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3 open minutes with Vernon Crowder

PD Editor Walt Cooley Published on 26 August 2011

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Rabobank N.A., a leading provider of agricultural financing and full-service banking products to the Californian agriculture industry, recently released a report entitled, “California Dairy: Turn West,” illustrating the state’s opportunities and competitive advantages as a global dairy exporter. Progressive Dairyman Editor Walt Cooley discusses the report with its author, Vernon Crowder.

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Q. What will producers find most surprising in this report?
A. CROWDER:
We’re putting it right on the table, and we’re talking about some of the new limits in terms of domestic growth for California producers. The report may not be a total surprise because a lot of dairymen have suspected these issues.

One finding that might be a surprise is the one that shows New Zealand dairy producers have been getting a better price for their milk than California operators. Everybody’s been used to the idea that the global markets used to be a place to dump milk and that those prices were lower. Now they see there’s actually a premium. We see the opportunity for California to come in and get a share of that good market.

Q. What about the good old days of California-style dairying probably gone?
A. CROWDER:
It’s going to be difficult to get back to the place where feed costs are low again. Given world demand for protein and corn for ethanol, pressures on land availability and even demand for our hay abroad, I doubt if we’re going to go back to $2-to-$2.50 bushel corn.

Historically, there were times California dairymen could buy grain from the Midwest at a cheaper price than a Wisconsin grower could grow it. That’s definitely something in the past.

Q. The report says market shocks have significantly contributed to dairy margin volatility. What are you referring to?
A. CROWDER:
There’s a long list of them. The big one is what I call the two perfect storms in terms of what happened back in 2008 and 2009. You had the perfect storm that brought dairy prices to then-record highs.

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Back then there was a weak dollar, a shortfall in European production, troubles with New Zealand production and rising global demand. So you saw milk prices go to a record high, and in that case, it happened before feed prices went up, so the U.S. started producing a lot of milk. There was a lot of expansion, and people were making lots of money.

And then you started getting into the second part of that perfect storm, or the backlash to it, and that was the financial crisis throughout the world. All of a sudden liquidity dried up. The dollar went up. Europe’s production came back on. Foreign demand fell off, and all of a sudden we had more milk than we knew what to do with. We saw prices over 18 months go from $20 to $10.

Q. Do you anticipate more market shocks like the dairy industry has seen in the last two years? Why or why not?
A. CROWDER:
I think it would be highly unlikely to see that severe of an event again, just because so many things came together at that time. Is there going to be continued volatility? Most definitely, not only on the feed cost side but also on the market side, and we can’t avoid it.

We’re already into the global market, not only California, but the U.S. dairy industry as a whole. The market’s been globalized, and so it would be very difficult for us to build a fortress around ourselves in an attempt to avoid the volatility of the markets.

Markets by nature are going to be volatile based on climate changes, demand changes and different tugs and pulls from economies. We expect to see a continuation of the volatility in both the revenues and costs.

Q. What is the new model for profitable dairying in California?
A. CROWDER:
A continuation in trying to reduce the cost of production. The economies of scale are going to tend to still favor larger operations, but you’re also going to see more flexibility.

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Some dairies in California have chosen to buy additional acreage for various reasons, but one of them is to produce their own feed, and that kind of vertical integration certainly is a good hedge to cover the feed cost of their business.

Other dairies are diversifying into other crops to manage their market risk. Still other dairies are choosing to manage with financial hedging tools, such as forward contracting on the feed cost side. Some are dabbling in the ability to trade in futures to manage milk prices too.

Q. Which of these two cost strategies – hedging input costs or growing more of their own feed – do you think more of California’s producers will pursue?
A. CROWDER:
We’re very aware that it depends upon each individual operator’s skill set, their financial sophistication or their resources and land. So the strategies are all very different.

Hedging is fairly new. California dairies, for decades, have enjoyed a very good competitive position. They typically have had a lot more upside opportunity in the market than downside risk. Sure, there were occasional times that things got tough, but they didn’t happen very often, and they didn’t last very long. So producers tend to be an optimistic lot, looking for that upside.

By history, they’ve been hesitant to go out and take a position in the market on feed, grain or milk prices. They don’t want to cut themselves off from a better market opportunity, but we have seen, maybe over the last decade, that they are increasingly taking positions on the feed cost side. Maybe it’s limited. Maybe it’s just for the next six months, but they’ve taken positions.

And then, as I said, there’s a small minority of the market who are starting to take a position on the milk price, or revenue, side too.

Q. What are California’s competitive advantages as a dairy exporter?
A. CROWDER:
California, because of its location on the Pacific Coast and near a couple of major shipping points, has a bit of an advantage over other regions of the U.S., which makes them competitive even with New Zealand, in terms of transportation.

Also, California has a strong infrastructure, and while there’s some cost to it – be it environmental or the cost of land – they still have the opportunity to expand.

Q. Really, California is as competitive as New Zealand when shipping to say, China? Why is that?
A. CROWDER:
The shipping distances aren’t all that different, and those boats with imported products would go back to China empty if they weren’t being backfilled with U.S. products, so that makes the fees for shipping to China relatively competitive.

Q. What must California do to seize its export opportunities?
A. CROWDER:
The primary thing they’re going to have to do, and I think they’re already starting to do this, is they are going to have to increasingly see exports as a steady market. It’s not just some temporary market for getting rid of excess products, and if it’s going to be a steady market, they need to develop relationships with these buyers directly, not just working through brokers.

They need to develop those relationships, learn more about what the buyers want and what their preferences are, and then make adjustments in what products they’re making and how they price them to meet the demands of those buyers.

Q. Even if producers want export opportunities, shouldn’t they be skeptical the processing and marketing will follow?
A. CROWDER:
The San Joaquin Valley is nearly 90 percent of the milk production in California, and the major processors that buy milk in the San Joaquin Valley are cooperatives. Dairymen lead those cooperatives as members on their boards of directors. So it’s not like an “us versus them” thing.

We’re talking about basically vertically integrating the industry here, so dairymen have a lot of influence on what direction their processors are going. Again, there’s a cost though, because these changes are going to require some increased capacity and some changes in manufacturing process. Members of these co-ops are going to have to work with their co-ops to make those investments.

Q. Can you explain the types of increased costs and infrastructure that will be necessary for exports and why?
A. CROWDER:
One of the clear examples is the product much of Asia wants. They want whole milk powder (WMP), while we in California have traditionally produced non-fat dry powder (NFDM), and that’s because of the history of our government buying that product during times of surplus.

It’s my understanding that for manufacturers to make WMP, it takes a lot longer to dry the milk than NFDM because of the additional fat. I’ve heard that a processing facility would have to increase its capacity by about 30 percent.

Q. Is this report more of an ultimatum or a pick-me-up to a beaten-down industry?
A. CROWDER:
Because our lending portfolio includes food and agriculture and because we examine these things internally, we share these reports to hopefully provide value to our clients and their industries. We hope to help provoke thought and consideration for a change in trends.

Our only objective here was to facilitate discussion and consideration of some opportunities that are out there.

Q. Is the best way to describe the tone of this report its final paragraph, ‘Reach for the sky’?
A. CROWDER:
We are doing a lot of business with California dairies, and we’re putting on more and more deals, so we’re clearly optimistic about the future of California dairies.

Q. What is it about California that gives you hope of a bright future for dairying in the state?
A. CROWDER:
This industry has proven its success and its ability to adapt over the decades, so given what we’ve talked about regarding the state of the California dairy industry, the competitive technology it’s employed, its proximity to the market – yeah, we’re optimistic about the future of this industry. PD

Walt Cooley
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