Highlights

Higher yields have improved Japanese milk production in 2016, but weather-related impacts could constrain potential growth in the fourth quarter and beyond. Soaring Japanese beef cattle feeder prices are limiting replacement heifer production through greater use of wagyu genetics in dairy management plans. 2016 Japanese imports and consumption outpace record 2015 levels, with sharply expanding, price-competitive imports from European Union suppliers eroding U.S. market share. Increased Japanese butter production and extraordinary butter import volumes should restore balance and preclude perceived butter shortages during the remainder of 2016.

Executive Summary

An expanded crop of highly productive young milk cows in Hokkaido has more than compensated for further reductions in milk cow numbers in the rest of Japan and a decline in the national dairy cattle herd. Continued contractions in the dairy industry outside of Hokkaido have created a growing deficit in fluid use milk for drinking in the rest of Japan, particularly in urban population centers. As beef cattle feeder calf prices across all three major categories (i.e., wagyu, F-1 cross-bred, and Holstein steers) have continued skyward, dairy operators have expanded utilization of wagyu genetics in their dairy management programs at the cost of significantly diminishing prospects for the next generation of milk cows.

Following two successive years of highly visible butter 'shortages,' in which retail shelves were empty during the peak November / December Japanese baking season, the Government of Japan announced its intention to import record butter volumes in Japanese fiscal year (JFY) 2016, which ends on March 31, 2017. Coupled with reduced demand for fresh cream and markedly lower prices for imported cheese, Japanese dairy manufacturers have allocated additional factory use milk towards production of butter and non-fat dry milk (NFDM) in 2016. Accordingly, Post does not anticipate a third successive year of butter shortages in 2016. 2016 Japanese NFDM production has risen alongside growing butter volumes, satisfying a significantly higher level of Japanese ingredient demand in 2016 and sharply curbing imports. Post projects that the Japanese supply-demand balance for butter and NFDM should return to equilibrium in 2017.

2016 Japanese importation and total utilization of natural cheeses will break record highs set in 2015. Higher volumes of lower-priced European Union (EU) origin natural cheese continue to outcompete U.S. natural cheese in the Japanese market, driving imports of U.S. natural cheese sharply lower for a second consecutive year. Adjustments in global supplies of milk and dairy products may signal a modest recovery of global cheese prices, setting a floor for natural cheese price offers in 2017.

Production, Supply and Distribution Data

Fluid Milk PS&D Table

Dairy, Milk, Fluid

Market Begin Year

Japan

2015

2016

2017

Jan 2015

Jan 2016

Jan 2017

USDA Official

New Post

USDA Official

New Post

USDA Official

New Post

Cows In Milk

750

750

745

752

0

750

Cows Milk Production

7375

7379

7340

7420

0

7400

Other Milk Production

0

0

0

0

0

0

Total Production

7375

7379

7340

7420

0

7400

Other Imports

0

0

0

0

0

0

Total Imports

0

0

0

0

0

0

Total Supply

7375

7379

7340

7420

0

7400

Other Exports

0

0

0

0

0

0

Total Exports

0

0

0

0

0

0

Fluid Use Dom. Consum.

3920

3935

3900

3965

0

3955

Factory Use Consum.

3400

3390

3385

3400

0

3390

Feed Use Dom. Consum.

