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Perspective:
Dairy Markets

Has whey become the new pork belly?

Joe Schmit

Joe Schmit is a broker at Rice Dairy,* Chicago. He contributes this column exclusively for Cheese Market News®.

Prior to focusing on dairy markets, I spent a few years as a hog market analyst. Hog slaughters are driven by profitability and slaughters increase as the prices of the cuts increase. The hog cuts are priced independently based on demand. Hams could be up while shoulders are down. As long as the average price is up, the butchering will increase. However, there is one cut that can drive slaughters entirely on its own. If the pork belly price is high enough, farmers will be in the black even with lower priced pork chops and loins. Just as an inflated pork belly price leads to increased hog slaughters, I began to wonder if it was possible that premium whey prices could be enough to pull milk into processed cheese channels despite already burdensome cheese inventories.

Milk production has been robust this year, running 1.5 percent-2 percent above the previous year’s production. Additionally, butterfat production has been up 2.3 percent-3.4 percent which leads to higher cheese and whey yields. This is the result of dairy profitability in 2016 when high cheese prices fueled herd expansion. The U.S. dairy farmer was the outlier last year as producers were profitable while the other major dairy exporting regions suffered from low prices. Extraordinary demand for processed cheese proved to be the driver, and the United States was the only store in town. The American dairy processor was making the right product at the right time to meet massive international foodservice orders. The industry responded by adding cows and adding barrel processing capacity.

Fast forward to early 2017, prices have normalized, exports subsided, and cheese inventories started to build. Most dairy components appeared to be well supplied with the exception of whey. Simultaneously, milk production rose above processor demand. The bulk of the milk burden originated in the Upper Midwest where a mild spring lead to very comfortable and highly productive cows. Extra truckloads of fluid milk began to change hands at a discount to Class. Fluid surpluses needed to find a processing channel and manufacturers chose the processed cheese channel. Excess barrel cheese started to come to the Chicago Mercantile Exchange spot market, pushing prices lower. Class III was slightly discount to Class IV at the time, which is a stark contrast to historical premiums of $0.60-$1.00 per pound. It was interesting that manufacturers chose the processing channel with a lower utilization based on the price of barrel cheese and dry whey. It seems that the premium price of various high end whey products influenced their decision. The premiums associated with WPC-80 and whey protein isolate seemed to steer fluid milk into processed cheese channels.

Abundant barrels pushed the block/barrel spread to a historically wide differential and sent the Class III price below Class IV. Milk, however, continued to flow into the cheese vat despite higher-priced alternative avenues. Yes, the milk originated in the Midwest where you find a great deal of cheese manufacturing capacity, so it’s understandable that cheese was made. Perhaps the proximity to cheese processing outweighed the gains returned by shipping fluid milk across the country to run through higher valued Class IV channels. The choice to make barrel cheese, however, remains a bit confusing. On May 26, the block /barrel spread stood at $0.25 per pound with whey prices at their peak. The processor paid the dairy farmer Class III and then sold barrels at a $0.125 per pound discount. The math only works if you assume the processor is making a premium plus on specialty whey products. The return on investment for the processor existed in the whey stream while barrel cheese became a pass-through.

One could argue that the cheesemaker has the massive cost of the plant and the only way to monetize that investment in bricks, mortar and stainless steel is to keep the plant full. Simply put, an idle plant has a massive opportunity cost. While this is true, the latest Dairy Products report tells a different story. As whey prices moved sharply lower during June, American cheese production slowed considerably. After dry whey prices moved from the high $0.40s per pound to the mid $0.30s, cheese production in June dropped to 10 million pounds below the 5-year average while nonfat dry milk production surged. Without the premium that high-end whey buyers provided, processors chose alternate avenues for their milk. It is clear that the price of butter and the myriad of whey product offerings are as important to determining milk flows as cheese and nonfat dry milk. In essence, whey has become the new pork belly.

CMN

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

*The risk of loss trading commodity futures and options can be substantial. Investors should carefully consider the inherent risks in light of their financial condition. The information contained herein has been obtained from sources believed to be reliable; however, no independent verification has been made. Information contained herein is strictly the opinion of its author and not necessarily of Rice Dairy and is intended to be a solicitation. Past performance is not indicative of future results.

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