In a year when most American farmers can expect lower earnings than in 2013, U.S. milk producers are having a windfall.
Prices have never been higher, feed costs are down, and output is headed for an all-time high as exports surge to buyers from Mexico to China. While the average farm will see a 21 percent drop in net-cash income, led by declines for corn, wheat and soybeans, dairy farmers will earn 28 percent more at $334,100, the U.S. Department of Agriculture predicts.
"Dairy farmers are making the best money they’ve made in many, many years," said Peter Gutierrez, vice president of global ingredient sales for Agri-Mark Inc., a 1,200-member dairy cooperative in Methuen, Massachusetts, that makes Cabot Creamery cheese and sells about 120 million pounds annually.
Milk futures in Chicago are up 23 percent this year and cheddar cheese gained 19 percent, with both reaching records last month. The higher prices are eroding profit margins for domestic purchases including dairy processor Dean Foods Co., sandwich chain owner Potbelly Corp., and Annie’s Inc., a maker of organic macaroni and cheese.
While the USDA expects domestic milk output to rise for a fifth straight year, up 2.2 percent to 205.7 billion pounds (93.1 million metric tons), exports now account for 15.5 percent of sales, compared with 5 percent a decade ago, according to the U.S. Dairy Export Council, an industry group based in Arlington, Virginia.
Global economic growth is expanding the middle class from Asia to South America, boosting demand for dairy products including cheese and processed foods containing milk. U.S. dairy exports reached 162,999 tons in January, up 19 percent from a year earlier, while the value rose 35 percent to $583.7 million, council data show. Cheese shipments jumped 46 percent to 32,118 tons, with a 38 percent increase to Mexico, the biggest buyer of U.S. dairy products, and a doubling to China.
"The export market is very firmly in everybody’s mind, from farmers to processors," said Peter Vitaliano, vice president of economic policy and market research at the National Milk Producers Federation. "No one really has dairy surpluses anymore."
Demand is expanding in China, the world’s most-populous nation, with 1.355 billion people, which overtook Japan as the second-largest economy in 2010. China’s dairy imports probably rose 30 percent last year, Yvon Guerin, the chief executive officer of Parmalat SpA, an Italian dairy processor, said during a March 10 earnings call.
Chinese dairies have been unable to keep pace with rising demand, and the pace of import buying has "caught a lot of people off guard," said Bill Schieck, an economist with the Dairy Institute of California, the largest U.S. milk-producing state. "The number of cows, as best as we can tell, is down, which has left a huge hole that they’re trying to fill."
Class III milk futures, which track a variety used to make cheese, are up 23 percent this year on the Chicago Mercantile Exchange, after touching a record $24.15 per 100 pounds on March 24. That same day, a 40-pound block of cheddar reached $2.4325 a pound, the most since data begins in 1997. The Standard & Poor’s GSCI Spot Index of 24 commodities rallied 2.6 percent in the first quarter, while the MSCI All-Country World Index of equities advanced 0.6 percent. The Bloomberg Treasury Bond Index gained 1.7 percent.
Dairy costs tracked by the United Nations are the highest since the data began in 1994, after climbing 9.8 percent in the three months through February, outpacing the 1.2 percent gain for all foods.
"These unusually high raw-milk prices are an undeniable headwind for our business," Gregg Tanner, chief executive officer of Dallas-based Dean Foods, said in a Feb. 11 earnings call. While the company’s costs may rise by as much as $600 million this year, any increase to consumers has to be weighed against the risk of "letting prices get so far out of whack that people just stop buying milk," he said.
Rising dairy and meat costs are the biggest sources of "potential inflation" at Chicago-based Potbelly, Chief Financial Officer Charles Talbot said in a Feb. 18 earnings call. The company may raise menu prices, he said.
Higher cheese costs are contributing to a "tough commodity inflation environment" at Berkeley, California-based Annie’s, Zahir Ibrahim, the chief financial officer, said March 13 at an analyst conference.
Dairy costs are "a concern" at Seattle-based Starbucks Corp., the largest coffee-house chain, said Troy Alstead, the chief operating officer. "You’re not able to protect it more than a handful of months going forward," he said in a March 19 interview. "It’s a very thin market in terms of futures."
Rising output may overwhelm demand. New Zealand, the largest dairy exporter, expects a 4.5 percent rebound in production in the year ended May 31 after the most widespread drought in three decades. European Union production will grow 2.6 percent in the first six months of the year, according to Rabobank International.
Fonterra Cooperative Group Ltd., the world’s largest shipper of diary products, said it will boost capacity to process more milk into powder, which is the primary form of dairy exports. The Auckland, New Zealand-based company "processed as much of this milk into the higher-returning milk- powder streams as we could," Chief Executive Officer Theo Spierings said in a statement.
Production unexpectedly rose in California, where drought conditions have led to water shortages and higher feed costs as pastures dried up. The state’s 5.3 percent increase in February to 3.4 billion pounds was second only to the 6 percent gain in Colorado.
The dry conditions have been ideal for cows, helping the seasonal "spring flush" begin sooner than usual, according to Tom Barcellos, a dairy farmer in Porterville, California, with 1,300 cows. His herd is producing a record 13,000 gallons a day, and one of the two plants he sends his milk to has sent notices that it is nearing capacity.
While exports are rising, domestic demand is shrinking. Per-capita consumption of fluid milk in the U.S. has been dropping for at least the past four decades, down 25 percent since 1975, according to the USDA.
Prices have already begun to retreat. The weighted average price of nine products traded at the GlobalDairyTrade, which serves as a worldwide benchmark, dropped 5.2 percent to $4,563 a ton. Milk futures for December delivery closed yesterday at $18.56, or 22 percent below the April contract.
"We’ve seen our peak for the year here in the first quarter" for Chicago milk futures, said Katelyn McCullock, a dairy and forage economist at the Livestock Marketing Information Center in Denver. "Milk prices are going to decrease throughout the year."
Output may begin to slide in California, where 95 percent of the state was rated in severe to exceptional drought as of March 25, according to the U.S. Drought Monitor. Dairy farmer Barcellos said he pays $350 a ton for hay, $50 to $75 more than last year. If conditions linger or the summer gets too hot, production will slow more than it usually does in the warm summer months.
"The big problem is going to be a few months from now when we don’t have water to grow our forage crops," said Barcellos, 58, who’s been in the business for 26 years. "We’re going to be scrambling to find some kind of feed. There could be some herd reductions off of that."
So far, demand for dairy products remains strong. Demand from overseas is forecast by the USDA to boost industry sales by 7 percent this year to a record $43.1 billion.
"As the recession has eased, we’re seeing an uptick for certain categories," said Greg Rodriguez, the international sales manager for Grassland Dairy Products Inc., based in Greenwood, Wisconsin. "Demand for butter has been very strong this year."
Sales have been unaffected at Baraboo, Wisconsin-based Foremost Farms USA Dairy Cooperative, which produces 545 million pounds of mozzarella, provolone and cheddar cheese with milk from its 1,700 members, according to Dave Fuhrmann, 62, the president. "In the past, when we would have cheese prices over $2, we would typically see a slowdown in sales," he said.
"Dairy products are still a relatively good buy," said Bob Cropp, a dairy economist at the University of Wisconsin- Madison. "The market will sustain a higher price than it used to."