So, what's the deal with cheese stocks?

Andrew M. Novakovic, The E.V. Baker Professor of Agricultural Economics,
Cornell University

"Cheese Stocks at Record High"

Headlines like this have been showing up in various dairy stories since last fall, maybe earlier. (Check out what American style cheese stocks look like over the last few years below).

Small wonder we are hearing about stocks. Cheese stock levels started to rise in early 2017 but at least continued to follow typical seasonal patterns of building after the spring flush of milk production and declining during the high usage season of fall and winter…until last fall. As shown in the chart, stocks rose and remained unusually high for the remainder of 2018 and only in February showed signs of declining.

Why does this matter?

For most, if not all of you, your farm milk price is based on federal minimums, plus (or minus) various premiums, hauling charges or other pricing factors not regulated under Federal Orders. The federal order "blend price", which represents most of your price, is a weighted average of the four class prices. Class III prices are one of the movers of the Class I price, which impacts every area, but Class III prices are especially important in the Upper Midwest, and to a lesser extent California, where Class III utilization is so high. Class III price is driven by the wholesale prices of certain cheeses, bulk butter, and dry whey powder. The cheese price is a weighted average of prices for bulk cheddar cheese made in blocks, and barrel cheese, used primarily to make processed cheese products. The Class III price changes based on the combination of price movements in these four dairy product categories. In the last few months, the cheese price has been mostly pulling up but is on the low side, the butter price has been high and holding, and the dried whey price has been declining. Since last September, the Class III price has been dropping but looks to be stabilizing in 2019. It is hoped that cheese prices will continue to recover, assuming cheese stocks return to more normal levels.

So, what's the deal with increasing cheese stocks?

Whether it is stated or implied, most of the blame for higher cheese stocks is placed on the perception that we have a surplus of milk production. To be sure, growth in milk production has exceeded our ability to find profitable outlets for dairy products, but we didn't just suddenly develop new milk production last fall. Actually, national milk production looks to have started slowing down starting around September.

There are two things that argue against the runaway milk production story. First, cheese plays a relatively small role in seasonal or cyclical balancing. When milk production is long relative to profitable sales, the dairy industry, primarily through operating cooperatives, looks to bank the surplus in a form that is easing to make and cheap to store. Typically, that means nonfat dry milk and butter. Butter, cream and other full-fat dairy products have actually been selling well lately, so most of the "surplus" is really skim milk, which ends up as nonfat dry milk that is ultimately sold to foreign customers. This is a key reason keeping trade doors open and unhindered is so important to the dairy industry. Cheese production tends to follow seasonal milk production patterns, no more, no less. 

The second factor is cheese demand. Cheese stocks exist for three major reasons. First, there is always pipeline inventory, product held for a short time for a near-term future sale. Second, some cheeses are aged as part of their product development. Three to nine months, maybe a year, is common. There is probably less aged cheese today than there used to be. In either the first or second cases, these cheese stocks are not "surplus." This kind of storage is really part of the normal marketing process. The last category is unplanned or unbudgeted cheese stocks, stuff we made but couldn't sell. More often than not, I would say this happens because we were surprised by demand (it's less) than production (it's more).

Is something going on with cheese demand?

Maybe, probably. Public data on cheese consumption is not as detailed or as current as we need to give a definite answer, but there are a few indicators that support industry reports that certain cheese sales are lagging. 

Domestic usage of so-called American cheese grew by only 1 percent, relative to total production in 2018, compared to 3-5 percent in the previous four years. Note that in government reporting, American cheese refers to cheddar and other styles that are similarly made. This includes consumer products such as Colby but also the big category of barrel or processed cheeses. USDA per capita consumption data has not been reported for 2018, but 2017 data indicates cheddar-type cheeses were continuing to grow. Italian style, especially mozzarella, were actually down a bit, and processed cheese foods were down, although processed cheeses were holding their own. This seems to have been changing in 2018 as we have more reports of push back against processed cheeses, especially in food service, where they are the most popular.

Last October, Bloomberg ran a story entitled: How Millennials Are Killing American Cheese.

“Millennials can now be blamed for killing another institution: American cheese. They aren't eating it. Instead they're going for fancier, more natural varieties. Sales of processed cheese from Kraft and Velveeta are expected to drop 1.6 percent this year, the 4th straight year of declines.”

Similar stories have been reported elsewhere. If you look at quick serve restaurant menus, you see more touting natural Cheddar or other cheese varieties, either in addition to or instead of processed cheese.

There is also evidence that sales of upscale, fancy, high-margin cheeses are up.  Across the U.S., grocery stores are expanding their cheese deli and sales are growing briskly. That's great, but there are two problems with respect to offsetting the drop in processed cheese sales. First, some of these high-quality, expensive cheeses aren't made in the U.S. Second, people don't substitute expensive cheese for cheaper cheese used on hamburgers on a pound-for-pound basis. Profits for cheese makers may be higher with more exotic cheeses, but volumes are not. This is also a limiting factor in food service. There are more sandwiches and burgers offered with natural Cheddar cheese, but the substitution is not one-for-one.

So what?

It will be interesting to see how the cheese industry responds to all of this. Many companies have built a business around making large volumes of commodity cheese at a low cost. This includes cooperatives as well as proprietary or investor-owned firms. It is not easy for these companies to alter their product line. Even switching from barrel to block cheese is not that simple. While there are plenty of these plants in the Upper Midwest, there is no other part of the U.S. that has such a rich variety of cheese making plants and businesses. It is important to use this asset to full advantage but also to not get complacent. Other parts of the U.S. will also be adjusting to these changes.