah, already, since we know for many years in a tariff…the United States doesn’t have a tariff. They’ve had zero tariff.
T3: So, cheese coming from the U.S. has been coming into Mexico at 0% tariffs, but cheese coming out of Europe has been coming in at a 25% tariff. So, now we’re on equal ground. We’re at 25%, they’re at 25%. But what’s going on in Europe right now is the milk production in Europe is tight enough that the European cheese price right now is higher than the U.S. cheese price. And so if that’s the case even with a 25% tariff I don’t think we’re gonna be losing a lot of cheese sales to Europe.
Yara: Yeah. The only concern in my opinion about Mexico, Mexico is gonna still buy in cheese and nonfat and all the products from United States because it’s very convenient, but if Mexico approved cupos to those countries and don’t approve cupos to United States maybe it’s gonna reduce a little bit. But it’s something that I don’t think. So, it’s very convenient shipping all the products from the United States most than the other countries. Even though Uruguay or Chile, that Chile doesn’t have any tariff. Chile, all the products is zero. But even though from Chile is they buy more from the United States because they don’t have the capacity also.
T3: Right. The dairy industry in Chile is too small to really have extensive exports.
Yara: Yeah, it’s too small, that’s right.
T3: And also just for everybody to know a cupo is essentially a quota or a license to import at reduced tariff rates, and right now those cupos, the volume of those cupos are relatively low. And so the concern would be if the Mexican government increased those cupo quantities so that Europe could import more into Mexico at reduced tariff rates.
Yara: Yeah, that’s correct. Yeah. But it is difficult because it’s money that the countries pay, so because of tariff, that’s what they are paying. So, it’s difficult as Mexico will increase the volume for the cupos because they haven’t done. So, we have a history they haven’t done.
T3: And it’s also, changing where you’re getting your cheese from is not something you can do overnight. The other thing is most of our export sales that we do are planned out three to six months in advance and the production is committed. And so I would say both in the U.S. in terms of their exports to Mexico and in Europe in terms of their exports to wherever, the production capacity has already been spoken for, it’s already been committed and you’re probably not gonna get a significant change in volume for another six months. And so this is not something that’s going to change overnight. It’s gonna take some time. If you think about it in terms of Oceana, which might be another place that they can get….cheese from Oceana’s in the part of the season where they’re not producing a lot and they’re not gonna have product for export for three to six months. And so with those two factors in mind, yes, they’ve increased the tariffs, yes, they’ve increased the tariffs effective almost immediately, but they’re not gonna be able to make changes for some time.
Yara: Yeah, immediately and they start in June thus, it was a reaction from their tariff that they apply to their aluminum and steel. It was 10% this month in June pretty much all the cheese in some one food preparation. That’s the only thing about dairy. And starting in July, it’s gonna be between 20% and 25%. It depends, semi-hard, hard cheese or fresh cheese. That’s just the most cheese going to Mexico. So, they are gonna be slow taking decisions. In Mexico, they are talking about the dairy industry, obviously in Mexico to protect their products in Mexico. They are talking about tariff the nonfat dry milk. That is the second product or commodity they wanna tariff. But we haven’t had any information for sure, but this is something that they are asking.
T3: And if the Mexican government put tariffs on nonfat dry milk, that could be pretty significant for the U.S.
Yara: That’s correct. Pretty significant.
Ted: Explain to me how the Mexican government can put tariffs on nonfat dry milk when they’re the major buyer in nonfat dry milk…is the government.
T3: Well, here’s why. Right now Europe has approximately I think at the last count, 400 million pounds worth of powder in their inventory. Now, the powder is relatively old but that’s a lot of powder in inventory. The world market for skim milk powder nonfat dry milk, essentially, is still relatively long. The reason I think Yara and I think that there’s a bigger threat if they were to put tariffs on nonfat dry milk is that’s a product that’s much easier to get from Europe and from elsewhere and much quicker because of the oversupply in the global marketplace. A significant percentage of U.S. powder exports go to Mexico. If the Mexican government or the Mexican customers start sourcing their powder from Europe or from Oceana or elsewhere instead of from the U.S., we could see a significant change quickly.
Now, to your point. And I agree with this point. It’s really more a game of musical chairs than anything else, you know. Mexico will source more powder from Europe, less powder from the U.S., that means there’s less powder available out of Europe to Algeria or North Africa or the Middle East or wherever. However, if you think about it logistically, it’s a lot cheaper for us to ship powder to Mexico than for us to put powder on a boat and ship it all the way to Algeria. And so the cost change that will affect the U.S. in terms of price is basically a logistics cost. So, if it costs 10 cents a pound more to ship to Algeria than it does to Mexico, and I’d say it’s probably somewhere between 6 and 10 cents, that’s approximately what the price change would be for the market. So, you’re talking about somewhere between 60 cents a hundredweight or to one dollar a hundredweight from a milk perspective.
