The US dairy sector will likely invest in additional churning capacity to meet demand from the now "proven" export market for butter, says DairyReporter.com commodities expert, John Geuss.
US butter stocks are half of what they were one year ago, and were at a five-year low at the end of June.
This is mostly the result of the current volatility in exports.
Prior to 2008, very little butter was exported from the US.
In late 2008 and early 2009, however, butter exports surged to over 12% of US butter churning production.
This was short lived and butter exports dropped sharply after this short surge. This pattern was repeated in 2013 and early 2014.
This time, the surge has lasted longer with 10 months of exports above 8%.
This was not sustainable and has caused the very low inventory levels and resulting high domestic prices.
In July, the domestic wholesale price of butter reached $2.35 per lb ($5.36 per kg). This represents a 50% increase over 2013 average butter prices and is a record price.
Following the 2008/09 surge and decline in exports, churning capacity was increased to support export levels of around 5% of production.
The 2013/14 surge in exports again reached 12% but has now fallen back to a more sustainable level of 5%. This has stopped the decline in butter inventories, but it has not allowed a recovery in inventories to normal levels.
The high price of butter impacts the consumer prices of the two products that respectively use of most of the butterfat in the US, cheese and butter.
There is elasticity of demand for these products based on retail prices and the higher prices will undoubtedly shrink domestic consumption and allow inventories to recover.
With lower prices, exports may again surge.
There is now a proven export market for butter, which can be penetrated if sufficient capacity is available to meet both domestic and export demands at a competitive price.
How this proven butter export market is pursued depends on whether or not butter churning capacity is increased. How might this play out?
The US pricing system for producers links the price of butter to payment for butterfat in milk.
Because of the high butterfat prices, producers are experiencing excellent prices for their milk. This means that sufficient capital is available to expand milk production and finance new technologies like amino acid balancing to increase component levels and buy new equipment like robotic milkers to increase milk production efficiency.
Added churning capacity will likely follow because there is a proven market and reasonable margins.
The global demand has been tested at the higher levels of exports and margins are established by the 'make allowances' in the established US Department of Agriculture (USDA) pricing formulas.
Over the next few years, additional churning capacity is very likely.
John Geuss (left) is the editor of US dairy commodities blog, MilkPrice.
For John's detailed month-by-month examination of American dairy commodity movements, click here .