Milk per cow (lbs/month)*

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1 Dec. 31, 2018 Executive Summary Drivers for the dairy industry include low milk price, the new Farm Bill and dairy product inventory. Low milk prices continue to linger. The 2018 Farm Bill increases support for dairy operations. Butter consumption set a record in November while cheese supplies remain burdensome. 12-Month Profitability Outlook Northwest FCS 12- month dairy outlook is slightly unprofitable. Futures markets suggest unprofitable prices through the first half of 2019 with increasing prices into the third quarter. Class IV milk prices appear optimistic as butter and powder inventories shrink. Northwest Situation In November, Idaho, Washington and Oregon milk production grew 4, 6 and 2 percent, respectively. Idaho and Washington cow herds grew while Oregon remained stable. Milk production in the Northwest grew by 4.3 percent year over year. National milk production eased, growing 0.8 percent. Disclaimer: This material is for informational purposes only and cannot be relied on to replace your own judgment or that of the professionals you work with in assessing the accuracy or relevance of the information to your own operations. Nothing in this material shall constitute a commitment by Northwest FCS to lend money or extend credit. This information is provided independent of any lending, other financing or insurance transaction. This material is a compilation of outside sources and the various authors opinions. Assumptions have been made for modeling purposes. Northwest FCS does not represent that any such assumptions will reflect future events Northwest Farm Credit Services Idaho milk producers continue to report a surplus of about 2 million pounds of milk per day. A company has plans to construct a processing facility in the Magic Valley, which could provide relief to the milk surplus. Their construction timeline has not been released and the new plant will not help in the short term. Mild fall and early winter weather was favorable, fostering increased milk production. Milk cows and production: December 2018 compared to December 2017 Milk cows (head) Milk per cow (lbs/month)* Milk production Idaho +10, % Washington +6, % Oregon No Change % Northwest total* +16, *4.3% 23 states total -16, % Source: USDA NASS, Milk Production Dec. 19, *Weighted average by head count Trend

2 Processors in Idaho and Washington have announced the potential enforcement of quotas. Projections show processors will continue to be oversupplied for the first half of Penalties may include $1 to $2 per cwt deductions for production over base levels. Dairies are reducing heifer raising costs and extracting additional value from calves by breeding to beef semen. The resulting crossbred calves are creating concerns about flooding the beef market Farm Bill The 2018 Farm Bill was signed into law in December. The bill includes revisions to the Margin Protection Program, renamed the Dairy Risk Management Program (DRMP). DRMP offers dairy farmers greater protection against low milk prices. The Federal Milk Marketing Order Class I minimum price calculation is updated to the average of Class III and Class IV skim prices plus $0.74. The bill also forms the National Animal Disease Preparedness and Response Program, creating a bank of vaccines. This will allow a rapid response to animal diseases, including foot-and-mouth disease, with the most damaging effect on human health or the economy. Farm Bill provisions will not come into effect until the USDA publishes implementation rules. Support Programs Dairy Risk Management Program (DRMP) The DRMP (formerly Margin Protection Program or MPP) has been adjusted in the new Farm Bill, adding coverage levels of $8.50 and $9 per cwt for the first 5 million pounds of production. The schedule of premiums for the first 5 million pounds is now as much as seven times less expensive. Payments for MPP in 2018 have been made through October and are expected to be made for November and possibly December. Producers who purchased coverage in 2018 at the $8 per cwt coverage level saw MPP payments ranging from $0.57 to $1.38 per cwt, with an average of $1.06 per cwt. Dairy Revenue Protection (DRP) The DRP, which provides protection against an unexpected decline in revenue from milk sales, became available in October. Within the first month, nearly 600 policies were sold, covering over 1.5 billion pounds of milk production. Two pricing options are available: one based on a blended class III and IV price; the other based on the value of protein, butterfat and other solids. Producers may cover up to 95 percent of their expected quarterly revenue. Insurance must be purchased from a crop insurance agent. Dairies can participate in DRP and DRMP at the same time. National Situation USDA reports indicate continued growth in milk production. Despite a smaller herd, total production increased 0.8 percent year over year. Weak 2019 returns will further reduce the dairy herd, which will be partially offset by increasing milk per cow. Dairy cow and cull cow prices have fallen 25 percent year over year, reflecting what producers see as a loss in income-earning potential. 2

