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Parachute pants help throw light on butter price surge

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The causes of the butter price rally are becoming clearer.

Values of the dairy fat have soared this year, by 27% in Chicago, 53% on Europe's EEX futures market, and by 34% to a record high at the GlobalDairyTrade auctions run by New Zealand-based Fonterra, the world's top dairy exporter.

As to why, full explanations for the price surge have been harder to come by.

But the two prime movers of the rally are now becoming evident – a mixture of European Union dairy policy, and the same mindset which ditched the likes of tight-fitting nylon trousers, mullet haircuts and expansive shoulder pads.

'Butter is better'

… that is to say, a change in fashion, such as that which ditched the parachute pants popular in the 1980s, beloved indeed by breakdancers, and which has now promoted sugar to public health enemy number one.

"Consumers have reached a consensus - dairy is a tasty, natural source of fat, and the low-fat fad of the 1980s and 1990s deserves to go the way of parachute pants and windbreakers," said the US-based Milk Producers Council.

"Butter is better, and the whole world knows it."

Dry powder

And this when butter production "is not keeping pace with demand" both in the US and elsewhere, creating a void in export supplies which saw US shipments, for instance, hit 6.4m pounds in June, the highest in nearly three years.

The primary cause of the output shortfall is where EU policy steps in, and the intervention buying aimed at supporting milk prices, and thus the bloc's dairy producers.

As Martin Richenhagen, the German-born chief executive of tractor-maker Agco noted a couple of weeks ago, intervention buying is focused on skim milk powder, for warehousing reasons.

"They basically usually turn everything into low-fat powder," Mr Richenhagen told investors.

"And the reason why they do low-fat is storage. If you have too much fat content, it can't be stored as long."

'Not throwing off butter'

Indeed, the fat is typically processed into butter.

But this butter supply tap has been turned down with a reluctance by EU dairy producers to manufacture skim milk powder, in the face of price pressure from the huge overhang of EU stocks, of some 350,000 tonnes.

Skim milk powder prices are down 25% so far this year at GlobalDairyTrade.

The European Commission is "having a very hard time moving [skim milk powder] at prices that they think are acceptable", said Chris Bellairs, finance director at US dairy giant Dean Foods.

"So what that's done is it disincentivised everyone from making more powder. When you're not making more powder, you're not throwing off butter."

Cool reception

The upshot is that "a lot of the milk production on a global basis has now turned toward cheese production, and fat has gotten very expensive as a result of that", Mr Bellairs said.

Unfortunately for Dean Foods, which supplies more than 30% of drinking milk in the US, the rise in fat prices has only added to the problems of company laid bare in a profit warning on Tuesday, blamed largely on strengthening competition, and a focus on milk in supermarkets' price war.

(Walmart, one of Dean Foods' largest customers, is opening a plant in Indiana which will shift some 90m-95m gallons of milk business from the processor over 2018 and 2019.)

Dean Foods, whose shares tumbled 21% on Tuesday, is attempting to offset its headwinds in fluid milk by expanding into other markets, such as ice cream, where its volumes rose 9% in the April-to-June quarter.

However, with butterfat a key ingredient for the ice cream operations, "higher-than-expected butter prices… are driving up input prices versus our previous projections".

By Mike Verdin

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