Monday, February 27, 2017

Churning at the Price of Butter

You've seen it at your local grocers or in your weekly ad:
Butter on sale! Only $3.99 a pound! Down from $4.50...such a bargain!

Yeah...I may be old, but I'm pretty sure it wasn't that long ago butter was $2.00 a pound, then $2.50 and on sale for $1.99.

Ah, to dream...those days are long past, I'm afraid. My question is, will it ever return?

Being the never-satisfied-gotta-find-all-the-answers-I-can type of person, I decided this morning to go and dig a bit. WHY are prices so high? And WHY have they been high for so long? And WHEN will the prices drop?

You see, I am the type of person who keeps 20 pounds of butter in the freezer. I panic if I have less than say, 12-15 pounds at any given time.

My freezer. No joke.

Back to the butter...Here I am going to throw a lot of information at you, but don't fear, I will sum it up at the end:

According to the National Dairy Product Sales Report which came out Feb. 23, 2017:
Butter prices averaged $2.16 per pound for the week ending February 18, 2017. The United States (US) price per pound decreased 5.1 cents from the previous week.
The Dairy Product Mandatory Reporting (DPMR) program consists of 97 reporting entities selling one million pounds or more of dairy products as defined by statute (7 USC 1637b). There are ... 22 plants reporting butter.

Translation: Not including small or local dairy farmers, 22 dairy plants nationwide are mandated to report their sales and of those sales, butter averaged $2.16 per pound at the wholesale level.  This is not the price you pay at the grocery store. There are transportation fees, distributor fees, delivery fees, etc. that must still be factored in.

© Brian Gould, Agricultural and Applied Economics, UW Madison 

According to University of Wisconsin at Madison, Agricultural and Applied Economics:
CME spot dairy prices > CME butter price, with the CME butter price at $2.129 per pound.
The CME (or sometimes, The Merc) is the Chicago Mercantile Exchange, and is the larges options and futures contracts open interest (# of contracts outstanding) of any futures exchange in the world, including New York City.

The CME is a cash market and a futures market for butter.
Cash market means the commodity is sold now, futures market is a contract to buy specific quantities at specific prices at a specific date in the future.

Currently for the week of February 24, 2017, the CME Daily Dairy Report Cash (spot) vs Futures price of butter:

It doesn't seem like there's a big price difference. I mean, come on.... .05 cents on average?
But that .05 cents to a trader is money into or out of their pocket. (Assume you have a futures contract to buy 1 million pounds of butter at $2.15/lb. --you saved .04 cents/lb on the futures market, but could have bought it from the cash market for .02 cents/lb cheaper. That's the risk of buying/selling in the futures market.) That's an oversimplified portrayal, but it gives you the idea.

So- on the cash market, butter is $2.13/lb. The support price of butter is $1.05/lb. That means the government, in order to support the milk supply, has agreed to purchase butter (the finished  byproduct of milk production) for $1.05 per pound.

Translation: Under the 2008 Farm Bill, the Secretary of Agriculture supports the price of cheddar cheese, butter and nonfat dry milk by providing a standing offer to purchase such products made from cows’ milk produced in the United States. When purchases exceed certain statutory levels, the Secretary is required to make temporary price adjustments to avoid the accumulation of excess inventories. Through the Commodity Credit Corporation (CCC), the government has historically purchased butter, cheese and NDM in further processed forms or in consumer-size packages to support the price of milk.

Now this is what I'm finding interesting....stay with me here....according to the USDA:

The Dairy Promotion and Research Program (DPRP) is a national producer program for dairy product promotion, research and nutrition education and strives to increase human consumption of milk and dairy products and reduce milk surpluses. This self-help program is funded by a mandatory 15-cent per-hundredweight (100 pounds) assessment on all milk produced in the 48 contiguous states and marketed commercially by dairy farmers. It is administered by the National Dairy Promotion and Research Board (Dairy Board).

Let that sink in....I'll wait....

Got it??
Basically, the government is taxing milk producers in order to support milk producers who in turn advertise to get you to consume more milk products.
And if we don't consume enough milk products, the government makes a price adjustment downward so we will buy and consume it. Of course the opposite is true, too. If we are buying too much, they do a price adjustment and raise the price so we slow consumption down.

So what's the deal? Oh yeah, we export our butter to places like Saudi Arabia, Morocco, Egypt, and Iran. The U.S. is now the 2nd largest exporter of milk products after New Zealand. But the U.S. is also importing butterfats.

According to a report from July of 2014, that 'surge' in butter was not supposed to last. U.S. butter was no longer cheaper than competitors. New Zealand's price on butter was $1.43/lb when the U.S. price was $1.88. Remember the futures market I mentioned? Well, once those 3-month and 6-month futures contract for butter ran out, it was estimated they wouldn't be renewed.
Butter was just plain cheaper somewhere else.
It's important to remember that cash market price of butter is not the retail price of butter. When the spot (cash market) price of butter at the Merc was $1.88/lb, the retail price was $3.04/lb.

However, butter prices have managed to increase anyway. Consumers have increased the amount of butter they purchase by about 5.9% from 2013-2014, and that's 36% higher than in 2010. Mostly due to the decline in margarine purchases.

Because the U.S. prices for butter are still high, that has attracted greater imports. Imports were up 24% in 2016, but U.S. companies have continued to sit on large product inventories.
Yet, according to Capital Press in an article from Sept 2016, despite the availability of cream and the largest butter stocks in more than 20 years, butter prices remain high:
  • U.S. Producers continue to increase milk production & the avg fat content and butterfat prices are low.
  • There is an increase in butterfat production, currently at 19%.
  • The U.S. butter imports are up 60%, anhydrous milk fats up 15%
  • Ample cream availability, low price.
  • Butter production up 62 million pounds.
  • Butter inventory at about 333 million pounds (highest since 1993).
So, what's the problem??
Ice cream.
You scream, I scream. We all scream for Ice Cream.
Well, that and cream cheese.

U.S. butterfat production on the buy-side is divided with 50% going towards ice cream, cream cheese and plain butter, and 30% going to cheese. The sell-side?  There's where we have this structural breakdown of the butter market. If we assume that most of the 19%  butterfat production (supply) is sold on the futures market, and that market consists of mostly sellers with sitting inventory, that will reduce the amount of butter for sale while keeping the inventory high. What few sellers there are must save inventory so it is available to sell when their futures contracts come due.

So now we have high inventory, few sellers, and lots of buyers. Sellers are sitting on their stockpiles because the price of butterfats will most likely go up in the near future (like they did in 2013 and 2014) so they are 'hedging their bets'.

And what happens when you have more buyers than sellers (with or without a stockpile)?
That's right, prices go up for you and me at the store.

But don't worry. High butter prices and low milk prices are just one component of the dairy market. The good news is we've been making up for the high butter prices and low milk-drinking consumption by doubling the cheese on our pizza's!

I knew pizza would save us!

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