Milk supply outpaces demand

The organic milk industry has enjoyed steady 20 to 25 percent annual market growth for the past several years. By nearly all accounts that growth was capped only by the supply of organic milk. In fact, in 2006, companies were aggressively competing for organic milk from farmers, bidding up the price and offering conventional dairy farms incentives to switch to organic dairy farming.

Now, many of the farms that converted to organic have nowhere to sell their milk. With an estimated 40 to 70 percent increase in organic milk production, supply, for the first time since organic milk entered the consumer market, has outpaced demand. Industry sources say the glut has dampened organic dairy prices to the point that some farmers are selling organic milk on the conventional market.

Most people point the finger at the so-called Harvey rule, a change in the National Organic Program that tightens regulations for organic dairy farms as of June. The changes are widely expected to make obtaining organic dairy certification more difficult and more expensive. Sara Unrue, a spokeswoman for Boulder-based Horizon, the largest U.S. supplier of organic milk, says the effects are likely to be short-lived. “Farmers wanted to make the transition to organic before the ruling goes through in June, and the supply will start to normalize after that,” Unrue says.

Even so, Horizon’s parent company Dean Foods (NYSE: DF) announced FY 2007 profits will likely fall short of projected earnings because of higher dairy prices and an oversupply of raw milk. Horizon is locked into contracts with farmers that guarantee the price it pays for organic milk for the remainder of the year, but the company will have to reduce the price of its milk for consumers to compete in the saturated organic milk market. The company’s announcement caused its share price to drop 8.3 percent, as analysts from Morgan Stanley and Prudential Equity Group downgraded their ratings of Dean Foods’ stock.

In an effort to combat falling prices, some companies are trying to expand their product portfolio. Horizon recently released organic milk fortified with the omega-3 fatty acid DHA — the only product of its kind on the market — and six new ice cream flavors (currently available only on the East Coast but making their way west by the end of the year). Meanwhile, Dean Foods announced in early June it plans to bring Horizon’s U.K. brand of organic yogurt — Rachel’s Wickedly Delicious Yogurt — to the United States. Advocacy groups, including the Cornucopia Institute, are quick to point out the U.S. version is made with “natural,” not organic, milk.

Mountainside Farms, which manufactures and distributes both conventional and organic milk, recently launched a line of Ultra Pure milk, which is from cows not treated with antibiotics and hormones and is filtered to deliver what the company claims is improved taste and shelf life.

Cyrus Schwartz, president of Mountainside, says the glut, combined with higher-than-usual conventional milk prices, also presents an opportunity for small companies such as Mountainside to sell more organic milk. The narrowing price gap could also lure new consumers to purchase organic milk, eventually bringing demand back up.

Not everyone believes the glut is a short-term problem, however. Mark Kastel, of the Wisconsinbased Cornucopia Institute, places the blame on large-scale dairies, such as those owned by Dean Foods, which manage thousands of cows.

“Dean Foods and Horizon worked hard to legitimize factory farms in the organic milk market,” Kastel says. “But it may come back to bite them in the ass because they’ve paved the way for other such farms, many of which are supplying private label organic milk to customers such as Wal-Mart (NYSE: WMT), Trader Joe’s and Safeway (NYSE: SWY), thereby flooding the market with cheaper organic milk.”