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  • Dairy export signposts, Part I: The macro factors

    By USDEC Staff January 14, 2022

    USDEC’s annual look at the primary factors expected to influence dairy consumption and export demand in the year ahead.

    signposts final

    Every year, the U.S. Dairy Export Council summarizes the key “signposts” our analysts will be watching in the year ahead. Like signposts on the road, these markers will help determine the course of U.S. dairy exports over the next 12 months.

    This year, we’re splitting the piece into two parts. In Part I, we focus on the macro factors that will influence all the major dairy products: milk production, input costs, supply chains and the macroeconomic environment. In Part II, to be published next week, we’ll focus on one key signpost for each of the major U.S. dairy export products. For Part I, let’s start with a look at the supply situation.

    Global Milk Production Paul Rogers

    Tight milk supply was the defining feature of global dairy markets in the back half of 2021.

    After a healthy 1.9% first-half increase in milk production from the “Big 6” global dairy suppliers (the U.S., EU27+UK, New Zealand, Australia, Argentina and Belarus), output from those suppliers flatlined in the second half (based on data through October for the EU and through November for the other five). When the year-end numbers arrive, there’s a very good chance production will be down over the final six months, putting the calendar-year change at less than 1%.

    Chart1 (2)-Jan-13-2022-08-54-05-48-PM

    Looking to 2022, there is little basis to believe a major turnaround is in the cards until at least the spring flush in the Northern Hemisphere—and possibly not even then.

    First, despite strong farmgate milk prices, a concurrent surge in input costs has limited investment in herd expansion and productivity gains. Tighter pocketbooks come as both EU27+UK and New Zealand milking cow numbers have already declined for five straight years. On top of that, U.S. farmers are starting with a smaller dairy herd this year than they did last year alongside slower increases in milk yields due to feed and labor costs (to be discussed next).

    This economic situation is likely to be exacerbated by environmental regulatory pressures on dairy producers, which continue to ramp up in both Oceania and Europe. At the end of 2021, the Dutch government proposed a 13-year plan to cut livestock numbers by as much as one-third. Ireland, the fastest-growing dairy producer in the EU, is debating a plan to meet long-term emissions targets that could lead to a cull of up to a million dairy and beef cows. Denmark, Belgium and Germany, Europe’s largest milk producer, are thought to be in line for similar proposals. While these proposals are either theoretical or voluntary at this point, an uncertain political environment is likely to disincentivize farmer investment.

    Finally, weather (a perennial wild card) was a major cause for New Zealand’s lackluster 2021/22 production season. While a shift in weather to supportive pasture-growth conditions is certainly possible, increasingly frequent climate events are negatively impacting production growth potential in Oceania and all over the world.

    Should New Zealand and EU27+UK milk output growth tend closer to +0.5% than +1.5%, it will restrict their capacity to expand export markets and potentially cause some tough decision-making on product and geographic target mixes.

    Bottom line: today’s economic and political environment is not the kind of atmosphere that leads to major milk production growth. On the positive side, production weakness elsewhere could translate into greater opportunity for U.S. suppliers.

    Dairy Input Costs – Stephen Cain

    Input costs will be a critical factor in determining the United States’ ability to grow milk production in 2022 and take advantage of expected opportunities stemming from slower growth from Europe and New Zealand.

    Last year, input costs, particularly feed and labor, climbed faster than milk prices, impacting farmers’ ability to stay in business and dampening U.S. milk production growth, particularly in the second half of the year.

    Starting on the feed side, prices for corn, soybeans and alfalfa rose last year. From 2015 through 2020, corn prices averaged $3.54 per bushel. But last year, corn prices steadily increased, reaching an eight-year monthly high of $6.32 in August; essentially double the average price over the last six years. While prices have eased from the August high, corn prices are still above $5 per bushel, nearly 50% higher than the prior six-year average. Soybean meal prices were also elevated in 2021 compared to 2020 (+21%) and alfalfa hay was up 13% year-over-year.

