Dairy’s “New Normal”

Published on: 11:35AM Dec 20, 2010

In 2007 and 2008, we thought we had reached a new normal in feed prices and cost of production. Today, the dairy industry’s new state of “normal” can be summarized by three words.

Marjorie Stieve, marketing services manager for Vita-Plus Corporation, raised an intriguing question as she opened her company’s two-day recent Dairy Summit in Minneapolis. Her question was: “Is the dairy industry entering a new normal?”
Yes, we’ve heard this claim before. Recall 2007 and 2008. Back then, we thought we had reached a new normal in feed prices and cost of production. The cost of production then hovered around $15/cwt. for much of the country. And the belief, the new normal, was that milk prices could not fall below this level. And if they did, they would not and could not stay there for very long. Then 2009 happened. And we all learned the folly of that logic.
But I think Stieve has a point this time about a new state of what is considered “normal.” This new normal can be summarized by three words: Uncertainty, volatility, risk. Consider:
• The global economy seems to be in recovery, perhaps coming out of the Great Recession faster than the United States. But whole countries—Greece, Ireland, Spain, Belgium—are on the brink of default and put all of Europe at risk. And with that comes the chance of a faltering euro, strengthening the dollar and weakening U.S. exports.
   Oil prices continue to gyrate. Just the threat of war in Korea means gas prices have surged 20¢/gal. here in the United States. If war does break out, $4 gas will seem like a bargain.
• Ever since 9/11, the United States seems to be in a state of constant war. Though things are (hopefully) winding down in Iraq, U.S. troops will likely be fighting (and dying) in Afghanistan through 2014—at least. And then there’s Korea, and Iran, and the Sudan, and Yemen….
• The political system here in the United States is in a permanent state of tumult, staggering through one election only to have politicians positioning themselves and their parties for the next election. The ascension of Tea Party candidates adds to the acrimony and the uncertainty.
• Animal rights activists continue to challenge how farmers house and manage livestock. This activity is already leading to a decline in pork and poultry consumption. And new laws could create new barriers to production technology, adding cost and uncertainty.
• The speed of information transfer can affect markets instantly, causing run-ups to $6 corn or crashes on the cheese market.
• Technology advancements now allows thousands of dairy cattle to be housed under one cross-ventilated barn roof. But such housing also adds ammunition to animal rights concerns (however unfounded) that if these cattle are out of sight, how are they being treated?
• The ethanol credit, which was renewed under the guise of the tax bill last week, inflates the value of corn. This leaves grain farmers with million dollar tax problems and dairy producers wondering how they are going to pay feed bills with $14 milk. (But even without the credit, grain prices won’t return to 1990 levels due to China’s insatiable demand for Iowa corn.)
• Within dairy, we now have volatility times four on the milk and inputs—grain, protein and energy. Much of this volatility is being driven by the above factors.
• In addition, the U.S. dairy industry is now export dependent, with upwards of 13% of milk solids now being sold and consumed offshore. The good news is these exports supported good prices this fall. The bad news is that exports are subject to glitches in the global economy, China’s appetite for Kiwi whole milk powder and the value of currencies (both foreign and domestic).
Stieve’s conclusion, and it’s dead on, is that risk management is now more important than ever. Locking in profits never caused a foreclosure. Even protecting against losses, when positive margins aren’t available, can be the better part of valor.
But Stieve’s main point is that risk management goes well beyond locking in hedge positions. It involves strengthening your relationships with your family, partners, employees, consultants, vender and lenders. Having all these folks on your side and working with you through these highly volatile and uncertain times is an absolute business essential.
The holiday season, come to think of it, is the perfect opportunity to renew and reaffirm these longstanding partnerships. Merry Christmas, Happy New Year and all the best for an uncertain 2011.