T3 and Ted Jr. got together to talk next year’s milk pricing, and they made pretty quick work of the topic. Both have bearish outlooks to start the year. After Q1, their predictions start to diverge.
How far down will milk prices go? Will they jump back up above $20 next year? When? How will the market respond to recession? The duo works through Class III and Class IV supply and demand to come up with some answers.
T3 expects macroeconomics to stifle demand, and Ted Jr. puts his faith in butter to maintain its position as a staple spread. They skim the surface of an exports discussion, with China in lockdown but looming. Fifteen minutes and a friendly wager later, they settle on a confident outlook for most of next year.
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T3: Alright. So, Dad, you tend to be bullish, especially compared to me, but lately it seems to me that you’ve been a little bit more bearish than me. So since we’re sitting here in the middle of November, what do you think markets are going to be like in 2023? What are your thoughts right now?
Ted Jr: Well, I think it’s rather scary that I’m the bearish one right now and evidently you’re not.
T3: I’m not saying that I’m not bearish. I’m just saying I’m not as bearish as you are.
Ted Jr: First of all, let’s look at the overall marketplace. We’ve got production now on the upside in the US. Cow numbers are up. Production’s up over 1%. We’re heading into a recession. I think that’s generally an accepted dogma. But the international environment is also changing. The European production is starting to mosey up a little bit. And evidently, feed is moving out of the Ukraine and feed prices are not on an upward trajectory anymore. I’m not saying that the feed prices are going to go down. I guess, the point that I’m trying to make is that the dichotomy has ratcheted up to a little bit lower level.
So if we go back a couple of years, pulling numbers from the air, the lower level was probably Class III somewhere around $15. And today with the corn price doubling or more, I’m going to argue that the lower level is probably somewhere around $19 on the Class III. That translates to cheese prices around a $1.90 and it translates to for whey prices to be somewhat higher than they are now, which my suspicion is even though China’s got their own ration economic problems, they’re still going to need to feed pigs.
And then the butter market is going to be stronger than normal, but it’s certainly not going to be $3. So that also would translate to a Class IV price somewhere in the $19 range. So look at where we are. We’re up limit today and evidently people are buying cheese and I don’t really get the feeling that cheese is all that short. I think filling the pipelines for Christmas is more than likely still the reason it’s going up. But with butter and with cheese and other dairy products, when we get to Christmas time, as far as I can see, it’s over. So I’m not arguing that the bottom is going to drop out and we’re going to get down into the lower teens, but I’m arguing that the market is going to settle to what I consider a lower ratchet level in the $19 range. So that’s the extent of my bearishness.
There’s obviously other things that could happen. I mean, you have a war going on in Europe and maybe the feed price situation changes and maybe a lot of cows expire and so on.
T3: And actually I would agree with you. I think we’ll be right about in there too. So, Dad, here’s my question for you. I’ve got my Class III and Class IV calculator spreadsheet out. So what do you think the butter market’s going to be in the first quarter?
Ted Jr: I’m going to say $2.
T3: What do you think the nonfat market will be?
Ted Jr: It’s hard to say bucking a quarter $1.30 maybe, somewhere in the area.
T3: I’ll put in $1.30. So if we have $2 butter in 1.30 non-fat, you’re talking a Class IV price of $17.48. Let’s go ahead and round it up to $17.50. Now in this case, I am a little bit less bearish than you. I think butter’s going to be more like $2.25 in the first quarter. But I do agree with your nonfat at $1.30. So I’m at $18.50. So I’m about a dollar higher than you. If we kind of think of Class IV around $18.50 to $19, we’re probably on the same page. But we’re looking at the beginning of the year, dropping below $20 for Class IV price and settling somewhere between $18 and $19, which is probably at this point, especially in California, below the cost of production. So dairy farmers probably were profitable in 2022 and at least at the beginning of 2023, they probably won’t be based on what you and I think the year will start out as.
Ted Jr: Let me point out that there’s a broad disparity in cost of production for dairy farmers.
Ted Jr: And a lot of them, rightfully so, avail themselves to the government program, which essentially protects their operating costs. So even if the numbers argue against production, it just takes a while for those numbers to bite for dairymen to actually pull the trigger and start calling aggressively. Most of the time when the numbers get tight, they add a few more cows down at the end of the barn. That’s the first thing that they do. And then after a few months if that’s not working out, then they start selling cows so that they have cash flow.