3 December milk production change Source: USDA and Dairy Markets and Policy Cold Storage Nonfat dry milk prices steadily increased throughout 2018 to an 18-month high in December, creating optimism in an otherwise dismal dairy outlook. Manufacturers November stocks were down year over year, but still higher than 2016 and 2017 levels. Butter inventories dropped by 33 percent to a three-year low in November Butter stocks typically decrease around the year-end holidays. However, the latest drawdown is the largest November drop in over 100 years of record keeping. Stocks are expected to increase some during the beginning of Demand for butter continues to be strong, but the growth in demand is expected to level out. Cheese stocks reached 1.4 billion pounds in October, the highest since federal recordkeeping began a century ago. In November stocks dropped by a larger-than-average 17.3 million pounds, but an abundance of cheese in storage continues. Cheese prices had been on an overall upward trajectory since the beginning of 2018 yet have steadily fallen since September. Consumer preferences are changing from processed American and plain cheddar to foreign varieties such as mozzarella. This creates a challenge for cheesemakers who are focused on traditional varieties. Some processors are adding new varieties to their lines, while some are hoping the export market will increase and absorb some of the excess. International Situation Canada Fluid-milk consumption has remained steady to slightly decreasing. It is expected that production will increase even as the number of cows will decrease due to greater efficiencies from herd management and genetics. Cheese and butter reserves are at a record high. Canadian dairy cow imports from the U.S. decreased significantly from the 2017 high of over 30,000 head to around 10,000 head in

4 European Union Fluid-milk consumption in the EU is expected to decrease following continued consumer preferences toward plant-based milk substitutes. Fluid-milk exports are expected to remain stable as lower demands from China will be offset by higher exports to Africa. Cheese and butter production will increase. Drought in Northern and Eastern Europe resulted in feed shortages and will limit milk production through the first half of New Zealand Fluid-milk production in New Zealand increased 5.8 percent, tying the record high hit in October This increase in milk production further decreased U.S. spot and futures prices. Dairy exports are forecast to increase through 2019, with China taking many of the exports. China China s consumers believe that dairy products are health foods; they also believe imported dairy products are safer than domestic. Therefore, fluid-milk (primarily UHT milk and yogurt) imports are expected to increase by 13 percent in Most fluid-milk imports come from the EU and New Zealand. Whole milk powder (WMP) consumption is expected to remain level in Domestic production of WMP will decrease, resulting in a 15 percent increase in imports. The majority of WMP imports comes from New Zealand. While U.S. exports of WMP to China had been increasing in recent years, the additional 25 percent tariffs will likely slow that progress. To meet demand, China relies on imports of skim milk powder (SMP), primarily from New Zealand and the EU. There is hope that the trade truce between China and the U.S. will ease the tariffs and provide greater access to the Chinese market. China s fluid-milk production is expected to decrease by 1 percent (34.7 million tons) in The Chinese dairy herd is shrinking as smaller farmers exit the market due to stricter regulations, higher feed costs and lower profitability. The 25 percent additional import tariff on U.S. alfalfa (accounting for over 90 percent of alfalfa imports) and soybeans imposed in the ongoing U.S.-China trade war contributes to the higher feed costs. Fundamentals and Trade Trade tensions and low milk prices continue to cast a cloud over dairy producers profitability. Dairy farmers are expected to lose $1.5 billion from the ongoing trade wars. A $12 billion bailout program was created by the Trump administration to help make it up to farmers; only 8.5 percent of it has been distributed. This includes $0.12 per cwt for dairy producers. In December, a second round of payments to farmers from the bailout was announced. The U.S. and China struck a 90-day trade truce, postponing threats the U.S. would raise tariffs on $200 billion of Chinese goods from 10 to 25 percent. Despite tariffs, U.S. dairy product exports to China have increased. As part of the truce, China agreed to purchase a substantial amount of agricultural and other products from the U.S. China s recently announced purchase of U.S. soybeans is part of this agreement. The EU adjusted its free trade agreement with Mexico following trade tensions between Mexico and the U.S. This increased the EU s market share in Mexico in the short term. U.S. dairy product exports to Mexico declined during the latter half of 2018 due to 10 to 25 percent tariffs. 4

5 Outlook Current reports from the USDA suggest 2019 forecast price for all milk is $16.40 to $17.20 per cwt, over the 2018 all-milk prices of $16.15 to $ This likely assumes stable production levels. Greater international market share through trade negotiations and the shrinking dairy herd may result in more positive returns. Nonfat dry milk (NDM) provides a bright spot in the market. Prices hit an 18-month high in December and U.S. and EU exports were 25 percent higher than in No breakout moves beyond the current range of $16 to $18 per cwt are expected in the all-milk price. Historic and forecast milk prices (annual, in US dollars) All Milk (per cwt) $16.30 $17.65 $ $ Class III (per cwt) $14.87 $16.17 $ $ Class IV (per cwt) $13.77 $15.16 $ $ Cheese (per lb.) $1.61 $1.63 $ $ Butter (per lb.) $2.08 $2.33 $ $ Nonfat Dry Milk (per lb.) $0.83 $0.87 $ $ Whey (per lb.) $0.29 $0.44 $ $ Source: USDA ERS, AMS, FSA and FAS World Agricultural Supply and Demand Estimates. Dec. 11, Additional Information Northwest FCS Business Management Center Insights AgDairy CME Group edairy Insider (log in required) Milk Producers Council U.S. Department of Agriculture (USDA) Learn More For more information or to share your thoughts and opinions, contact the Business Management Center at or bmc@northwestfcs.com. To receive notifications about Northwest and global agricultural and economic perspectives, trends, programs, events, webinars and articles, visit or contact the Business Management Center. 5