While commodity futures markets from Class III to soybean oil have kept buyers and sellers on their toes, the cash-settled butter futures market has calmly drifted sideways since the beginning of June.

Commodity futures prices are notorious for carrying big premiums or deep discounts based on perceptions of future value. Those price disparities have seemingly evaded the butter futures market lately as prices have reflected a more sensible 1- to 1?-cent cost of carry structure from the spot price. But to those whose bottom line is sensitive to the price of butter, the winds of value may not be so calm to finish out the year.

Although the latest Dairy Products Report showed butter production 9.3 percent above year ago levels, the production trend is lower. In typical fashion, U.S. butter production has fallen since the beginning of the year from over 150 million pounds in January to just over 110 million pounds in June — still plenty of production and inventory to quell U.S. demand.

We’re not looking at a supply issue here in the states. But just as the U.S. butter picture looks rosy for butter buyers, the world picture is quite a bit different.

Due to severe drought conditions in major milk producing regions of Australia, milk production there is estimated to have fallen by more than 5 percent in 2006-07. Persistent drought siphoned irrigation water, causing reduced pasture growth and driving feed costs sharply higher. Any rainfall received earlier this year has not been enough to right the problem and expectations are for a continued loss of milk production.

That loss has then markedly reduced dairy exports. Estimates vary, but it’s safe to say the value of dairy exports out of Australia has declined by about 12 percent over the past year.  

In the European Union — another of the world’s large dairy product exporters — milk production is expected to grow by 1.5 to 2 percent in 2007. That production is expected to be largely offset by strong EU demand. The effects of strong domestic demand and a slow growth outlook, which have rationed those available supplies by pushing EU butter prices to more than $2.40 per pound, are amplified by the recent export subsidy cutbacks of the European Union’s Common Agricultural Policy. Those cutbacks will only further hinder dairy product exports.

So what does the admittedly brief world overview mean for the price of U.S. butter? So far, not much. There has been no wall of worry to climb as U.S. butter buyers are quite comfortable with the supply of milk flowing into butter/powder plants. The same milk that goes to make high-priced nonfat dry milk to quench the world’s thirst is also making pallets and pallets of butter.

Since the end of May, the CME Spot Butter price has had a 10-cent trading range, with the high-end stalling in the mid-$1.50 range — not what I would call a “sleeping market,” but not nearly as volatile as other commodities.  

Still, butter’s day for volatility may not be too far off. If butter consumption at home and abroad remains strong over the next year, the risk of substantially higher butter and cream prices will undoubtedly grow.

For now, I’m not too concerned with U.S. supply. The best bull markets in history are demand-driven.