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California at the Crossroads

10:55AM Nov 17, 2010

The dairy giant will look different going forward.


Rumors of the demise of California’s dairy industry are greatly exaggerated, but the nation’s No. 1 dairy state will look different in the future.

That’s the assessment of California dairy producer Tony Mendes in his “The State of My State: A Dairyman’s Perspective,” presented at the Elite Producer Business Conference last month in Las Vegas, Nev.

“The trauma and the drama of 2009” ended California’s golden age, which lasted from 1970 to 2008, says Mendes, who milks 1,500 cows and farms 1,000 acres near Riverdale, Calif.

Mendes is a third-generation dairyman with a law degree. He’s also board chairman of the Alliance of Western Milk Producers and immediate past chairman of California Dairies, Inc., the state’s largest dairy cooperative.

Bonus Content

California's Future Look

Leprino Foods

Dairy Today's Elite Producer Business Conference

Mendes notes that the state’s dairies steadily churned out a 3% to 4% annual growth rate from 1970 to 2008, becoming the top-ranking dairy state in 1993. Annual milk production rose from about 10 billion pounds to nearly 40 billion pounds. It was the era of megadairies, when producers achieved their lowest production cost per cwt.

But the negative margins of the 2008–09 financial crisis, wrought by low milk prices and high feed costs, ended that. The number of dairies in California declined from more than 2,000 in 2004 to 1,600 in 2010.

“I can’t overstate how dramatic those negative margins were to dairies,” Mendes says. “We saw unprecedented loss of producer equity.

“That caused a major disruption in dairy families,” he adds. “It was hard to lose your equity, but even harder to lose your father’s and grandfather’s.” 

The sun has not set on the Golden State’s dairy industry, however. “It’s growing and vibrant, but it will look different,” Mendes says.

He predicts California’s milk production will grow at just 1% to 2% per year, but even that will require a new mindset. The state’s dairy producers must meet new challenges and adapt to a new way of doing business. “There will be little to no room for mistakes,” he says. “We’ve got to do it right the first time.”

Mendes outlines the four biggest challenges for California dairy producers and how they can tackle them:

1. Access to capital. “Large numbers of dairymen are not finding capital for their operations,” Mendes says. Commercial banks and the Farm Credit System are the industry’s major financing sources. In the wake of 2009, some lenders are demanding that dairies re-establish their equity position. Some banks are scaling back or exiting from dairy lending. Interest expense is a larger line item on financials.

To meet the funding challenge, producers must seek refinancing on different terms, Mendes says. They must protect against inflation with hedge tools such as interest-rate swaps. And they must involve the lender by education, communication and more frequent contact. “We want the bank to understand our decisions,” Mendes says.

2. Positive income over feed costs. In California, grain and forage are approximately 50% of a dairy’s operating costs. While most forages are homegrown, grain is often imported from the Midwest.

Mendes says producers must mitigate feed cost volatility with hedging tools, such as milk futures options, swaps and margin protection hedging. They must also continue or even expand their use of California’s many food byproducts in their dairy feed rations. Acquiring additional water supplies is also needed.

“Water is a big deal in California,” Mendes says. “We have enough, but our recent shortages are purely political. California’s dairy industry has been on the periphery of the water wars. But it’s time for us to go to the front line.”

3. Plant capacity. While California’s milk supply, location, population and make allowance make it an attractive location for processing plants, some huge negatives exist. These include higher building and operating costs and more regulations.

Mendes stresses that California has no excess plant capacity and that the state’s major new plants are being built by producers through their co-ops.

To meet this challenge, producers must decide why more plants should be built. Growth by dairy producers is essential to the industry’s long-term survival. Co-ops must build plants to balance production growth with new, primarily foreign, buyers. They must also concentrate on building or expanding plants for niche domestic markets.

4. Increase efficiencies and meet environmental regulations. Few new dairies are being built in California due to environmental costs. Studies, permits and other requirements can push expenses to $800,000 “before you even move dirt,” Mendes says.

The initial costs to comply with the new environmental regulations totaled $60,000 on his dairy, he says. He budgets his annual regulatory costs at $40,000.

To compete, producers must find efficiencies in per-cow production using the latest technologies and look for alternative technologies to reduce air and water pollution.

“As environmental rules move east, our competitive position will improve,” Mendes says.

A Manufacturer's Perspective

California looks like a negative bet in nearly every way when Leprino Foods considers whether to build a plant in a certain location—except when it comes to supplying global markets.

Sue Taylor, vice president of dairy policy and procurement for Leprino, says California will remain attractive for processors looking for an export platform.

“Our experiences have shown that the U.S. is uniquely positioned to supply the global marketplace,” says Taylor, who also serves on the board of the U.S. Dairy Export Council.

California’s competitive position in attracting plant capacity has decreased for several reasons. Taylor says. These include its regulatory and business environment, the health and competitiveness of its dairy producers and its water concerns. California also takes a plant-siting hit because of its distance from major domestic markets in the East and higher freight costs.

For a new plant site, California also suffers from its regulated price risk, Taylor says. The state is not part of a Federal Milk Marketing Order, but has its own pricing system.

“Minimum milk pricing is mandatory for all plants in California,” she says. “Participation by all manufacturers other than fluid processors is optional in Federal Milk Marketing Orders. There is no opting out as a safety valve if regulated prices get out of sync with finished product values.” In addition, she says, California’s milk pricing decisions have become more political.

Plant capacity will follow growth in milk production, Taylor adds. Under current biofuels policy, that likely will occur east of the Rockies.