July 15 2014 08:02 AM

The Class III futures market expects $18 prices in early 2015

May's Class III price announcement of $22.67 per hundredweight was just the start of what is likely to be more cuts.

Holstein cows in dry lotAnnouncement of the $1.74 dip in early June hardly came as a shock, but the outlook for where prices are headed may surprise some producers. It will disappoint them at least.

Fond memories of April's all-time high of $24.31 still linger, but the reality is that record prices never last. They always fall back, hopefully above whatever the current cost of production is. But not always.

April's price figures to become even more happily recalled in the months ahead, because there's a clear expectation by buyers that there will be no shortage of milk to support high prices. In fact, Class III in early 2015 is expected to be $6 less than April's high. That's right, $18 milk may be just 7 or 8 months away.

Daily futures prices at the Chicago Mercantile Exchange have been sounding that wake-up warning for quite a few months now. In fact, early 2015 prices have been just under $18 on several occasions.

The question we posed to dairy operators and industry leaders in seven different states is, are producers prepared to cope with such a drastic drop in milk prices in such a short period of time, and if so, how?

Somewhat to our surprise, they almost unanimously said yes.

They also gave very similar reasons why: because milk producers still painfully remember the financial collapse of 2008 to 2009 and are reluctant to take on debt; because they have been focusing on paying down debt; and because spending has mainly been limited to doing needed maintenance and repairs, and replacing worn-out key equipment. More cows or additional facilities have not been common reactions.

Rick Naerebout
Idaho Dairymen's Association

"Next year will be here quickly and there are so many factors out there that can play into what happens.

"I think the feeling is our feed costs going forward will be about the same as they are now, and that structure is probably putting our dairies at a total cost of production of around $18.50, give or take.

"As far as what they are doing with these healthy milk checks, there are only a few out there who are expanding, mainly because of CAFO permits whose clock was ticking to fulfill provisions about building. But predominantly, people are using this income to pay down debt, take care of maintenance that hasn't been done over the last few years, and replace worn out equipment. That's been the main focus of a lot of our producers; getting themselves prepared to battle through the next downturn.

"They learned a lesson from the collapse a few years ago; there's a different focus now. If you back up to 2006 or even before, if we'd had $6 margins back then the number of expansions and new facilities would have been far greater than what we are seeing right now.
"And lenders also remember what happened in 2008 to 2009. I don't know of any lender who is loosening credit requirements right now, which is a big factor. If the money isn't there, then the (expansion) thought process isn't either, because the decision has already been made for you."

Bruce Miles, accountant

"We've been warning them and telling them to pay down debt so they are prepared for it. And a lot of them have been doing that. Very few have been expanding. Cost of production is between $18 and $19 and milk prices look like they will be, too, so we're going to be back at break-even or slightly worse. We have to wait and see where prices actually wind up, but it could get ugly again.

"People are paying down debt, fixing things that are broken, and replacing what they really need to have to operate. But they aren't rushing to have the most cows. It's a hard lesson they had to learn, but they did it."

Terry Dye, dairy owner
Ft. Collins, Colorado

"These super high prices have been a lifeline for marginal dairies that were close to Chapter 13 or 11.

"That said, they will be back in trouble when prices return to something more normal, whatever that is. My suppliers say there has never been such a large gap between good producers and the marginal kind. Some things never change.
"The answer to your question would have to be that good ones will thrive under most anything and the rest will keep struggling. I hate being so cynical, but 44 years in business makes me that way.

"The gossip around here is that many banks were ready to exit the dairy business, but high prices kept them hanging in for now."

Ellen R. Jordan
Extension Dairy Specialist
Texas A&M University

"Our producers have been realistic that current milk prices won't hold. Many have used this time to recover from past slim or negative margins and to position themselves for the next swing. They are all watching input costs and planting reports to try to protect margins.
"We have more producers growing their forages, not only as a way to manage nutrients but also as a way to protect the upside on costs. Our continuing drought has kept our producers cautious."

Frank Boyce, dairy manager
Stanfield, Arizona

"I can only speak for us, but we feel we are prepared for a $6 cut in prices to the extent that feed costs stay in line.

"The biggest thing for dairymen in the west is that we are seeing huge savings in grain prices. Using today's futures on corn I can guarantee a $1 savings on cost per hundredweight from where I was in 2013. The goal we are striving for is to keep our total production cost under $16 for the year. With that said, it becomes imperative that I contract corn for 2014 to 2015 at $4.75 per bushel or less.

"The wild card in the feed theater will be alfalfa and other forages. We have pretty much been operating hand-to-mouth on protein by not taking a long-term position on soy or canola. All other expenses are in line with the lean years and capital is being used to update and improve equipment and processes."

Jay Gordon, Executive Director
Washington State Dairy Fed.

"You can't cope with money that won't be in a milk check; you can cope with money you have today to reduce expenses later when prices fall. So investment in new equipment now improves efficiency, reduces parts and service expenses later, and gives you a depreciation expense that will reduce taxes.

"Pre-purchasing feed with cash today protects you against future margins that are tight or negative, and it puts expense in this year that helps on taxes. Growing or buying most feed this year reduces expenses this winter if and when prices fall. These are strategies for evening out the highs and lows."

Robert Hagevoort
Extension Dairy Specialist
New Mexico State University

"I believe the answer is a resounding no.

"With the continued and expanded severe drought in the Southwest, even though eastern New Mexico received 2 to 4 inches of rain Memorial Day weekend that gives us some severely needed soil moisture, I think the forage situation is shaping up much like 2011. Especially with California producers looking everywhere the rest of the West normally shops, like Utah and Colorado, all the while shipping their own to China. The mad dash for forage will continue pushing up costs.

"Dairies have not rebuilt their equity positions and banks have not adjusted their lending and appraisal policies yet, so nothing has changed, except high milk prices and maybe a little relief on the grain front if we do get the crop being expected based on planting intentions.
"It probably all depends on the weather as usual. Because everything else is so tense, weather will either make or break the camel's back. So the roller-coaster ride continues with no sight of what's next, like riding one at night! Maybe El Niño will come to the rescue this winter."

Rob Vandenheuvel, Manager
Milk Producers Council

"A few months of profitable milk prices don't erase the $2.8 million hole that the average California dairy is in. Like any business in the world agriculture or otherwise our dairy families need a steady, long term, profitable milk price in order to be a sustainable business."

This article appears on page W-78 of the July 2014 issue of Hoard's WEST.