Guest Editorial
The world waits for the tipping point

Marc A.H. Beck is senior vice president of marketing for the U.S. Dairy Export Council. He contributes this column exclusively for Cheese Market News®.

One of the things we’re discovering in 2007 is that dry ingredient markets are more important — and more dynamic — than we ever imagined. And to understand dry ingredient markets, we have to understand the global marketplace.

Nearly half of America’s dry ingredient production — skim milk powder (nonfat dry milk), whey proteins and lactose — is sold overseas. Therefore, as the world market goes, so goes our home market.

None of this would matter so much if the world market for dairy solids hadn’t taken off like a scared jackrabbit last fall and not looked back. International demand, surging since the early 2000s but masked by long-standing large global inventories, finally broke to the surface as stocks disappeared. Global prices for whey, milk powder and lactose have risen for the last nine months, more than doubling from third quarter 2006.

We understood then, as we do now, that strong world demand and tight global supplies were on a collision course. But what goes up must come down, right? There’s an adage in the dairy industry that the cure for high prices is high prices. Typically, supplies increase while demand simultaneously drops back, and soon enough the market retreats to its previous levels.

So here in the middle of 2007, with global dairy ingredient prices perched at record heights, everyone keeps wondering when the medicine will take effect. It can take awhile to ramp up supply, but why haven’t we seen widespread demand resistance as prices moved higher? Here are some of the factors that will determine the tipping point:

• There’s a much longer lag in international trade. Multinational dairy users typically contract to buy 3-, 6- or 12-months’ supply at a time. Therefore, many processors have been paying 2006 prices for 2007 production.

• Meanwhile, as dairy commodity prices have risen, major buyers have been absorbing most of the increase in hopes of maintaining market share. In Mexico and Japan, retail prices are mostly unchanged from a year ago. In Malaysia, Dutch Lady Milk Industries has increased the price of condensed milk by just 7-9 percent. In the second half of the year, it says it will tack on another 5 percent across-the-board increase in its product offerings. Rival Fraser & Neave Holdings is raising retail prices on canned sweetened condensed and evaporated milk “gradually” throughout 2007. In the Philippines, Nestlé is taking the same tact, passing along increases in ingredient costs in small increments.

• In Japan, buyers are as concerned with supply availability as price. So in times of inflation, they are willing to take higher prices for awhile to ensure steady deliveries.

• In Southeast Asia and China, infant formula is not very price-sensitive. Parents in China’s mandated “one-child” market will spend what it takes to provide what they believe is the best nutrition for their children.

• In some developing countries, government price controls on finished dairy products help keep essential foods affordable for consumers. This creates difficulties for processors, but consumers are less affected.

• Significantly, the weaker U.S. dollar has partly offset higher ingredient costs in markets where local currency rates are allowed to float freely.

• Formulators have been stymied in their efforts to substitute because the costs of other proteins and carbohydrates have escalated as well.

• In some applications, dairy content is relatively small. In confectionery or bakery uses, for instance, dairy might make up less than 5 percent of the recipe, so higher costs aren’t as crippling.

• Drying capacity in developing countries is limited or non-existent. Formulators have to continue to import to keep finished products on the shelves.

That’s not to say higher prices can be maintained indefinitely. Demand resistance for whey and lactose for the feed sector has been pronounced, and orders have backed off in the last two months. And even where consumers aren’t feeling the heat yet, importers and processors are complaining loudly and actively seeking substitutions. Accordingly, international prices for dry sweet whey have weakened slightly from earlier peaks and lactose prices have flattened.

Nor are importers of ingredients for food-use standing still. Processors in China and Mexico, among others, are reducing imports of powdered milk and relying more on local, fresh milk production. Mexico’s Liconsa, the government social agency responsible for feeding the poor, plans to boost purchases of domestic milk by 1.1 billion pounds this year and cut powdered milk imports by 75-100 million pounds.

USDEC office representatives in key markets say sales of U.S. dairy ingredients have been very good in the first half of 2007, but they expect higher prices will result in a pullback — not a crash — in import demand in the second half. The timing and extent, naturally, is still unknown. Most expect volumes to be down — but prices to remain relatively strong — in part due to seasonal production declines in the United States and the European Union throughout the summer.

And even when prices do adjust, many believe we’re in the midst of a period of generally higher overall price ranges.

At the American Dairy Products Institute/American Butter Institute annual conference in Chicago last month, Rabobank global dairy industry specialist Mark Voorbergen predicted the structural imbalance between world dairy supply and demand “will cause global dairy ingredient prices to remain relatively high for the next five years.” Production is expected to expand and demand growth in some areas will moderate, but new plateaus are forecast for the balance of the decade.

That prediction has strategic implications. In an environment of sustainable demand and higher price plateaus, U.S. industry leaders have to adjust their thinking on the milk powder business. That means milk powder needs to managed as a “core” business, not a “disposal and balancing” business, as historically has been the case.

CMN

The views expressed by CMN’s guest columnists are their own opinions and do not necessarily reflect those of Cheese Market News®.