From Farm To Table: Milk Supply Economics

Dr. Marin BozicMilk SymposiumSt Paul, MNJuly 20, 2017

Agenda For Today2

2

34

5

1

Price Discovery

Milk Supply Dynamics

Federal Milk Orders

Conclusions

Giving Context to Fluid Milk Consumption Trends

Milk Production Growth Fueled by Increased Demand for Processed Dairy Products (Cheese, Butter, Powders)

3

Source: Dr. Bob Yonkers, IDFA based on USDA, NASS and ERS

Fluid Milk Sales Declining4

3,500

3,700

3,900

4,100

4,300

4,500

4,700

4,900

5,100

20

00

20

01

20

03

20

04

20

06

20

07

20

09

20

10

20

12

20

13

20

15

20

16

Source: USDA AMS – Estimated Fluid Milk Sales Report, various issues

Q1 Sales Bil lbs

2000 14.1

2003 14.0

2006 13.9

2009 14.0

2012 13.5

2015 12.6

2017 12.3

Butterfat No Longer an Enemy5

Milkfat Demand Surging Across All Products6

Source: DMI Monthly Snapshot

Are Organic Consumers Different? 7

Whole Milk, 38%

Organic

Whole Milk, 35%Conventional

Whole Milk

Reduced Fat (2%)

Lowfat (1%)

Skim

Conventional Milk Sales in 2016: 46.5 billion, decrease of 464 million lbs over 2015.Organic Milk Sales in 2016: 2.57 billion, increase of 164 million lbs over 2015.

Which Dairy Beverage Categories are Prospering?8

Source: DMI Monthly Snapshot

Non-Dairy Alternative Beverages9

Source: DMI Monthly Snapshot

Consolidation of Dairy Farms10

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

Nu

mb

er o

f D

airy

Far

ms

Technological Progress Favors Size11

0%

5%

10%

15%

20%

25%

30%

35%

40%

Perc

ent

of

US

Dai

ry H

erd

100-200 200-500 500-1000 1000-2000 2000+

1000-2000:2007 / 16.1%

2000+:34.7% and Rising

500-1000:2005 / 14.3%

100-200:1997 / 20%

200-500:2000 / 18%

Milk Production Growing in Areas Far From Population Centers

12

Source: Mark Stephenson, UW-Madison

U.S. Milk Cows Are Most Productive in the World13

Cow Productivity Gains Outpace U.S. Population Growth Rate14

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

5-Yr CAGR Yield Per Cow US Population Growth

Dairy Herd Size Stabilized when Exports Took Off15

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

8,500

9,000

9,500

10,000

10,500

11,000

11,500

1980 1985 1990 1995 2000 2005 2010 2015

Exp

ort

s as

% o

f U

.S. M

ilk S

olid

s

Tho

usa

nd

s

Average number of milk cows in the U.S. U.S. Dairy Exports as % of U.S. Milk Solids

Domestic SNF Demand in 202516

Conservative(10-YrTrend)

Optimistic(Above Trend)

Realistic(Long-Term

Trend)

Population Growth 0.8% 0.8% 0.8%

Per Capita Growth -0.1% 0.3% 0.0%

Total CAGR 0.7% 1.1% 0.8%

SNF U.S. Demand in 2015 15,583 15,583 15,583

SNF U.S. Demand in 2025 16,774 17,458 16,943

Additional Milk Needed 13,387 21,071 15,282

Domestic Butterfat Demand in 202517

Conservative(Below 20-Yr

Trend)

Optimistic(At 3-YrTrend)

Realistic(10-Yr Trend)

Population Growth 0.8% 0.8% 0.8%

Per Capita Growth 0.5% 0.9% 0.6%

Total CAGR 1.3% 1.7% 1.4%

Butterfat U.S. Demand in 2015

7,583 7,583 7,583

Butterfat U.S. Demand in 2025

8,667 9,018 8,753

Additional Milk Needed 28,514 37,756 30,794

Milk Production Growing in Areas Far From Population Centers

18

$0.00

$0.50

$1.00

$1.50

$2.00

$2.501

96

1

19

64

19

67

19

70

19

73

19

76

19

79

19

82

19

85

19

88

19

91

19

94

19

97

20

00

20

03

20

06

20

09

20

12

$/g

allo

n

Inelastic Supply meets Inelastic Demand19

Farm Share of Retail Dollar20

0% 15% 30% 45% 60%

OrangesPotatoes

Ice CreamLemons

Orange JuiceWheat Flour

Iceberg LettuceSugarPork

TomatoesCheddar Cheese

StrawberriesBeef

Whole Milk

Retail Prices are Sticky21

2009

2014

$1.00

$1.20

$1.40

$1.60

$1.80

$2.00

$2.20

$2.40

30% 40% 50% 60% 70%

Fam

Val

ue

of

Bev

erag

e M

ilk

Farm Share of Retail Dollar

Price Discovery: How Much is Milk Worth? 22

The Pool: producers are paid based on their milk components and pool-level utilization of milk

