Examining the Drivers of U.S. Dairy Prices for 2021
Even in an industry accustomed to the impact of government policy, it was a wild year in the U.S. dairy market.
About 40% of net farm income in the U.S. came from government payments in 2020, according to data from the U.S. Department of Agriculture (USDA). Government funding – and in particular, the size and timing of government payments to dairy producers in response to COVID-19 and purchases of surplus products – has driven a sizable amount of volatility in the dairy market.
Considering that the COVID-19 pandemic began with widely viewed news reports of dairy farmers dumping milk that could not find a way through shuttered foodservice channels, those payments and purchases have been a lifeline for producers. But they have also created uncertainty for end dairy users regarding when and how to lock in prices.
The question on the minds of those dairy users now is: What’s next? With a new U.S. administration taking over this month and vaccines giving us the first glimpse of the end of the pandemic, what will drive prices in 2021?
Understanding this landscape will be essential for building a dairy price risk management strategy. Here are a few underlying factors to keep in mind.
Government action is likely to support prices
The biggest question is what comes next from Washington, D.C.
First is COVID-19 stimulus. The most recent bill passed late in December includes billions of dollars for farm payments. The Democratic Party generally views dairy as an important constituency – especially small- and medium-sized dairy farms. So, Congress and the USDA could well look to continue supporting the dairy sector with this funding.
Direct purchases for food programs also had a significant impact on prices last year, and the latest bill includes billions in additional funding for these programs, too. A Democratic administration is likely to maintain or increase support for dairy, as it is viewed as a healthy protein and a core element of nutrition programs.
More up in the air are the ad hoc government payments that have risen considerably the last few years. When and to what extent the new administration winds those down remains to be seen. And it’s unknown whether Congress will pass further COVID-19 relief.
In total, it is likely that government support for the dairy sector – in the form of both direct payments and purchases – could very well help keep prices higher in 2021.
A post-pandemic breakout?
The other big question mark for U.S. dairy market participants is the speed at which we move through the pandemic and see the confidence of both policymakers and consumers rebound. This will be an especially important factor in foodservice, as well as other channels like school lunch programs as districts resume in-person learning.
In fact, we may even see a release of pent-up demand, as people make up for a lost year by dining out more often, traveling, going to sporting events, and more. If this happens, demand for dairy products could spike. This, combined with likely continued government support, indicates that prices could remain strong throughout 2021.
But it’s hard to predict the timing of government purchases, or exactly when we’ll reach an inflection point where most consumers are again comfortable eating in a restaurant. And spreads among different classes of dairy products could continue to fluctuate. Depending on your specific needs as a dairy user, you may want to consider a hedging solution that provides protection if prices move up as well as the option to participate if prices go down in the short term.
Managing price risk in 2021
Uncertainty in 2020 has caused changes in the way producers and consumers think about risk management. Companies that remain profitable and return value to shareholders during times of market volatility consistently follow these four commodity price risk management habits.
- Plan: Focus on your company’s needs, budget margin goals and risk tolerance.
- Diversify: Don’t put all your eggs in one basket. Utilize futures and options from the exchange, as well as swaps and tailored products. And consider leaving a portion of your portfolio unpriced.
- Advocate and educate: Review internal company policies to ensure pricing decisions and positions are in alignment. Advocate and educate within your organization to ensure you have the tools you need to be effective.
- Choose wisely: Select your counterparty carefully. The best partners look to understand your business, challenge your thought process and offer solutions that align to your company objectives.
No matter what your needs, Cargill Risk Management can work with you to define a strategy that’s tailored to your situation so that when the unexpected arises, you have the protection and confidence you need to run your business. Contact us today.
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