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Guest Columns

Perspective:
Dairy Markets

Will Europe stop drying milk?

Nate Donnay

Nate Donnay is the director of dairy market insight at StoneX* and has been applying his interest in complex systems and statistical analysis to the international and U.S. dairy markets since 2005. He contributes this column exclusively for Cheese Market News®.

In the past few weeks, natural gas prices in Europe have blown out to new record highs. U.S. prices are at elevated levels but are only one-tenth of the price in Europe. But what impact does this have on the cost of processing dairy products and the value of milk?

I am not an expert in energy markets. Often when I see non-experts try to analyze the dairy markets, they get it completely wrong. If you are an expert (or at least know a little more than me), feel free to reach out and tell me if I say something wrong. That said, in my view, the exceedingly high natural gas price has two potential impacts on European dairy processing. It reduces the amount a dairy plant can afford to pay for their milk, and it likely changes the relative profitability of producing different dairy products.

There has been this narrative going around that due to the high drying costs, maybe milk would shift into cheese, so you don’t have to dry the SMP/WMP. But if you put the milk into cheese, you still end needing to do something with the whey, which is most likely drying it.

The rub is, of course, that no matter what stream a processor chooses to put the milk into, they’re still likely to end up running a dryer. Moreover, the cost to process cheese and dry whey has gone up by nearly the same as butter and SMP, so processing costs won’t really drive shifting between those streams.

Since all solids going into WMP need to be run through a dryer, the cost of processing WMP has gone up more than cheese or butter. That suggests EU WMP prices will need to increase relative to the other dairy products to cover the increased cost of processing, or else processors will shift milk away from WMP and toward other dairy products (when and where possible). Given the big premium that EU WMP is trading at versus Oceania, we’ve already seen EU milk shifting out of WMP so I’m not sure how much more capacity there is to switch between WMP and other products.

Don’t get me wrong, the cost of processing dairy products is surging higher, but the cost of processing all streams is going up so the relative change in profitability between the different uses of milk isn’t changing much. It begs the question: At what gas price do processors actually shut off the dryers?

It doesn’t make sense to turn off the dryer until the cost of processing rises above the price of the dairy product. If dry whey is selling for 950 euros, and the cost of processing goes from 550 euros to 750 euros, it still makes sense to dry it. You’re going to pocket 200 euros in net revenue even at the higher processing costs.

Processing costs would have to rise above 950 euros before it would stop making sense. You would still have to do something with the liquid whey though. With current environmental regulation, it would be hard to find a place to dump it. But if those regulations were loosened, our rough estimate is that it would cost about 200 euros per load to haul it and spread it on fields or dump into manure pits. So, the price of whey would have to fall an additional 200 euros below the cost of processing before processors would choose to dump instead of dry.

Mapping Dutch TTF gas price versus our estimated cost of processing SMP gets us an idea of how high gas prices would need to go before we stop drying dairy products.

We have a tendency to worry. And while those worries are justified today, I’m not expecting a material shift out of powder and into cheese production in Europe. Not yet at least. Given the current market prices, we have a long way to go before energy costs are high enough to justify shutting down dryers.

CMN

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

*Comments in this article are market commentary and are not to be construed as market advice.

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