Economic Status of the Dairy Industry: 1996

AFPC Working Paper 96-4

June 1996

Ron Knutson, Joe Outlaw, Bud Schwart, Allan Gray, John Miller
James Richardson, David Ernstes, Rene Ochoa

Each year following the development of the FAPRI/AFPC baseline, the AFPC dairy faculty develop a status report placed in the context of current industry issues and problems. This year's report emphasizes three significant developments:

There are three basic differences between our analysis and that of other reports of this type:

These differences are possible because of cooperation among land grant universities under the umbrella of FAPRI. Three units of FAPRI work very closely together in developing this baseline:

In addition, AFPC faculty work with Cornell University dairy economists on dairy industry modeling, adjustment and policy issues. Data compiled by the Agricultural Marketing Service (AMS), Farm Service Agency (FSA), National Agriculture Statistics Service (NASS) and the Economic Research Service (ERS), USDA are also utilized. We all depend on the support of the U.S. Congress for our survival! This is one of the very best examples of industry, land grant universities, USDA and the Congress working together to facilitate change and adjustment.

Farm Bill Provisions

The 1996 Farm Bill represents a watershed change in U.S. crop and dairy policy. Not since the Agricultural Adjustment Act and Agricultural Marketing Agreement Act was enacted in the 1930s has there been policy change of this magnitude. Many of the core crop programs were completely eliminated, with a resulting direct impact on dairy feed costs. In year 2000, the milk price support program is scheduled to be eliminated. The dairy industry is challenged to become a factor in the export market.

Crop Policy

Changes in crop policy are often overlooked as factors affecting the dairy industry. Sometimes crop policy changes are misunderstood or misinterpreted. The following represents a brief summary of crop policy changes that are likely to have the greatest impacts on dairy.

The bottom line is that crop policy under the 1996 Farm Bill favors fence row-to-fence row production. Only the most highly erodible farmland will be removed from production.

Dairy Policy

Dairy, along with peanuts, cotton and rice, is generally classified as a loser in the 1996 Farm Bill. This may be unfair since all commodities, except sugar, lost subsidies. But, while crop subsidies, arguably, will not exist after year 2002, the dairy support program is eliminated in 2000. This Bill clearly represents the most change in dairy policy since 1949 when the milk price support program was authorized. The major changes in dairy provisions include:

Dairy Sector Economic Indicators

As indicated previously, one of the virtues of the FAPRI consortium is that it allows for integration of the crop sector development into the dairy analysis. This is particularly important when both crop and dairy policy change simultaneously and when weather adversities result in major crop price adjustments.

Crop Indicators

Table 1 provides a year-by-year summary of major input prices affecting dairy through 2002. Because feed costs are approximately half of the cost of producing milk, the emphasis here is upon the outlook for concentrate prices.

In 1996, crop prices approached and, in some cases, set new records. High crop prices reflect low commodity stocks at the end of the 1995/96 crop year (Figure 1) combined with weather uncertainty heading into the 1996 growing season. Commodity stocks at the end of the 1995/96 crop year will be lower than those experienced in the 1973 world food crisis. Dairy farmers who buy concentrates could be literally caught in a supply availability crunch until the Fall of 1996 when the new crop is harvested. Unfavorable weather in the 1996 growing season would transition these high input prices and potential shortages through and beyond the 1996/97 crop year.

Rationing feed supplies with high prices is relatively foreign to the U.S. dairy economy. However, in the absence of government programs to manage stocks and in the presence of periodically strong export demand, tight input supply conditions could become more common.

Given favorable weather, the expectation is that as stocks build, corn and soybean prices will return to the more normal levels that characterized the early part of this decade (Figure 2). Yet, because of the potential for unfavorable growing conditions and in the presence of more volatile import and product prices, dairy farmers (like crop producers) are well advised to sharpen their risk management tools -- futures, option, storage programs, and cooperatives.

Dairy Indicators

Table 2 summarizes some of FAPRI's major price and performance indicators for the dairy sector. The projected drop in the price of butter and NDM to world market levels is the most important single factor influencing the price outlook. Cheese prices, on the other hand, are projected to hold above world market levels based on their strong domestic demand and the continued presence of import quotas as authorized under GATT.

Milk production increases by 14 percent to 179 billion pounds in 2002 as output per cow rises 18 percent to an average of 19,344 pounds and cow numbers decline 3 percent to 9.1 million head.

The lowering of the price support level by $0.15/cwt through 1999 leads to a reduction in the average all-milk price, but by a smaller magnitude (Figure 3). This reflects the moderating impact of the cheese price relative to that of butter and NDM. In the absence of the price support program, the all-milk price drops abruptly in year 2000 by $0.42/cwt to about $12.30. Subsequently, by year 2005, the milk price rebounds to $12.55/cwt, about $0.50 below the level of a decade earlier prior to the policy change.

