Economics with Ken
Bailey
By Ken Bailey
University of Missouri-Columbia
Extension Dairy Economist
Dairy Commodity
Market News
Trades on the CME are made anonymously. That means buyers and sellers could change prices without facing public scrutiny. The reason the CME offered anonymous trading was to seek greater participation in the cheese market which in the long run would improve the market.
Cheese Trading
But why is cheese trading at such low levels when milk production is fairly tight? March milk production was up less than one percent. Is it due to supply and demand forces, structural changes in the industry, or price manipulation?
While cheese inventories fell in February, they are still ahead of a year ago and are predicted to increase through May (see Figure). American cheese inventories averaged 10.2 and 6.2 percent ahead of a year ago during January and February of 1997. Cheese production is expected to increase through May, but not at rates above a year ago. And commercial disappearance of American cheese was up 7.4 percent during the three months December 1996- February 1997 relative to a year ago. Moderate growth in demand through May (i.e. 2.5 percent) will not be enough to prevent a stock buildup.
Another reason is that western cheese production capacity increased significantly in 1996. New plants in Idaho, Washington, Arizona and California greatly expanded processing capacity. Those plants are very sizable and will likely be kept full this year in order to operate economically.
Cheese prices fell during April and the first week in May due to the market perception of ample supplies of cheese. We are right in the middle of the spring flush and a lot of that milk is ending up in the cheese vat. American cheese production is predicted to increase from 267 million pounds in February to a peak of 297 million pounds in May.
But where do we go from here? Are prices going to rebound? My guess is that they will once we are past the spring flush and inventory levels drop below year ago levels.
It is possible that cheese production will fall below year ago levels in the months ahead due to pure economics? Milk production is not likely to increase much above 1996 levels due to low farm-gate prices. That will restrict the amount of milk available for cheese production. Also, low cheese prices will result in lower cheese margins (the difference between income and costs for cheese processors). My estimates are that cheese margins, which averaged over 80 cents per hundred pounds of milk in 1996, will shrink to below 20 cents this year due to lower cheese prices. While American cheese production grew over 5 percent in 1996, 1997 will see very little growth.
Cheese Consumption
Consumption of cheese is the other factor to consider. The economy is very strong right now, with little or no inflation and low unemployment. As fast food buyers begin to use promotions and as American's fire up their barbecue grills, we should see greater demand for cheese. Overall I'm expecting consumption of American cheese to exceed 1996 levels (commercial disappearance of American cheese was up 2.4 percent in 1996). In fact, if commercial disappearance were up 4 percent this year, we would move enough cheese to prevent any additional stockpiling.
My projections for inventories of American cheese though 1997 show a buildup during April and May. Thereafter they show inventories falling below 1996 levels. This estimate is based on a restricted milk supply and strong commercial demand for cheese.
In the end it appears that old fashioned supply and demand describes why cheese prices move where they do. There are no conspiracies driving cheese prices. Inventories are building and buyers sense an abundance of cheese. But that won't last for long. Milk production and hence cheese production will tighten just as demand picks up. Supply and demand forces should then move cheese prices higher this summer.
The April Basic Formula Price (BFP) fell $1.05 from the previous month to $11.44. This drop was due to changes in the Base Month survey price and the commodity adjustment formula. March cheese went up a penny a pound from the month before and butter went up 7.4 cents. For some reason the March base month milk price at 3.5 percent butterfat went down 5 cents per cwt. While this is based on a survey of plants in the Upper Midwest, it does appear odd that it would drop when commodity prices rose. That would leave the rest of the drop (the adjustment formula) in the April BFP to be $1.00. Most of this change was due to the drop in cheese and butter prices in April.
The BFP is predicted to bottom out at $10.50 in May and then rebound thereafter.
Dairy Outlook:
http://etcs.ext.missouri.edu/agebb/dairyout/newsltr.htm
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