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Dairy Markets

Supply and demand drive the block-barrel spread

Mike McCully

Mike McCully is owner of The McCully Group LLC, New Buffalo, Michigan, and contributes this column for Cheese Market News®.

Over the last two years, there has been a lot of talk about the historically wide spread between Chicago Mercantile Exchange (CME) block and barrel cheese prices. Various reasons have been offered up, but the causes are rooted in several supply and demand factors. These include plant capacity, cheap surplus milk in the Midwest, export demand for blocks, and the long-term downtrend in process cheese demand.

The barrel market has moved from oversupply to balanced back to oversupply in the last five years. Three barrel cheese plants closed in 2013-15 that produced 125-135 million pounds of barrel cheese per year. These plants were Kraft’s Bentonville, Arkansas, plant, DFA’s Monett, Missouri, plant, and Twin County in Iowa. After a year of relative balance and a narrow spread, around 100 million pounds of net capacity was added by 2017, largely as a result of two new plants. For blocks, there were several expansions with the largest being Hilmar’s Texas plant. However, quite a bit of the new capacity was in 640-pound blocks and not 40-pound blocks. In addition, 40-pound block production declined at several other plants. By 2018, relative to demand, 40-pound blocks have been tight while 640-pound blocks and barrels have been in surplus.

A number of other factors also have contributed to the wider spread over the last two years. Before slowing in recent months, export sales of cheese have been strong — those are largely 40-pound blocks with minimal/no exports of barrels. Another big reason for the wide spread is that surplus milk has been moving into Wisconsin and barrel plants at prices below class. How can barrel plants make money when the spread is 10 to 20 cents or more? If they buy milk for $2-4/hundredweight under class, the math works. This dynamic looks to be changing in 2019 as less cheap surplus milk will be available to cheese plants in Wisconsin. Whey plays a factor too. As white whey demand increases, whey from barrel production can command a premium in the market helping offset losses on the cheese side. Finally, demand for processed cheese is declining given the consumer trend toward natural and less processed (having “processed” in your name doesn’t help). From 1995-2007, per capita consumption of processed cheese averaged 8.06 pounds per year, but dropped to 6.91 pounds over the last decade. There was a small increase to 7.07 pounds in 2017, but the longer-term outlook remains weak.

One way to measure the balance in the market is to look at sales volumes of block and barrel cheese. From 2016 to 2017, nearly 1,000 more loads of barrels were traded on the CME while the block volume increased only modestly. Close to 85 million pounds of additional barrel cheese was reported in the National Dairy Products Sales Report (NDPSR) in 2017 vs. 2016, twice the increase seen in CME trading. In 2018, the CME barrel volume is running above last year while block volume is lower. However, the average weekly barrel volume on the NDPSR is up about 700,000 pounds. Assuming the market was in balance in 2016 (average spread of $0.023), the barrel market is likely in surplus by 75-100 million pounds currently.

The block-barrel price spread has seen record highs over the last two years. On Dec 12, 2017, the spread hit $0.225, the widest on record to that point. 2018 has brought new records with the spread averaging over $0.13/pound through October and exceeding $0.30/pound on several days. The graph with this column shows how the spread in 2017 and 2018 compares to the historical range of $0.02-0.04. For 2019, I am forecasting a $0.10 spread through May and then $0.08 for the balance of the year. As noted earlier, less surplus milk will be available in 2019, so that should help to reduce the supply of barrels. And barrels are only one part of the spread equation. Additional 40-pound block capacity will come online next spring which will put downward pressure on block prices and, therefore, narrow the spread. Changes could happen at other plants as well.

Big decisions like adding block packaging lines to a barrel plant or closing a plant are not made quickly. I expect at least one barrel plant to close in 2019 while I’m aware of two other plants recently adding block capacity. The biggest impact comes when the new Glanbia plant in Michigan opens in late 2020. This will bring additional volume of block cheese to the market.

In summary, the wide block-barrel spread is not the result of some nefarious actors as some claim … it’s just simple supply and demand at work.

CMN

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

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