Margin outlook tightens as new DMC deadline looms
December 17, 2019
While specific details of a trade deal between China and the U.S. remain to be seen, dairy farmers must make decisions on 2020 participation in the Dairy Margin Coverage (DMC) program by this Friday, Dec. 20. The U.S.-China deal could impact both the feed cost and milk income sides of DMC margin calculations to varying degrees.
On Dec. 11, the USDA extended the deadline to enroll in the 2020 DMC program by a week, from Dec. 13 to Dec. 20. Then, on Dec. 13, U.S. and Chinese government officials confirmed they had reached a “phase one” trade deal that would roll back some tariffs and guarantee increased purchases of U.S. agricultural goods by China.
Statements from the National Milk Producers Federation (NMPF) and International Dairy Foods Association (IDFA) indicate both organizations are following developments to determine how the trade deal will impact dairy. It is expected that phase one of the deal will be signed in early January and become effective 30 days after it is signed. Negotiations on a “phase two” deal could begin soon after that.
“That lack of details means we can’t yet describe how this will impact dairy,” said Jim Mulhern, president and CEO of the National Milk Producers Federation (NMPF). “But we do expect that several issues on which NMPF has worked closely on with the U.S. Dairy Export Council to address with the White House – such as infant-formula imports and facilitating plant registrations, and as well as issues related to defending common cheese names – will be included in the agreement. We hope that other key issues, such as China’s current retaliatory tariffs on dairy products, are also addressed in the deal, so that U.S. dairy producers can re-enter the Chinese market in a significant way and boost exports.”
According to the Office of the U.S. Trade Representative (USTR), the deal ensures that exports of American goods and services to China in 2020 and 2021 will increase by $200 billion over the 2017 baseline totals, according to an analysis by IDFA.
U.S. dairy export value to China peaked in 2017 at $577 million, fell 29% to just over $500 million in 2018, and has reached just $305 million through September of this year – a 30% drop over 2018, according to an analysis from IDFA.
Phase one of the trade deal could spur Chinese whey demand. Until this year, China had become the leading market for U.S. whey and a growing customer for U.S. cheese. China bought 33% of U.S. whey exports by value in 2018. Overall, U.S. whey shipments to China totaled to $174 million. However, retaliatory tariffs and lower feed use due to African Swine Fever contributed to a decline in whey product exports to China. From January to September 2019, exports declined 41% year over year. In addition, through September 2019, U.S. cheese export value fell 39%, on top of a 39% loss in the second half of 2018.
Feed costs affected
On the cost side of the DMC ledger, completion of a phase one trade deal shows promise for stronger corn and soybean prices in 2020, according to University of Illinois agricultural economist Todd Hubbs.
After weakening earlier last week due to uncertainty over the trade talks, CME soybean meal futures prices rose an average of about $7 per ton in December 2019, January 2020 and March 2020 contracts in two days of trading, Dec. 13 and 16. Over the same two-day trading period, CME 2020 corn futures rose an average of 10 cents per bushel in March, May and July 2020 contracts.
U.S. markets are also still weighing 2019 U.S. crop harvest challenges, with the USDA scheduled to update harvest estimates and stocks reports on Jan. 10, 2020.
And, even before the phase one deal was announced, recent USDA export estimates indicate October sales of alfalfa hay to China were a new record high. Christy Mastin, international sales manager with Eckenberg Farms Inc., expects Chinese demand for alfalfa hay to continue to remain strong. Through October, China had purchased about 30% of all U.S. alfalfa hay exports for the year.
So, while there are still questions remaining regarding how a trade deal with China will impact dairy prices, indications are feed costs for dairy producers will be pushed higher.
Cheese market plummets
For dairy farmers bumping up against the 2020 DMC participation deadline, recent weakness in the cheese market is also changing the margin outlook.
While strong cheese sales helped provide higher fourth-quarter 2019 prices and some attractive floor prices for those who use the futures market for the basis of risk management decisions, the CME cash cheddar barrel market fell to $1.695 per pound on Dec. 13, down 53.25 cents per pound in a week. Cheddar blocks finished down 17.25 cents during the week, to $1.7975 per pound. In trading on Dec. 16, cheddar barrels lost another 8.5 cents, falling to $1.61 per pound, and blocks declined 2.75 cents, settling at $1.77 per pound.
CME Class III futures didn’t initially reflect the full impact of the cheese price decline, but in trading on Dec. 16, January, February and March 2020 prices fell 68 cents, 42 cents and 24 cents per hundredweight (cwt), respectively. As of Dec. 16, the 12-month 2020 CME Class III price was down about 25 cents per cwt from Dec. 10.
Also potentially impacting dairy markets, the USDA is scheduled to release its latest monthly Milk Production report on Dec. 18, reflecting November production and cow number estimates. Relative to year-earlier levels, both September and October milk production totals were stronger than the first part of the year due to increased milk production per cow and a reversal in declining cow numbers.
Based on milk and feed futures prices as of Dec. 2, DMC margins were expected to peak near $12 per cwt in December and January and remain above $11 per cwt in February-March and stay well above $10 for the rest of 2020. With latest developments, that’s changed.
The USDA’s DMC Decision Tool estimates margin ranges and payment probabilities based on current futures prices. While the online calculator still sees DMC margins remaining above $10 per cwt through all of 2020, as of Dec. 16, DMC margins had a 20%-30% probability of falling below the top insurable level of $9.50 per cwt between March-August 2020, and a 7%-14% chance of falling below $9 per cwt over the same period.
Editor's note: CME cash cheese and Class III milk futures prices have been bouncing around in the week leading up to the DMC deadline. Both markets declined further on Dec. 17 but then rebounded on Dec. 18. At the close of trading on Dec. 18, DMC margins had a 15%-28% probability of falling below the top insurable level of $9.50 per cwt between March-August 2020 and a 5%-13% chance of falling below $9 per cwt over the same period.
Check with your risk management adviser for latest market outlooks. All producers who want DMC 2020 coverage – even those who enrolled in 2019 and took advantage of the 25% premium discount by locking in the coverage level for five years of margin protection coverage – are required to visit the FSA office during this signup period to pay the annual administrative fee. Premiums will not be due until September 2020.