Management: Balancing Act

U.S. dairy farmers now global market balancers

Over the past decade, the dairy world as we’ve known it has changed.

The European Union has decided it no longer can afford to subsidize surplus dairy products from its farmers. Almost overnight, it seems, global dairy product prices jumped to the level of the next residual supplier—the U.S. dairy farmer.

"The U.S. has been dropped into a new role as a world exporter and world balancer of global dairy markets," says Mark Stephenson, director of dairy policy analysis at the University of Wisconsin.

The European Union is still the No. 1 dairy exporter followed closely by New Zealand. The U.S. is now ranked third. With its vast agronomic resources and ability to rapidly ramp up dairy production, the U.S. is often the country others look to when they need extra dairy products.

Though changing, the U.S. still supplies mostly commodity-type products. So it is also among the first to see orders canceled when there are unforeseen shocks to the global economy.

The biggest beneficiaries of this new world dairy order are New Zealand dairy farmers. Kiwi milk prices have tripled from their levels in the early 1990s. But because New Zealand produces milk by grazing, the only way to expand is to buy more pasture.

Just like corn farmers in the Midwest who have bid up land prices on the strength of $7 per bushel corn, Kiwi farmers have capitalized higher milk prices into astronomical land prices. "New Zealand land values increased sevenfold between 1998 and 2008," Stephenson says.

Once they’ve sunk money into land, however, those costs become fixed. "The goal then is produce as much milk per hectare as you can," Stephenson says.

The U.S. cost structure is much different. Fixed costs are smaller, but U.S. variable costs—most notably feed—are double those of New Zealand.

From an economic standpoint, it only makes sense to continue to produce milk, at least short term, when milk prices exceed variable costs.

The U.S., however, is not one monolithic industry that produces milk in the same way across the country. The Midwest and Northeast have more dollars sunk into land and facilities, and grow much of their own feed. Dairy producers in the West buy a larger percentage of their rations.

In other words, Western producers have higher variable costs. Thus, they are the first to feel the cost-price squeeze. And that is exactly what has happened—both in 2009 when milk prices plunged and in 2012 when feed prices went through the roof.

In essence, Western milk producers are balancing the U.S. milk supply and the world milk supply, he says.

What can U.S. dairy farmers do? Stephenson suggests:

• Some U.S. farms might buy more land to grow more feed to reduce purchased feed costs.
• Some U.S. farms will need to actually plan to turn off production in a down phase.
• Many dairy farms will need to use more risk-management tools—which require time and attention but do work.
• Dairy policy and regulations need to be evaluated as to whether they help or hinder U.S. farmers competing in a globalized market.