2015 is sizing up to be a fight between Mother Nature and dairy farmers – the prize global dairy prices. Presently, CME and NZX dairy futures are showing a carry structure whereby the futures forward curves are positive to today’s spot cash markets. Likely the futures are holding a premium to today’s spot markets for a few reasons. First, buyers are more concerned about supply uncertainty in the latter half of 2015. Weather issues are starting to worsen at the tail end of the southern hemisphere’s growing season. Dry and hot conditions in Oceania and South America are starting to become more prevalent. Drought conditions in Oceania and South America could cause pasture quality in those regions to deteriorate. Dairy producers would then need to purchase feed to replace pasture – something that could be rather challenging as farms face multi-year lows on this season’s milk price. Collectively these events could bring milking to an abrupt end in the southern hemisphere. As a result, buyers, looking to mitigate risk later in the year, are finding value at current futures prices – an action that has been supportive to the second half futures contracts.
At the same time, dairy producers are looking at those same futures forward curves with some cynicism. Last year, U.S. dairy producers felt they “left money on the table” by selling, what at the time, were historically high milk prices only to watch milk prices climb even higher. With the talk of weather disruptions, dairy producers could be reluctant to sell large quantities of milk in the second half of 2015 concerned that prices will rise once again. Also, U.S. and European dairy farmers were able to build a bit of a war chest last year – one that could help many ride out what futures markets are projecting to be a rather short-lived down event. Current lack of sell-side interest coupled with buyers looking for protection has kept the back half of 2015 futures elevated to start the year.
Therein lies the issues with 2015. Do weather conditions in the southern hemisphere worsen over the next few months allowing dairy producers in the northern hemisphere continue to produce milk at the current pace with price rising at the end of the year as demand once again outpaces supply? Or does Mother Nature relent permitting late season rainfall in the southern hemisphere, abating pasture concerns, so that U.S. and European dairy farmers watch the second half forecast fizzle if they continue with milk output at the current pace? Lastly, what if Mother Nature dials up the heat and northern hemisphere dairy producers cut-back milk sending world dairy prices sharply higher as yet another supply shock hits the system. All highly plausible outcomes; all impossible to predict.
With so much unknown at this point, 2015 is sizing up to be yet another interesting year for dairy products. That said, there are a few things that are tangible that can help provide some insight into 2015 dairy markets. Milk powder prices are at multi-year lows – a factor that has brought back many buyers shut out of last year’s market. Interest from Africa, the Middle East, Southeast Asia and Mexico are rising as milk powder prices hover near $1/lb. Over the past six months, China has ratcheted back milk powder buying and has been able to bring its stocks more in line. Although, last year’s buying spree is unlikely to reoccur in 2015, China is still not self-sufficient on milk and dairy products. With lower stock levels, that imply China could be in the market at more normal levels this year.
On the supply side, dairy producers are not making as much money, but most are still profitable. Despite significantly lower milk price projections in 2015, feed prices were also meaningfully lower as well. Effectively, farm break-evens have dropped compared to the last two years. As a result, dairy producers can profitably produce milk at much lower prices. Typically, for milk supply to abate, margins have to move into the red for a time. Oceania dairy producers are facing a grimmer situation compared to the outlooks in the United States and Europe. That said, dairy producers in Oceania believe one bad season is not enough to curtail milk production mid-season. Based on today’s futures markets, U.S. dairy producers are likely to move out of the expansionary mode, but unlikely jump to contraction resulting in a holding pattern over the next few months.
At a macro level, oil prices are below $50/barrel a blow to oil producing countries but a shot in the arm for consumers. For now, analysts expect oil to continue to flow even though prices are low and do not foresee a slowdown in production unless oil prices breach $35. At the same time, current oil prices have likely slowed new investments a factor if and when demand once again outstrips supply. Additionally, the U.S. economy is growing at a faster pace, and consumer confidence is on the rise. While a strengthening U.S. dollar could stymie U.S. dairy exports; a strong domestic economy could spark food service demand as consumers have more money in their wallets to eat out. Globally, Europe and China’s economies are on shaky ground – something that merits monitoring.
The 2015 market scale continues to tip back and forth between bullish and bearish factors. Unfortunately, the only certainty in 2015 is uncertainty. There are several key items that are worthy of observing in 2015. Mother Nature and dairy producers are two key factors to eye as round one of 2015 dairy markets gets underway.