23

Federal Milk Marketing Orders Map24

Source: Progressive Dairyman

Class I Utilization Percentage of Milk in Federal Milk Orders 25

0%

10%

20%

30%

40%

50%

60%

70%1

94

7

19

54

19

61

19

68

19

75

19

82

19

89

19

96

20

03

20

10

YearClass I Util. %

1956 62.5%

1966 65.7%

1976 54.9%

1986 43.2%

1996 43.5%

2006 37.6%

2016 30.7%

Source: USDA AMS Dairy Program (2016) Measures of Growth in Federal Milk Marketing Orders.

How much does ‘beverage milk’ contribute to farmer’s milk check?

26

$0.00$0.10$0.20$0.30$0.40$0.50$0.60$0.70$0.80

Average Producer Price Differential, Central FMMO

Due to declining share of milk that is processed into beverage milk, producer price differentials are diminishing over time.

When ‘realized’ manufacturing value of milk ends up being much higher than ‘anticipated’ manufacturing value of milk charged to fluid milk processors, then residual value of the pool is negative and producer price differential is also negative.

Federal Milk Orders: The Institution We Love to Hate27

Externalities of School Milk Programs28

• Dairy processors who innovate to increase consumption of milk in schools do not capture the full benefit of their activities.

• School milk innovations increase the percentage of population who will drink milk as adults.

• Dairy producers will benefit from increased future consumption even if the dairy processor which innovated may not capture that market in the future.

• In economics, this is called a positive externality. R&D should be subsidized by the dairy industry or innovators should be rewarded for their innovation beyond what they capture through direct additional profit from sales.

• Dairy check-off is one way to support R&D. Can Federal Milk Orders help?

Idea 1: Innovation Credits 29

• Processors who wish to make a sizeable investment likely to increase both current and future nationwide fluid milk sales can apply for investment credits that can be used to partially offset capital expenses of new product lines.

• Can be used to either reduce risk of new innovations or return on investment for large capital expenses.

• The concept of ‘credits’ is well established in Federal Milk Orders. • In Appalachian and Southeast FOs, funds are accumulated into

transportation credit balancing fund by assessments on Class I producer receipts. During months when milk supply is lower than local demand handlers may request transportation credit payments from the fund to offset the additional costs of securing long distance loads of supplemental milk.

Dumped Milk versus Total Producer Milk

0.0%0.2%0.4%0.6%0.8%1.0%1.2%1.4%1.6%1.8%2.0%

Dump Milk as a Percentage of Total Producer Receipts, Northeast Federal Order

prepared by A.M. Novakovic, Cornell University 30

Idea 2: Multiple Classes for Beverage Milk: 1a, 1b, 1c.31

• Class 1a: School Milk In Demand-Enhancing Packaging: school milk marketed in packaging that is known to be stimulative of school milk utilization can be classified as “Class 1a” milk and charged 50% of the regular Class I differential (over manufacturing milk).

• Class 1b: High-protein Fluid Milk Products: Processors who market milk with high protein content would be allowed to pay to the pool somewhat lower price for skim milk if the volume of raw skim milk intake in the plant is e.g. more than 15% higher than the volume of skim share of their beverage milk.

• Class 1c: Donated Fluid Milk Products: Fluid milk donated to food banks should be pooled at the lowest-price class.

Idea 3: Forward Contracting for Class I products32

• Forward contracts between a buyer and a seller are typically fixed-price arrangements where buyer promises to pay, and seller agrees to receive a fixed price for the product to be delivered at a future point in time.

• Since Class 1 handlers have to participate in the federal milk order pools, a different kind of forward contract would be necessary:

➢ dairy processor agrees to pay a fixed price for Class I milk➢ Milk supplier (farm, coop) agrees to receive that fixed price for

the milk supplied and compensate the dairy processor for their net obligations to the pool if positive. If Class I handler is allowed to draw from the pool (roughly speaking, when Class I price is below Class III milk price) then draw is passed on to the milk supplier.

Think this is Un-American?33

From Farm To Table: Milk Supply Economics

Dr. Marin Bozic

mbozic@umn.edu

Department of Applied

Economics

University of Minnesota-Twin

Cities

317c Ruttan Hall

1994 Buford Avenue

St Paul, MN 55108

Photo Credits:

Mara at Blue Diamond Dairy

© Sadie Frericks, 2010