Drivers for the dairy industry include government purchases, increasing feed costs and trade.
• Cost of production continues to rise, weighing on producer profitability.
• Risk management will become increasingly important as the nature of government support changes.
• Dairy products are more competitive internationally.
12-month dairy outlook anticipates slightly profitable returns. Higher feed costs will weigh on producer profitability. Risk management strategies will be increasingly important as the prospect of direct government assistance fades. However, the cost of risk management is higher, and producers must adapt to the new cost structure. The USDA projects modestly lower milk prices in 2021 as class III prices wane and class IV prices gain export tailwinds.
Northwest Situation
In 2020, most dairy producers were profitable. Many producers paid down operating lines and made strategic year-end purchases of feed and other inputs. Producers are well positioned to weather the transition to higher cost structures.
Northwest dairy producers usually fare well in a rising feed cost environment. A larger portion of feed is grown on farms in the Northwest than other regions of the U.S. Higher labor, fuel and herbicide costs will drive captive feed production costs higher.
Concerns over higher labor costs in Washington continue. Since November 2020, dairy producers in Washington have been adjusting to new overtime pay requirements. Wages for individual dairy employees have increased on average. To moderate increasing wages, producers are actively evaluating labor requirements and business units for opportunities to reduce overtime pay structures. As producers work to minimize overtime, on-farm business units like calf and heifer programs will be carefully evaluated.
Reducing labor needs by eliminating business units allows dairy producers to limit overtime while keeping the same base of employees.
Fuel prices in the Northwest are on the rise and add cost for producers who produce a large portion of their own feed. Crop inputs like herbicides and pesticides are petroleum-based and will increase.
As input prices are increasing, the USDA estimates 91.1 million acres of corn will be produced in 2021. This is the highest since the 2016-17 season but well below analysts’ expectations. Likewise, soybean plantings missed industry expectations, coming in at 84.9 million acres. Corn and soybean futures rallied on the news providing more headwinds for Northwest dairy producers and their feed costs. Producers who will fare well in this environment are those who made advanced purchases on inputs at the end of 2020. Managing feed contracts and other feedstuffs will aid producer profitability.
Pricing Risk
COVID-19 has driven unprecedented levels of volatility in the market. Implied volatility is a measure commonly used to price options. As implied volatility increases, so do options prices and the associated Dairy Risk Protection (DRP) insurance premiums. While implied volatility has been abnormally high since the onset of COVID-19, pre-pandemic volatility was not normal either. Volatility in class III futures decreased from 2008 through early 2020. Producers adopting new tools like DRP, released in October 2017, were able to manage price risk with historically low premiums and options values.
Northwest Production
Northwest February milk production decreased -0.5%, led by Washington with 4,000 fewer cows and milk production down 18 pounds per cow. This is counter to the national increase with 88,000 more cows year over year, producing an additional 2.3% more milk. The additional 88,000 head bring cow inventory to a 30-year high.
National Situation
National milk production increased 2.3% in February, adjusting for the leap year. Also in February, the USDA reports cold storage inventory of butter is up 16.8% year over year. Likewise, cheese inventory is up 5.4%. Projections from the world agricultural supply and demand suggest the all milk price will be $17.75 per cwt in 2021, down from $18.32 in 2020. Class III is forecast to average $16.75 per cwt, down from $18.16 in 2020. A bright spot for class III is whey. Whey prices are forecast 39% higher year over year. Class IV is projected to average $14.45 per cwt, up nearly $1 per cwt from 2020. Butter and non-fat dry milk, class IV products, are both projected higher on favorable export demand and increasing domestic consumption.
International Situation
The global dairy trade auction closed down 2.8% in the March 16 auction. Butter and powder both closed lower after the runaway 15% gains in the March 2 auction. This modest correction leaves the auction index at multiyear highs.
Higher world prices provide the U.S. a competitive advantage in global markets. U.S. prices for butter, skim milk powder and cheddar are well below world prices. Accordingly, demand for commercial exports of butter and powder products is anticipated to increase. The USDA forecasts commercial exports on a fat basis to increase 11.8% year over year. Similarly, commercial exports on a skim-solid basis is forecast up 3.2%.
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