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The Future of Food Prices: Dairy Products


Milk prices are expected to be volatile and unpredictable over the next few years of trading. Here's why.

Looking back, 2007 might officially have been the Chinese Year of the Pig, but for dairy farmers and producers it was also the year of the cow. Dairy prices in the supermarket and the commodities market hit their highest marks ever, with a gallon of milk averaging $3.80, international prices of whole milk powder shooting up over 100% to $5,000 per ton, and dairy foodstuffs going to $22 per 100 pounds.

"Global demand has been extraordinary for American dairy products, but global supplies of dairy products have been exceptionally tight," Michael Marsh, head of the Western United Dairyman trade group in California, summed it up for Associated Press in August 2007. "From the American dairy farmers' perspective, you have almost a perfect storm."
Analysts agree the perfect storm that created those record highs is unlikely to happen again.

The primary cause of the 2007 price boost – a drought that doused dairy exports from New Zealand, the world's largest dairy exporter at 15 million tonnes annually, creating an unexpected opening for the U.S. to supply the milk-hungry Asian market – is no longer in play.

At the time, the US was already producing less dairy than normal, as dairy farmers sold off milk cows for price-fetching beef or sold the corn they'd been growing for feed on the skyrocketing corn market – the beneficiary of new 15% ethanol fuel production – instead. That the price of milk in relation to corn was the lowest in 25 years, with the lowest corn crop in decades, just further cemented the either/or situation, according to Shawn Hackett, president of Hackett Financial Advisors, Inc.

"Demand," or more accurately the price that demand would fetch, plummeted in 2009 on the heels of the economic downturn and relative overproduction, creating record lows. The break-even point for milk producers is about $17.50 per 100 pounds, according to the Washington Dairy Products Commission; in 2009, prices were about $13.50.

Average prices for 2010 rebounded at about $17.25 per 100 pounds, but although the U.S. exported more dairy in 2010 than ever in its history, prices didn't keep pace with 2007. As of mid-February 2011, the price for Class III dairy futures contract for March was $18.77, the highest it had been all year and will be through 2012. Contract prices are expected to hover above $17 for most of the year before dipping to above $16 for the end of the year and leveling out at around $16 through 2012.

Waiting For a Turnaround
Market watchers and farmers, especially those in the Midwest who grow their own feed (feed can account for between 50 to 70% of the cost of dairy farming, depending on the state), are cautiously optimistic that the turnaround will continue and the market volatility will stabilize.

That optimism is based on the continued rise in demand, especially in Asia where a doubling in milk consumption over the past 25 years has pushed this region into the strongest growing area for milk and dairy. In fact, Asian consumers have generated nearly half of the global dairy product demand over the past decade. China highlights this growth. Per capita milk consumption has risen from 5K to 22K in the last seven years and, despite economic setbacks, will likely only continue to rise with the successful market infiltration of cheese-pushing chains like Pizza Hut (YUM), along with the general rise in protein consumption that accompanies development.

China's 2008 melamine scare, which involved at least 22 dairy companies whose chemical-tainted milk products made some 300,000 children ill, hasn't exactly bolstered confidence in homegrown product. The Chinese government is taking some steps to improve quality control and efficiency, and dairy prospects continue to be strong with continually rising incomes prompting strong dairy demand. Hackett indicates, however, that China's "arable land is stagnant and shrinking," meaning that to increase milk production, it would need to import grain. "It will never be self-sufficient in milk," he concludes.

Theoretically, China's voracious appetite for whole milk powder will increasingly lead the rise in U.S. exports, which hit a record level in 2010, according to the International Dairy Foods Association. To date, though, the figures don't yet bear that out. Mexico is still the No. 1 importer of U.S. dairy as of 2010, absorbing $836.8 million worth; Canada is second at $385.5 million and China only third at $237.3 million, according to the IDFA.

Hackett estimates that what he deems China's impending economic crash will happen within the year and will precipitate "much more deceleration of growth" than many analysts are currently saying aloud. He points out that 70% of China's GDP is from construction, clearly unsustainable. Investors should go into dairy futures only to sell short, he advises.

Brian Gould, a University of Wisconsin-Madison Department of Agricultural and Applied Economics professor, also finds the outlook perhaps overly rosy. He tells Minyanville that "near-record cheese stocks" in the U.S. could ultimately depress the price of dairy.

Europe's Influence
Probably the most uncertain factor in future market milk prices is the EU question; Where will the EU go with its quota system? On paper, the member states have agreed to phase out quotas by 2015, but not everyone believes this will happen. The EU is the world's largest dairy producer with production estimated by FAO at 155 million tons in 2010 with approximately 11 million tons destined for overseas markets. By contrast the U.S. produces 87 million and exports only 3.5, about 6%, though that figure rose to 11% in 2008.

Without quotas, dairy producers will have difficulty keeping up with demand, Hackett notes. Increased milk demand means exponentially increased production costs that won't necessarily be covered by the market price at any given time. Production is further complicated by the fact that the EU, at least for the moment, refuses to use genetically modified grain as feed.

Fixing prices, both legally and allegedly, is also a factor in the dairy market. Dean Foods (DF), the largest dairy producer in the U.S., has been hit since 2007 with Northeast-based and Southeast-based antitrust class actions, as well as a Midwest-inspired, Justice Department-led suit declaring Dean's acquisition of Foremost Farms killed competition for school milk in Illinois, Michigan and Wisconsin. If Dean is forced to divest, prices in those states could rise as competition returns to the region, Gould notes.

Dean executives protest, not unreasonably, that as the most visible target, the company is a convenient cash cow for disgruntled dairy farmers. The company is agitating for reform of the government's dairy pricing controls, which affect markets in all milk-producing states except California. California is the highest-producing milk state and makes its own rules that fall more or less in line with the U.S.

At the moment, processors are required to pay farmers a regulated minimum price for raw milk; this price fluctuates based on a monthly industry survey of wholesale prices of commodity milk: skim milk powder, whey, cheese and butter. Lag time is built into the current system, Gould points out, so farmers don't know how much they'll make until they've sold the product, and processors don't know how much they'll pay until they've bought the product.

Demand Will Rise, Prices Will Fall
High prices benefit milk producers and farmers up to the tipping point when the price deters consumption domestically, and makes the U.S. an unattractive trade partner. So far, neither scenario has come about. Overwhelmingly American farmers produce for American consumers, who take in 200K per capita per year. Even when gallon prices are high, some retailers who function on repeat business are loath to pass the cost on and will keep gallon prices artificially low, either absorbing the loss or shifting the cost to less basic products.

As a global trading partner, America's days of market separatism may be over, says Gould. "The fact that we've been in and out of the market means we haven't built relationships," he explains. "We need to be a more consistent player in the export market. The consensus is that we cannot exclude the foreign market."

The Organisation for Economic Co-operation and Development and the Food and Agriculture Organisation of the United Nations predict in their joint Agricultural Outlook for 2010-2019 that dairy prices will plateau at about 50 percent of 2007 prices.

The OECD-FAO Agricultural Outlook for the next 10 years shows growth explosion for India, where milk production is expected to rise 4% annually; demand is also expected to increase as, fingers crossed, the global economic situation improves. Pakistan will also see a large rise in production and consumption.

In the near term, through 2012, the OECD expects both production and consumption worldwide to rise and prices to drop for all dairy, but especially whole milk powder – from $2,550 per tonne in 2011 to $2,476 in 2012.

READ MORE: For a different take on the future of milk prices and why consumer prices may be set to rise, see The Future of Food Prices: What Will Food Cost in 2015?
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