Milk production is down in the eastern half of the U.S., tightening markets nationwide as surplus milk is pulled eastward from western dairies. Ted, T3 and Anna discuss what it could mean for stressed dairy farmers.
Also, we observe a surging nonfat market that is sending Class IV milk prices upward. How high will Class IV get? And what will that mean for Class I prices?
Anna: Welcome to The Milk Check, a podcast from T.C. Jacoby and Company, where we share market insights and analysis with dairy farmers in mind. Today is January 10and we want to talk about where the milk has gone as we’ve noticed a decline in production and a shift in distribution, particularly in the Northeast. So let’s jump in right there.
Ted: Yeah. Well, where is all the milk? The milk is alive and kicking because we’re not seeing any great reduction in the cows. We’re listing dairymen who are we’re going out of business in every publication you read. Large and small are going out of business. Small more than large but still are giving it up, but the cows aren’t disappearing. They’re going to the neighbors for the most part. There is a slight increase in slaughter. I’ll give the point, okay. But basically most dairymen are using up the silage they’ve got by keeping the additional cows.
T3: That is going on. And the reason it’s going on is because the cattle market is crap. You can’t get anything for your cows right now. It’s about as low as it’s been in probably two decades.
Ted: That’s right. So when it comes time to talk about what the prices are going to be, you know, it’s going to involve a lot of ex-cows. Until we see less cows, you know, it’s not going to be changed much.
T3: Adding from a milk production standpoint, you’re right. Well, I think it’s clear that one of the big problems right now that dairy farmers who want to exit the business have is the cattle market is so bad that there’s no value for your cows. And as a result, it’s actually forcing farmers who want to go out of the business to stay in the business or it’s forcing banks who want to foreclose to not foreclose because there’s no value there, if they do it. But one thing that is going on is you’re getting an increasing percentage of farmers who are breeding their Holstein cows with Angus cows and literally breeding for beef cows.
You may be struggling to sell cows out of the business, milking cows out of the business. But there’s an active reduction in the heifer pipeline going on. Now, we’re three years away from that affecting this market. But maybe there’s some long-term hope there that because of this market is so bad, they don’t even want to invest in future Holstein cows. They’re literally breeding the Holstein cows with Angus cows for beef and not making dairy cows.
Ted: I wonder if there isn’t sex semen to go for male instead of female. Interesting question. But you have to ask somebody who knows.
T3: I would agree. I wouldn’t even try to answer that. But I do think that one of the reasons that this trend has started is because of sex semen. I mean, once you got to the point where, you know, 65%, 70% of all the calves are female, it was inevitable that you had a problem with too many cows coming into the marketplace and you really have to do something, too many heifers. You’re going to have to do something about it by breeding for beef cows that counteracts that problem.
Ted: It’ll be down the road where we could see a real spike, if we run out of heifers. I think it’s just, what, two years to bring heifer into the…
T3: About 24 months.
Ted: Yeah, and right now you’re looking at 2021 before you’re going to look at any efforts coming in. 2022, really. So we could be looking at some big numbers between now and then sometime, if we run short of cows. However, today that’s not the problem. The only way we’re going to see this change is for fewer cows in the milk herd.
T3: I agree.
Ted: It’s going to be this summer before it starts to really bite.
T3: The good news is I think there’s a couple of bright spots on the horizon. You know, first, if you look at what’s going on in the dairy industry, east of the Mississippi overall nationally, milk production numbers will probably stay in the black. East of the Mississippi they’re already in the red and they’ll probably stay in the red. You’ve had significant reductions in milk production in the Northeast, Pennsylvania, and New York, specifically. You’re starting to see some significant reductions in milk production in what we call the Mideast, Michigan, Indiana, and Ohio. I think Indiana was down as much as 7% in the most recent report.