T3: I would agree with you, but I would argue that meat prices have been good enough lately maybe that’s not the go-to mode this time if they’re not making money. With high feed costs and high meat costs, they might be better off this time just selling a few cows rather than trying to produce more milk.
I would argue that’s why I’m a little bit less bearish than you is because I think that’s what they’re going to do. Take the cows out of the herd rather than keep a few extra in and that’ll end up having a bit of a reduction in the milk supply.
Well, for the first half of next year, it probably won’t make any difference. If we ratchet down to that reset level, let’s call it a reset level, then we’ll set up a scenario through the end of 2023 and so on for pretty strong markets as everybody retrenches individually.
So that’s bearish in the long run.
T3: And just kind of sticking with our Class IV discussion, we’ll get to Class III in a second, I think when with non-fat at $1.25 to $1.30 and we’re down here for a number of factors. But one of the major ones is right now, China is in lockdown. They’re not buying like they usually do and that’s reverberating across the powder market globally because Fontera is starting up. They’re trying to clear their powder. Europe’s got some extra powder. They’ve been making extra powder to kind of get in front of an anticipated increase in gas prices. At the moment, we have more supply of powder than we usually do combined with less demand than we usually do. But I think it’s almost like loading the slingshot because I do believe that what’s going to happen is China will come back into the market and start buying. And when they do, instead of a $1.30 powder market, I easily see as getting up, let’s call it $1.55 to $1.60.
By the time we get to the third quarter, I see butter getting back up to about $2.50, maybe even $2.60, but we’ll type in $2.50. So this is the conservative side of it, $2.50 butter, $1.55 for no-fat. And now in Q3, we’re back to $21.75 Class IV price, which is probably profitable for dairy farmers, which means they’ve got a three to six month time period, at least when we’re talking Class IV where maybe they’re losing money, but by the end of the year they’re back to making money. Does that make sense?
Ted Jr: Yes, it does make sense and I’m sort of in sync with that, but I would say the potential for the butter market is a lot higher. I think the demographics of the butter market has changed and I think we need to recognize that. Butter was competing with margarine for many years. Margarine has disappeared pretty much. And butter has become a very more sought after spread. So I’m not at all surprised to see butter prices go up above three bucks, stay there for a month this year. And when we get into a tight market at the end of next year, I think the upper limit on butter prices is, who knows? I think it’s quite high.
T3: So now you and I are reverting back to our usual relationship.
Ted Jr: Yep.
T3: Because I am not so optimistic about butter in 2023 and the reason I’m not is because I think we’ll be in a mild recession. I think we’re going to be in a shallow, let’s call it 12 to 18 month recession. And of all of our dairy products, the most luxury-based dairy product is butter. And so if income is constrained, I think butter demand drops and it doesn’t need to drop too much to keep it below $3. And so this year, meaning 2023, I think we struggle to get above $2.50 for butter.
Ted Jr: Well, let’s agree to disagree. I think the potential for butter is higher and I think it’s achieved its old spot, the spot of 60, 70 years ago as the preferred spread that you really can’t do without. What are your choices these days? You can’t get margarine. It’s not even there anymore. So it’s butter versus a can of Crisco.
Secret guest: Olive oil.
Ted Jr: Or olive oil. So that’s your choice.
T3: And I agree, but I think we’ll have enough butter. I think supply and demand will be in balance at $2.50. So now, let’s go back to the handy calculator and let’s talk about the Class III price. Over 50% of all milk gets used in Class III these days. So what is your call first quarter of next year for cheddar?
Ted Jr: Well, I’m in your backyard now, but I think the cheddar market will be down below two bucks. Somewhere around $1.80, $1.90 in that area.
T3: And again, I’m more bullish than you right now when it comes to cheese. And the reason I am, I should qualify this because I have a feeling this is more about timing than anything else. I think exports of cheddar right now are pretty decent, at least what we’re seeing. And so I think that’ll keep the market kind of cleaned up in the first quarter. I think demand for both barrel and natural cheddar, processed cheese demand and natural cheddar demand has been pretty good. And so I think we average above $2 in the first half of the year. So I would call it $2.10, let’s call it $2.05 to $2.10. So I’m going to plug $2.07 and a half into the calculator with $2.05 for barrels.
