The oldest newest buyer of dairy
Wednesday, July 29, 2020
By Mike North, principal, Commodity Risk Management Group
Many can recount times when Uncle Sam has stepped into agricultural markets to provide relief during periods of low prices or to offset market turmoil created by certain events. The events and consequent low prices created by COVID-19 have provided an open door for such intervention.
A quick examination of how the U.S. Government has entered American dairy markets during the current crisis reveals participation on four main fronts:
- Section 32
- Trade Mitigation Purchases
- The Coronavirus Aid, Relief, and Economic Security (CARES) Act
- Farmers to Families Food Box Program
Section 32 is a permanent appropriation that was set forth in the Agriculture Act of 1935. It authorizes the Secretary of Agriculture (in this case, Sonny Perdue) to remove surplus food from supply to be delivered to schools, food banks and households through approved nutrition programs. Following the passage of the 2014 Farm Bill, dairy products became eligible for this program. The USDA by way of current legislation has an additional $873.3 million available to buy a variety of food products, dairy among them.
Another program pre-dating COVID-19 is Trade Mitigation Purchases. These are funded by the Commodity Credit Corporation and were constructed in response to Chinese tariffs. These purchases will end in September and be distributed among food banks and food pantries.
Early in the COVID-19 relief assistance programs, the CARES Act emerged as another vehicle to purchase of dairy products. $850 million was made available for the overall program. At least $600 million had to be used for food purchases. The use of these funds will be determined by needs of the food bank and product availability.
Perhaps the most intriguing program is the Farmers to Families Food Box Program. In it, the USDA signaled it will spend up to $1 Billion on dairy products alone. As of now, purchases have been announced through the end of August, and there are still dollars remaining for one more round of meaningful purchases to occur in September and October. Since it was authorized by a “State of Emergency” declaration, the program ends when the emergency is declared to be over. When measured in terms of impact, this program stands out as the largest influence on dairy markets today. (See chart below.)
Earlier this spring, unprecedented departure from food service combined with significant ongoing growth in retail demand caused substantial stress on the supply chain. On the heels of restricted milk production, restaurants nationwide made efforts to welcome back customers in May and June as states reopened. The market responded positively, as cheese supplies balanced and the market was solving the problem that was presented in the weeks prior. However, it was not prepared for a new market participant, which was the Food Box program and the oldest newest buyer of dairy – the government.
With food box demand representing around two percent of U.S. milk production, the implication to markets was profound. And with cheese finding favor in the food box, not all dairy products were treated equally. Class III milk prices moved higher by skyrocketing cheese prices driven by bids of applicants who won the contracts to fill these boxes. Cheese prices blew past old records near $2.40/lb. to set a new high at $3/lb. With more government dollars still in play, many wonder if that can hold.
Remember this program ends when the dollars allocated to the emergency end. When will it happen? According to details shared thus far, October seems to be that approximate timeline. While exact details of the timeline remain in question as we wait for further direction from the government, what lives on the other side of this program seems somewhat obvious. Historically, government bids for product have swift impacts on markets, both up and down.
Without government intervention, traditional players will be left to determine value in the market. Anecdotally, pushback in traditional buying channels is being noted among these participants. Where will they find “fair” value? Will milk production continue to rise to reward a market currently signaling for more milk? Don’t forget that another sizeable cheese plant will be coming online in November and the election will be behind us. These are legitimate concerns held by most dairy farmers we speak with.
These are not just concerns, but the lens through which farmers should consider the market. It explains why the Class III forward curve (the price currently traded for each contract month looking forward) has constructed a discount that measures over $7 from July through December at the time of this writing. With first quarter prices already subject to seasonal weakness, how much further can those prices fall?
While this is not designed to build fear, these questions should be asked and thoughtfully considered as we move through historic highs. We have all lived through this pattern enough to know that markets like the one we are living through don’t last forever and are eventually met with an opposing reaction that balances these opportunities. Proper price risk management is prudent and recommended. Several tools are available to tackle the risk that lives on the other side of this and while future prices do not compare to current prices, action is still warranted. Connect with your advisor to work through a plan of attack.
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