You know, one of the things that we’re seeing very clearly is this past fall, there was a lot more milk that went into the Southeast. And we were having an active debate as to why. Well, as it turns out, one of the big reasons there’s a lot more milk going into Southeast is milk production in the Southeast, in Florida, Georgia, Alabama, and South Carolina, even North Carolina, Virginia, is down significantly. And so the Southeast in the second half of the year needs a lot more milk than it used to because the Mideast and the Northeast milk production is down, you know.
They may be shipping more milk into the Southeast or the same amount. And you’re also pulling more milk from the Southwest into the Southeast. And that really tightened everything up this fall. Milk was much tighter this fall than we expected. And it was because you saw negative milk production in the Mideast, in the Northeast, and in the Southeast all simultaneously.
Ted: I don’t know whether the Southeast drew that much more milk. I think that the demographics changed in that they had been drawing quite a bit from the Northeast. And the Northeast is the first one that ran short because of the way that their industry is structured there with the smaller farms and co-mingled loads and so on. So they didn’t have the milk to ship and then production is down a little bit in the upper Midwest. And so they wound up making up the difference with Texas. It took us awhile to figure that out. But I think they did buy a little bit more for the reasons that you described. I think, you know, Carolinas and Virginia production’s down too. And so that affected the whole market down there.
T3: Absolutely. And you’re starting to see Wisconsin turn, as well. Wisconsin has been more or less flat here, I believe the last couple of months. But with less milk coming from Michigan into Wisconsin and with plant capacity being added in the western part of the Upper Midwest, specifically South Dakota, the I-29 corridor, you’ve got two plants that are both going through significant plant expansions. You’re going to see Wisconsin’s milk supplies tightening up.
Ted: I think you also need to observe that Michigan with their surplus is now shipping milk the more traditional way towards the East whereas for the last five or six years, there’s been such a surplus in the East that they haven’t shipped that way. It went to Wisconsin instead because that was where they could get rid of the surplus. Now that demographic has changed somewhat back to more traditional patterns. We’re seeing more demand from places like Cleveland and the eastern part of Ohio and so on, and of course, that then stair-steps back up towards the Finger Lakes, Buffalo, and in that area. That’s a more traditional pattern of distribution that we’ve had for the last few years.
T3: I think there’s also a subtle undercurrent. The balancing plants in the Mideast and the East are butter powder plants whereas if they were shipping that milk into Wisconsin, it was going into cheese plants. On the surface, you would think, okay, the milk will stay back in the Mideast, the powder plants will stay full. But there’ll be less cheese made because there’ll be less milk going into the cheese plants. That’s actually not how everything’s going to play out. What I think is going to happen is you’ve had a couple of big cheese plant expansions in the Southwest.
And when you have these very large cheese plants, they always run full. We’re producing too much cheddar at the moment. You’ve seen in the press. Wall Street Journaljust yesterday had another article about cheese surpluses. And so we certainly have a lot more cheese in inventory right now than we’ve had in probably at least the last 25 years.
T3: Ever since the government was buying cheese in massive quantities back in the 70s. So we have an oversupply of cheese being made from milk out in the Southwest, in the West. Yet at the same time you’ll probably have less commodity cheddar being made in the upper Midwest this year because there’ll be less surplus milk.
Because we have so much cheese inventories, I’m not optimistic about the cheese market. I think we could have a very similar cheese market in 2019 in terms of an average price for the year that we had in 2018. On the other hand, the powder market is heating up significantly. Let’s just assume for the sake of this discussion that the butter market kind of stays within the range it’s been in the last couple of years and stays somewhere within 15 cents of $2.25, $2.30. But the powder markets, it’s been an ugly market for the last five to six years.
It’s been below $1. It got as low as $0.69 at one point. And it’s pretty much been between about $0.70 and $0.85 for the last three years with a significant oversupply of powder, primarily in Europe with over a billion pounds of powder in intervention in Europe. That intervention stocks, it’s essentially gone now. Over the last six months, they have pretty much sold out of that inventory, significantly tightening up the market. The amount of global stocks of nonfat dry milk and skim milk powder today is significantly less than it was a year ago. And the powder market’s starting to reflect that.