Ted Jr: That’s for the first half, right?
T3: That’s for the first quarter.
Ted Jr: I think you’re too high for the first quarter. Don’t forget you got a reset period in there after Christmas and Super Bowl. So I’m not saying $1.80-90 for the first half, I’m saying that for the first quarter has the low as it resets.
T3: I’ll plug in $1.90 for you.
Ted Jr: Alright.
T3: $1.85 barrels. And what about whey. Whey price right now is about $0.43 and it’s been falling a little bit.
Ted Jr: I think why don’t you use about $0.45 for the first quarter?
T3: So you think we’re pretty close to the bottom of whey?
Ted Jr: Yeah.
T3: Alright. So you got $19.03. So you basically got a $19 price for Class III. So you’re talking $18.50 Class IV, $19 Class III.
Ted Jr: What do you got for butter in there? With butter prices the way they are, that has an impact on it.
T3: Well, $2 butter … $18.82. So if we go to $2 on butter, $1.90 on cheese, $0.45 on whey, we’re going to end up with $18.82 Class III price in the first quarter.
Ted Jr: Well, I’m $0.18 Off.
T3: Now, I think we’re closer to $2.05 in cheese, little bit more bullish than you, but I’m a little bit more bearish on whey. I’m going to go $0.40. And then butter, I’ve got $2.25. So for me, I’m $20.32. Seems to me like you and I have the makings of a bet.
Ted Jr: I’m already stretched on my bet with Joe. For the record, I bet Joe that the butter market will tick — tick — once below two bucks sometime before the end of January.
T3: And I agree with our butter trader who says it’s probably not going to get below $2.20.
Ted Jr: Well, he has nearly seen Christmas holidays trying to move cream. And if you’re a cream buyer … I have trouble, I’m visualizing how a cream buyer, a churn, how’s he going to hedge his cream purchases? That seems fraught with danger. You got loads scheduled, you got loads don’t show up, you got loads that you can’t unload and they’re sitting in the lot and now all of a sudden you’re supposed to be hedging your purchases to make sure that the market doesn’t drop out from under you.
T3: It’s not easy. I agree with you there.
Ted Jr: So we’ll see whether I win in that bet. Now your bet, you think the market Class III price going to stay over two bucks, right?
T3: Well, let’s call it $20 cwt. First average of the first quarter, I’ll take the over, you take the under.
Ted Jr: I’ll take the under for five bucks.
T3: You got it. I think that’s a good bet. We’ll see. But I think the reason I mentioned timing is because I actually get bearish into the second and third quarter when it comes to cheese. We’ve got a couple of new plants coming online. I think that we’ll be into the heart of a shallow recession by then. And so I actually become bearish cheese by the time we get to May. And so that’s when I start looking at it and I start thinking $1.80 is in the cards. And so in the second quarter, I actually think we’re going to be right around $18 cwt for Class III. So I don’t disagree with you. I would bet our first half averages for 2023 are probably pretty similar. But I’ll also say that we revert back to our usual relationship on the second half of the year because I probably remain a bit bearish on cheese. And my guess is you’re going to go bullish again.
Ted Jr: I am bullish for the second half. You figured that corn silage in those tubes now is in there at $7. For the second half of the year, you’re looking at a pretty high operating costs. But I also think by the time we get towards the second half of the year, we should have sort of a handle on this inflationary environment. And it’s going to be a tough row to hoe, but by that time, I think they’ll start to see what they need to do to bring it back in line. Maybe I’m giving them too much credit, but we’ll see.
T3: So where we’re looking at, if you take the Class IV price and the Class III prices and average them together, think about it in terms of an overall blend price for the nation. We’re probably talking about an all milk price first half of next year between $19 and $20. And then the second half of the year I think probably Class IV goes up, Class III goes down. So they switch sides, but probably $20 to $22 would be my guess in the second half of the year. That seems a little bit too high to me. I think I’d tend to want to think the second half of the year is going to be similar to the first, but there’s more demand in the second after the year. That’s for sure.
Ted Jr: The area where I think your estimates are vulnerable is on the butter. I think the butter is going to be a lot more volatile than you realize. I think it’s going to be lower the first quarter and then higher in second half, but that’s fine. I think that gives us a little bit of a guideline as to what we’re trying to plan for here and that’s I guess, the whole idea.