North American dairy farms are struggling today, thanks to trade wars, shifting consumer preferences, a worldwide milk surplus, and a complex, often opaque pricing system. In early 2014, U.S. cheese exports reached a record high fueled by a 100% increase to China, a 142% increase to Australia and a 48% increase to Mexico. It takes about a gallon of milk to make a pound of hard cheese, so dairy farmers were running at full throttle to keep up with demand.

Then markets tumbled.

China realized it had imported too much milk powder. Russia banned most food imports from the United States. North America was awash in milk, and consumer tastes were changing to favor a wide range of other beverages such as sports drinks. A worldwide surplus of milk has driven down the price farmers receive to the point where many have lost money for months, or even several years, at a time. Nearly 3,000 U.S. dairy farms folded in 2018, according to U.S. Department of Agriculture figures.

Even the cows have lost value. As recently as 2017, dairy cows sold for about $1,500 or more in Wisconsin. Today, they often sell for less than $1,000, and farmers who used to rely on selling heifers and calves to supplement their income have lost much of that revenue.

Dairy Pricing

Fresh milk, unlike corn, soybeans or other agriculture commodities, can’t be placed in storage while farmers wait for higher prices. Milk prices in the U.S. are based on a complicated patchwork system of formulas and rules dating back to the 1930s. The U.S. Department of Agriculture sets minimum prices based on the value four categories of products made from milk. Class I milk is for beverage products. Class II is for soft dairy items, such as yogurt, ice cream, sour cream and cottage cheese. Class III is for hard cheeses. Class IV is for butter and powder products such as nonfat dry milk.

Calculating the prices begins with valuing cheese, dry whey, nonfat dry milk and butter using weekly average wholesale marketplace trends monitored by the USDA. The actual minimum price received by farmers is a blend of prices weighted by the percentage of milk used in each class. They may receive premiums over the minimum price based on the value of various milk components, such as the amount of butterfat and protein.

Farmers can also use forward contracting to lock in prices, reducing risks but limiting the upside should market prices rise more than expected. This complex pricing system leaves farmers in limbo, sometimes not knowing what they’ll be paid until a month after their milk is shipped to the processor.

Economies of Scale Push Prices Lower

Large dairy farms, farms with 1,000 cows or more, benefit from economies of scale. They can negotiate lower prices for necessities, such as animal feed, and have lower costs of production, per hundred pounds of milk, than most small farms.

However, as profit margins shrink, they squeeze out increasing amounts of milk to cover their costs which adds more milk to the market and erodes prices even further. An average cow today produces almost four times more milk than it would have in the 1950s, thanks to advancements in genetics and feed science. But lowering prices are hurting large farms as well, and some big farms have closed in Michigan, Texas, Colorado and New Mexico.

Tariffs Worsen Dairy Crisis

The U.S. dairy crisis was worsened when China and Mexico imposed steep tariffs on U.S. dairy products in retaliation for U.S. tariffs on foreign aluminum and steel. Mexico is the largest foreign market for American dairy products, importing $1.4 billion in dairy products in 2018 – 25% of U.S. dairy exports. If the U.S. and Mexico continue at odds, Mexico could look to other providers and the U.S. dairy market could be hit even harder.

Learn how one dairy company is making better hedging decisions, minimizing exposure with Eka.

Technology Enables Smarter Trading

In order to profitably navigate challenging dairy markets, dairy companies need a flexible, easy to use CTRM software solution for managing complex pricing, changing trade policies, and escalating risk. They need advanced analytics with the ability to run real-time scenarios to help them determine the best choices for their products.

Eka’s app-based CTRM system provides just the functionality dairy farmers need to stay ahead in rapidly changing markets. Eka’s apps aggregate and analyze data from multiple data sources across the entire value chain and beyond – including Excel spreadsheets, ERP, and data from external sources like pricing data – to deliver a complete, accurate, real-time picture of the business. Users can view current hedging positions and run simulations to determine hedging policies. They can analyze P&L, track physical inventories, and monitor and manage mark to market, ensuring they are making the most profitable trades.

The key to profitably managing challenging dairy markets lies in real-time data, rapid analyses, and data-based decision making.

Learn how one dairy farm improved hedging effectiveness and decreased risk with Eka’s CTRM software.

Mary DeFilippe spends her days creating engaging content – blogs, white papers, articles, and more – that helps readers better understand new technology. She can frequently be found walking around the office listening to heavy metal music while pondering ideas for her next blog.