We’ve gone from, you know, something in the $0.70s about three months ago. It was trading in the $0.80s. The last two months it’s now trading in the $0.90s. After this news about intervention running out, I wouldn’t be surprised at all if, by the time we get to February, we’re trading powder over $1. Frankly, I can see the powder market…it’s very easy for me to imagine a powder market around a $1.25 by this summer. Maybe sooner if this market gets a little ahead of itself. And as much as I think the dairy farmer would like this powder market to go to $1.25 as soon as possible, I think it’s a much more healthy market if it takes its time to get there because it will work out the inventories along the way and it will have a better chance of staying up there. But at $1.25 powder market and $1.30, $1.35 butter market.
T3: Excuse me, thank you, $2.35 butter market, that puts you over $18 a hundredweight for your Class IV price. That’s not bad. That’s a number that works for the dairy farmer. Now I think you’ll still be in the $16.00s in Class III and we’re going to have a…
Ted: I think the issue is the blend. The blend is class three plus the PPD, right?
Anna: Well, the blend is really the average of all of the usage of all four. They announce it based on the Class III plus the PPD but it really depends on all four prices. So if you’re in an order that’s mostly Class I, it’s not going to really matter what Class IV is, if that’s not a big part of your blended price.
T3: The class one price is determined—is it the higher of or is it now the average?
Anna: It’s going to be the average.
T3: Starting when?
Anna: I’m not sure. I’d have to check.
Ted: As soon as they sign the Farm Bill within two or three months.
T3: Right now it’s still the higher of?
Ted: Let’s assume…did the Farm Bill gets signed?
T3: Yes, December 20th.
Ted: Then it’s probably February or March it’s going to be on the average.
T3: So the Farm Bill got signed on December 20th, which means, you know, February or March it will be the average. Ironically, just about the time when the dairy farmer would probably benefit from it being the higher of, this Class IV takes over from Class III that go to an average, which means that the Class I is going to be based off… You’re going to get through a time period when the Class IV will be higher than the Class III. It happens.
It’s more often than not, the Class III is the higher of the two. But I would say for 2019 the Class IV is probably going to be the higher of the two. You could see the second half of the year something in the $18.00s in the Class IV, something in the $16.00s in the Class III. So let’s call it a $17.50 base, $17, $17.50 base in terms of the average plus, what, $1.70? What was the calculation?
Anna: It’s $0.70.
T3: It’s $0.70, excuse me. So let’s say $16.50 Class III price, $18.50 Class IV price gives you $17.50 plus a $0.70 addition when they do the formula gives you $18.20 base for the Class I plus the zone. You know, it depends on where you are in the country.
Ted: You call it $2.
T3: Let’s call it $2. So you’re talking about a Class I over $20.
Ted: Yeah. And we’re competing with almond milk.
T3: That’s the problem. Now how much is that? It used to be if that was 40% of the milk supply. Today it’s what, 20%, 22% I believe last I heard. Going back to what happened to all of the milk, so we lost the milk in the East. East of the Mississippi milk is down/ That’s tightened up the milk supply. The I-29 corridor in the Southwest, New Mexico, Texas area, that is where I think I see the most stability.
Anna: I would agree.
T3: Both because there are plants coming online and there’s demand for the milk and—
Anna: And their prices never dove quite the same way as they did, you know, premiums. And hauling charges never went up there as much. They weren’t moving as much out there, especially in the I-29 corridor.
Ted: Their markets are based on cheese and powder.
T3: I agree, the big question is, is the loss in milk supply in the East going to be enough to bring overall milk production in this country below, you know, into the red? Are we going to actually reduce milk supply in this country? I don’t know if we’re going to get that far but I would say that if milk production for 2019 stays under 1%, that should be ultimately positive for prices. The sooner and lower it goes, the better it is in terms of price. But it just never happens as fast as we would like.