    Naturally, elevated feed costs pinched margins in 2021. While the All Milk Price has increased in recent months (nearing $21/CWT in November), the average milk price for 2021 was only up 1%, which pales in comparison to the double-digit increases in feed. As a result, the Dairy Margin Coverage’s calculation for milk margin above feed costs averaged $6.68 in 2021; the lowest level in recent years and 29% lower than 2020.

    Chart2 (2)-Jan-13-2022-08-55-06-85-PM

    Moving forward, feed costs are expected to see some slight easing. Last year, there was incredibly strong demand for corn abroad, primarily from China, along with weaker output from other exporting countries like Brazil, resulting in U.S. corn exports increasing by 38% year-over-year through November, which in turn boosted prices. In 2022, Ukraine, Brazil and Argentina are all expected to have better harvests. This will likely ease U.S. corn prices in 2022 as global supply increases.

    Additionally, U.S. domestic use is not expected to increase substantially. Corn futures support this argument with easing prices over the course of 2022. Soybean futures, while showing some slight strengthening in the first half of 2021, are also anticipated to weaken in the back half of 2022. USDA’s 2021/22 forecast of soybean meal prices are projected at $364/MT, significantly lower than the early 2021 highs of nearly $485/MT.

    Ultimately, feed costs should see some easing in 2022, which when combined with higher milk prices, should support productivity gains and even some herd expansion.

    U.S. dairy farmers (and plants), however, will still need to secure (and pay for) sufficient labor. Dairy farm labor has long been difficult to find, and the cost of that labor has continued to rise throughout the pandemic. A recent Cornell University study looking at dairy farm labor in New York put hard data behind the facts known by many dairy farmers. The study showed that labor cost per hundredweight of milk sold increased 10% over the last 10 years and even accelerated in 2020, surging nearly 4% in one year from $2.97/CWT in 2019 to $3.08/CWT in 2020.

    The acceleration was further entrenched in 2021 as pandemic-induced difficulties exacerbated an already tight labor market. According to USDA, the gross wage rate for livestock workers (not exclusively dairy) increased 6% in 2021 (January-October) while the average All Milk Price in 2021 was only up 1% over 2020.

    Chart3 (2)-Jan-13-2022-08-55-58-43-PM

    Looking to 2022, labor costs are anticipated to rise further. The difficulty in hiring and retaining labor is not new to dairy, but the pandemic exacerbated pre-existing trends. On a positive note, milk prices are anticipated to surpass 2021 levels, meaning margins should climb along with those prices, supporting U.S. milk production (and thus export) growth in 2022 (at least in the back half of the year).

    Port Congestion – William Loux

    Even if the U.S. does have the product available, exporters must be able to get the product to customers on time.

    Clearly, supply chain challenges – both inland and at ports – were a major hurdle for U.S. dairy exports in 2021. For this article, we focus on the issues at ports. Higher costs, rolled bookings, unexpected fees and slowed export delivery times all stemmed from congestion at ports in 2021. In general, the major West Coast ports were the epicenter of the delays as lack of equipment, labor and unloading space limited inbound turnover and, on the outbound, carriers opted for empty containers over U.S. dairy exports.

    So, what does 2022 hold?

    Overall, our expectation is that there should be some easing in ocean traffic, but we’re not anticipating a return to 2019 costs or carrier reliability.

    Fundamentally, if we break down the major drivers of port congestion, we can place it into three categories: consumer spending, manufacturing inventories and port inefficiency.

    Starting with consumer spending, the pandemic combined with fiscal stimulus measures pushed consumers to purchase more goods. Even accounting for inflation, the amount of goods purchased by consumers skyrocketed in 2020 and further accelerated in 2021 (as seen in the chart below). Greater demand for goods naturally increased traffic at ports.