Ted: It’s a good way to look at it. I really do feel that it’s appropriate to renegotiate these deals. And I really also feel that dispute reconciliation should be an important part of the renegotiation. But in the newspaper coverage of all this, everybody is talking about “Smoot-Hawley Trump” and all this. They don’t take note of the fact that one of the things that Trump said which was completely ignored by everybody, he said in that exchange with the Prime Minister of Canada, he said, “Well, if they wanna reduce all, take all their tariffs off, then we’ll reduce all of ours and we’ll have free trade between the two countries. Nobody noticed that. That’s exactly what he said. And of course, you don’t hear anybody in Canada. Of course, their dairy lobby in Canada is very strong. I think keeping a positive outlook with regard to how this plays out is important and, yeah, it might have some minor impact on milk pricing, but I think that impact will be temporary. And also the economy seems to be cooperating with what is trying to be done also. So, Yara, let me ask you a question. With regard to trade and the presidential election coming up in Mexico, what will be the difference in attitude between (current Mexican President) Nieto and (presidential candidate) AMLO (common abbreviation of Andres Manuel Lopez Obrador)?
Yara: And AMLO, yeah. The election…
Yara: And Obrador, yeah. The election is July 1st. So, it’s coming up. Last Tuesday night it was the last debate, the third debate in Merida, Yucatan and AMLO looks like a… All the surveys look like is increasing. So, I think it’s gonna be a big difference between Nieto and AMLO. AMLO is like a different party in Mexico that is gonna be the first time and all these years in Mexico. He doesn’t trust in the NAFTA, he doesn’t trust in many thing that’s affected to the country, but he thinking about helping poverty people, helping to the education, and… I don’t know. He says something like millennials, they like it because they want something changed. They don’t want a PAN, they don’t want PRI because always is the same. The currency is so high. The exchange is really high in many years because it was different parties and they are trying to stay stable, but with this party is not, is really high. And we hear that it’s gonna be about 23 pesos for $1. So, very soon, this year.
Ted: So, the peso is weaker.
Yara: Is very, very weak. Yeah. Is weaker than many years. This is the first time for a long, long time. So, being the peso very weak affected the business also because they have to pay in dollars. So, it’s hard. It’s hard right now for make that decision. But Mexico, the population want a change. Probably, AMLO is the winner, yeah. So, doesn’t look good for United States by the way because AMLO doesn’t have very good relationship with Trump right now. And it’s gonna be tough, yeah.
T3: You think AMLO and Trump will end up having a stalemate where nothing will get done, NAFTA won’t get renegotiated with AMLO in power?
Yara: It’s gonna be hard because he doesn’t wanna accept that everything. He say that he’s gonna fight all decision, he sees no good for the country. That what he said. But you know what? Sometimes the election and the propose because they want to win the votes they say something and made a different way. So, we hope that he understand this is good relationship with United States and keep going with the dairy industry very well because it’s good for the country. It’s really good for Mexico. It’s very convenient. In two days the loads are in the border and then the customer can have in four days the products and to find a customer too. So, it’s very convenient, so they will understand, yeah.
T3: Well, maybe we ought to switch the topic now to just markets in general. Spring flush this year was muted, I would say. That’s probably the best way to describe April and May. We did not have as much surplus milk in the upper Midwest and the Mideast as we usually do, and as a result, the discounts that were made to move surplus milk were not near as steep as they’ve been in years past.
Anna: I would disagree with that.
T3: You would disagree with that?
Anna: Yeah. Especially over the last month, May was a rough month for spot premiums.
T3: So, spot premiums really came down?
T3: Why was that?
Anna: That’s what I was gonna ask you.
Ted: Well, one of the reasons is we have music… Speaking of musical chairs, we have this going on with the small to medium-sized chain store accounts where the major bottler in the United States has lost to Walmart business. And the Walmart plan is starting up. Obviously, startups very seldom go according to plan. And evidently, the startup in Fort Wade hasn’t going according to plan because the orders from the people who lost the business are up for next week. So, you have certain chain store accounts without… I’m trying not to mention names. But you have certain chain store accounts which changed hands precipitously over the last month or so where people had milk supply lined up and then suddenly the account changed hands and then the people who had the milk supply are gonna have to…are out there selling it on the market, where other people wind up relatively good shape because they picked up the additional business.
So, this confusion has added to what to what Anna is referring to, added to the perception that the market is a lot longer than it really is. I tend to feel that it’s muted also, but it just depends on whose ox is getting gored by all this confusion. And I think it will sort out relatively quickly. And you notice that the markets have plateaued here the last week or so and actually gone down a little bit. From my perspective, I don’t see there’s any real change in the direction. I think the pricing direction is up. But given the inventories that we have it’s obviously not gonna go through the roof, but stronger as the year progresses. And I would suspect that with the hot weather that we have right now and so on, that by the time we get through June that actually the markets could be in relatively good balance. It would take a major change, a weather event or something to change that, in my opinion.