55

54

55

55

0

55

Total Dom. Consumption

7375

7379

7340

7420

0

7400

Total Distribution

7375

7379

7340

7420

0

7400

Butter PS&D Table

Dairy, Butter

2015

2016

2017

Market Begin Year

Jan 2015

Jan 2016

Jan 2017

Japan

USDA Official

New Post

USDA Official

New Post

USDA Official

New Post

Beginning Stocks

15

15

18

19

0

22

Production

64

65

63

67

0

65

Other Imports

16

16

17

12

0

11

Total Imports

16

16

17

12

0

11

Total Supply

95

96

98

98

0

98

Other Exports

0

0

0

0

0

0

Total Exports

0

0

0

0

0

0

Domestic Consumption

77

77

77

76

0

76

Total Use

77

77

77

76

0

76

Ending Stocks

18

19

21

22

0

22

Total Distribution

95

96

98

98

0

98

Non Fat Dry Milk PS&D Table

Dairy, Milk, Nonfat Dry

2015

2016

2017

Market Begin Year

Jan 2015

Jan 2016

Jan 2017

Japan

USDA Official

New Post

USDA Official

New Post

USDA Official

New Post

Beginning Stocks

35

35

50

53

0

55

Production

127

129

125

132

0

125

Other Imports

53

53

35

33

0

32

Total Imports

53

53

35

33

0

32

Total Supply

215

217

210

218

0

212

Other Exports

0

0

0

0

0

0

Total Exports

0

0

0

0

0

0

Human Dom. Consumption

140

139

140

137

0

140

Other Use, Losses

25

25

25

26

0

25

Total Dom. Consumption

165

164

165

163

0

165

Total Use

165

164

165

163

0

165

Ending Stocks

50

53

45

55

0

47

Total Distribution

215

217

210

218

0

212

Cheese PS&D Table

Dairy, Cheese

Market Begin Year

Japan

2015

2016

2017

Jan 2015

Jan 2016

Jan 2017

USDA Official

New Post

USDA Official

New Post

USDA Official

New Post

Beginning Stocks

15

15

15

15

0

15

Production

42

46

42

45

0

45

Other Imports

249

249

250

265

0

265

Total Imports

249

249

250

265

0

265

Total Supply

306

310

307

325

0

325

Other Exports

1

0

0

0

0

0

Total Exports

1

0

0

0

0

0

Human Dom. Consumption

290

295

292

310

0

310

Other Use, Losses

0

0

0

0

0

0

Total Dom. Consumption

290

295

292

310

0

310

Total Use

291

295

292

310

0

310

Ending Stocks

15

15

15

15

0

15

Total Distribution

306

310

307

325

0

325

2016 Situation Summary and Outlook

Fluid Milk:

Improved Hokkaido Production Stabilizes National Milk Supply

The 2016 outlook for total national milk production and utilization looks set to rise above 2015 levels, in contrast to the contraction anticipated in Post's 2015 forecasts. The central factor driving higher production appears to be the increased number of young Hokkaido milk cows demonstrating higher productivity traits. Post anticipated the entry of this expanded crop of young, Hokkaido milk cows in its 2015 analysis, but Post had not anticipated that a related increase in per cow productivity in Hokkaido could offset the continued decline in milk cow numbers in the rest of Japan.

Through the first eight months of 2016, total national milk production totaled 5.019 million metric tons (MMT), slightly outpacing 2015 levels. A two percent expansion in the number of milk cows, coupled with higher per-cow productivity, helped drive production in Hokkaido up three percent to 2.662 MMT, despite a slight decline in the total Hokkaido dairy herd. In the rest of Japan, a near across the board contraction in dairy cattle numbers and flat productivity growth have resulted in a one percent decrease in milk production, falling to 2.357 MMT.

The total number of dairy farms continued to decline across the country in 2016 (Hokkaido down three percent to 6,490 farms, and the rest of Japan down five percent to 10,510 farms) as aging dairy farmers continue to exit the industry without successors. The average number of cows per farm across Japan appears to be continuing along its gradual upward trajectory (up two percent in Hokkaido to 121 head; up one percent in the rest of Japan to 53 head) as the industry continues to consolidate with the support of government subsidy programs to promote necessary infrastructure investments.

As fluid milk production in the rest of Japan has fallen, and the demand for fluid use milk products (including fermented milk beverages) has remained relatively firm through August, Hokkaido producers have expanded shipments of fluid use milk for drinking to the rest of Japan (up 17 percent to 0.218 MMT), particularly to urban centers like Tokyo and Osaka. With higher prices for fluid use milk (relative to factory use offers) and lower direct subsidy payment rates for processors (down two percent in JFY 2016 to 15.28 yen/kg for natural cheese production; down almost two percent JFY 2016 to 12.69 for designated dairy commodity production), a large volume of Hokkaido's expanded production has been diverted into these fluid use markets rather than pushing up production of factory use milk dairy products. Through August 2016, fluid use milk consumption is up two percent over 2015 levels (to 2.650 MMT), while factory use milk consumption is up only marginally to 2.334 MMT.

Hot and humid summer weather coupled with an unprecedented string of four typhoons that delivered torrential rains over much of Hokkaido in August and September 2016 are expected to negatively impact

Hokkaido's fourth quarter milk production. However, even after taking those factors into account, Post projects 2016 total national milk production to increase slightly to 7.42 MMT, with fluid use milk up less than one percent to 3.965 MMT, factory use milk marginally higher at 3.400 MMT, and feed use at 0.055 MMT.

Through August 2016, production of fresh cream, a major source of fluid milk demand in recent years, fell three percent (to 71,637 MT) relative to 2015 levels, driven in part by convenience stores scaling back offerings of small-sized sweets, which had utilized large volumes of fresh cream. Over that same period, national production of butter and non-fat dry milk (NFDM) rose six percent (to 48,751 MT) and two percent (to 90,441 MT) respectively.

