By Bob Yonkers, IDFA Vice President and Chief Economist
By now everyone in the U.S. dairy industry should be very familiar with the growth of global dairy trade in the past decade. Especially noteworthy is the growth in the demand for U.S. dairy products. The growth is the result of a number of factors, but the key has been policy changes, both in domestic policies in many countries around the world and trade policies in multilateral, regional and bilateral trade agreements.
One result of this trend toward greater globalization in the dairy industry has been a narrowing of differences between dairy product prices in various countries. Admittedly some significant differences between domestic dairy prices and world prices still exist in some countries due to attempts to hold on to protective domestic policies, but the trend in most countries is for less government intervention in dairy markets. Certainly domestic dairy policies here in the United States, and our willingness to enter into free trade agreements have resulted in a greater convergence of U.S. and world dairy market prices.
Therefore, it is unusual to see the situation being experienced in the butter markets over the past two months. In the spot (cash) market at the CME Group in Chicago, the wholesale price of butter has risen in recent weeks to over $3.00 per pound, exceeding the previous record high of $2.81 set in 1998. Meanwhile, at the Global Dairy Trade exchange in New Zealand, butter prices have fallen in recent weeks to about $1.20 per pound. So, what is going on here?
Pricing Reports Reflect Differences
First, let’s look at these markets and other dairy market price data. The CME Group provides a trading opportunity every week day for sellers and buyers to exchange loads of butter for delivery in the next few days. The reported price is a local price, meaning that if the sale occurs between a seller and buyer who are both on the West Coast, for example, the CME Group reported price is higher than the actual sale price due to a location adjustment.
The Global Dairy Trade (GDT) provides a trading opportunity every two weeks but not for immediate delivery. In fact, at every auction there are six contracts that could be traded, one for each of the next six months beginning with the next month. At the most recent trading event held September 16, for example, the first contract was for delivery by the end of October and the sixth contract was for delivery by the end of March 2015.
Many market reports of trading results at the GDT give only one price, usually a weighted average of all trades for all six contracts. So one reason for the difference in prices is that the CME Group spot butter market is a price for butter delivered today, while the GDT butter price is an average for butter to be delivered over the next six or seven months.
The GDT has only been offering this trading opportunity for a few years now, and initially only butter from the New Zealand dairy cooperative Fonterra was offered for sale. Today other dairy cooperatives and manufacturers also offer butter for sale.
Of course, there are other price series on butter available around the world. Several sources report butter prices in Europe, usually weekly, for local prices there. In the United States, the Agricultural Marketing Service (AMS) of the U.S. Department of Agriculture reports every two weeks on international market prices for selected dairy products in specific regions of the world regarding sales that occurred during the previous two weeks.
For butter, AMS reports a price for both Europe and Oceania; the last report was for the two-week period ending September 12, and the reported prices were $1.70 for butter in Europe and $1.35 for butter in Oceania. Because this price is for current sales during this period and not for sales to occur over the next six or more months, many comparisons between U.S. prices at the CME Group spot market and world prices use this price series. The data is available here.
Trade Barriers Play a Role
Second, while international trade agreements over the past 20 years have resulted in fewer barriers to move product around the globe, barriers still do exist. For example, the United States permits a limited quantity of butter to be imported every year while paying a low import tariff; this quantity is known as the tariff rate quota or TRQ, and the low import tariff is called the within-quota tariff. For quantities above that limit, a much higher import tariff, called the over-quota tariff, must be paid.
The over-quota tariff for butter to be imported into the United States is about 68 cents per pound, which is paid to the U.S. government, but there are other costs involved. The most obvious is the cost of transportation, followed by other costs like changes in packaging and labeling. So, unless the U.S. domestic butter price is more than 75 cents to 80 cents per pound higher than the world butter price, the United States is not an attractive market for butter imports.
How often is the U.S. butter price more than 80 cents above the world butter price? Not very often. As seen in Figure 1, the last time the U.S. butter price as reported by AMS was above world butter prices for any length of time was more than seven years ago. Since the summer of 2007, the U.S. butter price has consistently been lower than the AMS reported price for Europe, and often it was at or below the AMS reported price for Oceania also.
Remember that it requires a difference of over 80 cents per pound for imports to be competitive with U.S. butter prices. The last time that happened was in the second half of 2004, and the difference only lasted for about a month. However, there were several months in the first half of 2004 when U.S. butter prices exceeded world prices by much more than 80 cents per pound.
All Butter Not Created Equal
So, now that we have reached, and far exceeded, that magic 80-cent difference between U.S. and world butter prices, why aren’t imports of butter flooding into the United States at prices below the CME Group spot market? There are several reasons.
First, unlike you or I, butter does not travel around the world on airplanes; it moves first by truck or train from a manufacturer or storage facility to a port and then by ship to the United States, and that takes time. Second, no foreign supplier wants to be caught with product on the water or at a U.S. port when prices quickly adjust back to more historical relationships; look at late 2004, when the 80-cent per pound difference was reached but quickly eroded. It takes more than a week or two, or even a month or two, of prices remaining high before foreign suppliers become really interested in sending butter to the United States.
Third, not all butter is created equal, and that is a very important point. In the United States, we mostly consume USDA Grade AA butter, which requires the product to contain at least 80 percent milkfat, and we like the salted variety. Unfortunately, we are the only major market in the world that mostly consumes 80 percent milkfat, salted butter. The rest of the world mostly consumes butter with a minimum of 82 percent milkfat and no salt.
So there is no butter that is 80 percent milkfat and salted just sitting around in warehouses waiting to be sent by truck, train and ship to the United States. This makes sense since the last time the U.S. market was an attractive destination for foreign manufactured butter was 10 years ago. Think of U.S. butter as a special order: A foreign manufacturer would have to change its type of butter output from 82 percent milkfat, unsalted, to 80 percent milkfat, salted; change its packaging; and store and transport the butter separately from its regular production and shipments for any country other than the United States.
U.S. Dairy Exports Soar
Clearly, one reason for U.S. butter prices to be moving up in recent weeks is that U.S. exports of butter and other dairy products soared in the first half of 2014. This meant more of the U.S. milk production was used to manufacture products for export customers. Most in the United States welcome that increased demand for our products.
But the U.S. dairy industry has a long history of building inventories of butter in the first half of every year when milk and cream tend to be more plentiful. Those inventories then are used to serve domestic demand later each year, especially in the fourth quarter for holiday baking and other events. We are now in a period when retailers and other domestic customers are looking for more product to meet expected demand next quarter, and they’re willing to pay to make sure that product is available.
So, while the rest of the world is seeing lower butter prices, the United States is dealing with lower butter inventories heading into peak demand season. However, U.S. markets appear to expect that domestic demand will ease over the next few months and/or supplies of butter will grow due to greater domestic production or lower U.S. dairy exports. It’s also possible that foreign butter will start to show up here.
The markets are forecasting that the current market situation likely will change by the end of the year. At the CME Group, butter futures for the December contract are trading at $2.10 per pound. Contract months into 2015 are trading at prices between $1.69 and $1.82 after January.