2018 OUTLOOK - Rising milk production to pressure dairy sector
DEMAND sufficient enough to handle increasing glob-al milk production will be the largest challenge for he dairy sector in 2018, according to Nathan Payton, director of dairy services for Informa Economics IEG.
Payton explained that there were some pretty nasty margins for the international market in 2016, which hampered milk production in the European Union. Poor weather in Oceania also affected production in New Zealand and Australia. “Margins were so bad that the government put in milk production reduction incentives in Europe, and producers responded,” he said.
Global milk production declined pretty significantly in late 2016, which spooked the market and caused dairy product prices to rally late in 2016. “That is starting to flow back to the farm level internationally,” Payton said. “Production is responding, although the EU hit some snags with their production early in 2016, but now it’s starting to re-cover.”
Weak production that continued into early 2017, along with some rebound in demand, drove inter-national prices higher again in late spring and the fall of 2017, Payton explained, “but we’re now starting to see some pushback on the global dairy markets, particularly from small players, which add up to a significant portion of demand.”
Demand from the small players has been running about 6-7% below year ago in 2017, he noted. “We feel this is going to be bearish, along with the recovery in production globally across all the major milk ex-porters into 2018,” he said.
Payton said EU production is re-bounding in response to very favor-able margins. New Zealand was off to a rough start with excessive moisture, but cattle slaughter is down, and weather is beginning to improve there.
“We are going to see solid growth out of Europe and New Zealand, and we expect Australia to rebound as well,” he said.
According to Payton, U.S. milk production has been running at a 1-2% growth rate. IEG projects U.S. milk production to be 215.5 billion lb. for 2017 and 219.1 billion lb. for 2018.
In the U.S., some moderate expansion in the herd is still likely early in the year. Even though slaughter levels are up, it has been running below producers’ estimated replacement cow level, Payton noted.
He said, “The big takeaway is that we’re going to see solid growth in milk production across all major exporters, barring any weather challenges”.
IEG’s projection for the Class III milk price is $16.15/cwt. in 2017 and $15.15/cwt. in 2018. However, Payton said there is significant risk to the downside, based on where fundamentals are. “Futures look overvalued, given where we expect milk production to be, and there are heavy stocks,” he explained.
Additionally, Payton said there are going to be very heavy supplies of manufactured milk. “There is going to be a lot of distressed milk out there in early 2018 trying to find a manufacturing home, and if we don’t see some significant increase in domestic demand, I think there’s some risk that futures could even dip down into the upper $13.00s,” he said.
Producer margins are currently profitable at about $12.50/cwt., Payton said. Breakeven is around $10.50-11.00/cwt.
Starting in January, however, this picture will change, and negative margins are anticipated late in the first quarter. They are also expected to be fairly negative in the second quarter.
“Margins could dip down to the low $9s early next year during the spring flush,” he said.
Still, profitable levels could return late next year, depending on how New Zealand’s season plays out and whether there is decent U.S. demand, Payton added.
On the export side, there has been solid growth in U.S. exports in 2017, driven by competitive U.S. prices.
“Most notably, we’ve seen a good jump in cheese this year,” Payton said. “We were looking for that earlier this year. We’ve seen strong production in cheese in the U.S. and heavy stocks. We’ve needed to see some rebound in cheese exports, and 2017 year to date, cheese exports are up 29%. It’s probably going to be a little more difficult next year, with milk production recovering in New Zealand and Europe. We’re looking for growth in cheese exports to slow.”
Some rebound is expected in domestic consumption of cheese, which Payton said will help clear the market, “but that’s going to take lower prices.”
He explained that in “the past few years, we’ve seen some very strong increases in domestic demand of cheese. In 2014, ’15 and ’16, we saw demand increase in the 3-4% range. That’s dropped to below a percent increase this year, which is be-low trend, following three years of strong growth.”
This is expected to rebound a bit in 2018, which Payton said will help clear those heavier stocks, but it will likely take lower prices to accomplish that.
Butter demand has also been very strong through the spring and summer of 2017. In fact, Payton said there was a lot of concern midyear that record-high international butter prices were going to drive some considerable exports out of the U.S. and support even higher prices into the fall.
“That hasn’t developed,” he said. “We have not seen exports ramp up significantly. As a matter of fact, the U.S. was a net importer of butter in July and August, despite some very high EU prices. That’s taking some steam out of the butter market.”
Moving into 2018, steeper declines in the butter price are expected than what the futures market is suggesting right now.
“Futures are fairly flat for butter, but I think there’s some risk that we could see butter drop below the $2.00/lb. level in early 2018,” Pay-ton said. “The stocks-to-use ratio is at the second-highest level in eight years.
“So, we’re looking for lower prices in early 2018,” he added.
Overall, Payton said it looks like domestic demand for the year is go-ing to be up just 0.4% for 2017, which is the lowest growth in four years, “but the butter price is also going to be a record high for the year.”
IEG projects the 2017 butter price to be $2.35/lb., while the 2018 price is expected be lower, at $2.15/lb., with a downside risk. IEG projects the block cheese price to be $1.62/lb. for 2017 and $1.60/lb. for 2018.
According to Payton, the outlook is fairly bleak for the nonfat dry milk and powder markets.
“We’re sitting on record-high non-fat dry milk stocks,” he said. “Europe is still dealing with massive amounts of aging skim milk powder in government intervention. They’re trying to figure out a way to sell that or move that out of intervention, and there is even talk now of changing the way they provide price support next year with their government intervention program.”
Due to the heavy stocks on hand and the high butter price, Payton said the EU is considering switching to a tendering-type system where a committee decides on what volume should be accepted and at what price.
“There’s more downside risk for nonfat in early 2018 if they switch that tendering system, and that re-ally weighs across all the whey protein powders as well,” he noted.
Also, in the U.S. dry whey market, there has been an incredible shift in production to plain dry whey. “Pro-duction was very strong in July and August, and dry whey stocks are also very, very heavy. So, that’s all weighing on the whey market,” Payton said.
The largest challenge for the dairy industry in 2018 is going to be the recovery in global production, Payton said. “We’re looking for an increase of 13 billion lb. of new production of milk in 2018,” he noted.
Where that’s going to get cleared is the big question, he added.
“Exports are going to have to pick up. They’ve been running weak relative to expectations the past couple years. China has stepped up in 2017, but the real concern is the demand from the smaller players. If we don’t see some rebound in demand from those smaller players, it’s setting the stage for some pretty low prices in early 2018,” Payton said.
Domestic processing capacity will remain an issue, he said, especially in localized regions like Michigan.
“The challenge in early 2018 is go-ing to be building supplies, increasing production and whether we’ll see global demand pick up to clear those,” Payton concluded.