Butter

Increased 2016 Supplies Restore Balance Butter Demand, Push Up Stocks

The recovery of Japanese butter production that began in 2015 continued through the first eight months of 2016, rising another six percent to 48,751 MT . This expansion comes on top of the 13,000 MT of butter that Japan's Agriculture & Livestock Industries Corporation (ALIC) committed to importing (i.e., 7,000 MT from current access commitments and 6,000 MT from additional import tenders) through the end of 2016. While rising production and robust imports through Japan's state owned enterprise have bolstered total supplies, domestic demand appears to be slackening, as ALIC estimates total butter utilization over the first eight months of 2016 has fallen three percent (to 45,600 MT) from 2015 levels. Household butter consumption is up four percent (to 303 grams per household) through August 2016, maintaining strong demand for Japanese-origin, retail packages of butter. However, declining demand from the confectionary and baking sectors, evident in the recent moderation of wholesale prices, has more than outweighed retail sector growth. Combined, these market dynamics have driven August 2016 month-ending butter stocks up 42 percent over 2015 levels to 28,389 MT, equivalent to more than three months' supply at peak monthly utilization levels.

Despite the reduced forecast for fourth quarter milk production in Hokkaido further tightening factory use milk supplies, solid retail demand should help to push Japan's 2016 total butter production higher for the second year in a row to 67,000 MT (up three percent from 2015, but still below 2013 levels). Declining utilization of fluid milk for cream (down two percent through August 2016 to 0.851 MMT) and of factory use milk for natural cheese (down five percent through August 2016 to 0.305 MMT) reflect the reallocation of limited milk production towards butter and non-fat dry milk (NFDM). With 2016 total imports at roughly 12,000 MT, Post projects year ending stocks to rise 16 percent over 2015 levels to 22,000 MT.

For JFY 2016, Japan fulfilled its current access commitments designated dairy commodity imports (137,200 MT milk weight equivalent) by importing 7,000 MT of butter, 2,000 MT of NFDM, 4,500MT of edible whey, 330 MT of butter spread and 200 MT of butter oil. Through the end of calendar year 2016, in addition to the 7,000 MT of current access butter volumes, Japan will import approximately 5,000 MT of the 6,000 MT specified in the May 2016 additional import announcement. Japan will import the remaining 1,000 MT of the May 2016 announcement volume as well as a further 4,000 MT of butter (announced at the end of September 2016) during the first quarter of calendar year 2017 (which is the final quarter of JFY 2016). The second additional butter import announcement in September 2016 came ahead of Japan's peak November/December baking season and fresh on the heels of the revised fourth quarter outlook for Hokkaido milk production. Following two years of highly visible public criticism related to perceived butter shortages in major urban centers, the Government of Japan took this additional measure to ensure that more than sufficient butter supplies will be on hand through the end of JFY 2016.

NFDM:

Ample Stocks, Rebounding Butter Production Reduce 2016 NFDM Imports

Directly tied to expanding domestic butter production, Japanese NFDM production increased two percent through August 2016 to 90,441 MT. With substantial year-beginning stocks (up 51 percent over 2015 to 53,000 MT), higher production, 4,000 MT of NFDM arriving in 2016 through current access (2,000 MT), and additional imports announced in May 2016 (2,000 MT), ALIC appears to have taken sufficient measures to meet domestic demand and to halt the upward trend in NFDM wholesale prices ALIC estimates ingredient demand for NFDM has remained sluggish through August 2016, driven in part by reduced production of processed milk and milk beverages, driving August month-ending stocks up 10 percent over 2015 levels to 55,594 MT.

As Hokkaido's fourth quarter milk production outlook is reduced, anticipated tightening of factory use milk supplies over the same period should lower the ceiling on increased production of butter and NFDM in 2016. Post projects Japanese 2016 total NFDM production modestly higher at 132,000 MT (up two percent over 2015), with total imports down nearly forty percent from 2015 to around 33,000 MT(4,000 MT through current access/additional imports by ALIC, 26,000 MT through the TRQ foranimal feed and the rest to be allocated across the TRQs for the national school lunch program and others. Total NFDM consumption is projected down one percent in 2016 to 137,000 MT (excluding the TRQ for animal feed), leaving year-ending stocks modestly higher at 55,000 MT.

