American Butter Institute Market Situation & Outlook

First Quarter 1998
Volume 1, Number 1

Editor: Chris A. Nubern

Throughout 1997, the butter market proved to be one of the most interesting and exciting product markets in the U.S. dairy industry. For example, the historic price levels in October and November focused much attention on the supply and demand situation in both the domestic and international markets. Also, new research discussed the potentially harmful effects of margarine consumption. The results of this research stimulated discussions concerning the effects on the demand for butter. Another issue that involves the butter market is the future of the cash markets for Grade A and B butter at the Chicago Mercantile Exchange (CME). A more detailed analysis for some of these issues is presented in this ABI Market Situation & Outlook.

What’s Up With Prices?

Surprisingly, marketing conditions for butter in 1997 were even more volatile than those experienced in the previous year. Figure 1 compares the weekly CME cash market prices of Grade AA butter for the past two years. In 1996, butter prices started the year at about $0.72 per pound, climbed to a high of $1.53 by July, and returned back to the seventy cent level by November. Although the pricing trend in 1996 was unusual, the market experienced only one distinct pricing cycle. This pricing cycle began with increasing prices in April and culminated with declining prices in October.

In contrast to the previous year, the butter market in 1997 displayed several different pricing cycles. Figure 1 shows that the first price cycle lasted from January through May. In the first quarter of 1997, butter production was down about 23 million pounds, or six percent, compared to 1996 (Figure 2). This decline in production resulted in Grade AA butter prices increasing from $0.90 to $1.16 per pound. This price level remained stable until April. Production statistics for April estimated butter production at 118 million pounds, which was 13% above March production and 8% higher than April 1996. This increase in production resulted in a sharp price decline that stalled at $0.91.

Beginning in June, the butter market became unsettled and price movements were more difficult to predict (Figure 1). For the second quarter of 1997, butter production was up about seven percent when compared to 1996 levels. Even with this increase in production, the seasonal ice cream demand elevated the value of cream and butter prices responded.

Figure 1; Source: USDA Dairy Market News

By August of 1997, a serious deficit in the supply of butter was developing throughout the market. Production reports show that the supply of butter from August through November was about seven percent less (23 million pounds) than 1996 levels (Figure 2). This shortage in butter resulted in a Grade AA price increase of about 80% in less than eight weeks (Figure 1).

The butter market ended 1997 with a total production of about 1.2 billion pounds, which is about one percent less than 1996 production. The Grade AA price averaged $1.16 per pound for 1997. What is most surprising about the butter market in 1997 is the volatility in price. In 1996, the Grade AA price spread was $0.81. In 1997, this price spread increased to $1.05,

Figure 2; Source: USDA Dairy Products

with a high of $1.95 in October and a low of $0.90 per pound in January. Based on these statistics, 1997 was one of the most volatile marketing years ever recorded for the butter industry.

International Market Outlook

The price strength shown in the U.S. domestic butter market stands in contrast to rather weak prices in the world market. Prices FOB European ports ranged from $1,800 to $2,000 per metric ton in mid-February. Prices were lower FOB Oceania ports, in the range of $1,750 to $1,825 per ton. Buying interest from Russia is expected to be light to non-existent for the next several months, and little buying activity appears to be on the near-term horizon for other countries as well. Butteroil prices are reported between $2,200 to $2,400 per ton, FOB Europe.

The combination of weak demand with low prices internationally and tight supplies with higher prices domestically is putting the U.S. on the sidelines as an export supplier of butter and butteroil. Since the beginning of 1998, export bonuses have been granted under the Dairy Export Incentive Program (DEIP) for only a few, small sales of butter, butteroil and anhydrous milkfat. As of February 20, DEIP bonuses have been awarded to export a total of 15,585 metric tons, butter equivalent, of butterfat products in the current WTO reporting year, which began July 1, 1997. This represents about 45.5 percent of the total allocation for the year. The balance of this year’s allocation, 18,647 tons, must be utilized by this coming June 30. It is therefore very likely that the U.S. will end the year with substantial unutilized DEIP allocations for butterfat.

In other international news, New Zealand has brought a complaint against the European Union (EU) in the World Trade Organization (WTO) for blocking imports of spreadable butter. The EU permits butter imports under a tariff-rate quota negotiated during the Uruguay Round GATT talks but has so far refused to classify spreadable butter as a product eligible to be imported under this quota. The resulting lack of market access is affecting the value of a multi-million dollar investment in a processing plant that New Zealand made based on the promise of greater access to the EU market for the spreadable product.

A WTO dispute settlement panel has been formed to rule on New Zealand’s challenge, but reports are beginning to circulate that New Zealand and the EU may be discussing a negotiated solution to the problem in lieu of a dispute settlement ruling.

CME Grade A & B Cash Markets

The Chicago Mercantile Exchange is the industry’s most reliable price discovery mechanism for butter. The CME provides a cash market for Grades AA, A, and B as well as a futures contract for Grade AA. Although interest in the futures market is still limited (open interest is about 80 contracts), a majority of the industry uses the CME cash market prices as a reference price for spot market transactions.

Recently, there have been some discussions at the CME concerning the possibility of no longer providing a cash market for Grades A and B butter. The most likely reason why the CME is considering eliminating these two cash markets is limited trading volume. For Grades AA, A, and B, 1997 market volumes totaled 405, 15, and 3 carlot units, respectively. Trading activity in 1996 for the A and B markets totaled 18 carlots, or about 740,000 pounds of butter.

From an industry perspective, terminating the Grade A price would result in some adjustments in the pricing of cream. Much of the cream in the U.S. is priced by using the CME Grade A price as a base. In the absence of Grade A prices, the industry could use Grade AA butter prices as the new base if there exists a consistent relationship between the two markets. Figure 3 illustrates the weekly price spread between Grade AA and A butter prices since 1996.

With the exception of a few spikes, the pricing relationship between the two butter markets is strongly correlated. Although the price spread has been as large as $0.27, the average difference over the past two years is about $0.08. A statistical analysis of the two price series reveals the following mathematical relationship:
Grade A Price = Grade AA Price*0.9681 - .0506.

In the absence of a Grade A cash market, this pricing formula can be used to estimate the Grade A price. Using this formula, the average difference between 1997 actual and estimated Grade A prices is less than one cent per pound. Because the relationship between Grade AA and A butter prices is so consistent, the results of this analysis suggest that the industry can use Grade AA prices as a base when determining the value of cream. Ultimately, using Grade AA as a base price for cream should result in a more efficient and reliable price discovery system.