• Cheese Price Meltdown

While pizzeria operators celebrate this fall's steep drop in cheese prices, those in the dairy and cheese industries are in no mood to party.

The cause of the plunge is under examination by some who suspect an erroneous government report played a prominent role in the price decline. Dairy producers in California are even calling for a USDA investigation.

After rising for eight straight months, cheese prices peaked at a cheddar block rate of $1.74 a pound in August. The price held just below that until Friday, Sept. 21, the day the National Agricultural Statistics Service (NASS) published its monthly Cold Storage report. The report contained a 31-million pound upward revision of the nation's cheese inventory, and when trading resumed on Monday the 25th, prices began a steady decline that didn't bottom out until Oct. 16 at a $1.16 a pound.

Experts say it's likely that the NASS revision heightened fears of cheese buyers already concerned with the drop in foodservice sales attributed to the Sept. 11 terrorist attacks on the World Trade Centers and the Pentagon.

"Since the attacks, end-user demand has really fallen off," said Alan Levitt, a dairy market analyst in Crystal Lake, Ill. "But part of this big price decline -- why it happened when it happened -- is because of the (revised) inventory report."

History Repeats Itself

This marked the second time in three years that the NASS Cold Storage report listed an error that, when revised, sent market prices tumbling. In August of '99, block cheese prices reached an all-time high of $1.97 per pound. Late that same month, the Cold Storage report included an upward revision of the June '99 cheese inventory of 65.4 million pounds. Eleven weeks later prices had sunk to $1.10 per pound.

Similarly flawed estimates were made this year, said Linda Simpson, an agricultural statistician for the NASS, a department within the USDA. The July inventory was estimated and reported in August, the 31 million pound error was uncovered that same month, and a revision was made in the September report.

Simpson said that while 31 million pounds seems like a lot, it represents less than 6 percent of the nearly half-billion pounds of total cheese in the U.S. inventory.

"Even a small percentage, which for us would be under 10 percent for a revision, would be considered quite reasonable," said Simpson. "But I don't think that fully explains why prices are falling."

Simpson added that Cold Storage reports are estimates based on numbers supplied voluntarily by commodities producers. Only about 70 percent of those companies submit numbers monthly, and occasionally, the reports are filed late or contain errors.

Levitt agreed that the NASS is challenged to acquire accurate data through volunteer reporting, but he said Simpson's 6 percent figure incorrectly minimizes the error's true impact on the market. He said that at the time of the revision, as much as 350 million pounds of the country's total 500 million pound cheese inventory was "already in the pipeline" near the point of use or purchase.

"So if you subtract the amount of cheese that's in the pipeline, you end up with 150 million pounds," said Levitt. "Then, when you find out that there's almost 31 million more pounds than you thought, and you add that to the 150 million, then you're over by 20 percent" instead of 6 percent. "The impact on people's thinking is much greater then."

Levitt illustrated the error's significance in another way. Thirty-one million pounds of cheese is equal to about 800 "loads." (A load is a 40,000-pound unit of cheese traded on the Chicago Mercantile Exchange.) On busy days 15 loads can be traded, and on slow ones none moves.

"So when you have 800 more loads than you thought you had, it changes people's perception," said Levitt. "The inventory problem doesn't deserve all the blame, but it was one more bearish indicator, and the market moves on these indicators."

Dave Deal, a procurement and distribution consultant with The Food Source, agreed.

"One load of cheese can affect everybody's transactions," said Deal, whose company is in Lathrup Village, Mich. "For a co-op the size of the Dairy Farmers of America (DFA), it's nothing to buy up five loads of cheese, and it's not that difficult for Kraft either."

Elvin Hollon, director of fluid marketing and economic analysis for DFA, agreed with Simpson's views, saying that already-slow foodservice sales worsened by the Sept. 11 attacks are more to blame.

"If you take just one operator whose business is off by a few percent, he's going to start ordering a little less cheese," Hollon said, from DFA's Kansas City, Mo. headquarters. "So now think about 50 pizza chains that are ordering a little less, and you see how the inventory starts to back up in to the system. You have to consider the scale of what's going on."

Relief or Grief?

While pizzeria operators are enjoying the price relief, groups such as the Western United Dairymen are calling for a USDA investigation into the inventory error.

"We as an industry want to better understand what went on," said Tiffany La Mendola, a WUD economist in Modesto, Calif. The price declines, she said, followed too closely to the Cold Storage report's release to ignore its influence. "It obviously had an impact on the market ... the report came out on a Friday, and the following Monday we had a decline in cheese prices."

Whether stronger legislation to force all cheese producers to participate in inventory surveys would be beneficial is a subject of debate, said Hollon.

"There is some legislation in place, but the NASS believes it doesn't give them the legal ability to perform an audit; they say it 'lacks the teeth' necessary to do that," he said. "I think they could use the additional legislation, but no one wants them to become something like the IRS."

Murmurs within the pizza industry that cheese producers might have manipulated prices by underreporting their inventories are typical with huge market swings, according to Levitt. This time, however, neither he nor Hollon believe that's the problem. Dick Groves, editor/publisher of the Cheese Reporter, added that if "funny business" were at work, it wouldn't be the first time in the history of the American cheese industry.

"I guess it doesn't surprise me that there are concerns," said Grove, whose weekly tabloid is published in Madison, Wis. "There was the National Cheese Exchange in Green Bay that closed its doors in '97 after being investigated for the umpteenth time."

Knee-jerk Reaction?

Historically, said Groves, the cheese market simply overreacts to negative reports and other indicators when it really shouldn't. The dairy industry is well established, carefully managed and largely predictable, he added, so price spikes and declines really don't warrant panic buying or selling.

"It never should have gotten up to $1.97 in '99, it never should have gotten as high as it did this summer, and it shouldn't be dropping as much as it has," Groves said. "It's simple market psychology: No one's going to buy more than they need for the short term if they see prices dropping. But once prices hit rock bottom, buyers are going to get right back in and fill out their warehouses while prices are low."

With prices at their lowest in months, should pizzeria operators rejoice? Analysts say yes and no.

Price drops like those of late fatten the bottom line. If an operator buys 1,000 pounds of cheese a week, he pockets about $500 a week more now than he did in August.

Savings on cheese, however, are only valuable when pizzas are sold, and according to published reports and multiple interviews with operators, sales at many pizza companies are flat to slightly down following the terrorist attacks.

Additionally, in the weeks since, strong indications that the economic slowdown may extend well in to 2002 could lead families to reduce restaurant expenditures. Ultimately, though, Tim Carlin, a senior consultant at the Chicago food industry analyst firm, Technomic, believes Americans won't stray far from affordable foods like pizza.

"Pizza is a comfort food, and when push comes to shove, that's what people want," said Carlin. "People aren't going to stop dining out altogether, but where a few months ago a family might have gone to a casual restaurant for an evening out, they'll probably go to a pizzeria or have it delivered instead. We think they'll be trading down and choosing less-expensive options."

Can pizzeria operators do anything to safeguard themselves before the market inevitably returns to high prices?

Hollon and Deal say yes, that operators, no matter how large or small, are wise to consider hedging, the practice of lowering one's investment risk by contracting in advance for set amounts of product at a set price. Operators should educate themselves about the benefits of hedging now, said Deal, instead of waiting for a price increase.

"The problem is that nobody asks the question when cheese is at a dollar a pound, they ask the question when the block is $1.60, and by then it's too late," said Deal, who helped several pizza clients hedge cheese purchases last year. "As a result we were able to protect them with ceiling prices that were dramatically below the market. You've got to have a willingness to do that when price is low."

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