In recent years, for better or worse, milk prices in the U.S. are determined increasingly by forces at play in other parts of the world. It was rapidly growing demand from China that helped propel prices upward in 2014. And it was a global oversupply of milk and a slowdown of import demand that weighed on prices in the years after. Our expectation this time around is an extended period of higher, albeit more volatile, prices.

Ben Laine, Rabo AgriFinance
Repeat of history?

The obvious similarity between 2014 and today is the high prices for dairy commodities, energy, and feed. In February 2022, Brent crude oil prices surged above $100 per barrel, a price level not seen since 2014.

Between 2011 and 2013, corn prices averaged over $6 per bushel, straining dairies’ margins. RaboResearch estimates the average U.S. on-farm corn price to be $5.60 per bushel for the 2022 marketing year. If the Black Sea region is unable to export corn, RaboResearch estimates that average will climb to $5.77 per bushel in 2022 to 2023.

Another area that may feel like déjà vu is the global trade activities and geopolitics in 2014. Leading up to 2014, we experienced multiple years of strong growth in import demand from China. In 2010, China imported 780,000 metric tons (MT) of dairy products. By 2014, imports had doubled to 1.56 million MT. In recent years China’s import demand has grown steadily, then dramatically in 2021, with 24% year-over-year growth (YOY).

The other major disruption to global import demand in 2014 was Russia’s annexation of the Crimea peninsula. In response to that action, much of the world, including the European Union (EU) and the U.S., imposed sanctions on Russia.

Where the déjà vu stops

What ensued last time weighed on global markets. RaboResearch expects a different outcome for dairy prices this time around.

In 2014, Russia responded to the sanctions with an embargo on dairy imports (among others). Annual global exports to Russia fell from 500,000 MT in 2013 to below 100,000 MT by 2015. The embargo primarily impacted the EU, with the 27 nations needing to find new buyers for the lost export volume. That shift weighed on global markets.

The product volume that lost its would-be home in Russia couldn’t find a new home in China. In 2015, China’s imports fell 22%. The decline was mostly driven by a slowdown in whole milk powder (WMP) imports. Until that point, New Zealand had been in growth mode, expanding its production by an average annual growth rate of 7% from 2010 to 2014, largely enabled by China’s growing demand for WMP. When that demand fell, WMP inventories backed up in Oceania.

Meanwhile, the EU prepared to lift its 30-year-old quota on milk production. Producers were eager to capitalize on the higher milk prices. After remaining stable under the quota system, milk production grew by 4.5% YOY in 2014, representing an additional 829,000 MT of milk solids hitting global markets.

The combination of the lost exports to Russia and China and higher global milk production resulted in a significant volume of milk without a clear buyer on the global stage. As a result, much of it headed into driers and became skim milk powder (SMP). Government and private inventories of SMP grew dramatically and hung over markets for several years. Between 2015 and 2017, the European Commission purchased intervention stocks of SMP totaling 380,000 MT. Global markets were aware that any uptick in powder prices would result in more of that powder being released onto the markets.

What should soften the blow?

While China’s import demand has grown steadily in recent years, that strength began to slow during the second half of 2021. China’s purchasing will continue to be slower in 2022 and will likely reflect a double-digit drop from 2021.

A slowdown from the No. 1 buyer of global dairy commodities would be a bearish factor in normal conditions. This time around, however, slower milk production out of the major global milk producing regions will soften the blow.

Base programs and tiered pricing programs continue to limit the ability of producers to expand in many regions of the U.S. Replacement heifer inventories are low, which will make rebuilding the milk cow herd a challenge.

New Zealand production growth has plateaued in recent years and is expected to see flat to even negative growth in milk production in the years ahead. The country’s restrictive environmental regulations, including the Zero Carbon Act, and efforts to include livestock in the country’s emissions trading scheme are all threatening to reduce livestock numbers. The prospect of similarly restrictive environmental regulations in the EU will likely limit livestock numbers in its major milk producing areas.

The impact of conflict

The possible direct damage of the current Russia-Ukraine conflict to dairy trade was already done in 2014. Trade routes and export patterns have already been altered. Now RaboResearch is watching for the indirect market impacts.

High energy prices and Europe’s dependence on Russia as a major supplier of natural gas will have impacts on the processing sector. Transportation costs will climb, and so will the cost of spray drying milk powders, an energy intensive process. If processing slows, global markets for milk powders and whey could tighten, providing more lift for prices.

Another factor includes the high wheat price and what that means for products that are traditionally complementary to dairy. Could, for example, high wheat prices and tight supplies drive the price of pizza higher? And that does not include the higher fuel costs for delivery.

The U.S. dairy impact

RaboResearch’s base-case scenario is a 1% gain in domestic demand across 2022 with somewhat weaker export demand growth. On balance, the limited supply growth will struggle to keep up with demand, and dairy prices should stay higher for longer.

There is a large amount of uncertainty in global markets, heightened by a volatile geopolitical landscape. Overall, we have moved out of the seven-year rut of low prices. However, it’s not going to be a smooth ride.