December 18, 2020
In a marketplace where the hand of the government can cause markets to rise and fall with the slopes of the Sierra Nevada mountains, it’s nearly impossible to predict what lies ahead. Nobody understands that quite like dairy farmers following a year like 2020 where each announcement of coronavirus aid would send dairy markets surging to a new high only to have them fall when each wave of aid ran out.
Each year we do our best to provide dairy producers with a fundamentals-based market outlook they can count on to be a guide for the year ahead. However, multiple analysts told us that for 2021 hedging your bets on a price forecast made at this point in time would be foolish. So instead, we’ll outline some factors that will undoubtedly influence your income over the next 12 months.
COVID-19 Supply and Demand
“COVID is going to live with us for a while on a number of different fronts in dairy,” says Mike North of Ever.Ag. “From a supply and demand perspective, foodservice is kind of the dark cloud in the conversation for dairy. A lot of fat, cream, and butter –those things that we really enjoy about that sit-down meal—that's all been missing [from the demand picture].”
While North admits we’ve made up for those losses in other areas like retail, Nate Donnay of StoneX group says there’s some concern that retail demand will not continue to keep the supply and demand balance afloat.
“We’ve got the retail dairy sales numbers for November and they're showing a slowdown,” he says. “We went from 9% growth in October to 8% growth in November, and the gains in volume terms are lower than the gains in dollar terms. So, retail movement to dairy on a milk solids basis is up less than 8%.”
Donnay notes that it can become a bad situation when retail sales and food service sales are slowing down. Add on top of that the current projection that government purchases will be drastically lower than they were in 2020 and things begin to look even darker.
The government has a long history of purchasing dairy products to distribute to food banks and to food insecure populations throughout the country. That has never been truer than it was in 2020 and with a new Administration moving into the White House, there is a high level of uncertainty that purchases like we’ve seen recently will continue.
“The big thing that COVID did to the dairy market was bring government involvement into our marketplace in a way we've never seen it before,” North explains. “As you go back through the year, what you're going to find is massive movement in price, every time the government renewed the food box program.”
North is referring to the Farmers to Families Food Box program that USDA debuted as part of the Coronavirus Food Assistance Program in May.
The first round of the program which purchased billions of dollars of cheese sent Class III prices rocketing higher through May into June, North says. Then as that first round came to a close, prices softened.
“Then [the government] renewed it again and prices took back off and then again, prices softened and we repeated that [cycle] multiple times,” he says. “As we go into 2021, right now we're asking the question again. We're wondering, ‘are we getting another one?’”
Within the stimulus bill that is up for a vote on Friday, December 18, there’s $26 billion to be appropriated for food aid. Of that, $500 million set aside for commodity purchases and $200 million on top of that for the cost of distributing those commodities.
Donnay estimates $125-250 million would go to purchasing dairy products.
“I'm pretty sure we're going to have something like that, in whatever stimulus bill, eventually gets passed,” he adds.
North notes that within the proposed bill there are some nontraditional approaches to appropriate the funds including a dairy donation program of up to $500 million.
Through that program processors would partner with nonprofit food distribution organizations. They would purchase dairy products, donate them to the nonprofit and receive a refund from the government. However, Donnay says the reimbursement calculations are complicated and could cause the program to fail.
“The reimbursement calculation looks funky, it's based on milk equivalents and class milk prices and I don't know how it's going to work,” he says. “If the reimbursement rate is high enough to at least cover the cost, this program could clear a decent [volume] of dairy products and give the market some support, but at this point there isn’t enough detail to know a whole lot.”
Additionally, within the bill is $9.9 billion in discretionary funds USDA could use to purchase dairy products like they did for the food box program, or to provide farmers direct payments. However, Donnay points out that the bill requires USDA to do a study on the impacts of COVID in agriculture and which segments of the industry still need help.
“So theoretically, the funding in this is going to be a little bit more targeted than just throwing money out all over the place,” he says. Because the USDA has to sit down and do a study on this, it might push the decisions around how this discretionary money is spent into the Biden administration which probably lowers the odds of another round of the food box program at least a little bit.”
Over the past few days milk prices have been up 30-50 cents just to fall 30-50 cents. The marketplace is trying to wrap its brain around all of this as the markets have shown over the past week, North says.
“Nobody really knows how to take this,” he says. “We thought we were starting to see a little bit of a clear picture up to about a week ago when this language all rolled out. And in that picture, it looked pretty clear that we had a lot of downward pressure. So my advice to producers is to make sure that you are still being intentional in the marketplace yourself, because as we saw through 2020, and as we may see more of in 2021, the moment the government spending stops, the market falls flat on its face because it has to.”
