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0808 PD: It’s a small world after all – even for dairy

Ben Yale Published on 19 May 2008

The U.S. Dairy Export Council reported in February 2008 that on a total-solids basis, more than 9.5 percent of U.S. milk production was exported.

This was an all-time high, but continued growth of dairy exports is expected for some time. With this growth in exports comes a number of major policy issues that our regional pricing and pooling programs are incapable of addressing.

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Several events last year illustrate how the international market has an enormous influence on domestic dairy prices. The most significant was the high demand for dry whey.

The demand for simple dry whey was so great that there was a price inversion between traditionally cheaper dry whey and higher-value whey protein concentrates. The escalating dry whey prices drove the minimum price for Class III up, thereby contributing dollars to the minimum prices. At the same time, it placed a severe stress on cheese plants that either had no way of recovering whey or were producing high-value concentrates. The pricing systems in both the Federal Milk Marketing Orders (FMMO) and the California system assumed that the different commodities would always retain their relative position, but they were proven again to be incorrect. The California Department of Food and Agriculture (CDFA) ultimately addressed the issue by fixing a value for dry whey that is maintained regardless of market price. But the FMMOs have not made any changes. In the meantime, more traditional relationships and pricing levels have returned.

The other event of note was the misreporting of non-fat dry milk (NFDM) in the National Agricultural Statistics Service (NASS) product surveys. Higher-value NFDM export sales were not being reported to NASS, resulting in lower Class IV prices. At the same time, plants sought to avoid reporting NFDM sales by moving milk solids as condensed skim or skim milk powder or in other forms.

Generally, the Class IV FMMO price and the Class 4a CDFA price track very closely. Over the last several months, we have seen spreads in both directions. In large part, these differences reflect how each agency deals with long-term foreign sales. (The CDFA uses contracts with terms of no longer than 5 months and USDA uses only sales within the last 30 days.)

Last year, exports of NFDM resulted in NFDM prices that were so high that for the first time in years, Class IV was the mover for Class I in the FMMOs. Between the higher NFDM prices from exports and the higher whey values from export sales, as much as one-third of minimum prices in both the FMMOs and California could be attributed to exports.

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What goes up, also comes down. So it was for the powder price and corresponding milk prices when international buyers balked at higher NFDM prices.

What is it that happened during the last year that allowed foreign markets to have such an impact on U.S. dairy prices? First, the weak dollar makes our exports cheaper to importing countries, resulting in more buyers. Second, the E.U., which traditionally exported a lot of powder, is short of milk. Its quota program finally reached domestic needs and in some cases fell short. There was no powder available domestically. Third, Australia suffered a drought and production in New Zealand has been down. Fourth, demand for milk solids increased, particularly in Asia. With the E.U. and Oceania short of product and U.S. products cheaper, increased U.S. sales followed as a matter of simple economics. That was the good news. Today’s Class IV and 4a prices are one-third lower than six months ago because of changes in international markets.

Domestic milk prices are now linked to external forces. Changes in the value of the dollar, demand for milk solids in China and elsewhere, production in other areas of the world, government policies on quota in the E.U., trade balances, war and a whole host of other international factors now play a role in the milk checks of U.S. dairy producers.

The emerging role of exports also exposes the weaknesses in our national dairy policies. Pricing milk used in commodities each month after the milk has been sold will not work in international markets. When a foreign buyer puts in an order for product next month, they want the price now. Using pooling as a price hedge for buyers of milk and milk producers is no longer viable. A true market price for milk and milk products is necessary so that buyers and sellers can enter into long-term contracts and offset their risk. Until that happens, export sales will not grow as fast as we expect.

Efforts at domestic supply management, such as those managed by Cooperatives Working Together (CWT), will be ineffective in controlling the value of product. This is because the sheer volume of milk now being exported is nearly 10 times the amount removed by CWT’s programs. CWT simply does not have the resources to remove enough cows fast enough. Even if it did, it would be counterproductive because when conditions for export rebound, and they will, there would be no U.S. milk to deliver and our role as a supplier will be harmed immeasurably.

We are in a new world and the old way of looking at dairy economics (domestic sales) is no longer valid. The resulting boom time is well deserved and well overdue for producers. But we must be careful not to apply ancient thinking to modern realities because if we do so we will destroy what is not only a present but a future economic benefit for dairy producers. Killing off the foreign demand-driven bull market will result in a rapid reduction in prices for a long period of time.

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Imagine being on a teeter-totter that is 24 feet long with the bar 3 feet off the ground. As one side goes down, one side goes up, but it will not go up more than 6 feet off the ground. Now imagine the same board, but double the height of the fulcrum to 6 feet. The board can swing more than twice as high as before. At the same time, if the counterweight on the bottom side is released, the board will fall further down.

The higher the fall, the greater the possibility that fall will be violent. Growing global demand for dairy products is like a taller fulcrum for the dairy industry’s teeter-totter. It makes the potential for profit, and loss, greater at the same time, which is the definition of volatility.

Similarly, efforts to interfere with the current world market for milk could remove the counterweight. If that happens, the fall can be fast. There is no cow kill program, supply management program or other program, private or government, that can remove supply fast enough to stop the bleeding that will occur. We need to encourage more of a hands-off approach to enjoy both increased production and prices.

Milk is no longer sold at the county seat or even the next state over. It is marketed in an international market. It is a world market that is engaged enough to change our prices and powerful enough to demand we change our policies. The policies will change, either by proactive participation of progressive dairy leaders or through managing a crisis. It is a small world, but one we have to learn to live in. PD

Ben Yale
Attorney at Yale Law Office

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