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Cow numbers hold clues to the 2023 outlook


If you had to pick one dominant factor that drove the U.S. dairy economy in 2022, the top candidate would be constrained milk production. It goes without saying that if you had to predict the dominant one for 2023, continued production recovery also would be a good bet.

The amount of milk produced in the United States was below year-earlier figures during each of the eight months between November 2021 and June 2022, and except for the 0.1% uptick in October 2021, this string of lower year-over-year production would have lasted for 10 months. You have to look back a long way to find similar episodes of this length. In fact, it hasn’t happened since the two nine-month-long strings that ended in September 1996 and in April 2004 and the 11-month-long one ending in October 2001.


U.S. milk production recovered during the second half of 2022, but somewhat moderately, with production up over a year earlier by 1.7% in August but up just 1.3% in November. USDA’s World Agricultural Supply and Demand Estimates (WASDE) report for November projects that U.S. milk production for calendar year 2022 will be 0.3% higher than 2021 production, and that calendar year 2023 production will be up by another 1% over 2022. WASDE’s 2022 estimate implicitly assumes that combined November and December production will be 1.8% higher in 2022 than during the same months a year earlier.


For milk prices, the November WASDE report estimated that, with just two more months to be announced, the U.S. average All-Milk price will be $25.50 per hundredweight (cwt.) for all of calendar year 2022. For 2023, the WASDE estimate was $22.60 per cwt., while the CME futures as of early December were estimating $22.90 per cwt.


Key takeaways from these observations are that the milk production recovery in mid-2022 was not significant enough to keep last year’s milk prices from blowing away the previous annual record of $24 per cwt. in 2014, and that this year’s expected milk production gains are not anticipated to be large enough to prevent that year’s milk prices from coming in at a solid third highest ever.


Other than 2022 and 2014, the next highest annual average milk prices were $20.10 per cwt. in both 2011 and 2013. Of course, 2022’s record-high feed costs, and the prospect of more of the same in 2023, play a large part in causing these price behaviors, as well as preventing those high prices from producing banner years for dairy farmers’ bottom lines. The feed cost situation may also underlie USDA’s cautious outlook for more milk in 2023.


However, closer examination of this relatively comfortable outlook reveals that dairy cow numbers may be telling a somewhat different story than the scenario of a long span of lower milk production, modest recovery, and relatively restrained growth going forward. For more than two decades, changes in cow numbers have exhibited a very definite cycles. The cycles look like this: The national dairy herd expands month-to-month relative to a year earlier by increasing amounts and reaches a peak level. Then, it recedes in an almost symmetrical pattern, and then usually, but not always, enters a contraction cycle with a similar shape except in mirror image.


These cycles are caused by, and in turn cause, countercyclical movements in milk prices, and their size and duration are shaped by growth in total demand for U.S. dairy products. More specifically, the ideal number of cows in the country at any one time would be the milk equivalent of total demand for U.S. dairy products divided by production per cow. Too many cows over a period of time will depress milk prices and eventually slow the changes in cow numbers, and vice versa.


Enter exports


Growth in U.S. domestic demand has been slower than growth in production per cow. A few decades ago, when exports were relatively small and contributing little to total demand, cow numbers tended to decline as persistent excess production kept a general downward pressure on milk prices. More recently, export growth, which considerably outpaces domestic demand growth on a percentage basis, has had an increasingly positive impact on total demand growth, allowing it to outpace gains in per cow productivity and enabling the national cow herd to expand again, starting in 2005.


What might this cow cycle analysis mean for production and prices this year? As of last November, the U.S. cow herd had finished a contraction cycle, one of the shortest in more than two decades, and was three months into a subsequent expansion phase. Looking at similar contraction-to-expansion transitions over the past few decades, this recent one was the strongest in terms of net changes in cow numbers over six months of these transitions.


Last June, the dairy herd contained 86,000 fewer cows than the previous June. In November, there were 38,000 more animals than a year earlier, for a net swing between those months of 124,000 cows. This was the second largest of seven such net swings during the past two and a half decades, which ranged from 56,000 to 140,000 and have been a rough predictor of the length and magnitude of the ensuing expansion cycles.


This would indicate that there is a greater likelihood for more, as opposed to less, milk production going forward than is generally anticipated, and therefore more pressure on milk prices than the markets and other forecasts were indicating in December. Historically, periods of exceptionally high milk prices have tended to unleash rather rapid expansion of milk production during the following months that even continued high feed costs cannot fully suppress.


A look forward


The cost of feed, as indicated by the Dairy Margin Coverage (DMC) formula, could average about a dollar a hundredweight lower in 2023 than the prior year, based on futures prices in December. But milk prices, as indicated earlier, are expected to drop this year by substantially more than that, so lower DMC margins can be expected, with payments to the top few Tier 1 coverage levels likely to occur during multiple months.


The current situation bears many resemblances to the aftermath of 2014’s high prices, when milk production growth persistently challenged demand growth in the face of low to mediocre milk price-feed cost margins. An added wrinkle will be the likely continuation of high retail price inflation for dairy products well into 2023 as well as some uncertainty about how international price inflation and China’s continued stringent COVID-19 policies may impact further growth of U.S. dairy exports.


Bottom line: Keep an eye on what happens to cow numbers in 2023, and hope that the coming herd expansion cycle will turn out to be moderate and compatible with the year’s total demand growth.


Peter Vitaliano

December 21, 2022


hoards.com

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