During the ongoing COVID-19 pandemic, U.S. dairy markets have increasingly felt the effects. Supply and demand issues not just domestically but internationally continue to trickle down to U.S. farm milk prices. Inflation is a major topic, and the general economic debate is focused on whether the high inflation we have recently experienced is driven by supply chain issues (i.e., labor shortages) or excess demand because consumers are spending less on services (i.e., too much money chasing too few goods). Of course, it is more than likely that both are contributing factors. This discussion is important because the policy prescriptions differ. Supply chain issues could begin to resolve when more people can get back to work as the pandemic subsides with schools and daycare consistently open. Higher interest rates from the U.S. Federal Reserve would be counterproductive to solving this set of issues. Excess demand, on the other hand, is more likely to influence policymakers to increase interest rates to rein in inflation. Excess demand for goods at the current time could be driven, for example, by decreased consumer spending on services resulting in more money available for goods.
With respect to the U.S. dairy market, demand issues to watch include the retail price of dairy products domestically, U.S. household income, and international dairy product prices relative to those in the U.S. Consumption of dairy products when eating away from home differs when compared to at-home dining. This showed up in 2020 as fluid milk consumption halted its long-term decline. Unfortunately for the dairy industry, in 2021, as eating patterns returned to some semblance of normal, fluid milk consumption resumed its declining trend. Other impacts of the food-at-home consumption trend included more yogurt and cream cheese which benefited the Northeast dairy industry. Longer-term trends, including consumption of whole fat dairy products continued. This makes the ability to export any excess solids-not-fat in the form of milk powders key to balancing the domestic market.
U.S. milk production in the second half of 2021 grew at below-trend rates concluding in a decline in December compared to the prior year. Among the causes of this tepid milk production growth were drought effects in Western states, high feed prices and cooperative base programs. New York milk production in December 2021 declined by -1.7% year-over-year, while Vermont saw a decline of -1.4%. Labor costs increased on farms and labor availability continue to be a challenge for the entire dairy supply chain. Hauling costs were one of the largest sources of inflation and milk haulers experienced major transportation issues.
Despite these domestic transportation issues and congestion at ports, U.S. dairy exports through the first three quarters of 2021 were at record pace. China was a major destination for U.S. dairy exports in 2021. China has been rebuilding their swine herd using, in part, dairy imports as feed. It is not a coincidence that when China increases imports from the U.S., it supports higher dairy product prices.
Globally, New Zealand and Australia have had contracting milk production while the EU has been essentially flat. The causes of production declines in Oceania include weather patterns — currently experiencing a La Nina in the Pacific — as well as increasing environmental regulation. Taken together, the lack of production growth in major dairy exporting countries has put a real tailwind behind dairy product prices going into 2022.
Sources of uncertainty in 2022 on the demand side in addition to the pandemic and related income effects, include geopolitical concerns. While increased dairy exports provide an outlet for U.S. dairy products — particularly powders — the flip side is that the domestic industry is vulnerable to trade disputes. At the current time, tensions with Russia vis-à-vis Ukraine and China with Taiwan provide uncertainty to world markets that may affect milk prices.
On the supply side, major concerns include the pandemic, weather and geopolitics also. The pandemic is constricting labor markets and snarling supply chains. Weather is always an issue. As noted above, Oceania’s milk production has recently been affected by weather. Weather will also affect corn and soybean production in North and South America in the year to come. Finally, tensions with Russia and China have the potential to affect dairy markets depending on sanctions and other effects.
Even with the port challenges in 2021, large amounts of dairy products were exported. As ports work through their capacity issues, exports could improve in 2022. Domestically, the dairy industry will continue to struggle with finding employees, particularly milk truck drivers. This might provide friction for farm milk prices, but dairy product demand is very strong.
Current dairy stocks for butter and cheese support a bullish outlook. Class III milk price is currently forecast to average above $21/cwt while Class IV milk price is forecast above $22/cwt. The result is that the farm milk price outlook for 2022 is as strong as we have seen since 2014. Actual farm profitability will depend heavily on feed and labor costs. If farms have plentiful feed production, they should see an above-average year.
While the Dairy Margin Coverage (DMC) Program is not forecast to make payments in 2022, it remains an important tool for risk management. The DMC program feed cost calculations were changed in 2021 to use supreme alfalfa prices to reflect the cost of dairy quality hay. Additionally, some producers were be allowed to increase their historic milk production (for the first time since the program came about in 2014), through a process termed “Supplemental DMC Enrollment.” Under this enrollment eligible dairy operations with less than five million pounds of established production could increase their base according to a formula which uses 2019 actual milk marketed. 75% of difference between 2019 actual marketings and previous production history subtracted will be added to the old production history to create a new production history up to five million pounds. Producers must pay additional premiums on the increased production history, but they will also receive retroactive payments on their 2021 coverage. This increase in production history will be applicable through the 2023 Farm Bill. Again, at the current time, the forecast is essentially for no DMC payments in 2022 given the current strength in the milk market (although feed is expensive), but things can certainly change over the course of 2022. Historically, the DMC program has been a net positive in almost every year.