Increased volatility in exports, which is creating price instability, signals that U.S. dairy farmers are operating in a global market more now than ever before, according to Matt Gould, analyst with Dairy Food and Market Analyst Inc.
“The bottom line is: It doesn’t take much of a change in exports to impact the price of milk,” Gould reported to attendees at the 2016 Financial and Risk Management Conference earlier this fall in Summerdale, Pennsylvania. “But we need exports to balance our increases in milk production.”
How did we get here?
The overall trend in dairy exports as a percent of total milk solids steadily increased from 2000 through 2014, providing an outlet for increased production while domestic per-capita consumption remained flat.
During that time, the growth in exports presented a window of opportunity for U.S. farmers, reversing a 20-year trend of declining cow numbers from 1985 to 2005 and driving farmgate price increases. The industry responded to the opportunity by investing in “greenfield” cheese plants, new butter plants and added capacity at milk powder facilities.
Throughout 2014, Russia’s embargo against U.S. agricultural products halted imports of dairy products. Then China over-purchased U.S. dairy products and swiftly left the market in 2015, leading to a steep decline in exports.
Throughout 2015, New Zealand and Australia experienced economically induced production decreases, while weather slowed production in South America, causing an overall cut in the global supply of dairy products.
Also in 2015, the European Union lifted production quotas, creating an oversupply of milk on the market as EU farmers re-invested in their herds.
While European countries increased production by 15 billion pounds, nearly half of that is in storage. Stocks in the U.S. were down due to market volatility through 2015, and efforts to refill the “pipeline” kept prices up. Now, the stores are filled and inventories of domestic dairy products at 10 to 20 percent over their five-year average are disquieting.
“It’s not just about increasing consumption anymore,” Gould said. “Competition is a factor.” What happens abroad creates competition for the U.S. dairy industry, as exports as a percentage of production increase.
What’s next for the U.S. dairy industry?
International dairy markets are just starting to recover from an imbalance in supply and demand. According to Gould, the U.S. is the only major importer in positive production that allows us to gain market share with some products.
U.S. non-fat dry milk and skim milk powder prices are trending up but still lower than the international market, while cheddar cheese prices are also below the international market price.
Over the past three months, all U.S. dairy product sectors have started to recover with the exception of skim milk powder, as the European government has been the biggest consumer.
Gould sees the recovery continuing through 2017 as export demand grows, supplies decrease, and inventories normalize. Domestically, our production is still growing through increased production per cow, all while product stocks are building. It could potentially take another 12 to 18 months for prices to return to levels above $18 per hundredweight.
Adapting management is key to success
Sam Miller, managing director of agricultural banking at BMO Harris Bank, spoke of Wisconsin’s fight to stay competitive in the dairy industry since 2004 and the characteristics of the state economy and environment which ensure their success.
In the early ’90s, California passed Wisconsin as the No. 1 dairy-producing state in the U.S. during a period of lower feed cost. According to Miller, Wisconsin dairy farmers aided in this process by selling cows to California’s dairy farmers at a price cheaper than the cost to raise a calf to breeding age.
Wisconsin’s dairy industry responded to this “wake-up call” by creating a dairy task force of government officials, education and industry leaders who recognized the inherent strengths of their dairy industry, like a strong infrastructure, water, climate and rich soils.
Miller said, “In Wisconsin, we see dairy as a business first, so we treat it as such.”
The dairy task force worked to decrease regulatory obstacles and increase market opportunities, specifically for specialty cheeses. According to Miller, the specialty cheese market in Wisconsin creates competition, which supports higher product prices, in turn allowing dairy farmers to be profitable against commodity markets.
Miller counseled that to adapt to the current market, dairy farmers must build liquidity, focus on margins, maximize yields and production, control costs, maximize crop insurance coverage, keep crop rotations and employ new technology.
Miller also stated that successful dairy farm businesses incorporate price risk management habits of identifying, assessing and analyzing many types of risks, including succession, crops as they relate to feed and weather, environmental concerns, interest rates, labor, input costs and disease.
In addition to risks, Miller emphasized that profitable farms monitor production and financial metrics to stay competitive with their peers. After identifying bottlenecks and weaknesses in the business that they can control, successful farmers adapt their management to boost profitability and reduce risks.
Miller specifically pointed out that dairy farmers should monitor their return on assets because it ties together a farm’s balance sheet and income statement and is useful in considering opportunity cost. “Look at your return on assets and compare it to the interest rate,” Miller said. “If it’s above the interest rate, you can likely borrow profitably.”
When successful dairies expand, the management team puts together scenario plans at various price points, creates “what if” scenarios, monitors cost control and often sells excess assets to improve working capital. They execute the plan, then monitor actual results, complete variance analysis, track production and financial metrics daily, monthly and quarterly, and make adjustments as needed.
“Every dairy expansion will bring the farmer to their knees,” Miller said, quoting a peer. “How well they did in the planning process will determine how long they stay there.”
The Center for Dairy Excellence hosts the annual Financial and Risk Management Conference as a professional development program exclusively for dairy lending and financial consulting professionals. The center is a non-profit organization focused on strengthening the dairy industry in Pennsylvania.
Alan Zepp is the risk management program manager at the Center for Dairy Excellence.