U.S. dairy suppliers will be tested next year, as drought diminishes milk supply and ag production around the world, according to the U.S. Dairy Export Council. As of Oct. 2, 40 percent of the contiguous U.S. was classified as being in “severe” drought or worse. As bad as that number sounds, it hadn’t been that low since early July. The U.S. remains mired in the worst drought since the 1930s and it is having a momentous impact on the U.S. and global food industries.

USDEC projects milk output will drop 0.3 percent for the remaining four months of the year and remain in the red through at least the first quarter of 2013, with costs squeezing margins and discouraging expansion.

The decline will hit U.S. milk powder and butter the hardest. USDEC estimates nonfat dry milk/skim milk powder (NDM/SMP) production will drop 8-10 percent over the next 12 months, which equates to about 90,000 tons.

“That could significantly impact U.S. milk powder exports – our largest volume product after whey proteins,” says Alan Levitt, USDEC vice president, communications and market analysis.

“We estimate about half – 45,000 tons – could come from volumes earmarked for the world market, but the extent to which suppliers pull back from exports largely depends on price movements and the strategic position world markets occupy at individual companies.”

U.S. NDM/SMP price indices as of late September were nearly at parity with Oceania spot prices – a rare occurrence for the usually lower-priced U.S. product and a blow to U.S. competitiveness.

Cheese supplies are expected to be sufficient, but pricing also poses a challenge. Since early 2006, U.S. cheddar prices had only been above Oceania spot prices for a handful of weeks. Since July, however, the tables have turned, putting the U.S. at a cost disadvantage.

U.S. suppliers will be challenged to maintain share and volume should conditions hold.

Demand steady to rising... for now
The good news is that the fundamentals behind the long-term rise in global dairy consumption remain in place. Emerging market demand has been strong, despite slowing economic growth in key Asian markets.

But whether demand growth continues at a strong pace into 2013 is another story.

Severe weather has stunted agricultural production in a number of regions, suggesting the world is due for another run-up in food prices that could erode consumer purchasing power, particularly in developing countries where a large proportion of income is spent on food.

Downside risks, like a deepening of the European debt crisis, could heighten the situation.

That does not necessarily portend a major demand pullback. The Food Price Index from the U.N. Food and Agriculture Organization grew 8 percent from June-September, yet demand held.

“Recent history has shown that emerging market consumers appear willing and able to maintain dairy consumption levels at relatively higher costs,” says Marc Beck, USDEC executive vice president, strategy and insights.

“With supply short and the price gap far thinner than normal, the U.S. could lose share of global NDM/SMP. But strong developing world demand, constrained supplies out of Europe and the prominent position the U.S. holds in global NDM/SMP trade – 30 percent of the market – suggests we will remain a significant player.”

How the U.S. ultimately recovers from the drought will heavily depend on when normal weather returns. USDEC expects U.S. milk output to bounce back in 2014 and 2015 with gains of 2.1 percent and 1.8 percent, respectively.

“U.S. processors and producers have received the message that if U.S. dairy is to continue growing at a healthy pace it must be an eager, active and committed player in international markets,” says Levitt.

“Rising U.S. production is dependent on demand from outside our borders and to capitalize on that potential, we must face the challenges that come with serving that market, including the challenges caused by drought.”

The USDEC's prediction mirrors recent comments from U.S. Chief Agricultural Negotiator Isi Siddiqui, who said that he expects farm exports to be down between $1 billion and $2 billion this year because of the drought.

The U.S. exported $137 billion in agricultural products last year, and after this year’s falloff, sales are projected to hit $143 billion in 2013, Siddiqui said.

He added that he doesn’t believe a one-year dip would lead to a lasting slowdown in sales to Asia, where China is a major buyer of U.S. dairy and meat, or elsewhere. PD

—Compiled from U.S. Dairy Export Council's Export Profile and an Associated Press article