The author is vice president, economic policy and research, National Milk Producers Federation.

Last year was an extraordinary year for U.S. dairy farmers. A combination of very strong demand for dairy products by the major dairy importing countries, led by China, and very slow growth in milk production around the world produced milk prices that blew past all previous records.

Looking ahead to this year, the basic supply-demand factors that made 2014 such an extraordinary year are clearly reversed. Dairy imports are down significantly from the great import demand surge of a year ago, and milk output in the major dairy exporting countries has been expanding rather strongly. The dairy futures are currently indicating that milk prices in 2015 will be well below last year, by at least $7 per hundredweight (cwt.).

Fluctuating signals
Demand for dairy products by the net dairy importing countries around the world has become one of the major determinants of milk prices received by U.S. dairy farmers. At the same time, demand from importing countries has been variable.

From the perspective of U.S. exports, the big import demand surge lasted from May 2013 to June 2014. The United States exported the equivalent of 16.4 percent of its total milk production during those 14 months. Following the transition month of July 2014, exports have averaged 14.1 percent of production between August and November 2014. This change is equivalent to suddenly having an additional 2.3 percent of the nation's total milk supply on the domestic market. Export markets have been the fastest growing segment of the total U.S. dairy market over the past decade, and will continue to be for the foreseeable future, but there will be temporary steps backward in this process.

Dairy import demand will likely remain subdued through the first half of 2015, particularly in China, which still has sizeable inventories acquired during its big buying surge a year ago. Russia is importing less dairy following its embargo of the European Union (EU) and other Western suppliers last August. These slumping purchases are mostly due to the major contraction that has gripped the Russian economy and collapsed its currency in the wake of falling world oil prices. The large drop in world dairy prices, particularly for milk powders, has generated greater import activity by more price-sensitive importing countries in Southeast Asia, the Middle East and North Africa, but not enough to rebalance the current world supply-demand situation.

Simply more supply
Rising milk production in the major dairy exporting countries is also keeping world prices depressed. USDA's Foreign Agricultural Service estimates that the five largest exporters raised milk output in 2014 by almost 4 percent over the previous year, with two-thirds of the total volume gain coming from the European Union. EU production grew by 4.7 percent last year due to favorable margins and farms expanding ahead of EU milk production quotas ending this spring.

By contrast, USDA/FAS projects that 2015 production growth in the "Big Five" will grow by just 1.4 percent, with almost three-quarters of that volume growth coming from the United States. The U.S. has been relatively slow to expand milk production following last year's excellent margins. The nation's milking herd started to expand last June, but the annual rate of expansion had not exceeded 1 percent as of November. Production per cow has grown at a faster rate, but USDA has actually been dropping its forecast of 2015 U.S. milk production for several months now.

These numbers still imply that the EU and the United States, who together account for about 85 percent of milk production by the "Big Five" dairy exporters (the other three are New Zealand, Australia and Argentina), are currently producing more milk than their large domestic markets can absorb.

The lower prices that result will last as long as it takes to bring supply and demand back into balance internationally. Lower prices will boost demand for dairy products in the EU, the U.S. and in the more price-sensitive importing countries. They will also put the brakes on the current surge in milk production around the world, as the USDA/FAS forecast suggests.

Somewhat sheltered
The good news for U.S. dairy producers this year, relatively speaking, is that they will be less impacted as this correction runs its course than dairy farmers in the other "Big Five" countries. The smaller exporting countries are more directly exposed to world market prices. Many of the large European dairy companies have announced milk price reductions that are already being described as burdensome to their producers.

In the United States, cheese and butter play a major role in milk pricing, and the domestic markets for these products are less exposed to world markets and can more easily sustain prices above world levels. World prices for these two products have dropped less over the past year compared to prices for milk powders.

The Cooperatives Working Together (CWT) Program focuses on just these products. CWT played an important role in enhancing producer incomes last year. It will be very active in assisting U.S. cheese and butter exports during this critical year, again generating returns to producers far in excess of their investment in the program.

In addition, over half of all U.S. dairy farms have signed up for coverage this year under the new Margin Protection Program (MPP). USDA's on-line MPP decision tool currently shows that margins are likely to drop below $8 per cwt., generating payments at the top end of available coverage, for just a few months this spring. But, for all of 2015, the margin will average just a bit below its long-term average of $8.60.

What does 2015 hold?
Finally, despite all of the foregoing, the questions still loom: How will this year ultimately turn out? Could 2015 be another 2009?

Based on all indications we see now, this year will not be a repeat of that dark year. By the first week of 2009, it was obvious that it was going to be a terrible year for dairy farmers. The U.S. had lost export sales equivalent to 5 percent of domestic milk production during the second half of 2008. The world was then in the throes of the worst global financial and economic crisis since the Great Depression. The milk volumes that need to be brought back into balance this year are not likely to cause the inventory buildup that was so crushing in 2009, especially in the United States.

USDA's MPP decision tool shows there is zero or a very low probability that the MPP margin will drop below $4.50 per cwt. in any consecutive two-month period this year. By contrast, the margin averaged about $4.50 per cwt. for all of 2009. So this year will not be as good as last year, but neither is it looking like a 2009.

This article appears on page 96 of the February 10, 2015 issue of Hoard's Dairyman.

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