Dairy commodities outlook: March-October 2011

The latest data released by the European Commission suggests a moderate recovery in raw milk prices after a disappointing 2009.

Further increases over the March-October 2011 period seem likely on the back of stronger demand for milk powder, which is used as an ingredient in a wide range of processed food categories.

Larger EU milk deliveries on the back of higher prices

According to the European Commission’s latest quarterly report on the dairy market (December 2010), farmgate prices paid to milk producers have now recovered from the record low levels seen in spring 2009, with the latest EU weighted average raw milk price (32.5 c/kg for September 2010) now higher than any monthly average price seen between 2003 and 2006.

EU milk production has increased on the back of stronger demand during the January-September 2010 period and was around 1% higher than compared to the same period in 2009. The latest data released by Eurostat in February 2011 shows an increase of 1.4% in milk deliveries over the January-November 2010 period. This suggests a reversal of the drop seen over the same period in 2009, when milk deliveries declined by 0.3%.

According to the December EU quarterly report, US milk production is steady to slightly higher for most regions of the country with intake above average levels. Milk production was around 1.8% higher in 2010 and is forecast to increase by 1.5% in 2011. The slightly lower growth rate for 2011 is due to growing concerns over the possible effects of higher grain prices.

Meanwhile, Australia’s milk production is currently at seasonal peak levels, according to the EU’s quarterly report. September 2010 showed a 1.9% decrease in milk production on September 2009 levels. On a cumulative basis for the first three months of the season (July-September), however, there was no change compared to the same period in 2009.

Lower milk allocation for powder milk production in EU region

Powdered milk is a manufactured dairy product made by evaporating milk to dryness. One purpose of drying milk is to preserve it. Milk powder has a far longer shelf life than liquid milk and does not need to be refrigerated due to its low moisture content.

Another benefit of milk powder is a reduction in bulk to allow for greater economies of transport. Milk powders of various types are used in a wide range of packaged food products, including baked goods, snacks, soups, chocolate confectionery, dairy desserts, ice cream and milk formula.

According to sources from Eurostat and Din Consultants, EU-27 SMP (semi-skimmed powder milk) and WMP (whole milk powder) production declined by 2% and 0.1%, respectively, between January and November 2010. SMP and WMP production has been hampered by a larger portion of milk deliveries being allocated to unprocessed cheese and liquid milk production, according to European Commission sources. Milk deliveries allocated to liquid milk increased by 0.7% over the January-November 2010 period. In addition, milk deliveries used for unprocessed cheese production increased by 2% over the same period.

Other than stronger demand for liquid milk and unprocessed cheese, EU manufacturers might have been discouraged from allocating production to SMP and WMP as a reaction to the sharp decline in prices registered by both commodities over the March-August 2010 period. SMP and WMP prices declined by almost 30% during that period, according to dairy information portal globalDairyTrade.

Research suggests that such a decline was partially driven by relatively high stock levels and weak demand for milk powder-intensive products. One key example was ice cream in North America and Western Europe. Ice cream demand in both regions declined as a result of sustained economic uncertainty, which prompted consumers to cut back on non-essential expenditure on indulgence products.

Retail volume sales of ice cream in Western Europe and North America rose by just 2% and 0.2%, respectively, in 2010. This represents a comparatively weak performance in relation to the growth recorded in 2009, when sales in both regions rose by more than 3%.

Interestingly, lower stock levels and prospects for stronger demand in key categories like chocolate confectionery and snacks – both on the back of the broader economic recovery – have underpinned the recovery of powder milk prices since August 2010. WMP prices rose from US$3,700/tonne in early January 2011 to US$4,350/tonne in mid-February, according to dairy information portal globalDairyTrade.

This increase has been even more marked in SMP, with prices rising by 30% since mid-December 2010, to reach US$3,900/tonne in mid-February 2011. This increase in prices is in line with predicted demand in SMP-intensive categories like indulgence products.

Global retail volume sales of chocolate, for instance, are projected to grow by 2% in 2011. This will be quite a robust performance when compared with the growth registered the previous year, when retail volume sales remained stagnant.

Other powder format-intensive categories projected to grow at global level in 2011 include dairy desserts (+1% retail volume) and milk formula (+6.2% retail volume). These gains will both be stronger than the corresponding increases seen in 2010 (0.4% and 5.9%, respectively).

A further reason for the growth of powder milk prices is the strong import volumes currently coming from the Middle East and Africa. Algeria, for instance, is tendering for supplies to meet demand until June, which is estimated to be between 10,000-15,000 tonnes of SMP a month. In Algeria, sales of powder milk as a final product for retail sale are alone predicted to grow by 6% in retail volume, to reach 54,000 tonnes in 2011.

Future direction

NZ WMP (New Zealand whole milk powder) prices, which are typically used as a costing benchmark by international dairy importers, suggest a slight slowdown in the rate of price increases over the next six months. Contract average prices for delivery in April currently stand at US$4,327 per tonne (15 February).

WMP deliveries in May-July are quoting slightly higher prices (US$4,423 per tonne). Interestingly, average prices for deliveries dated August-October 2011 are currently (15 February) 5% lower than contracts dated for May-July delivery. This difference suggests a slowdown in price expectations by traders over the second half of the year.

Price trends for SMP, on the other hand, suggest a moderate slowdown in demand after May. Average prices for deliveries in May-July will stand at US$3,861 per tonne (-1.6% change from the previous year). Futures contracts for August-October are projected to be slightly lower (-3.8% change from the previous year).

Average contract prices for powder formats suggest that current high price levels will prompt an increase in the milk allocation for these products. Stronger supply levels, which are already mounting for SMP, are likely to result in a moderate stabilisation in prices, provided that overall milk supply in key producing areas like New Zealand and EU countries does not decline.

This trend has already been factored in by traders at stock exchanges on both sides of the Atlantic. Futures contracts at the CBOT (Chicago Board of Trade) trading rooms, for instance, showed a decline of 9% in semi-skimmed milk powder over spot prices (23 February close) for August deliveries. Traders already going long that month (with open positions) might well set stop loss orders if CBOT futures go below the US$2,700 mark to hedge against further dips in prices.

There is consensus among industry sources that current international price levels for milk powder could have implications on fluid milk prices. A higher allocation of milk deliveries to powder milk in the EU area, for instance, might result in tighter supply for liquid formats over the March-October 2011 period. Understandably, increasing milk production could always be an option for EU milk farmers.

However, any further increases in output would take place on top of the 1.4% increase already registered in 2010. Research suggests that higher production might require not only investment in upgrading farming facilities but would also need time to materialise.

Until this happens, higher energy and cattle feed costs alongside strong competition from powder milk for industrial purposes are likely to keep pushing up global liquid milk prices over the first half of 2011. Crucially, international milk processors which keep a close watch on the market and adjust their supply strategies accordingly will be in a better position to compete in the context of dairy commodity price inflation.