    Chart4 (2)-Jan-13-2022-08-56-52-50-PM

    As we enter 2022, we believe that tighter fiscal policy, a potential rise in interest rates and a refocus on services spending will result in consumer goods demand returning close to its pre-pandemic pace. We shouldn’t get too excited by a reversion to the mean though. If consumer purchasing returns to its pre-pandemic pace that will still mean the volume of goods purchased will surpass pre-pandemic demand by a sizeable margin. Effectively, 2022 would mirror the second half of 2020, which resulted in plenty of congestion.

    Chart5 (2)-Jan-13-2022-09-08-15-86-PM

    Positively, the latest data shows that domestic manufacturing and trade inventories have climbed above 2020’s pace after trailing for much of the first half. That means, if this trend continues, manufacturers will no longer be in quite so dire need of product this year and will be better placed to supply consumers’ demand for goods. Lower inventories at retail persist – particularly in the auto sector – but, overall, the inventory picture is more positive than at this point last year, which should help ease the import traffic.

    Chart6 (2)-2

    The major question remaining is whether ports will be able to increase – or at least maintain – vessel turnaround. In the final months of 2021, despite a record volume of ships waiting to unload, port throughput deteriorated below prior-year levels, likely due to labor and equipment shortages. Reduced ship turnover only exacerbated carriers’ willingness to ship empty containers over filled ones.

    Chart7 (2)-3

    Even if equipment shortages improve, labor will continue to be a challenge in 2022. More worrisome is that there is potential for the situation to worsen as the contract between the West Coast dockworkers (the International Longshore and Warehouse Union) and the Pacific Maritime Association expires on July 1. The last contract negotiation in 2014 resulted in port slowdowns and even temporary shutdowns. If that happens again in 2022 – even if the inbound traffic is slightly improved from healthier manufacturing inventories and slower consumer demand for goods – port congestion will be a persistent headwind to U.S. dairy exports.

    Regardless, to help mitigate those pressures, USDEC remains strongly focused on leveraging input from our Supply Chain Task Force to prod Congress and the administration to further action to deliver relief for the shipping headwinds facing dairy exporters.

    Global Economy – Scott Lantz

    Turning to the demand side, a crucial signpost for U.S. dairy exports in 2022 will be the purchasing power of international consumers, particularly in China, the Middle East/North Africa (MENA) and Latin America. The reason is simple: in the long run, rising consumer incomes remain the best predictor for dairy consumption growth.

    Let’s turn first to China, the largest dairy importing market. In 2021, the country faced several major disruptions, but little dampened China’s dairy demand as its economy grew by 8%, consumers turned to dairy and importers built up inventories in pursuit of supply security.

    Unfortunately, looking ahead to 2022, the Chinese economy faces several downside risks that could slow purchasing power growth (and thus dairy consumption). Even excluding potential geopolitical tensions or further COVID disruptions, China faces an overleveraged and uncertain real estate market (reflected by major developers defaulting on debt obligations), as well as energy shortages and, critically, rising consumer inflation. As a result, the World Bank estimates China’s gross domestic product (GDP) will grow by 5.1%, a much slower pace than the average pre-pandemic growth rate of 6.6%.

    While growth of 5% from the second-largest economy in the world is still robust and should support dairy demand growth, the effects could be substantial if the downside risks to the economy materialize. China’s slower GDP growth will likely mean reduced dairy consumption gains in Tier 2, 3 and 4 cities, where dairy remains a premium item. Additionally, a slowdown in China would be a significant economic headwind to Southeast Asian markets that export products to China.

    Still, the picture appears more positive once we leave China.

    For one, Latin America, particularly Mexico, remains on the road to recovery from the pandemic, even as COVID-19 still casts its shadow over much of the region. The region’s economic recovery largely tracked with COVID-19 cases: robust in the first quarter of 2021, lost traction in the second quarter, then better through the end of the year.

