Dairy Market Scan - Feb 2023

Welcome to the first Dairy Market Scan of 2023!

Posted on Feb 16, 2023 by Prakash Kini (PK)

Just as for many commodities, 2022 has been quite a tumultuous year for the dairy industry.

At the outset of 2023, though milk production has risen and farm gate milk prices are on the retreat trending lower towards spring and beyond into H2 2023, the spread between retail dairy product prices (i.e. cheese, butter, whey) and sourced milk prices has been quite askew due to flawed government policies not keeping in synch with the rapidly evolving supply and demand equation, thus leading to several interesting regional scenes including producers dumping milk, disgruntled end consumers due to soaring retail prices despite lower milk prices, an unusually high rate of dairy product exports, and product sell offs in the spot market.

From a long term perspective, although per cow yields are improving due to new tech, milk production is slated to come down, due to lower cattle counts. This is happening due to a various reasons including lack of investment in processing plants, not helped in the least by rising interest rates, thus putting an artificial cap on sourced milk demand. That said, there has been a good amount of investment in New Zealand into milk processing.

Organic milk is falling out of favor in the EU where organic milk prices have fallen below regular milk prices. Will this trend extend to the rest of the world?

Precision Fermentation is coming out to be the tech to watch out for the future for producing specific enzymes or protein ingredients.

Now, let us get deeper into these themes, using the benefit of both our merchant’s diary and sift platforms …

From our Trading Desk

There are several relative value, calendar and forward structure opportunities in conjunction with FX overlays. These are not big tickets yet but opportunities nevertheless.

On the Supply front, NZ supply will be a smaller factor till Sep-Dec pricing period, with an exception of some shoulder milk collection recovery. Amongst the 3 origins, EU has the largest Milk production upside and the forward sentiment reflects some of it. One number does not make a trend, however the US herd started a structural decline starting October 2022. Increase in interest rates has outpaced the increase in milk prices and both working capital and new capex is stressed. Higher rates will arrest any yield gains from farm consolidations and aggregate milk production will start to plateau, about the same time a few new cheese plants are slated to start production in the South.

EU has a carry/out problem in SMP stocks and to some extent regular spec WMP stocks, which will need to trade lower and travel farther to find demand. Lower offer prices and accommodative Credit terms may find destination demand in Africa (Ghana, Tunisia, Egypt, Turkey, Bahrain, Angola) and some markets in Asia (Sri Lanka, Pakistan).

In the origin markets, US and EU, butter is trading to parity to replacement cream and at 3 year commercial budget levels (excluding the 2022 highs). Using US domestic demand (from commercial disappearance) for illustration. Cheese consumption climbed through the 2022 high/higher prices, while butter consumption reduced by 6%. Our thinking is that origin demand destruction/substitution/reconfiguration has occurred and any growth, albeit incremental is additive from here.

From our Narratives Scan

Dairy at a glance

Canada, India: Retail dairy product prices continue to rise

The Canadian dairy market continues to be highly influenced by government policies and regulatory hurdles.

The production quota system based on projected butterfat requirements, in addition to stagnating processing capacity, have resulted in the travesty of producers dumping milk while retail dairy product prices continue to trouble end consumers while contributing to food inflation, and exports remain high. Prevailing milk import tariff rate quotas (TRQs) are also receiving criticism from producers in neighboring US states.

Despite milk production improving and milk prices falling from recent highs, the retail dairy product prices continue to stay high. This is also being attributed to a continued rise in exports, which some opine is being carried out at the cost of the domestic consumer and even at the cost of food security.

Along similar lines, although India has risen to become the top producer of milk globally with 24% of the production share, it has been aggressive on exports, and retail milk prices have been hiked 5 times in the past one year, which is not sitting well with the mass consumers.

US: Dairy prices are down to a point where demand is starting to grow

On the policy and regulation front, the USDA retained low fat flavored milk in its latest school meal program guidelines though they have been expanded to include non dairy choices. This provides some temporary relief to the dairy industry, which has been at risk from the vegan and alternative protein industry.

US dairy prices have come down from the peaks of 2022, to a point where demand is starting to show up. These are good signs for the market.

UK, EU: Backwardation trend in product prices triggers spot sell off

In the UK and EU as well, there is a backwardation trend in product prices in contrast to the 2022 contango, and a rise in milk production. This has resulted in a producer squeeze, especially with farm input prices continuing to be high. This has also triggered a sell off in the spot market, with processors expecting to buy back later in 2023 as prices ease further through spring and rest of 2023.