Cheese:

Global Glut Pushes Price Offers Down, EU Exports to Japan to Set Record High in 2016

After rebounding in 2015 (up seven percent to a record high of 249,285 MT), Japan's total cheese imports have continued to expand through the first eight months of 2016. As overall demand for cheese remains strong, as global price offers have continued to fall, and as the Yen has remained relatively strong against cheese-supplying-country currencies, Japanese imports through the first eight months of 2016 have climbed five percent over record-high 2015 levels to 172,732 MT. According to market sources, sales of natural cheeses for direct consumption (mainly from EU suppliers) and of shredded cheese (mostly from U.S., Oceania and EU suppliers) for the pizza industry, bakery sector, processed food industry, and ready-to-eat foods have been strong, while intense price competition has driven importers' supply sourcing decisions.

Following a substantial 49 percent year-on-year increase in 2015, continued abundant supplies of competitively priced cheeses have helped to drive Japanese imports of EU-origin cheeses up another 26 percent through the first eight months of 2016 to 47,626 MT. Persistent low milk prices in the EU region in the wake of the milk quota system abolishment in March 2015, the continued Russian ban on a variety of EU-origin agricultural products (including cheeses and scheduled to continue until July 2017), and a relatively weaker Euro (in part due to "Brexit"-related economic uncertainty) have contributed to the significant expansion of EU-origin cheeses in the Japanese market through August 2016. The Netherlands (up 19 percent to 12,916 MT), Germany (up 20 percent to 8,763 MT), Denmark (up 37 percent to 8,414 MT),France (up 17 percent to 6,131 MT) and Ireland (up 104 percent to 2,907 MT) have collectively surpassed the United States and New Zealand, moving the EU into position as Japan's second-largest supplier (second only to Australia).

As imports of Australian natural cheese has remained roughly flat (at 59,242 MT) and imports of New Zealand natural cheese has expanded by seven percent through August 2016 to 42,254 MT (largely on lower New Zealand milk prices, lower global prices for butter and NFDM, and earlier stagnation of Chinese demand for cheese), EU gains in market share have largely come at the expense of U.S. suppliers. As EU and Oceania have expanded their shipments to Japan through the first eight months of 2016, Japanese imports of U.S. cheese in 2016 have fallen 22 percent (to 20,581 MT) following a 27 percent annual contraction in 2015. Despite a significant accumulation of U.S. cheese stocks and significantly lower domestic prices for milk and cheese, U.S. cheese export offers to Japan have not been as competitive as European and Oceania offers through the first eight months of 2016. According to industry sources, prices for U.S. natural cheese for shredding (a major source of U.S. cheese export growth in recent years) have remained relatively high, driving Japanese traders towards lower-priced offers from less-traditional suppliers.

Steady Japanese demand for processed cheese continued to drive utilization of the duty free quota for imported natural cheese for blending, comprising nearly 25 percent of the total imports from Oceania (New Zealand up slightly to 13,838 MT; Australia up four percent to 11,215 MT). The overall cheese import dynamics through August 2016 are reflected within the duty free quota for imported natural cheese for blending, where EU suppliers like Germany (up 19 percent to 1,446 MT) and Ireland (up 40 percent to 911 MT) expanded their share at the expense of the United States (down 55 percent at 2,286 MT). In JFY 2016, Japan allocated 62,600 MT for the duty free quota for imported natural cheese for blending, which requires Japanese cheese manufactures to blend Japanese domestic natural cheese with imported natural cheese at a 1:2.5 ratio to produce processed cheese products.

The total volume of Japanese factory use milk for natural cheese production fell seven percent in 2015 to 466,069 MT, resulting in Japanese 2015 total natural cheese production of 46,000 MT. Over the first eight months of 2016, Japanese factory use milk for natural cheese production has fallen an additional five percent to 305,368 MT. With ample supplies of lower priced, imported natural cheeses and greater utilization of limited supplies of factory use milk for butter/NFDM production, Post forecasts Japanese 2016 total natural cheese production to contract moderately to 45,000 MT. Meanwhile, though still small in volume, Japanese production of natural cheese for direct consumption has grown five percent over the first eight months of 2016, reaching 15,048 MT, as Japanese manufacturers continue to focus their efforts on producing domestically branded fresh, soft-type cheeses (such as camembert) for retail distribution.

Following Japan's 2015 and early 2016 cheese import surge, Post expects the anticipated recovery in global cheese prices in the fourth quarter will moderate the pace of imports through the end of 2016. However, year-on-year import volumes are expected to climb six percent to 265,000 MT, surpassing the record high set in 2015. EU suppliers are expected to capture a record share of the market in 2016, collectively supplying more than 70,000 MT (equivalent to better than 26 percent market share) for the first-time ever. Post projects Japanese 2016 total cheese consumption to also set a new record, growing five percent to 310,000 MT.

