Guest Columns

Perspective:
Dairy Markets

Where are dairy prices headed?

Mike McCullly

Mike McCullly is owner of The McCully Group LLC, South Bend, Indiana, and contributes this column for Cheese Market News®.

My April 22 Cheese Market News guest column entitled “Will high prices cure high prices?” predicted demand would erode as dairy prices hit multiyear highs, or in some cases, record highs. Over the last several months, there are signs this is happening. Retail sales of cheese and butter are trailing year-ago levels. U.S. exports of nonfat dry milk and dry whey have been below prior-year levels since December. Global prices are falling also, with the Global Dairy Trade price index down 25% since mid-March. Chinese buying activity has slowed given COVID lockdowns and building inventories. Increasing fears of a recession, a stronger U.S. dollar and persistent inflationary pressures have cast a bearish tone over all commodity markets, including dairy.

The term “shrinkflation” has generated numerous news articles in recent months. Some food companies are making their package sizes smaller to reduce the cost and keep the price of the package the same to the consumer, albeit with less in it. It doesn’t sound like much, but reducing a package of cheese from 8 ounces to 7 ounces is a 12.5% reduction in volume. Over millions of packages, that starts to add up. In 2014, another period of record high dairy prices, many yogurt companies downsized from a 6-ounce to a 5.3-ounce cup, more than an 11% reduction. Ice cream containers have also gotten smaller over the years. Some products, like a gallon of milk or a pound of butter, aren’t able to adjust their package size, but many other products can.

Reduced usage also occurs in foodservice and ingredient applications. A handful less Mozzarella on a pizza or removing a slice of cheese on a double cheeseburger are all negative for demand. What’s more, once a company decides to reduce the package size, they rarely increase it back to what it was, thereby making the drop in demand permanent.

Reformulation is another way high prices hurt demand long-term. A recent survey by TraceGains found nearly 90% of manufacturers surveyed said higher ingredient prices have changed the way they are doing business.

The most common change is either modifying existing formulas or creating new formulas. Analog cheese and butter blends with vegetable oil are examples of ingredients food companies use to reduce the cost of their products. Given record high prices for whey protein concentrate (WPC 80) and whey protein isolate, food companies have looked at milk proteins, casein and caseinates as potential substitutes, or if applicable, various plant protein ingredients. Over time, as prices move up and down, companies may choose to reformulate back to the original ingredient. However, with the time and effort needed to make the initial change, this doesn’t happen very often.

As companies start to plan for 2023, what will the dairy supply and demand environment look like and will raw material prices fall from 2022’s high levels? It seems the question of a recession is now when, not if, with guesses on the severity of it. Milk supplies around the world remain below year-ago levels with modest growth expected in the U.S. and Oceania going into 2023. However, European milk output is not expected to grow much, if at all. Relatively high feed and other input prices will keep the cost of production high for dairy farms.

This, in turn, will support higher than average dairy product prices. Milk prices under $20 per hundredweight will result in tight or negative margins for some farms, which would accelerate culling or sell-outs. My latest forecasts show prices for all dairy products in 2023 down from 2022 but remaining well above average. Some dairy products tend to do well during economic slow-downs as people eat more at home or shift to lower-cost options at restaurants where cheese is well-represented. Unless there is an economic collapse like 2009, dairy demand should hold up relatively well.

With so much uncertainty, solid strategies for purchasing and risk management are needed to reduce the fluctuations from volatile commodity prices. Given the supply chain challenges over the last two years, increasing the diversity of the supplier base is a common strategy being deployed by many companies. For products that are imported from other countries, buyers are exploring options within their domestic markets to shorten the distance from the supplier’s plant to their own. Where possible, end users have gone from “just in time” to “just in case” inventory management.

Companies employing sound price risk management strategies in 2022 have avoided the worst from price spikes of various commodity inputs. With futures prices moving lower into 2023, end users can start to hedge their costs at levels below this year. As budgets get set and volume forecasts finalized, a disciplined approach can lock in certainty against the plan. With more volatility ahead, options strategies could be a better tool for some companies as they could lock in a range of prices that allow for taking advantage of lower prices, if they come.

For the last several years, people have hoped the next year would be a return to normal only to find out it just brought new challenges. While supply chain issues are getting directionally better, the broader economy is dealing with issues not seen in decades with outcomes that cannot be predicted. Control what you can control and make contingency plans for various scenarios. Successful companies will meet the challenges and become stronger from them.

CMN

The views expressed by CMN’s guest columnists are their own opinions and do not necessarily reflect those of Cheese Market News®.

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