USDEC identifies the key issues, trends and signs for the U.S. dairy industry to watch as the world struggles to recover from the COVID-19 pandemic.
In the midst of the uncertainty, below are USDEC’s revised signposts for 2020 amid the COVID-19 crisis. These nine signposts, like signposts on a road, will indicate the direction of U.S. dairy exports in the uncertain year ahead.
1. Global Health and Economic Impacts of COVID-19
The first area to watch is the one that will be most visible to readers but least connected to dairy: public health, lockdowns and the economic implications, which are all interconnected.
As governments grapple with slowing the spread of COVID-19 and minimizing its impact on public health, the world’s economies are grinding to a halt. Recovery in China has been slower than hoped for so far in Q2, while the world’s other major economies are entering severe recessions. Quarantine measures, general uncertainty and stifled cash flow are impacting both individuals and businesses. The IMF projects global GDP will decline by 3.0% in 2020 with advanced economies taking the biggest hit with a forecast contraction of 6.1%.
In the short term, the macroeconomic uncertainty is strengthening an already-strong dollar as investors prioritize security. This impacts several key dairy importing countries, namely Indonesia, Malaysia and, most dramatically, Mexico.
A strong U.S. dollar makes all dairy imports more expensive in the local currency, which will dampen demand in price sensitive markets despite lower prices in U.S. dollar terms. The dollar should return to a more normal level as the global economic situation stabilizes, but how long that takes will be a key factor to watch for international dairy demand in 2020.
In the longer term, a prolonged recession will reduce purchasing power for consumers, which will in turn change eating habits. Namely, consumers will probably eat out in restaurants less frequently, even after quarantine measures are relaxed, and gravitate away from more specialty items when they go to the grocery store.
In international markets, a major signpost to watch will be whether consumers in importing countries view dairy as a diet staple or more of a luxury for special occasions if wallets are tighter.
2. Oil Prices
Alongside the economic turbulence from COVID-19, oil prices plunged in late February-early March as global energy demand fell and geopolitical disputes between Saudi Arabia and Russia resulted in increased output. For dairy, low oil prices reduce purchasing power for major energy producers. This will most readily affect Middle East/North Africa buyers, who purchased 21% of the world’s butterfat, 20% of the globe’s milk powder, and 13% of world’s cheese in 2019. While the EU is the predominant supplier to the region, any reduction in demand will result in more product without a home and increase competition in other markets.
The collapse in oil prices and COVID-19 disruption is also exacerbating underlying economic weakness in the U.S.’s largest market, Mexico. Mexico’s GDP had already declined by 0.1% in 2019 as government spending fell alongside decelerations in manufacturing activity and investment partly due to an uncertain policy environment. Now, with the U.S. economy under pressure from COVID-19, a sluggish government response to pandemic, and plunging oil revenues, the International Monetary Fund is projecting a 6.6% decline in real GDP for 2020.
Readers will want to watch how a severe recession in Mexico impacts dairy demand, especially for cheese.
Initially, Mexico will experience a similar decline in foodservice demand as lockdowns on restaurants and physical distancing requirements persist. This will weigh negatively on cheese demand even as retail sales likely accelerate in the short-term as consumers stock up. As day-to-day life returns to some normalcy, consumers will probably be working from a tighter budget and dining out less regardless of prolonged distancing requirements. Dairy is a strong staple in the Mexican diet so overall consumption may be stable, but more expensive imports or cheese used in foodservice may be impacted.
Additionally, a severe contraction and lack of investor confidence in Mexico’s economy will continue to weigh on the Mexican peso. As mentioned, the rapid decline of the peso makes imported product more expensive. In fact, the peso’s decline has been so severe, Mexican buyers have essentially missed out on the decline in price in the U.S., especially for NFDM/SMP. With Mexico buying roughly half of U.S. NFDM/SMP exports and more than a quarter of U.S. cheese exports, reductions in purchasing power and/or overall demand will be a key factor to watch in the months ahead.
4. China’s Recovery
For signs of recovery, exporters should watch the market where the COVID-19 pandemic first hit: China. China remains the world’s largest dairy importer, importing roughly 19% of global dairy exports, and the country’s recovery of foodservice and dairy demand will play a major role in global demand in the months ahead.
China’s demand will be impacted by two factors. First, inventories of milk powder are reported to be heavy. Domestic milk production is geared towards fresh milk outlets, including Starbucks, boba tea, etc., but with those shut during the lockdown, domestic milk production was sent to the dryer for storage.
Accurate figures on production and inventory levels are notoriously difficult to estimate in China, but it seems a safe assumption this will weigh on powder demand in the months ahead.
The second factor, especially for U.S. exporters, will be how quickly China replenishes its pig population following the devastation of African Swine Fever. Prior to COVID-19, China began buying more whey, and there were frequent reports of China’s herd rebuild. Likely some of that was put on pause during the lockdown period, but fundamentals still suggest China will want to restock quickly. This will drive international whey demand as China buys roughly one-third of the world’s whey exports.
Additionally, the Phase I U.S.-China trade deal should create opportunities for U.S. exporters to recover and expand market share. The question will be how much China wants to buy and whether importers will prioritize U.S. suppliers in an effort to abide by the terms of the agreement. The Phase I deal also allowed whey permeate to be used in food applications, rather than just feed. While it may take several years for this market to fully develop, U.S. exporters can lay the building blocks to capture a large, previously undeveloped market for whey permeate in 2020.