2017 Outlook

Fluid Milk

Japan Milk Production Projected Down as Beef Demand Diverts Replacement Stock

The long-term effects on the condition of Hokkaido dairy cattle, as a result of the 2016 typhoon season, could have a significant impact on Japanese total dairy production in 2017. With limited scope for expanding production outside of Hokkaido, and with aging operators across Japan continuing to exit from the industry without successors, Post anticipates the recent downward trend in nation-wide milk production to continue in 2017. Accordingly, Hokkaido producers will need to continue to expand their production to forestall the possibility of a fluid milk supply deficit in 2017.

Anticipating lingering negative impacts from the 2016 typhoon season, Post is projecting flat growth in Hokkaido milk production and marginally lower total national milk production at 7.400 MMT in 2017. Lower global feed grain prices and a relatively strong Yen could keep down the cost of formula mixed feeds and imported fodder in 2017 and improve dairy profitability. Continued strong demand for Japanese domestic beef has pushed beef cattle feeder calf prices up across the board, with monthly average wagyu feeder calf prices nearly doubling since 2012

Japanese dairy operators have benefitted from rising feeder calf prices by expanding the use of wagyu genetics in their artificial insemination programs, increasing production of so-called 'F1' cross-bred offspring for the beef cattle feeding industry. As a result of the sustained increase in beef cattle feeder calf prices over the last few years, the Japanese dairy industry is entering 2017 with replacement heifer inventories down seven percent (Hokkaido down six percent to 277,100 head and the rest of Japan down seven percent to 121,200 head) . According to industry sources, live cattle auction prices for first-bred replacement heifers have skyrocketed in 2016. At an October 17, 2016 dairy cattle auction in Hokkaido, the average price for first-bred heifers topped 830,000 Yen (approximately $8,250), nearly 50 percent above 2015 average prices and well above prices paid for high quality black wagyu feeder calves at an auction observed by Post in September 2016. While some dairy operators are reportedly using sexed semen to effectively manage their replacement herd, others are facing mounting difficulty securing replacement heifers at such extraordinary prices.

Post projects 2017 total national fluid use milk utilization to fall slightly to 3.955 million MT. With the possibility of greater volumes of Hokkaido fluid use milk for drinking delivered to urban centers across the rest of Japan in 2017, Post anticipates approximately 3.390 million MT of factory use milk will remain for processing (down less than one percent from 2016).

Butter and NFDM

Butter, NFDM Markets Could Return to Balance in 2017

Anticipating sufficient year-ending butter stocks heading into 2017and tighter factory use milk supplies persisting through 2017, Post expects Japanese domestic butter and NFDM production to contract modestly from projected 2016 levels. Post projects Japanese 2017 butter production down three percent to 65,000 MT. Assuming roughly flat demand for butter in 2017 (76,000 MT), Japan would need to import 11,000 MT of butter in calendar year 2017 (5,000 MT remaining from JFY 2016 additional imports to be delivered in the first quarter of calendar year 2017 as well as 6,000 MT through JFY 2017 current access commitments) to maintain the supply-demand balance without reducing 2017 year-ending stocks below 22,000 MT. Barring an unanticipated increase in demand for butter, or a reallocation of JFY 2017 current access commitments away from butter and toward other designated dairy commodities, Post does not foresee additional butter imports in 2017.

Post projects that ample 2016 year-ending stocks and relatively weak ingredient market demand for NFDM will result in 2017 imports falling slightly to 32,000 MT as Japanese 2017 total national utilization remains flat at 140,000 MT, excluding volumes imported under the TRQ for animal feed. Alongside lower butter production, Post projects Japanese 2017 NFDM production down five percent to 125,000 MTwith current access import volumes in calendar year 2017 at 3,000 – 4,000 MT.

Cheese

Import Price Increases Could Dampen Import, Consumption Growth

Considerable uncertainty in global dairy markets could continue into 2017 as major milk producers (including the EU, Oceania, and the United States) continue to adjust production levels in response to the accumulation of significant surplus dairy product stocks over the last two years. Australian milk production is projected modestly lower in 2017 following flooding in certain regions and production adjustments in response to 2016 global dairy prices. EU measures to reduce total milk and dairy production announced in September 2016 and U.S. measures to utilize accumulated cheese stocks for domestic feeding programs announced in October 2016 should also contribute to a moderate recovery in global cheese prices in 2017.

Post projects Japanese 2017 total natural cheese imports and consumption unchanged from projected 2016 levels at 265,000 MT and 310,000 MT respectively. Post projects that modest increases in price offers for imported cheeses could dampen further import and consumption growth in 2017.