First Quarter 2000
Volume 3, Number 1

Dairy markets entered the new millennium with some of the lowest milk prices in 20 years. Heavy stocks of cheese, butter, and milk powder have resulted in excess supplies. Meanwhile, milk production continues to move forward at a strong pace - possibly resulting in even higher stocks for 2000. In this issue of the ABI Situation and Outlook, a review of 1999 marketing conditions is presented. Also included in the analysis is an outlook for 2000 - both from a marketing and policy perspective.

In the past four years, the dairy industry has witnessed the extraordinary influence that changes in the milk supply can have on the market. For example, in 1996 the U.S. milk supply decreased by 0.8%, resulting in a record high milk price of $15.37. The decreased supply of milk also tightened up the supply chain for butter and cheese. By the fall of 1996, butter prices spiked at $1.5300 and the cheese market climbed to $1.6675 per pound. Only two years later, El Nino created another tight market for the milk supply. Faced with strong demand in 1998, the milk supply increased only 0.5% and this once again resulted in record highs for milk ($17.34), butter ($2.81), and cheese ($1.86).

As was predicted by most analysts, the market was only experiencing short-term adjustments to changes in the milk supply. Because the fundamental structure of the supply side of the market remained unchanged (namely, no substantial declines in cow numbers), analysts agreed that such high prices would eventually lead to increased milk production and lower prices. This is exactly what happened in 1999.

Last year, the U.S. milk supply was up 3.4% for a total supply of 162,776 million pounds. Although demand for dairy products remained on a strong upward trend, the available supply of fluid milk, cheese, butter, and nonfat dry milk exceeded consumer demand for most of the year. In total, commercial disappearance of all dairy products increased by about 3.2% in 1999. On a product basis, American cheese was up 7.3% and the demand for butter increased about 4.8%. Even with the growth in these product segments, dairy markets were in a constant state of disequilibrium for much of last year. The result of this market imbalance was huge stockpiles of dairy products and milk prices under $10.00.

Low prices for milk and other dairy products are likely to remain for quite some time. Because conditions in the current market are ideal for milk production, the industry should expect to see gains in inventory levels similar to that witnessed in 1999. Favorable weather conditions (mild winter, good moisture) and low feed costs remain two of the primary reasons why the milk supply continues to surge ahead. For example, the USDA estimates that January milk production was 14,273 million pounds, or up 4.7% compared to last year. This is the strongest growth in January milk production since 1986. In fact, 1986 is not even a good comparison because of the dairy buyout programs and their impact on milk production. Given this exception, one would have to go back to January 1981 to witness growth in the milk supply greater than 4.7%.

Based on current trends, the U.S. milk supply is likely to increase by about 2-2.5% in 2000. This level of growth will continue to dampen prices for milk and other dairy products. For example, milk prices are not expected to strengthen until August or September. Annual average price estimates show that the Class III milk price could average in the range of $11.25-$11.75 for 2000. This price estimate is substantially down from last year's mark of $12.98. The new Class IV price for milk used to manufacture butter/powder will be slightly higher than Class III for most of this year. The expected higher prices in this market can be attributed to the support price for nonfat dry milk and the relatively strong butter price as compared to cheese.

Both butter and cheese prices are also expected to be substantially lower in 2000. For example, in 1999 the CME Grade AA price ranged from $0.90 to $1.50 with an annual average of $1.25 per pound. Butter prices for this year are expected to range from $0.85 to $1.40 with an average of $1.19, which is about 5% lower than 1999. Among market analysts, there have been some discussions that butter prices could reach the support level of $0.65 per pound. Although anything could happen, current market conditions point toward a reasonably steady market that remains $0.25-$0.30 above support levels. Butter production is going to be up once again this year, but probably not a repeat of the 8% gain posted last year. With the expected gain in milk production, the total supply of butter could increase at least another 4-5%. As usual, supplies will become tight during the summer months, but available supplies for most of 2000 should be ample.

Although butter prices are soft, the cheese market is even more depressed. Over the past three months, cash prices for 40# blocks at the CME have fluctuated in a very narrow range with the highest mark being only ¢3.25 above the support price of $1.10 per pound. Like other product markets, the cheese sector is suffering from excess supplies. Total cheese production for 1999 increased to 7,947 million pounds - a 5.9% jump compared to 1998. The American cheese category posted the largest gain with a 7.8% increase in total production. The supply of Italian cheeses increased by about 5.1% in 1999. Because of continued growth in milk production, the cheese market will experience another year of heavy production that will at times keep the market depressed. For 2000, the current outlook is for 40# block prices at the CME cash market to range from $1.10 to $1.43 with an annual average of $1.23 per pound. This outlook can change dramatically based on weather conditions. Currently, there is some discussion of an early drought in the eastern and southern regions of the country. If a severe drought does develop in the milk producing regions of the country, expect dairy prices to increase accordingly.

Effective January 1, 2000, a new federal milk marketing system was implemented. This system determines a price for milk by using component values for protein, butterfat, nonfat solids, and other solids. Based on conversations with industry representatives, there still remains a level of confusion among producers and processors alike. A brief review may help answer a few question you may have.

First, the Class I and II skim prices and the Class I butterfat price will be announced on or before the 23rd of each month. These announced prices will apply to the following month (see table).

FMMO Prices for this Month	Announced on this Date @ 10:30AM EST
	Class I, Class II Skim	Other Class and Components
Jan.	Dec. 23	Feb. 4
Feb.	Jan. 21	Mar. 3
Mar.	Feb. 18	Mar. 31
Apr.	Mar. 17	May 5
May	Apr. 21	Jun. 2
Jun.	May 19	June 30
Jul.	Jun. 23	Aug. 4
Aug.	Jul. 21	Sep. 1
Sep.	Aug. 18	Sep. 29
Oct.	Sep. 22	Nov. 3
Nov.	Oct. 20	Dec. 1
Dec.	Nov. 17	Jan. 5

The Class I price mover will be the higher of the Class III or Class IV advanced skim milk price. The advanced skim milk prices for Class III and IV are not the same as the Class III and IV milk prices announced on or before the 5th of each month (see "Other Class & Components" in table). Aside from what these prices represent, one noticeable difference is associated with the NASS survey data used to compute the advanced prices. For example, the advanced Class I butterfat price and Class I mover (the higher of advanced Class III or IV) are calculated using only the two most recent weeks of NASS survey prices for butter, cheese, nonfat dry milk, and whey. This compares to the four weeks of monthly price data that is used to determine the component values for the Class III and IV markets, for example. This is just a brief summary of what most people are finding difficult to understand. If you would like to discuss these issues in greater detail, please call the ABI office in Arlington, VA.

Although the official dates have not been announced, the federal marketing order hearings on Class III and IV pricing formulas will most likely take place by late April or early May. Although the primary focus will be on the pricing formulas for Class III and IV, any changes in these formulas can have ramifications for the Class I and II markets. This is because the same formulas used to calculate Class III and IV prices are also used to calculate the skim and butterfat prices for Class I and II. Essentially, the only pricing issue not up for discussion at these hearings is the price differentials.

At these hearings, one should expect a lot of discussion concerning the higher cost of butterfat associated with federal orders. Because of changes in the way butterfat prices are calculated, the cost of fat originating from federal order milk could increase an average of $0.05 per pound. To address this issue, NMPF and other organizations have suggested that the butterfat price for Class IV products be the announced butterfat price minus $0.06.