U.S. Representative Farm Impacts

Through the assistance of producer panels located in each of the milk production areas indicated in Figure 4, AFPC maintains 22 representative dairy farms. In most of the locations, there is a moderate size farm and a large farm. The moderate size farm is designed to represent a full-time family-type farm whose enterprise mix is typical of the area. That is, most of the moderate size farms grow a substantial proportion of the feeds used in producing milk.

The large farms are typically at least twice the size of the moderate size farms. By virtue of their size, they are likely to purchase a larger share of the feed utilized in milk production. Some of the larger dairies buy all or nearly all of their feed.

Dairy Farm Description

Table 3 and Table 4 describe each of the farms. The abbreviations in the second line of the tables indicate the state where the dairy is located (first two letters), that it is a dairy farm (third letter), and the size of the farm in terms of cows milked (the numbers). For example, the first entry in Table 3, CAD1710, is a 1,710-cow dairy located in Tulare County California.

Farm size ranges from the 55-cow Wisconsin dairy to the 2,000-cow Florida and New Mexico dairies. Large size is not restricted to either the South or West -- a large dairy in Western New York milks 1,000 cows. Asset values range from $442,000 for the 77-cow Missouri dairy to nearly $9.7 million for the large Florida dairy.

Once constituted and described, the data agreed to by the panel is entered into a computer simulation model that generates a balance sheet and an income statement. The data underlying these financial statements are adjusted until the results are approved by the panel as accurately reflecting the farm they have described. Panel approval must take place before the farm is utilized in our studies and reports. In the absence of the ability to achieve such approval, the farm is dropped from the set.

Milk sales constitute 85-95 percent of the receipts for these dairy farms. The remainder of the receipts come largely from cull cow sales. At the time of publication, 9 of the 22 dairies had been updated in 1996, including the farms in California, Texas, Georgia, and Florida. During the update process, only three (TXCD825, GAD650, CAD1710) of the nine farms indicated that they were using BST. The other six of nine farms were run not using BST. Farms not updated were run using BST as had been assumed in previous years.

Farm Financial Experience Under 1996 Farm Bill

Tables 5 and 6 report the financial experience of the 22 representative dairy farms under the economic conditions projected by FAPRI as summarized in Tables 1 and 2. Figures 5-10 present the expense, receipt and net cash income experience for each of the farms over the period 1996-2002. In comparison with past years, several farms experience lower net cash income and growth in net worth less than in past years due primarily to high feed costs early in the period and the change in price support policy. The sharpest reduction in equity growth compared with past baselines occurred in California and New Mexico.

Six of the 22 dairy farms experience a negative net cash income in one or more of the years 1996-2002, the period covered by the 1996 Farm Bill. Four of these had a negative average net cash income. All but one of the six farms with a negative net cash income were located in the Southeast and Southwest. It is important to note that, despite criticism of Federal orders for its geographic pricing structure leading to higher prices more distant from the Upper Midwest, all six of these farms are located a long way from the Eau Clair basing point. For these farms, mail box prices are not sufficiently high to maintain a positive cash flow -- although they probably were at one time.

Farms consistently exceeding $100,000 in net cash income were all large. Yet, size alone does not guarantee a favorable net cash income. The large Vermont (186 cows), large Central New York (225 cows), large Florida (2,000 cow) and large East Texas dairies were unable to consistently generate $100,000 in net cash income.

Figures 11 and 12 indicate the average change in net worth accruing to each farm over the period 1996 through 2002. Seven of 22 farms decreased their net worth while 15 increased. Only three farms increased their net worth by more than 50 percent (TXCD825, NYWD600, and NYWD1000) -- all were classified as being large. All of the dairies projected to lose equity over the period could maintain equity by reducing expenses or increasing receipts by 7 percent or less.

In summary, from a U.S. perspective, the high feed costs at the beginning of the period put a decided damper on earnings to dairies that buy most of their feed. While lower feed costs in the remainder of the period help, the price support reduction offsets this gain. In reality, the outcome could be worse than projected. We are unable to adequately anticipate/model the level of input and output (milk) price instability that might be associated with this new policy regime. Most economists anticipate more unstable grain and hay prices as farmers shift production to the most profitable crops. This may be reflected in more unstable milk prices as well. Well-managed dairies will be able to deal with this instability through hedging and contracting. Our expectation is that larger dairies will be in a better position to cope with instability than moderate size dairies. However, this expectation could be offset by aggressive cooperative input and marketing programs. More will be said about these issues in the concluding section of this working paper.

