News

CHEESE: Dairy producers milk end-users

Dairy market manipulation by DFA may be legal, but it's not right. Pizza operators, along with average consumers, must demand change.

January 12, 2005

Pizza operators long have suspected the price of cheese is manipulated by dairy concerns. The market's inexplicably dramatic price swings render the cost of cheese affordable one week, but outrageous the next.

Now it appears there's solid evidence of potential price manipulation by the heaviest hitter in the dairy business, Dairy Farmers of America, a cooperative representing a significant share of U.S. milk producers. In an article published in the Dec. 30, 2004 Chicago Tribune, reporter Andrew Martin detailed DFA's calculated strategy to boost milk prices through carefully timed purchases of cheese on the Chicago Mercantile Exchange. The secretive and largely unregulated nature of the cheese exchange's inner workings helps this occur unquestioned.

According to the story, the Tribune obtained a copy of a videotape of DFA CEO Gary Hanman explaining this price enhancement strategy in an October speech to dairy farmers. Every year, DFA and its subsidiary, Borden Cheese, plan to make less cheese than they know their buyers will

Steve Coomes, Senior Editor

need in a given year. Over time, supplies tighten, and to meet demand, DFA buys cheese on the CME's spot market.

Since the CME is the nation's only central purchasing point for users needing tons of cheddar post haste, even a small increase in the number of daily purchases can create the perception that demand is greater than it is. That can plant seeds in the minds of traders that there is a shortage of cheese, and bids start rising.

In the end, higher cheese prices equate to higher milk prices for dairy farmers: good for DFA and its members, bad for pizza operators and consumers.

This strategy worked to perfection in 2004. In May, as cheese prices were slipping from April's record high of $2.20 per pound for blocks, DFA moved to stop the fall at a price of $1.80 per pound. By purchasing dozens of truckloads of cheese, including a record one-day buy of 52 loads (2 million pounds), the price held firm for a solid month.

According to the Tribune piece, as prices slid further south over the summer, DFA stepped in once again to buy 100 loads (4 million pounds) throughout August, holding the price at $1.55.

Though all CME trades are made secretly, dairy sources contacted last year by PizzaMarketplace believed strongly that DFA was on a summer-long cheese-buying binge. Quite simply, few other dairy market players have the wherewithal to do so, and no market player stood to benefit as much as DFA.

Even more intriguing was the question of where those millions of pounds of cheddar went. Sales at restaurant and foodservice companies were moving up, but they weren't spiking in a manner that would justify the disappearance of the cheese sold at the Merc and presumably elsewhere. And if DFA was merely stockpiling its purchases, the USDA's cold storage numbers didn't reflect it.

One source whom I spoke with in June said simply, "I don't know what they're doing with it, but you can bet they're not dumping it."

A powerful minority

If you've ever been confused by the cheese market, join the crowd. It leaves even the experts scratching their heads. Here's why.

Each year, U.S. cheese makers produce about 10.5 billion pounds of cheese of all varieties. About 1 percent of that — a scant 10.5 million pounds — is sold on the Merc, and those trades only include cheddar that's less than 30 days old. Not a shred of mozzarella comes to the auction block.

That sliver of the overall market not only is the rudder that steers prices for the remaining 10.4895 billion pounds of cheese sold away from the CME, it decides the price dairy farmers are paid for hundreds of billions of pounds of raw milk produced annually.

Not illustrative enough? Imagine an aircraft carrier being steered by a rudder the size of a business card and you'll start to get the picture.

In short, spot cheese sales have incredible control over an enormous dairy market. When market players are particularly skittish, a single load bought or sold can send prices tumbling or soaring. And yet, the entire U.S. milk supply never shifts more than 2 percent out of line. (What pizza operators wouldn't give to know within plus or minus 2 percent what their daily business would be like!)

Part of the problem is the fact that the dairy market is "thinly traded," meaning very few sellers and buyers make dairy deals on a daily basis. Compare this activity to the wheat market: At any given time, there are about 20,000 open dairy futures contracts on the market, as opposed to 200,000 open wheat futures contracts.

Therefore, such a small amount of interest in the dairy markets makes any interest seem larger than it might be, and that makes traders anxious.

Who's the villain?

So, does all this make DFA the official cheese market villain? Or is it merely a smart player taking advantage of a weakness in the CME's system?

Experts quoted in the Tribune piece say it's a little of both. DFA knows it can make the market move up or hold firm by timing its trades because there are no clear rules forbidding such behavior.

So is it unethical for DFA to create a perceived shortage of cheese just to jimmy market prices? If not blatantly so, such actions are at least immoral. It's simply not OK to stroke one party and slap another.

Does the Merc share any of the blame for the situation? When one party stands to gain substantially while others lose, it would lead one to think that its rules need updating. Currently, however, the CME has voiced no plans to do so, and it insists all the trades done within its jurisdiction are fair.

The hard question that most desperately lacks an answer is this: Why is the price of cheese sold at the Merc given so much importance? That no one has come up with a better plan or a barometer that measures actual supply and demand is no longer an acceptable answer. Somehow, somewhere, someone must take the first step toward figuring out a way to let the price reflect market supply and not market psychology. In the end, dairy prices in every category will moderate and all parties — even end-users — will benefit.