by Anupreeta Das

After years of being in short supply, organic milk is expected to flood the U.S. market as a regulation change and higher margins push more dairy farmers to produce it.

The dairy industry is expecting organic milk supply to surge by at least 40 percent this year from a previous annual growth rate of 20 percent, creating an excess of 25 million gallons, according to some estimates. [1]

Meanwhile, consumer demand for organic milk will continue to grow at 25 percent annually, leading some industry experts to predict that a retail promotion war is imminent.

U.S. dairy processors and distributors like Dean Foods, Stonyfield Farm and Organic Valley, a dairy farmers' cooperative that sells to retail grocery chain Whole Foods Market and others, are welcoming the news because it provides an opportunity to expand the market and offer more organic milk-based products.

"The oversupply situation is going to result in a pretty competitive marketplace," said Molly Keveney, a spokeswoman for Dean, which owns the best-selling Horizon Organic brand of milk. "Until last year we were in a supply constraint situation. We weren't innovating at all."

Greater quantities of organic powdered milk, yogurt, ice cream and cheeses are expected to hit store shelves as dairy processors divert their excess supply.

Consumer prices for organic milk, however, are unlikely to drop because the industry expects the glut to be short term.

"It would take a year before demand for fluid organic milk could catch up, assuming zero percent growth in supplies the following year," said JPMorgan Securities analyst Pablo Zuanic.

"But factoring in other potential uses for organic milk, we estimate the oversupply situation may last six months," Zuanic wrote in a research note.

NO SURPRISE

The dairy industry was expecting the glut, said Ed Maltby, executive director of the Northeast Organic Dairy Producers Alliance, representing 820 organic dairy farmers.

The change in regulation came last year after Arthur Harvey, a farmer in Maine, filed a lawsuit demanding stricter rules governing organic milk production.

The "Harvey rule," which goes into effect this June, requires farmers to feed their livestock 100 percent organic grain, compared with the earlier standard of 80 percent organic grain and 20 percent conventional grain.

Dairy farmers had a year-long grace period to switch to organic milk production. The new standard will increase costs to farmers because organic grain costs more.

As a result, organic milk production went up 30 percent in states like New York and Pennsylvania in the past year, Maltby said.

"Everybody is going to take a hit this year" as the oversupply causes some raw organic milk -- which typically sells at $24 to $28 per hundred pounds compared with $11 to $15 for conventional milk -- to be sold at lower prices.

"But from the long-term perspective, all projections for growth in demand are good," he said.

HANDLING THE FLOOD

Companies have used the grace period to encourage more farmers to go organic and lock in higher long-term supplies, on the expectation that consumer demand will eventually catch up. They have also planned uses for the short-term excess supply, or are stepping up promotions.

Dean Foods, the No. 1 U.S. dairy processor and distributor, added 64 organic farmers in 2006, taking the total to 350. Another 167 farmers are in transition, Keveney said.

Dean Chief Executive Gregg Engles warned last week of a "wall of milk" hitting the industry in the second half of 2007, and said second-quarter earnings would take a hit as the company aggressively promotes Horizon in stores.

The oversupply is allowing Horizon to introduce new products, such as an Omega-3-fortified organic milk and organic ice cream.

Yogurt-maker Stonyfield Farms, majority owned by France's Danone, said in April it will buy 48 percent more organic milk this year than in 2006 from Organic Valley/CROPP, a Wisconsin dairy cooperative of 966 organic farmers.

Stonyfield will resume using organic milk in its yogurts, after removing it in 2005 due to the shortage.

Beginning 2008, organic milk supply is expected to trickle off as retail promotions expand the market.

Raw prices for conventional milk are also expected to hit new highs in 2007 on strong cheese prices, global demand for whey and skim powdered milk, and higher grain costs.

"The conventional market now looks a lot more profitable so there will less incentive for farmers to move into organic," said Maltby.
Copyright © 2007 Reuters Limited.