The author is a dairy analyst with Rabo AgriFinance.

It’s common to calibrate our expectations of an uncertain future around benchmarks in the past. Over the course of the first quarter of 2020, speculation quickly shifted from wondering if the year would be the next 2014 to worrying whether it’s the next 2009. But, there are many moving parts in this collective industry and the broader general economy that we know will not line up exactly like they did at any other time in the past.

Beyond the plant

Dairy farmers usually focus on the portion of supply chain between the milking parlor and the processing plant. In the coming months, the industry will instead shift its collective focus to what happens beyond the processing plant. Demand from the end consumer, both domestic and international, will be critical to the direction of markets.

The weaker milk prices of the past few years have resulted from varying degrees of a global oversupply, or surplus of milk. Market dynamics were generally supply-driven. In 2019, relatively flat global growth in milk production finally gave the demand side of the equation a chance to catch up. A tightening market teed up what looked to be a home run for milk prices in 2020.

Major demand shocks will define the market now in contrast to the supply-driven market to which we had grown accustomed. The problem will still be that there is too much milk on the market. This time, however, it won’t be because production is growing too fast. It will be because end consumers are rapidly changing their behavior.

This is uncharted territory.

There isn’t a year we can look to when we abruptly shuttered restaurants, closed schools, canceled concerts and sporting events, and all stayed home. The usefulness of comparing this to other major disasters or disease outbreaks is limited. This global event, beginning with the pandemic and evolving into an economic recession, will play out in three waves that all impact the industry.

Three waves

Wave one. The first wave occurred when restaurants closed to all but limited drive-through and delivery options. The lost sales early on were largely offset by a surge at the grocery store. Consumers cleared out grocery coolers of milk and stocked up on cheese and other dairy products as fast as they could.

For the week ending March 15, retail sales of milk were up 47%, shredded cheese up 77%, and frozen pizza up 117% compared to the same week last year. Industry contacts indicated the biggest challenge was being able to load the trucks fast enough. Under other circumstances, this surge in retail purchasing would be a dream-come-true for the industry.

Unfortunately, once refrigerators and freezers were full at home, this panic buying slowed to more moderate levels. Retail purchases remain elevated, but they are not enough to offset the lost food service demand. The real impact will take time to measure as the data slowly roll in over the coming months, but the net effect on demand will be negative.

Wave two. The second wave is the logistical challenges that result from the lost food service sales and other supply chain disruptions as restaurants remain closed and traffic remains low. Rabobank estimates that if food service cheese sales fall by 50% during Q2, more than 110 million pounds of cheese each month will need to be held in inventory, pushing us well over our maximum historical levels this spring.

If that milk is diverted into powder instead of cheese, finding processing capacity will be a struggle. Rabobank estimates that January nonfat dry milk and skim milk powder production (before any impacts or concerns related to COVID-19) was already around 90% of the U.S. maximum capacity. Diverting milk from food service cheese to powder dryers would challenge capacity. It would also leave us with significant amounts of cream that would quickly overwhelm butter churns and add to cold storage challenges and costs.

Wave three. The third, and increasingly the most impactful wave that will result from the pandemic, is the longer term global economic recession. The impacts and severity of this are yet to be seen, but lost jobs and slower business in the broader economy will reduce spending power, and segments of food service will not survive a prolonged shutdown. All this will continue to weigh on demand.

Rabobank estimates that the lost demand from food service that will not be offset by gains in retail sales will amount to more than 5% of U.S. milk production per month through the summer. Processors and cooperatives deploy various base programs and other levers to limit expansion and will be asking for reduced milk in some cases.

Farm gate milk prices will be under significant pressure as a result through 2020 and into 2021. Rabobank has lowered its milk price forecast to reflect the rapidly changing situation and now projects a Class III milk price averaging $13.93 and Class IV averaging $12.22 in 2020.

A significant difference between other dramatically low-price periods and the current situation is the advances in risk management. Nearly 50% of 2020 milk production is hedged in one form or another. Some is hedged through traditional futures and options or forward contracts with cooperatives and processors, but there are also the newer offerings from Dairy Revenue Protection (RP) and the Dairy Margin Coverage (DMC) program.

Dairy topped the list

The COVID-19 pandemic has been devastating in countless ways and will have a lasting, painful impact on the dairy industry. If there is a silver lining, it may be in the behavior seen from consumers in an uncertain and anxious time.

When stockpiling food, consumers put dairy at the top of the grocery list. When survival mode kicked in, consumers found comfort in the healthfulness, affordability, variety, and availability of dairy. These are things they may have, until recently, taken for granted.

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