USDEC offers a preview of the new year, identifying the factors that will shape U.S. dairy export opportunity.
After most political prognosticators so spectacularly botched their predictions during this year’s presidential election, forecasting the future feels even more treacherous than usual. With that in mind, rather than offer a prophecy for dairy exports in 2017, the following five points are more akin to indicators.
These five factors will shape the strength of the U.S. dairy export supply opportunity in the new year.
1. The European Union (EU) spring flush. It took more than a year for EU milk output to respond to the global oversupply. Even as European commodity prices hit their lowest level in nearly a decade, farmers kept producing more milk, in many cases cushioned (at least temporarily) by processors offering additional support to maintain volumes at levels necessary to maximize the efficiency of manufacturing investments made in the run-up to quota removal.
After 14 straight months of year-on-year milk production gains, EU dairy farmers finally bowed to persistently negative market signals in June 2016. Milk production declined 1.8% from June-September, compared to the previous year. That trend is likely to carry through the fourth quarter, particularly given that farmers fully subscribed to the bloc’s voluntary milk reduction scheme, which pays them to produce less milk in October-December (with a small bit of spillover into January). Simply signing up for the scheme does not bind them to reduce output, but many are doing so already anyway.
Heading into 2017, however, the picture becomes less clear. EU farmgate prices are rising—up 10% from July-October—and all that new stainless steel didn’t just disappear. European butter, powder and cheese prices rose 22-68% since their trough in the spring.
The question is: Will the turnaround be enough to reinvigorate farmers in 2017, particularly in those states that contributed the biggest gains over the past two years, including Denmark, Ireland and the Netherlands.
While New Zealand production remains an important swing factor, the EU is the 800-pound gorilla in the room. A 1% shift in EU milk production equates to 1.5 million tons of milk. Ongoing declines and shrinking global shares, have made incremental production shifts in Argentina and Australia less impactful.
2. Demand headwinds. Global dairy demand will face some headwinds in 2017 as products grow costlier than 2016. International commodity prices are rising and will begin to filter through to consumers at the retail level. Recent forecasted increases in the value of the U.S. dollar could exacerbate the hikes.
Since the U.S. presidential election, the U.S. dollar has strengthened considerably, rising 2-8% against the currencies of major U.S. dairy buyers and main competitors. For many, it was a change of direction. While the Chinese renminbi and Mexican peso had been depreciating much of the year, other currencies had actually gained on the dollar in 2016.
The U.S. dollar index reached a 14-year high shortly after the election, and economists now believe it will rise higher under the new administration.
The main area of concern for a rising dollar is the potential impact it has on overall demand from major importing nations. Because dairy trade is denominated in U.S. dollars, a strong dollar could lift import prices that will eventually work their way through to consumers and potentially deter consumption. That can curb demand growth, and that would be bad for dairy exporters from all countries.
Oil prices could further restrict demand in oil-producing nations. The two-year slump in oil prices has strained economies across the Middle East, in Venezuela and elsewhere, undercutting dairy demand. Oil accounts for about a quarter of Venezuela’s economy and 95% of its exports, for example. The nation, traditionally a major dairy buyer, has cut dairy import volume by nearly 75% over the past two years.
OPEC members reached a compromise to cut production in late November, which could raise national incomes amongst many dairy importers, but that deal is contingent on non-members contributing to the reductions, an uncertain proposition to actually reduce global oil surpluses.
3. Dairy stockpiles. At the end of November, the EU was holding 355,000 tons of intervention skim milk powder (SMP), while an additional 70,000 tons of SMP and 75,000 tons of butter was housed under the bloc’s Private Storage Aid program. U.S. butter and cheese inventories reached record highs of 122,000 tons and 562,000 tons, respectively, at the end of September, while nonfat dry milk/skim milk powder stocks were almost 100,000 tons.
Global milk production growth may be declining and commodity prices rising, but we are still facing a substantially well-supplied market. The question heading into 2017 is: Can those inventories be metered out without swamping the nascent market recovery we’ve seen over the past few months?
We should get a taste for the global appetite for some of those stocks even before the New Year. This month, indicating it had seen adequate signs of dairy recovery, the European Commission decided to test the appetite for a limited volume—22,150 tons—of intervention SMP via a tender process. It is accepting bids through tomorrow, December 13.
4. U.S. trade policy. Any time a new president prepares to take office, questions arise about the incoming administration’s trade policy positions. President-elect Trump is no different.
