Milk Money
By Ron O’Brien
How Susceptible is Your Bottom Line to 2006 Price Spikes?
As we look ahead to 2006, price projections for dairy products look relatively favorable for end users. If the current 2006 average of $12.96 holds it would be the fourth lowest Class III average in the past 10 years.
Coming off two banner years for milk producers, rapid herd and milk-per-cow increases could cause supplies to outpace demand next year. However, don’t bet the plant on it just yet. Despite record milk production during fiscal year 2005, strong demand and extreme weather conditions could leave the door open for a 2006 price rally.
Global dairy product supplies were unable to recover from 2004 weather patterns, and a weak U.S. dollar has made every type of U.S. product extremely competitive overseas.  The seemingly insurmountable pile of government surplus nonfat dry milk stocks, costing taxpayers millions of dollars in storage fees, disappeared in a flash. Even 3- to 4-year-old skim powder continues to undercut markets abroad. Block cheese prices ending last year at $1.90 averaged $1.53 the first seven months of 2005, and butter prices made 2005 highs in early August. Both products performed well above price projections made by most analysts at the end of 2004. By year’s end, Class III prices should experience the third-highest annual average ever.
Unprecedented year-over-year milk production gains and anticipation of cheese production outpacing demand are key factors as to why one would anticipate further price decreases into next year. However, there are other variables outside of the three monthly dairy reports to which we must pay respect.
Cooperatives Working Together (CWT), a program designed to support milk prices for National Milk Producers Federation members, is currently making waves in the deep end, retiring 50,000 head in the past year as well as implementing a dairy export subsidy to further stimulate demand outside of the United States. Rumors of another retirement have also had an impact on late 2005 and 2006 futures. Their target block and barrel support price of $1.40 has yet to be seriously tested with price dips below that level met with aggressive buying interest. The psychological support price of $1.40, if anything else, has changed how many in the industry manage their purchases. CWT, hailed as a success so far, will continue to grow in membership and look for ways to support milk prices.  
Mother Nature always remains a key variable for price projections. Near record rains dramatically reduced hay crops to start the year and the lack of precipitation seven months later has led to near dustbowl conditions in the Midwest, currently raising fears of shortfalls in 2005-06 ending corn and soy stocks. Record summer temperatures throughout the nation in the past two months have successfully disrupted both milk per cow and component levels, yet the demand for butter and cream remains strong. The market consensus during the beginning of May was overwhelmingly bearish as prices were heading to $1.30. Now fast-forward just two months and prices are 40 cents firmer to $1.73, as of August 8.
That said, why have these sustained higher prices led to dramatically lower open interest and futures volume at the Chicago Mercantile Exchange? Because most end-user orders are sitting well under the market while producers, unwilling to sell their milk and face negative PPD, have for the most part thrown out five- and 10-year averages as targets following last year.
If history prevails, prices will eventually fall but it may take longer than year’s past. With milk production reports of 5 percent more milk than year prior unable to bring sellers into the marketplace, buyers are placing orders higher and earlier than where they have in the past.
Volatility will continue to affect balance sheets until managers throughout the industry learn to utilize price risk management tools available. The market’s consensus has projected supply to outpace demand during 2006, but the focus should truly be this — are you prepared if it doesn’t?  
Ron O’Brien is a dairy broker with Chicago-based commodities brokerage Downes-O’Neill LLC.