California dairies squeezing costs

Rabobank estimates that the average breakeven mailbox price for 1H 2016 for the largest one-third of dairies in California is approximately USD 15.20/cwt, with feed expense accounting for 10.75/cwt of the cost. These largest dairies are responsible for two-thirds of the State’s total milk production.

Recently, the mailbox price has fallen below USD 13/cwt. Since Q4 2014, prices for California milk have buckled amid a glut of global supply. Some dairies saw losses as early as Q1 2015; however, pre-purchased feed and deferred income from a very profitable 2014 help support many dairies through much of 2015. As feedstocks were worked through and cash reserves tapped in to, many quickly felt the effect of lower milk prices. Dairies who diversified into nuts were able to remain profitable, as nut prices were at record levels for much of 2015. Moving into 2016, these same dairies face even lower milk prices, with less available capital and have sought to alter their feed rations to further reduce input costs—and subsequently production. Most, if not all, California dairies are suffering amid these lower prices.

Relative to other U.S. producers, California dairies were the first to feel the pain of lower global milk prices—as they are responsible for 40% of U.S. dairy exports. They will also likely be the last of the U.S. producers to feel any relief provided by upward movement in global dairy prices because, over the last ten years, they have received an average of USD 1.85 per cwt less than the US All Milk price. This is in part due to the surplus of milk in the State, relative to population, compelling producers to ship their products east of the Mississippi—where 75 percent of the population currently resides—or abroad. The other part of the equation is the California minimum component prices relative to other dairy producing regions, specifically with regard to whey pricing.

U.S. prices will continue to suffer as there is a surplus of dairy products on the global market. The strong dollar combined with domestic price premiums weaken California dairy processors’ export competitiveness, leaving many processors with no choice but to store their products. Rabobank expects that prices will begin to slowly climb towards the end of 2016, but will remain a long way from the lofty prices of 2014. Some of the reduction in prices will slowly be relieved as China and other developing markets continue to creep back into the market. However, continued sanctions against Russia remain a burden to European exporters and hinder their ability to reduce surplus accumulating in European inventories. With lower milk prices causing 5 out of 7 of the world’s exporters to reduce milk supply, the market waits with bated breath for European and U.S. supply to apply the brakes. Rabobank believes this rebalancing is already in motion and dairy producers should slowly see a recovery in global prices toward the end of the year and into 2017. Relief could be felt sooner if there is a supply-side shock or if an unanticipated increase in demand materializes.

As California dairy prices are more reflective of the export market relative to other states, most dairymen will have to continue to wait for the market to rebalance itself—which will take time as processors will need to work through their surplus stocks. Subsequently, the State’s herd is shrinking, and has been since 2010. From 2014-2015, the herd, and total production respectively, decreased by 2.3 percent and 4 percent. A further 1.5 percent decline in the 2016 total herd size would reduce it to 1.72 million cows—the lowest since 2004. Combining this with lower quality inputs, California’s total milk production could be reduced by 3 percent, to 39.2 billion pounds, in 2016. Rabobank’s forecast suggests that prices will be below breakeven for a majority of producers through 1H 2017. Since prices are expected to remain below breakeven in the near term, dairies with the lowest fixed costs structure will overcome this current downward cycle.

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