Although the president-elect repeatedly criticized previous free trade agreements (FTAs) during the campaign and brings with him potential trade risks (such as previous threats to impose punitive tariffs in key markets and launch FTA renegotiations), he also brings the potential beneficial prospect of new bilateral deals. Indeed, signs exist of interest in exploring a new set of bilateral FTAs in the near term.
Given this combination of potential opportunities and possible challenges, USDEC will be providing information to the new administration with the goal of ensuring that current dairy trade continues to flow unaffected and that we harness the appetite to take a fresh look at U.S. trade policy by steering it in a direction that would be helpful to American agriculture, including, for instance, expanded work on enforcement issues to hold U.S. trading partners to their commitments.
Much is at stake in 2017. U.S. dairy export competitors are not standing still when it comes to trade. The EU continues to aggressively pursue FTAs and, despite internal populist pressures in some markets, will likely keep going. Asian countries are discussing a possible regional agreement parallel to or in lieu of the stalled Trans-Pacific Partnership. Australia and New Zealand already have free trade agreements with China, and New Zealand and China recently announced plans to launch talks to expand their deal, including its dairy provisions. The United States needs to be active in moving forward itself in order not to get left behind.
5. China’s product mix. Chinese dairy imports jumped 15% on a milk-equivalent basis in the first 10 months of 2016 (compared to January-October 2015). While whole milk powder (WMP) volume—the product that cemented China’s place as the world’s largest dairy buyer—rose 18%, trade data from the past five years indicates that we are seeing an evolution of Chinese dairy demand.
Chinese imports of fluid milk, cream, cheese and infant formula are well on their way to record years, with volume up 27-51%. Jointly, they accounted for 16% of China’s dairy import volume (milk equivalent) in January-October 2016. This marks the second straight year they held a double-digit slice of the pie—a clear shift from the aggregate 7% import share they averaged from 2012-2014.
WMP still commands the largest share of the dairy imports—30% (355,128 tons) in the first 10 months. But that share is down from 45% and volume is down from 621,010 tons during the 2014 peak when China overbought.
Few have doubts about China’s bright future as a dairy importer. But the mix of products it wants to buy appears to be shifting. Next year will provide further hints of its direction.
Other factors worth watching
The complete list of factors potentially influencing global dairy opportunity is virtually endless. And while we believe the five factors above are the main ones to watch, a handful of other notables deserve a mention, including:
Mexico’s U.S. dairy appetite. Despite significant depreciation of the peso in 2016, U.S. dairy exports to Mexico displayed surprising resilience. Most notably, U.S. milk powder shipments jumped 13% by volume in the first 10 months compared to January-October 2015, as the nation purchased 46% total U.S. milk powder exports. U.S. cheese exports to Mexico declined 4% through October, but the United States increased its share and Mexico remains the biggest U.S. cheese buyer by far.
In all, Mexico accounted for 26% of total U.S. dairy export value ($1 billion) through the first 10 months, up from an annual average of 23% from 2010-2015. In 2017, the question will be whether Mexico’s dairy appetite will rise, particularly in the key U.S. sectors of milk powder and foodservice cheese, and whether U.S. suppliers will devote the focus and resources to defend and grow their share in this critical market in the face of rising competition from Europe and Oceania.
New Zealand’s product mix. The bursting of the Chinese WMP bubble in 2014 drove home the reality that New Zealand had overcommitted to powder production. The nation, and most notably its near-monopoly dairy supplier Fonterra Co-operative Group, recommitted to diversifying output into pediatric nutrition, cheese, foodservice and other higher-margin products through both plant investment and product innovation. In other words, New Zealand is seeking to channel more milk toward products that compete directly with U.S. exports, rather than WMP where the United States is only a minor participant.
The coming year will provide more hints as to how successful the country’s industry will be in producing those products despite the highly seasonal nature of Kiwi milk production and the gearing of its manufacturing toward powder.
China regulations. China continues to evolve its food safety regulations to reduce the incidence of adulteration, contamination and counterfeiting that has undermined trust in the domestic food supply. Those attempts to shore up its food safety system have had far-reaching consequences for all dairy and food exporters looking to do business there, as evidenced by China’s facilities registration requirements. New e-commerce rules on infant formula and other dairy products are set to take effect in the spring of 2017. But the bigger question is, Might there be more changes in store?