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Cheese, Butter Prices Expected To Keep Rising; Protein Prices Expected To Stagnate

New York—The current global dairy price rally has further upside to come, as milk supply growth across key export regions will take time, despite improving milk prices, according to Rabobank’s recently released “Dairy Quarterly Q4 2016” report.

Milk supply from dairy export regions has “fallen sharply,” by 2.6 million tons, in the second half of 2016, with milk volumes from Oceania and Europe “severely challenged,” the report said. In addition, domestic demand in the US and Europe continued to strengthen, negating the need for further stock growth and reducing volumes available for export by 4.5 million tons in liquid milk equivalent terms.

As a result, global dairy prices have “rocketed upwards,” increasing by over 45 percent in the second half of 2016. Most of the domestic demand growth is for cheese and butter; thus, the spread in prices across the dairy complex stocks will remain wide, with demand for butterfat driving the market and surplus protein, including European stocks, weighing on the market.

Milk production around the world in the second half of 2016 “is in poor shape,” the report said. Europe’s production has tightened, not only because of low prices, but also in response to the milk reduction scheme instigated by the European Commission which, if farmers deliver on their commitments, should remove a million tons of milk from the market.

In New Zealand, the poor start to the season has affected farmers’ ability to respond, with this season’s peak production period being 6 percent down from last year’s level. Production growth is also struggling in Australia, where the market is still reverberating from the price falls at the end of last season.

While stock building was a major feature earlier in 2016, demand in export regions has remained positive, the report noted. This is particularly true in the US, where low unemployment, low oil prices and anticipated economic stimulus added to robust consumer confidence, fueling demand for cheese, butter and cream products.

The result of the tightening global production in the second half of this year, Rabobank noted, is that stockbuilding has ceased and prices have started to rise sharply, with butterfat prices rising more sharply than protein. As these prices filter through to farmers, reduced cow numbers and production conditions are likely to cause a lag in response, creating further upward pressure on prices.

A key factor will be what happens to the accumulated sell-side stocks, in particular skim milk powder (SMP) in the European Union (EU) and higher-than-normal levels of cheese in the US. Despite likely higher levels of exports to China, demand from other import regions is likely to remain subdued.

The European Commission, encouraged by strong local spot prices, has decided to start selling SMP stocks before the end of the year. Most thought that the Commission would wait until the price strengthened further and the subsidies the EU is paying to reduce production come to an end.

Many are questioning if the Commission is able to sell the year-old powder it is offering to the market while demand for protein remains weak (for an update, please see “EU Able To Sell Only 40 Out Of 22,000 Tons,” on page 8 of our Dec. 23rd issue by scanning the QR Code on p. 2 of this issue).

The problem is likely to become more apparent, Rabobank said, as the new year progresses and farmers respond to higher farmgate prices, limiting the level of any SMP and SWP price increases.

Moving into 2017, Rabobank sees prices of butterfat products continuing to be elevated, with cheese and butter prices continuing to climb, but with more stagnant protein prices. As the year progresses and production grows, commodity prices will start to moderate, limited by the headwinds of a strong US dollar and probably continued low oil prices.

Rabobank’s report listed five things to watch in the first and second quarters of 2017:

Currency moves: With the continued strengthening of the US economy and the inflationary pressures of expected economic stimulus, US interest rates can be expected to continue to rise. As a result, the US dollar will continue to strengthen, which will strengthen the headwinds to US exporters and, at the same time, act as a limiting factor on the level of price rises to be expected in US dollar-denominated markets.

Any changes in interest rate/ economic stimulus policy in the US or across any of the main dairy exporting regions can distort the competitiveness of export in the global market.

Affordability: The current price rally is caused more by falling supply than growth in demand.

As prices rise, emerging markets — already suffering the effects of a strong US dollar and slower income growth — will test demand thresholds in these markets. This “affordability” issue will counter some of the upward pressure as the price rally continues to develop.

Dutch manure: The Dutch dairy industry continues to wrestle with the problem of how to operate within the limited levels of phosphates and nitrates which can be applied to soils under EU environmental regulations. The expansion of cow numbers coinciding with the removal of milk quotas has led to a surplus of manure. Cow numbers will need to be reduced by around 170,000 cows in the first half of 2017 in order to bring phosphate applications within the required level.

Chinese buying: With Chinese stocks exhausted, the new lowtariff window for New Zealand and Australia about to open and a gradual uptick in demand entering 2017, China is likely to return to the global market once again. However, global price increases will make on-shore production competitive. The level of buying by Chinese companies may indicate the degree to which the capacity of small and medium herds has reduced, and the degree to which Chinese companies are willing to encourage local production.

California regulations: California dairy farmers are anticipating USDA’s recommended decision on a California federal order in early 2017. Should a final decision increase the average price farmers receive for their milk, it would increase profitability and, most likely, milk production.

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