    Moving into 2022, factors that are not directly tied to COVID-19 will be more relevant to GDP growth, namely inflation, elevated unemployment and government policies. Overall, the GDP outlook for Latin America is forecast to grow at a moderate rate of around 3.0% in 2022, according to the International Monetary Fund (IMF), which should support further dairy demand growth. Mexico, in particular, which the IMF expects will grow by 4.0%, should be buoyed by higher energy prices and a relatively strong U.S. economy even if a lack of investment and uncertain industrial sector present risks to their recovery.

    Perhaps most positively, many MENA economies appear poised to accelerate after a challenging 2021, in terms of GDP and dairy imports.

    Higher oil prices alongside increasing oil production within the region are boosting consumption and investment. Before getting too bullish, however, we should remember that higher oil prices are a double-edged sword.

    Oil exporting countries rightly see higher oil prices as a boon, helping boost foreign-currency-earnings generation capacity. However, the downside is that this can lead to rising inflation and increased prices for all other inputs (like packaging), which may dampen some manufacturers’ output. On the flip side, oil-importing economies face exacerbating fiscal and external imbalances, causing consumer price inflation. Still, higher oil revenues are expected to push real GDP growth in the MENA region from 4.1% in 2021 to 5.2% in 2022, which should support dairy consumption and imports.

    Overall, even while key dairy importing markets face downside risks in 2022, the outlook remains fundamentally positive for economic growth and dairy demand. However, many international buyers will face substantial sticker shock when it comes to dairy prices, which leads us into our final signpost of Part I: price sensitivity.

    Price Sensitivity Loux

    Market observers are well aware that global dairy prices have continued to strengthen. Nearly across the board, prices for the major commodities, regardless of region, have reached multi-year highs (U.S. cheddar naturally being an exception when compared to 2020’s $3/lb. peak). Yet, as discussed above, with elevated input costs on farm, higher prices have failed to translate into much additional milk from any of the major exporting regions. This dynamic will only lend further support to the markets through at least the first quarter. Combine higher prices in general with a strengthening dollar and importers – and consumers – will face historically high prices in 2022.

    Thus, a crucial signpost for global dairy exports is whether record prices, particularly when translated into local currencies, will burn off some demand.

    Generally, we can say that higher prices burn off demand when one of two things are true: 1) there is a much cheaper alternative that is anticipated to remain cheaper for an extended period of time to incentivize reformulation, or 2) consumers in market cannot afford to purchase as much.

    For No. 1, the obvious example is when higher butter prices burned off some demand internationally post-2014 as end-users switched from milkfat to alternative, cheaper fat sources like palm oil, particularly in Sub-Saharan Africa, MENA and Southeast Asia.

    Today, palm oil prices are soaring too – to an even greater extent than dairy prices. Higher palm prices (and higher prices for other dairy alternatives as well) should equate to reduced incentive for manufacturers to reformulate, even if dairy prices are elevated.

    Chart8 (3)

    If there is pushback, it is likely to come instead from the consumer side in a general inflationary environment. Much of that will be determined by the broader macro-economic factors discussed above. The most recent examples of reduced purchasing at the consumer level include Mexico in 2020 and MENA in 2021. In general, we can expect that if there is pushback by consumers to higher prices, it will first be felt by higher-value products (like sports nutrition powders) or premium products (like specialty cheeses) rather than bulk ingredients or cheeses.

    Ultimately, provided there are no major hiccups in the global economy, the demand outlook, at least at the macro-level, appears positive for U.S. dairy exports in 2022.

    Still, there are plenty of nuances depending on the specific dairy product you’re talking about. So stay tuned for Part II where we delve into the key signposts we’ll be watching for each of the major U.S. dairy export products.

    Editor's note: Dairy export signposts, Part II, which delves into specific dairy export products will post next week.

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    The U.S. Dairy Export Council fosters collaborative industry partnerships with processors, trading companies and others to enhance global demand for U.S. dairy products and ingredients. USDEC is primarily supported by Dairy Management Inc. through the dairy farmer checkoff. How to republish this post.  

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