We are, likewise, unable to predict the consequences of mandated Federal order reform which must be implemented in 1999. If the price surface becomes more level in this process, dairies in market areas more distant from the Upper Midwest could be further disadvantaged. However, several of these proposals were voted down in the process of enacting the 1996 Farm Bill.

The Mexican Dairy Economy

Over the past three years, AFPC has been supported by AMS/USDA to study the Mexican dairy economy. AMS's interest evolved from the realization that marketing order provisions would be affected by Mexican border issues. Our analysis has focused on two central concerns:

One substantial research report has already been issued on this project (RR96-1) and another is in process. As a result, what is presented here is of a conclusionary nature -- perhaps designed to whet your appetite to study the larger reports.

The Mexican study was initiated at a time when exports of milk to Mexico were booming (Figure 13). The interest was in how much and how long exports would continue to expand, although joint venture Maquiladora-type operations along the border were being quietly studied -- or, perhaps, not so quietly. Then came the devaluation of the peso in December 1994. Fluid milk exports to Mexico plummeted from a high of 28 million pounds in November 1994 to a low of 3.5 million pounds in May 1995 (an 88 percent decrease). Whereas before devaluation, U.S. and Mexican whole milk sold for approximately the same price in Juarez supermarkets (about $2.45/gal.), after devaluation, Mexican milk sold for $1.55 but U.S. milk sold for about $2.16. Since the devaluation, there has been a seasonal recovery of exports as Mexican milk production drops cyclically in the Fall. However, U.S. milk is still at a substantial price disadvantage.

It was found that Mexican products often are produced with ingredients that are bought at the world market price. For example, fluid milk may be processed from reconstituted whole milk powder or from a combination of NDM and vegetable fat. Such occurrences can create incentives for Mexican products to move across the border, in the absence of adequate inspection.

From a demand perspective, there is an important constraint on the average Mexican family's ability to buy milk. In 1993, only three percent of the Mexican population had an income of over $5,000. One can readily draw the conclusion that future Mexican consumption is dependent on income growth while production depends on economic policies that foster investment and lower interest rates.

Despite the fact that Mexico is substantially deficit in milk production, there are incentives for Mexican producers to want to sell milk in the United States. That is, whereas the Mexican producer price was higher than the U.S. price before the devaluation, afterward a Mexican producer could potentially have received a higher price in the United States -- if there was a willing buyer and a U.S.-certified inspection system for Mexican farms. The incentive to sell in the United States is particularly strong for Mexican producers who are not "founder/shareholders" members of Mexican cooperatives. Founders/shareholders get a higher price for milk under their quota share.

To analyze the long-run competitiveness of the Mexican dairy economy, we developed eleven representative farms with the assistance of producer panels located in the tropics (Chiapas and Veracruz), in the traditional production area of Central Mexico (Queretaro), and in two of the northern production areas (Delicias and Torreon).

Tables 7 and 8 indicate the Northern and Central Mexico commercial dairy farm characteristics in the same format as was previously done for the representative U.S. farms. These farms vary in size from 300 to 2,000 Holstein cows. Tables 9 and 10 indicate the characteristics for the farms in the tropical areas. These farms range in size from 25 to 100 cows and are normally crossbreeds of Holstein and the more heat-tolerant Zebu cattle, or just Zebu cattle being milked during the rainy season as a way of increasing the farm's cash flow. The level of management is very rudimentary and it can be characterized as a low input/output system.

The combination of Table 7 and 8 shows the greater variability of Mexican dairying than in the United States. However, our analysis indicates that the large Northern Mexico dairies have the potential for being fully competitive with comparable well-managed dairies in the United States.

Figure 14 presents the net cash income achieved by the Northern and Central Mexican dairies in 1996 compared with their California and New Mexico counterparts. Because of the absence of baseline milk and feed prices, we are unable to reliably project these earnings out into the future, as was done previously for the U.S. farms. However, these results clearly indicate that Mexican dairies are able to generate substantial net cash income. Yet, the lack of access to debt capital and a limited availability of forages and feedgrains constitute important constraints to Mexico being able to rapidly expand milk production.

Figure 15 indicates the net cash income levels achieved in 1996 by the four tropical dairies. All incomes were below the level that would be considered to be economically viable in the United States with the 60-cow Palenque farm experiencing a loss.


Dairy did not enjoy many allies in the 1996 Farm Bill debate. Moreover, it had problems getting agreement within the dairy sector on the appropriate policy direction. As a result, there are some significant dark clouds on the horizon for dairy resulting from:

On the positive side, mandates for Federal order reform hold the potential for making needed adjustments in pricing policy. While these adjustments will create considerable regional political stress in the short run, they hold the potential for addressing economic/political issues that have festered for years. Perhaps the most important of these adjustments include:

Appendix A:
List of
Panel Farm Cooperators

Dairy Panel Farm Cooperators