This article was written for Hoard’s Dairyman by Christopher Wolf, professor of agriculture, food, and resource economics at Cornell University.
It should come as no surprise to anyone in the U.S. dairy industry that supply and demand drive the milk price. In a competitive market, we expect profit margins, and therefore price, to move to values that create economic returns on the input factors.
The dairy industry is subject to shocks on both the demand and supply side that drive changes in market price. Demand shocks include recessions (such as consumer income), exchange rates, interest rates, and trade disputes. These can be international given the role of exports in balancing U.S. dairy markets. Supply shocks include weather, feed costs, and disease outbreaks. In this article, I will consider the current state of affairs relative to the U.S. milk supply response and potential supply shocks.
Production adjustments
Supply response can be extensive or intensive. Extensive supply response essentially entails adding cows. This can be done by bringing more of the available springing heifers into the herd, importing cattle (which is not common in any significant way), or keeping cows in milk rather than drying them off.
In the longer term, more heifers can be raised. This is particularly true with the advent of sex-sorted semen, so that gender can be selected with near-perfect accuracy. It takes nearly three years, though, from breeding to when that resulting calf enters the milking herd, so this is in no way a quick response.
Intensive supply response is milk per cow and component levels. Milk yield is affected by nutrition, genetics, management, and technology.
Milk production growth has stagnated or even reversed in the past year. Adjusting for the 2024 leap year effect in February, production has been below year earlier levels for 11 consecutive months as of May 2024.
While milk production is down, components are up. In particular, milkfat has continued a growth trend that began in 2011. From 2011 through 2023, milkfat yield rose almost 12%, while skim solids grew 2.5%.
Economic drivers of higher components on the demand side include relative fat and protein prices while supply aspects include management and innovations in areas such as nutrition and genetics. The incentives to elevate milk solids include price premiums as well as relatively lower per unit milk hauling costs.
At the extensive margin, supply response is about changing milk cow numbers. An examination of culling patterns differentiates between “voluntary” and “involuntary” culls.
Culling due to low production, aggression, or when a cow is sold for dairy purposes is referred to as voluntary culling. Involuntary culling is all other factors, including sales due to illness, injury, infertility, or death. The majority of culling is involuntary, as premature culling is expensive and should be avoided.
In the short term, farm managers can cut back on voluntary culls. Evidence suggests that this will happen depending on the relative profitability of keeping cows longer and the availability of replacements.
USDA data suggest that replacement heifers make up a historically low percent of the milk herd today. High beef prices have encouraged utilizing beef semen for crossbred bull calves where possible, and dairy farmers have increasingly selected heifers based on genetics to manage replacement costs. The extent to which heifer inventory affects farm situations will vary, but it puts a ceiling on supply response at the extensive margin in the short term.
Does size matter?
The changing structure of U.S. dairies also impacts supply response. The table compares the number of herds and amount of farm sales in herd size categories from below 100 milk cows to farms with more than 2,500 milk cows in 2017 and 2022.
USDA reported 36,024 dairy herds in 2022, a decline from 54,599 herds in 2017. Herds with fewer than 100 milk cows constituted more than two-thirds of all herds but only about 5% of sales. At the other end, the 2.3% of herds with more than 2,500 milk cows generated almost 45% of sales.
Previous literature examined the impact of changing farm size on supply response. The effects are mixed, but in general, they suggest that supply is becoming less responsive over time.
Modern production technology and farm management has been better at changing component levels — particularly milkfat. We might expect automation and technical change associated with larger dairy herds to generate a more responsive upside supply response along with a less responsive downside supply response.
A note on base programs
Another factor that has been overhanging milk supply response, particularly since COVID-19 roiled markets in 2020, is the use of base programs that many cooperatives implemented. Base or tiered pricing plans of varying types have existed in the U.S. dairy industry for decades, either from cooperatives or in the form of government policies.
These programs establish a base amount of milk production for each herd or farm member based on historic levels. Milk marketed in excess of that base is charged a deduction or paid a lower price generally determined by the costs entailed in finding that excess milk a market.
The available information estimates that about half of all U.S. milk production was marketed through cooperatives or processors that had active base programs as of the end of 2021. Many of these programs exist today, but the mechanics and implications are evolving specific to cooperative and regional economic factors. These programs have played a significant role in dampening supply response the past couple of years.