While “artificial” demand is welcomed in the short run, it’s not real in the long term and the market is quick to pick up on that and responds very quickly, North explains.
“The fundamentals suggest a very heavy picture, but they're overcome by any government involvement because it brings almost a false demand that wouldn't ordinarily be there, and it supersedes any understanding you would have of a normal environment,” he says. “I think any forecast right now, short of including absolute information about what the government is going to do in the space, isn’t worth the paper it's written on. At this stage in the game, we really don't know much.”
Milk Production Continues to Increase
In its November milk production report release on December 17, USDA noted milk production has increased 3% over 2019. That’s the highest year-over-year increase since 2014. Price has encouraged dairyman to produce more milk and we see it in the numbers from November. In November, 12,000 cows were added to the herd and October was adjusted 5,000 head higher, for a net increase of 17,000 head to the U.S. dairy herd. Obviously, a surge in supply while demand either stays the same or tightens as noted previously, would put a significant level of downward pressure on prices.
Exports Hang in There
Despite the coronavirus pandemic, world demand for U.S. dairy products remains robust, and China—the world’s leading importer of dairy products—has been the frontrunner in the demand spike.
“U.S. dairy exports posted formidable volumes in October, buoyed by exceptionally strong demand from Asian markets, including China,” says Monica Ganley, analyst for the Daily Dairy Report and principal of Quarterra, Buenos Aires.
In October, the most current trade data available, U.S. exporters shipped 469.5 million pounds of dairy products into global markets, up 13.2% from the year before. After adjusting for leap day, that puts 2020 exports through October up 12.2% compared to the same 10 months last year.
“In volume terms, 2020 year-to-date exports were the strongest ever, and a weak U.S. dollar should continue to support exports in coming months,” Ganley says.
The U.S. Dairy Export Council expects exports will finish 2020 just 1% lower than the record set in 2019.
“China truly flexed its buying power in October, with dairy product shipments to the country 2.6 times greater than during the same month last year,” Ganley says. About two-thirds of China’s U.S. dairy purchases were whey products.
“Strong demand from China was the principal factor that drove U.S. whey exports to a record-high of 120.2 million pounds in October,” Ganley notes. “U.S. dried whey exports, in particular, benefitted from China’s growing appetite, with exports to that country surging to 53 million pounds, the largest volume since December 2011.”
The Haves and The Have Nots
Negative Producer Price Differentials (PPD’s) created substantial differences in monthly farm income in 2020. Farmers who might have never given much attention to the PPD deduction line in their milk check statement were suddenly forced to understand and accept this detail of the Federal Milk Marketing Order (FMMO).
“Negative PPDs occur when the component value of milk (value of butterfat, protein and other solids) in the FMMO pool exceeds the classified value of milk (value of milk as utilized) in the pool,” explains John Newton, chief economist at the American Farm Bureau Federation. “In 2020, the component value of milk approached all-time highs due to the impact of the cheese price on the protein price. Then, because the higher-of was eliminated in the 2018 Farm Bill, the Class I price of milk did not entirely benefit from higher cheese prices. As a result, PPDs dropped to historic negatives and a significant volume of milk was de-pooled (making the PPD more negative).”
Fortunately, Robin Schmahl of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wisconsin, says the negative PPD’s as we have experienced were likely an aberration this year and should “go away or be minimal next year as butter and cheese prices more closely align with each other.”
Wrangle Your Risk
“You definitely don't sit back, because [government price support] can end in a moment and when it's over, it's over in a big way,” North warns. “You have to still be vigilant and as you look at strategy, I think the key descriptor to any strategy in this market right now needs to be flexibility.”
Similarly, Schmahl warns the current optimism we are seeing with Class III milk prices as futures contracts are in the $17.00-$18.00 range need to be viewed with caution.
“The recent estimates released by the USDA on the World Agricultural Supply and Demand report should cause one to be concerned and look for opportunities in the market to protect income while at the same time remaine flexible.”
He warns producers that often this type of income protection cannot be accomplished through forward contracting through the milk plant unless they allow you to do options.
“There were many this year that made the mistake of panic forward contracting through the milk plant in April, only to get run over and then deduct the negative PPD’s from those contracted prices and they had no ability to get out of those contracts,” he says.
North says protecting downside risk while leaving the upside open is the key heading into next year. He suggests producers rely on tools like the Dairy Revenue Protection program to minimize risk in the months ahead.