Tools to Price Your Milk Powder in the Global Marketplace

If someone asks you to name the current cheese price, you would probably quote the latest CME block cheddar close. And if you want to hedge your milk costs, your cheese sales or your inventory values, you can do so relatively simply using CME Class III or cheese futures. But if you’re in the milk powder business—either a seller or a buyer—how do you know what a load is worth? And how can you hedge against price movements when prices are all over the board, each series has different rules on which transactions are included and each actor may price off a different series?

Consider: one week in mid-April, the CME spot price for Grade A nonfat dry milk (NDM) averaged $1.78 per lb.; nearby NDM futures settled at $1.53; Dairy Market News reported that Western NDM was mostly trading in the range of $1.57 to $1.71; the USDA weekly price survey averaged $1.55; the California Weighted Average Price was $1.50; Global Dairy Trade auction winning bids for skim milk powder (SMP) averaged $2.16; and Dairy Market News said Oceania SMP was trading for anywhere from $2.18 to $2.87.

This isn’t an atypical example. And this isn’t just a powder issue. The NDM price has a direct impact on more than one-third of the milk priced in the United States, and an indirect impact on just about all the rest, regardless of region. All milk and product prices are linked, so to some extent as powder goes so goes milk, cheese and whey values as well.

Further, powder markets are especially volatile because NDM/SMP is the last product produced from the milk stream. Therefore, even small changes in global milk supply have big impacts on the NDM/SMP supply.

While price volatility is a common feature of the dairy business today, many have learned to mitigate it where fully-functional risk management tools are available. Unfortunately, because of the complexity and inconsistency of milk powder price discovery, risk management tools just don’t work here. Futures and options aren’t liquid enough, in part because there’s no common benchmark price.

In short, our ineffective price discovery system for milk powder makes it almost impossible to manage volatility and impairs our ability to respond to market signals, extracting costs to everyone in the supply chain.

Formulating solutions

An industry work group, gathering under the auspices of the Innovation Center for U.S. Dairy® —a pre-competitive forum for the industry established under the leadership of America’s dairy farmers through the dairy checkoff program—is addressing this issue and formulating solutions.

Collecting input from a wide range of stakeholders, the work group is evaluating various remedies to improve price discovery and reporting. Most agree the CME cash market can be a good price indicator, but improvements are needed. They also agree government reports don’t always reflect current market conditions, rules regarding which transactions are included need to be examined, and lags in price reporting delay price signals to the market. These concerns don’t weigh specifically on either the California or Federal Orders. But the group recognizes that if you get price discovery right and link it to futures, the futures volume and liquidity will naturally come.

At a late-April meeting, the work group agreed to drive several potential fixes, including a proposal to move CME spot trading to an electronic platform to boost activity and make the exchange more relevant; a request to directly link NDM cash and futures to enable traders to execute spreads between the two; and engaging in further consultations on the best ways to improve price reporting. Preparation is under way to outline the solutions and engage interested industry participants. There is widespread industry support for change and a sense of urgency to make it happen.

The health of the entire U.S. dairy business is predicated on becoming a consistent supplier of milk powder—our largest export product. But unless the industry fixes its broken milk powder price-discovery process, it will continue to suffer from damaging volatility, lost competitiveness and eroding global market share.

(This article first appeared in Cheese Market News in May 2013.)

The U.S. Dairy Export Council is primarily supported by Dairy Management Inc. through the dairy farmer checkoff that builds on collaborative industry partnerships with processors, trading companies and others to build global demand for U.S. dairy products.