T3: On the cheese side of the business the last three to four weeks have been interesting. The market has gotten very, very quiet. And it could just simply mean that people have enough demand, they have enough supply to meet their demand and things are in balance. It’s June and things are in balance and June, usually, things are long in June. And so quiet usually means things are in balance. And so if… Usually about the middle of June, which is where we’re at right now, between the middle of June and the middle to the end of July is kind of a transition period from a time of length to a time of shortness. As the weather heats up, milk production goes down and at the same time demand starts to pick up. So, we’re at the beginning of that transition and things are quiet right now. Things feel like they’re in balance right now. And I agree with you. As the summer heats up, things could get short and things could get tight. What I can say is it does not seem to me like right now there are any buyers out there that are particularly worried about that.
Ted: It’s the second week of June.
T3: Right. And I agree. It’s the second week in June and it’s probably not time for them to worry yet. And so I’m not ready to say we’re going significantly higher from here, but I’m still inclined to agree with you that higher prices are much more likely than lower prices in spite of the fact that there’s a lot of people out there worried about how the higher Mexican tariffs are gonna affect our industry. I think one of the reasons we’ve had this pullback is because of the reaction to the increased tariffs of cheese to Mexico, but I don’t think it moves the dial enough to have a huge change in the supply-demand balance.
Anna: Any thoughts on the fall coming up?
Ted: I don’t think my view of pricing this fall has changed. I still think we’re looking at pricing, class three prices may be another dollar over where we are now, maybe more depending on the weather.
Anna: We used to kind of makeup for the flush in the fall. Do you think it’ll have the same effect that it used to?
Ted: I think the variation is gonna diminish over time.
Anna: I would agree.
Ted: Yeah. The new style of dairying where the cows are confined, and the feed is brought to the cow reduces the impact of the flush in the shortage. Still there, but mostly because of hereditary rather than anything else.
Anna: So, we definitely haven’t sold as much milk for outside people calling in and saying, “Hey, I have extra loads next week.” We’ve definitely seen that reduce. But in terms of our own spot volume, I don’t think we’ve been lower than we typically would be. I would say we might even be slightly higher. And especially with June, we’ve seen people really hesitant to commit to anything even if they were committing at spot prices, they commit to take it for the month and people have been really resistant to that this year.
Ted: I think right now we’re in a period of change and it’ll be another month or two before people figure it out.
T3: I agree with you there. I think it may be more than another month or two from a basis perspective or a spot premium perspective, it may take a little longer than just a couple of months, but I agree that we’re in one of those transition moments in a market where we’ve gone from two or three years of growing length to a period of time where we’re starting to see demand increase at a faster rate than supply, and so things are getting shorter. Now, we’re still long, and so as of right now, nobody feels short. But as those inventory levels start to come down, as the new plants get built in places like Michigan, it’s gonna be one of those things where all of a sudden people are looking in the rearview mirror and going, “What just happened? All of a sudden I can’t get what I need.” But it’s probably it’s gonna… Most people it’s gonna be too late before they realize we’ve got there.
Ted: I think you’re right. And that’s what always happens when there’s a change. It always happens that the psychology of the marketplace is fixed in stone and when change occurs, it’s dramatic. And I think it’s coming. The timing is what’s important for us and it’s pretty hard to pin that down. But if you look at where we are right now, we think the price is going up. I think everybody agrees it’s gonna go up. We’re gonna have another buck or so per hundredweight on the pricing this fall, on the base pricing. Is that enough to foster increased milk production? No, probably not. But it will be…it will make… While it will make the existing good dairyman solvent, it’s not gonna cause other people to come into the business and spend $40 million, $50 million building a dairy plant or a dairy farm. So…
Anna: I think that depends on what part of the country you’re in, though, too. I think if you’re in South Dakota, I think you’re gonna go ahead and build anyways.
Ted: If you got a market, you are.
T3: Well, there’s two major expansions to large cheese plants in South Dakota right now. So, there’s a market for more milk in South Dakota right now.
Anna: That’s true.
Ted: And they got the permits to do it. But that’s a rather confined area and both of those plants produce commodity type products. Okay? So, that’s important, but when it gets to 2019 and 2020 and the economy continues to roar if it indeed does, then if you don’t have an increase in milk production, what’s going to happen?
Ted: So, that’s the way I’m looking at it. And there is a cycle involved here and I think we’re cycling out of the surplus situation. And yes, it is regional, and it’ll affect different people in different areas, but it happens in this way every time.
Anna: Are we still expecting contraction for farmers, producers?
Ted: Sure. I think so. I think the smaller ones in this kind of an environment are gonna have a lot of problems. They just don’t have the economies of scale. So, the comingled, you know, 5,000, 10,000 pounds a day dairymen are pretty much out of business.
Anna: We’ll keep watching production numbers and prices and update you in about a month. Thank you very much, Yara, for joining us. I have a feeling we’ll be talking to you more in the near future.
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