Awash in milk, while buyers sidelined
Let’s hope the folks in Europe have an appetite for pizza. Because as far as the world’s dairy buyers are concerned, the world has too much milk and the excess is coming from the EU-28. And facing a veritable mountain of skim milk powder (SMP) that entered warehouses back when David Cameron was still prime minister of the UK and a butter bubble that may not be fully deflated, a lot more cheese is going to be coming out of European vats in the months ahead.
Last fall, we wrote that world dairy demand today can only support February 7, 2018 GLOBAL DAIRY milk production growth from the major exporters of about 1.5% a year. In the second half of 2017, the growth rate from the EU-28, United States, New Zealand, Australia and Argentina was about double that. Since September, nearly all the surplus growth is coming from Europe.
Some of the increase, of course, is a function of a weak comparable; recall the Commission paid farmers to cut back on production in the fourth quarter of 2016. But with processor payout prices that increased more than 30% in 2017, farmers have responded. Milk cheques are coming down, but not quickly enough to stem the tide. A good flush is looming.
And then there’s the matter of intervention stocks of SMP – still near 380,000 tons. The Commission confirmed it won’t add any more to the stockpile this year. That takes the floor price out, though it was already more than €300 below the fixed €1698 euro/ton price anyway. That means there’s some room to go down a little further, but it’ll take some other creative measure besides price – like food donation, feed use, overseas placement or something else – to clear the inventories.
The United States, too, is sitting on record powder inventories that continue to grow. Year-end holdings were 150,000 tons, up 47% from prior year.
But at least in the United States, milk production growth has slowed to a more measured pace. Output in the last four months of 2017 was up just 1%. Feed costs remain low, but milk prices are down nearly 20% from a year ago, squeezing margins. Modest production growth – around 1% – is expected for 2018.
New Zealand, too, has seen a slowdown in production growth – though it’s more a function of the skies than of milk margins. Volatile weather limited the 2017/18 flush; production in the first eight months of the season was flat vs. a year earlier. Pasture condition is poor and feed stocks are limited. But Fonterra’s payout projection of NZ$6.40/kg MS (about US$14.91/cwt.) is still wellabove break-even and kiwi farmers aren’t feeling too anxious.
Buyers stocked up
The milk coming on has to deal with global dairy import demand that hit a speed bump last fall. Buyers appeared to be stocked up. Sure, China did its part for most of the year, with total imports up 12% in 2017, as local milk increasingly goes into fluid and fresh product production channels. But imports were flat in the last two months of the year.
After a buying spree in the first seven months of the year, Southeast Asia imports of milk powder, cheese, butterfat and whey products were down 12% in the AugustNovember period, leaving the region flat for the year.
Sales into the Middle East/North Africa region lagged all year – down 10% through November, though interest improved a bit in Q4. In short, fat was just too expensive in 2017. Butterfat imports were down 27% and WMP imports were off 14% in the first 11 months.
In the next tier of buyers, Mexico, Japan and South Korea all posted strong import performances in 2017.
Mexico imports were up about 7%, while Japan and South Korea posted double-digit increases. Japan, in fact, bought record volumes in December to offset local production declines. But imports from Mexico and South Korea slowed considerably in the last few months of the year.
The butter bubble
Last year, the European spot butter price nearly doubled in seven months. Before running out of steam, prices had exceeded the previous high by nearly 40%.
We’ve seen something like this before, actually. In early 2013, the Oceania whole milk powder (WMP) price jumped more than 50% in four months – a function of Chinese panic buying ahead of a production-curbing New Zealand drought. In that scenario, the WMP price remained firm for about a year before crashing.
So what happened with butter last year? Panic buying from the EU internal market. Milk and butter production in the early part of the year was down throughout the region, the spring flush was lighter than expected, global demand was still surging and butter users got caught short.
But as a result, overseas buyers walked away. Global trade of butterfat dropped 13% in the first 11 months of 2017 – a cut of nearly 10,000 tons per month. As mentioned, the MENA region was hit particularly hard.
Meanwhile, the price of palm oil and other vegetable fats remained depressed, leaving a record-high premium on butter and encouraging substitution. And even in Europe and the United States, domestic butter use slowed dramatically from the growth of 2015-16.
International demand still hasn’t come back, but EU production has. In September-November, butterfat output was up 8% year-over-year, an increase of nearly 12,000 tons per month.
The butter bubble already burst, but do we have further to go? Futures on all three continents suggest prices will be supported near current levels, but we’re not so sure. Panic buying won’t be there this year and the market is more balanced, notwithstanding relatively light EU inventories. At more than $5100/ton, EU butter is still well-above historical levels. Based on the cost of substitute fats, the butter price may need to come down further to unlock demand growth in the MENA region and elsewhere.
The counter-argument is that very weak SMP prices are a drag on the value of the butter/powder stream, encouraging milk to go into cheese and/or WMP production instead. So yes, butter production growth may be constrained again in 2018. Our view, however, is that current prices, even well off their 2017 peak, are not sustainable.
Which takes us all the way back to the pizza mentioned at the onset – as well as cheeseburgers and table cheese. EU cheese production was up 3.5% in the second half of the year to November. With more milk coming on and weaker valuations for butter/powder, the Europeans are going to continue to make more cheese. And nearly every other exporting nation is making more cheese as well, including the United States, where output was up 3% in 2017 and year-end stocks were an all-time high.
In addition, as with butter, domestic cheese consumption growth slowed in the United States and Europe last year, leaving more volume to look for a home offshore.
Among the world’s major cheese buyers, Japan, South Korea, China and Southeast Asia bought aggressively in 2017. Mexico, the MENA region and South America purchases were flat to lower. They’ll all need to buy more in 2018 to clear the market.
And of course, more cheese means more whey, which has already been under pressure since last April. Declining SMP prices, weaker demand out of Southeast Asia generally and Vietnam specifically, plus the possibility that European SMP intervention stocks will be offloaded into the feed sector, limit the upside on the whey complex.
Maybe H2 looks different?
Add it up and 2018 looks to be another challenging year for global dairy marketers. Prices have rallied in early 2018 on fears about New Zealand weather and supply, but we don’t see much on the horizon to suggest a sustained market lift here in the first half. However, there are a few positives to keep an eye on.
- Dairy prices are already starting 2018 lower than prior year and further declines should support demand growth, particularly in developing countries. In other words, greater trade volumes, albeit at lower prices.
- Oil prices have improved to nearly $70/barrel – up 28% year-overyear. If sustainable, that could provide an economic boost for oil exporting countries, another factor that could support demand growth.
- The U.S. dollar is the weakest it’s been in more than three years – off 7% vs. the euro since November. A weaker dollar makes imported dairy more affordable in importing countries. It also boosts the competitiveness of U.S. exporters.
- The dairy market landscape may look quite different by the time we get past the Northern Hemisphere flush. Production growth is tempered in the United States and Oceania, and EU output will moderate in the second half, in part because the comps will be so stiff. Globally, current production will be unlikely to be able to keep up with current demand, and we could finally start to see suppliers’ inventories drawn down.
The overhang will take a while to clear, but that could set us up for the green shoots of stronger markets in the latter part of 2018.
Alan Levitt is vice president of communications and market analysis at the U.S. Dairy Export Council. Marc Beck is USDEC executive vice president of strategy and insights.