Milk Prices Start to Soar

June 27, 2007 — -- Milk prices have soared recently, putting a strain on shoppers' budgets and on businesses that rely on dairy products including pizza makers and chocolatiers like Hershey's.

In the past two months, the average retail price for a gallon of whole milk increased by 19 cents to $3.26.

But that's still well short of the June 2004 record high of $3.57 a gallon for whole milk.

Much of the blame for the higher prices has been placed on corn-based ethanol. As farmers divert more ears of corn to be turned into energy instead of selling it as feed for livestock, prices have soared and dairy farmers are now paying more to feed their cows.

But ethanol isn't the only factor.

Several economists and analysts who monitor dairy prices, as well as an independent dairy trader at the Chicago Mercantile Exchange, stressed a common theme to explain the rising cost of milk.

Good old "supply and demand." Yes, for milk.

"It's not all corn and ethanol," said Ephraim Leibtag, a retail food price economist at the Economic Research Service with the U.S. Department of Agriculture. "We look at all the other products that use corn and they aren't rising as much. The majority of corn is used for feed. When prices first started to rise, we looked at beef, pork and poultry prices and those prices are up, but not rising as quick as dairy prices."

Powdered dairy products are traded globally and supplies are down, Leibtag said. He pointed to two recent changes that have had an impact on the international supply of dried dairy products: the European Union recently ended subsidies for dairy production, which has resulted in a reduction in supplies, and worse, Australia -- the world's second largest exporter of dairy products after the United States -- has been suffering through a severe drought for the past several years.

It "couldn't produce as much as it used to and world markets are looking for other sources of dairy," Leibtag said. They are looking largely to the United States.

"The cattle and feed industry is getting decimated," said Brian Rice of Rice Dairy, an independent dairy trader, of the situation in Australia. "Their milk production is down because it is very hot and very dry."

While milk production in the United States was up 1.1 percent in May compared with a year ago, Rice said international demand has increased as well, putting greater pressure on prices. He believes higher corn prices, thanks to increased ethanol production, account for less than 20 percent of the nearly doubling in wholesale prices at the Chicago Mercantile Exchange. On Monday, milk futures for the month of July traded at $22.30 compared with $11.21 a year earlier.

"We are producing more milk this year than last year, but not keeping up with demand," Rice said.

"Demand is soaring," said Sheldon Garvida, a dairy cattle and milk analyst with the U.S. Bureau of Labor Statistics. "There is higher demand in Canada, Mexico and China where the demand for whey products is growing."

Garvida also said that when prices rise, producers of cheese and butter products tend to increase their inventory as a hedge against future price spikes. But that hoarding can also push prices higher. Increased transportation costs due to higher oil prices is another factor, according to Garvida.

All combined -- high corn prices, increased global demand in the face of tight supplies, more costly transportation fees -- these factors translate to higher prices for that gallon of milk at the checkout.

If it all sounds oddly familiar -- "supply and demand" -- the same explanation given to drivers who have been paying more than $3 a gallon at the gas pump, you'd be right.