By Michael Swanson, Chief Ag Economist
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Summary: The transformation continues
The U.S. dairy industry increasingly relies on foreign demand growth to absorb domestic production growth. U.S. population growth has slowed considerably and per capita dairy demand has seems to have reached a plateau. However, foreign demand offers considerable upside to the U.S. dairy industry, but it also makes the pricing outlook even more difficult for domestically focused producers.
Estimating dairy imports and exports requires extensive assumption because of the varied formats the products possess. However, the following analysis uses historical per capita consumption and milk production to show estimated export intensity. In 2006, the U.S. had net imports of 0.8% of its equivalent domestic production, and in 2013 current estimates show net exports at 6.5% of its equivalent domestic production. By comparison, the export rate of both poultry and pork is about 20% of domestic production. Whether dairy continues to increase its export intensity is an open question, but it certainly gives the industry a different set of parameters to better manage in the future.
Analysis: What does it take to win globally?
The U.S. dairy market has been domestically focused since its beginning and foreign markets were only marginally important to setting prices. That dynamic has shifted, and the international markets are becoming increasingly important to overall U.S. dairy pricing. This change will also affect the competitive environment. For the last two decades, U.S. dairy producers simply needed to be better than their local peers to grow, but now they will need to out-produce their global competitors. Competition among dairy producers in different countries has a higher level of complexity. Two dairy producers in central California share so many factors in common that their individual performance is almost exclusively related to the management's decisions and execution. Dairy producers in California and dairy producers in Uruguay have almost nothing in common except cow biology. All dairy producers rely on a complex supply chain to establish their relative value to the global market.
In establishing their relative value in the global market, many factors come into play which depends on the final consumer's perceptions. The final consumer in China might not be interested in where commodities come from, only the relative price delivered to their door in their currency. If the final consumer cares about the origin of the product, the product is no longer a commodity but a specialty product, and some dairy products are specialty products. For example, some cheeses have a geographic origin that clearly makes them specialty products. Another important factor to remember is that commodity does not imply cheap or an indifferent quality. Commodity only implies that there is a standard of identity that once achieved makes it indistinguishable from another product just like it. Whole milk powder (WMP) has a standard of identity that includes food safety components. Once you have produced the WMP to that standard, it is all about the cost of the WMP delivered to the final buyers and in their currency.
For U.S. dairy producers to compete globally, they need to rely on a complex web of upstream and downstream contributors, and they need their financial environment to be competitive. Key upstream elements include feed producers and animal health products. Downstream success requires competitive processors with access to low-cost energy and strong logistics systems. No country ever has its success guaranteed because of the ongoing competitive adjustments internally and externally. Comparing Uruguay dairy producers to California dairy producers helps illustrate of some of the ongoing adjustments. While California producers might envy the low land and labor costs in Uruguay, they would not want to deal with the lack of transportation infrastructure both for feed production and milk processing. The U.S. also has a strong competitive advantage due to lower natural gas costs for the energy-intensive drying process needed to produce whole milk powder(?). California producers might like the lower regulatory burden and taxes in Uruguay, but they would suffer much higher financing costs and currency volatility risk for export pricing.
The U.S. dairy sector has some significant competitive advantages from being part of the overall U.S. economy. However, to a large degree, these competitive advantages have already been built into the U.S. cost structure. Countries like Argentina and Uruguay can improve their overall systems faster than the U.S., which would reduce that competitive advantage. The lower value of farm ground and labor in developing markets represents a discount to make up for the U.S. advantages in other elements. If countries like Uruguay and Argentina improve their food manufacturing environment, the dairy producers will be able to raise their milk prices to some degree.
Lastly, U.S. dairy farmers will also be competing directly with the dairy producers and processors in the major importing countries. There are plenty of anecdotes about Chinese dairy producers and processors with large goals for increasing their domestic production to meet their domestic needs. In 2007 China imported 3,000 metric tons of U.S. alfalfa, and in 2012 China imported 360,000 metric tons. Through March 2013, China is already 30% ahead of last year's record. The USDA FAS estimates that Chinese milk production has increased by 93% in the last 10 years. Whether China continues to grow its domestic supply is a question of relative value between internal and external suppliers. If U.S. dairy producers want to be preferred suppliers, they will need to compete globally. That will require a whole new level of awareness of global competition.
Wells Fargo Agricultural Industries presents this analysis as a complimentary service to its employees and customers. It cannot guarantee the accuracy of all the sources of data. And, commodity prices are extremely volatile based on unforeseeable changes. These estimates will change with all new market changes.