5. Southeast Asia's Appetite
If demand is limited in Mexico and China, the United States and other global exporters will be focusing heavily on Southeast Asia. As a region, Southeast Asia bought 30% of global NFDM/SMP exports in 2019 – roughly double the volumes of Mexico – and 28% of global whey exports. The region’s cheese demand is smaller relative to its demand for other dairy products, but it still imports around 130,000 MT annually.
Observers should watch how hungry Southeast Asia is for dairy imports, even at lower prices. COVID-19 is changing daily life in Southeast Asia as governments implement aggressive policy measures to contain the virus. In Singapore, for instance, tightened regulations have shuttered a variety of food manufacturing and retailing facilities.
The region’s economic outlook is heavily dependent on China’s performance, which remains subdued even after measures to open the economy have gone into effect. The uncertain GDP outlook is compounded by weakening currencies in Indonesia, Malaysia and Thailand.
For U.S. exporters, there is ample opportunity to gain market share and increase volumes even if overall demand takes a step back in the region. The U.S. accounted for 24% of total solids shipped to Southeast Asia in 2019. With U.S. prices competitive, we should see U.S. market share climb. The signpost to watch will be how much Southeast Asia is willing to buy and of what product.
Although this article is focused on the signposts for U.S. exports in the months ahead, dairy consumption within the United States will play a major role as well. Demand from foodservice and school channels is drastically reduced in the U.S., leaving significant quantities of fluid products, cream, butter and cheese without a home, and dramatically pushing prices down to lows not seen in more than a decade. That means more cheese and butter – two products that are primarily geared towards the domestic market – will need to find a home overseas to avoid going into storage.
A similar phenomenon is occurring in the EU. With foodservice closed, European suppliers will also need to export more product. However, the impacts of reduced foodservice sales have been delayed by virtue of a greater proportion of cheese and butter going towards retail. As a result, the U.S. is the most competitive supplier in the world as of writing, so U.S. market share should tick up globally and in many markets where the U.S. was not previously competitive.
7. Global Inventory Levels
With reduced domestic dairy consumption in the United States and the EU, a large spring flush in both markets, and headwinds in the international market, global inventory levels are anticipated to reach record levels.
Milk powders, due to their easier storage, are likely to bear the brunt. The European Commission announced on April 22 that they will provide private storage aid for dairy products. This will provide support to the market in the short-term, but it is unclear if it will be sufficient to avoid public intervention being the most profitable outlet for European manufacturers.
Under EU regulations, the Commission will purchase up to 109,000 MT of SMP at €1,698/MT, or at current exchange levels, about 84 cents/lb. With U.S. NFDM prices hovering near this price point at the time of writing and prices expected to continue downward, it is only a matter of time before European companies sell into the program. This will effectively place a ceiling on global powder markets.
Additionally, while the program is designed to put a floor on the market price, 109,000 MT in storage will likely be insufficient, the EU may need to increase purchase quantities.
Unfortunately, milk powders will not be the only products with heavy inventories. U.S. butter and cheese stocks are on track to reach record levels this summer in the face of widespread demand destruction. This will weigh on prices and necessitate greater quantities needing to find a home in overseas markets.
8. Milk Supply Response
Large buildups of product without a buyer and lower prices are signaling to the market that there is too much milk in the system. Implied Class III and IV prices on the CME are under $10/cwt. At those prices, it is only a matter of time before supply contracts. The question is how quickly milk production recalibrates to this new reality.
In a normal environment, milk production takes time to react. After the 2014 crash in price, the U.S. did not see a reduction in herd numbers until the second half of 2018. The reduction this time should be much quicker due to less equity having been built up in the months preceding the collapse and a much more severe reduction in demand.
Some of the reduction may come from industry initiatives. Some milk is being lost as farmers, cooperatives and proprietary companies dump supplies that no longer have a market. Additionally, National Milk Producers Federation and International Dairy Foods Association put forward a joint proposal for the U.S. Department of Agriculture (USDA) to temporarily incentivize a voluntary reduction of production to shorten the milk price pain without an overhang in inventory. At time of writing, USDA initial proposal doesn’t contain any milk reduction incentives..
Observers will want to watch USDA’s reported herd levels to get a sense as to whether and how drastically production is contracting, which will help gauge whether the market begins the road to rebalancing. However, regardless of whether the herd contracts quickly or more slowly, there will remain plenty of product available for export.
9. Impact of Low Prices on Global Demand
One potential positive signpost to watch in the months ahead is whether low prices throughout the dairy complex encourage buyers to increase their volumes. For instance, NFDM/SMP has returned to the lower price band it occupied from 2015 to mid-2019. During that time, global demand for NFDM/SMP increased by 3.8% annually. While the factors outlined above – namely concerns over purchases by Mexico and China – will weigh on global demand, some buyers in Southeast Asia and other regions less impacted by large inventories may be willing buy greater volumes at lower prices.
The declines in butter and cheese prices, which are well below their historic price bands, may encourage an even more aggressive response from international buyers.
If buyers in the Middle East or North Asia react to these historically low prices with larger orders, that will provide an outlet to the heavy inventory situation, particularly if they source from the U.S. Although this will not be an immediate panacea to low prices, greater buying activity by international customers will return the world to balance more quickly.