Meanwhile, organic milk seems to be losing favor in the EU, where organic milk prices fell below regular milk prices for the very first time. It remains to be seen if this trend extends to the rest of the world.

NZ: Investing in milk processing

New Zealand has invested over $4B in milk processing plants in the past couple of years. A few of these investments are also going towards more sustainable milk processing. New entrants are also making their presence felt. Overseas dairy firms are also making investments in New Zealand by acquiring existing setups or building new ones. Other required material such as stainless steel is getting into demand.

China: Big dairy bets in multiple regions such as Canada, Australia, NZ

More than a third of all Australian dairy shipped abroad in 2022 ended up on Chinese supermarket shelves. 36% of all EU dairy is exported to China, India and the Far East. China, which has always depended heavily on imports coming from dairy origin markets is now making its own large dairy investments in these regions such as Canada, Australia and New Zealand and Africa. China is buying out both dairies as well as milk processing plants. These investments will help in resolving China’s own ever growing food security problem, but may not help in resolving or might even further worsen local farmer issues in these regions and might even further harm broader global supply challenges. These investments are also helping China exercise their “soft power” over these regional dairy industries. Vietnam seems to be following suit.

And now, China just cloned three super cows sourced from the Dutch, which when grown will produce 50% higher than an average US cow. This could potentially change the shape and trajectory of the dairy and livestock industry.

Global Dairy Production may be heading to a discouraging H2 2023

Although new dairy tech and better control over cow health is helping improve the milk yield per cow, overall global dairy production is on its way down. This is due to a steady decrease in cattle count globally.

Although milk production in countries such as India and China is on the way up, it may not compensate for a dip in production in other countries such as USA, New Zealand and Australia.

One of the key reasons for this dip in production is a stagnation in domestic investments in milk processing plants in origin markets. Investments are shifting away from dairy into plant-based milk as well as plant-based and lab-grown meat. This puts an artificial cap on milk sourced for cheese, butter and other dairy products. Even large dairy companies such as Danone are hedging their investment bets between dairy and plant-based.

One way countries China are seizing this opportunity is by investing in dairies and milk processing plants in these traditional origin markets. This might help in resolving China’s own ever growing food security problem as China opens up, but may not help in resolving global challenges.

Moreover, although dairy demand is fairly resilient, it is likely to get weaker in the short term before any improvement, with many economies experiencing broad-based food inflation.

Producer margins are going to get squeezed because of high farm and feed input costs and dipping milk prices.

The global dairy market size reached US$ 893 Billion in 2022. Looking forward post 2023, IMARC Group expects the market to reach US$ 1,243 Billion by 2028, exhibiting a growth rate (CAGR) of 5.79% during 2023-2028.

Alternative milk marketed to be less polluting and more animal friendly

Alternative milk such as soy and oat milk is backed by a large marketing engine. The current narratives are about how plant-based milk such as oat or soy milk is less polluting than regular milk, and how they are much more animal friendly, bringing forth cruel dairy practices.

Meanwhile, dairy producers want the FDA to stop soy, almond, and oat beverages from using the term "milk." calling this to be misleading to consumers, as these products do not come from the traditional dairy process of milking animals and do not have the nutrients in regular milk, especially breast-fed milk for infants, and are being artificially fortified to bridge the gap. They are giving these names like soy/almond juice, plant-based beverage or faux milk.

Precision Fermentation

Precision Fermentation uses organisms such as yeast to produce pure dairy or egg proteins, or ingredients such as heme. This process has been used for decades to produce medicines like insulin and food enzymes like rennet (which is found in many cheese products). [Source: GFI Europe]

Innovations in dairy farm inputs, dairy management and processing

Imagine your dairy farm and farmhouse run by the power coming from your cows using methane digesters? How about robots milking your cows and robot vacuum cleaners keeping your barns clean? Dairy farm innovations help dairy farmers struggling with high inflation of farm input costs bring more cost efficiencies into their operations, helps them improve cow health and increase yield per cow, helps them scale, and produce improved quality milk with higher fat and protein content, and improved dairy products thus improving their margins.

New Dairy and Non-Dairy product launches

Dairy based vodka anyone?

To conclude this scan, sharing a few new dairy and non-dairy product launches including a dairy based vodka and an article on drive-through grocery stores.

We will conduct a deeper dive into broader food trends in a forthcoming exclusive scan on global food trends.