Ted: There is a demographic here that needs to be considered. You know, the Southwest is basically a rather encapsulated area. Anything that moves out of there is going to move along way.
T3: It usually moves out there in terms of a finished product, not in terms of milk, unless it’s milk to the Southeast.
Ted: Unless it’s milk to the Southeast, correct. Wisconsin is a little different, you have all those little specialty cheese plants up in that area that make very defined volumes of retail packages. Now a lot of the milk has been moving out of Michigan and out of the Mideast has been moving to Wisconsin. You know, that’s going to change. And you could see the over-order premiums up in Wisconsin get back to the level where they’re not going to be competitive for producing cheddar barrels, particularly but blocks also, if you’re looking at a premium getting up over $1, which is where they were four or five years ago.
T3: I agree with you. In fact, I think it’s going to be interesting. In the cheese market, my expectation is this. I think cheese prices like CME market prices will stay low. I mean, in fact, they could be lower than last year. There’s just too much commodity cheddar out there and so those prices will stay low. But the basis, and what I mean by that is how much over a CME market people would pay for cheese in different regions of the country, is probably going to change quite a bit.
Twenty years ago you would have to pay, I think even ten years ago, you would have to pay $0.10 over the CME price for cheddar in Wisconsin because nobody wanted to make commodity cheddar in Wisconsin because most people paid $1.35 to $1.50 over the blend price for their milk. That number for commodity cheddar in Wisconsin came down significantly in the last few years because you had milk coming into Wisconsin at $2 under for the good first half of the year from places like Michigan because Michigan was oversupplied and didn’t have the plant capacity.
There were a lot of those specialty cheese plants that we’re using that extra capacity to make commodity cheddar and the result was that you could buy commodity cheddar in the Upper Midwest at times for two, three cents over, four cents over relatively cheaply in the grand scheme of things. I think as soon as this year, you’re going to see that overage for commodity cheddar in the upper Midwest moved back towards eight, nine cents over.
And so you’ll see a better price for cheese in the upper Midwest over the market. But you will not see a higher cheese price because you’re still making a lot more cheese nationally because of the plant capacity additions in the Southwest, in New Mexico, in Texas, in the I-29 corridor in South Dakota. All that additional cheese capacity will continue to keep this market oversupplied in cheddar.
Ted: So what you’re saying basically is, by the time we get through this year, we’re going to be returning to more traditional over premium values.
T3: Yes or in other words, a Wisconsin dairy farmer who maybe last year averaged… I don’t even know what the blend price average for…
Ted: The average blend price are very nominal premium, but he paid his own hauling.
T3: Right. Let’s say the blend price was $15.00 last year and he got, you know, $0.30 cents over that.
Ted: He paid $0.50 in freight.
T3: Yes, a year from now by 2020 because it always takes time for these markets to shift though they are shifting now, you may only have a $14.00 blend price or a Class III price. But you’ll be getting something closer to $0.70, $0.80 over for your milk.
Ted: That’s the way I’m looking at it too.
Anna: I’m looking at it that way. But I don’t know that I would say—I think we’re going to get as high as we were on premiums, more traditional premiums, especially since I think a lot of co-ops have to dig themselves out of holes that they’re in for awhile.
Ted: It is. It is true that there’s holes that had been dug that have got to be filled in. So it’s gonna take a little bit for it to get to the dairy farmer. But I think by the second half of this year it should start reflecting back to the dairy farmer. We could see it in our own customers who are willing to make commitments for the second half of the year at much higher prices.
Anna: Well, and even just going back to the more traditional distribution should save on hauling, which should overall impact everyone positively.
Ted: That also.
Anna: That’ll be a big difference I think. We’ll be recording a second podcast this month after Dairy Forum and sharing some insights from that. We’re also hoping to discuss the idea of minimum prices to producers that we hear occasionally. If this is something you’ve thought about too, please send us an email. And we’ll address as much as we can in just a few weeks.
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