Tag Archives: Class I fluid milk pricing

Senate Ag subcommittee hearing on milk pricing: Agreement that Federal Orders need reform, but how? That’s the billion-dollar question

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By Sherry Bunting

WASHINGTON, D.C. — Federal Milk Marketing Orders, their purpose, performance, problems and solutions — including a recent change in the Class I fluid milk pricing formula — were the focus of a Senate Ag subcommittee hearing on ‘Milk Pricing: Areas of Improvement and Reform” Wednesday, Sept. 15 in the Capitol.

“We are in the midst of a modern dairy crisis, magnified by a Class I pricing change in the 2018 Farm Bill. The pandemic and economic downturn are not the only causes of this problem, but they did exacerbate it. This system cannot adapt to market conditions and thus is not fairly compensating our dairy farmers. The formula change is a symptom of larger problems in a system that is confusing, convoluted and difficult to understand,” said Gillibrand Wednesday.

She recounted the more than $750 million in producer losses when looking at the previous Class I fluid milk ‘mover’ formula that used the higher of Class III or IV manufacturing milk prices and comparing it to the current formula that uses an averaging method plus 74 cents.

The hearing was a first step Sen. Gillibrand had previously indicated in a press conference last June, when the full extent of dairy farmer financial losses was becoming known.

As the hearing got underway, Gillibrand observed that from 2003 to 2020 there has been a 55% decrease in the number of dairy farms in the U.S.

“We are using an almost 100-year-old system with the last reform 20 years ago, where dairy farms are not operating as they were then. We need to put the power back in the farmers’ hands.” said Gillibrand.

The power to make the issues known was in the hands of three dairy farmers making up the first panel — Jim Davenport, Tollgate Farm, Ancramdale, New York; Christina Zuiderveen, Black Soil Dairy, Granville, Iowa, and Mike Ferguson of Ferguson Dairy Farm, Senatobia, Mississippi.

This was followed by a panel with Dr. Chris Wolf, ag economics professor at Cornell University, Dr. Robert Wills, president of Cedar Grove Cheese and Clock Shadow Creamery, Plain, Wisconsin, and Catherine de Ronde, vice president of economics and legislative affairs with Agri-Mark cooperative based in Massachusetts with members in New England and New York.

One thing everyone agreed on, in differing degrees, is that reforms are needed in the Federal Milk Marketing Order System.

Testifiers agreed that a key purpose of the FMMOs is to make blended payments more equitable between producers supplying different classes and uses of milk.

All three producers agreed the FMMO system should continue, although they shared differing ideas about how reforms could improve it.

There was also agreement that the new Class I ‘mover’ formula is not adequate for changing and uncertain markets. They agreed that using the USDA rulemaking process is the way to make such changes to be sure all parties are heard.

However, the current change in the Class I ‘mover’, implemented in May 2019, was made legislatively during the 2018 Farm Bill, not through the USDA hearing process.

Ferguson, a 150-cow dairy producer in Mississippi said he supported bringing back the previous ‘higher of’ method while a longer-term solution can be considered through the USDA hearing process. He noted periodic reviews of the adjuster could also be helpful, and that the situation should be addressed in the short term.

He explained that the Southeast producers across FMMOs 5, 6 and 7, produce about 45% of the annual fluid milk needs of their growing population, and when supplemental milk has to be brought in, those Southeast producers pay the price to get it there. That was very difficult and costly when class pricing inversions happened last year for a prolonged period of time.

Davenport, milking 64 cows in New York observed that the Class I price was aligning better in the past few months, but “we’re not out of the woods yet,” on Covid-19, he said.

“The FMMO system has served farmers well but needs adjusted to reflect current product mixes and market swings,” said Davenport, adding that the fluid market is very important for smaller sized dairies and regional supply systems. He proffered the hope that Class I, long-term, could be stabilized by basing it on something other than the volatility of cheese, butter and powder prices.

“The rulemaking process USDA uses will work, it just takes time,” he said, adding that the Class I price should reflect how hard it is to supply the fluid market.

Zuiderveen, whose family has dairies totaling 15,000 cows in Iowa and South Dakota, said FMMO pricing for milk of the same quality should align and foster innovation and competition instead of consolidation. It should also be transparent and promote a nimble industry that can respond to changes, she said.

“Distortions can cause the system to become unglued,” she said, noting that if producers can’t anticipate which classes will participate in the pool and don’t know how that will drive their milk price, then they can’t manage their price risk effectively, losses become compounded, and this discourages risk management.

Zuiderveen and others noted a variance as wide as $9 per hundredweight was experienced in mailbox milk prices from region to region and neighbor to neighbor at intervals last year.

“That creates a sense of helplessness among producers,” said Zuiderveen.

Dr. Wolf noted multiple reasons for the negative PPDs and milk check losses under the new formula, including declining Class I fluid milk sales and increased milk components, but said the two biggest reasons for milk check losses under the new formula compared with the old formula were the large volumes of de-pooled milk that reduced FMMO pool funds as well as the Class I change itself.

Wolf explained multiple factors in the wide divergence between Class III and IV. A primary one was government purchases being tilted to cheese during that time. “This large divergence in butter and cheese prices meant that the Class I milk prices were lower than they would have been under the former pricing rule,” he said.

Ferguson noted that the government cheese purchases were intended to support dairy producers as well as the public during the pandemic, but it ended up having a “devastating effect on our fluid market,” he said, noting that a more balanced approach may have helped.

Through difficult times in the past, price alignments were more stable in large part because of the ‘higher of’ method keeping the Class I price above the blended price so no matter what was purchased, all farmers, supplying all classes of products, benefited more equitably.

Under the current formula, the pandemic cheese purchases helped support dairy producers, but also led to distortions that contributed to large differences in milk prices at the farm level.

Dr. Wills was the only processor testifying. He said the survival of dairy depends on being able to evolve on these pricing issues. “Farmers are only better off if the premium (shared in the FMMO pools) exceeds the value of other classes, and that’s inefficient,” he said, adding his opinion that FMMOs have outlived their purpose.

“The redistribution makes it appear that all farmers are winners, when the evidence shows pricing equity is being lowered,” said Wills. “I fear for the future of the dairy industry. The federally administrated milk pricing now functions opposite of its intent, resulting in higher prices for consumers and lower prices for farmers. It responds slowly, encourages inefficient trucking and promotes consolidation.”

Wills also mentioned the wave of competition from an array of plant-based and blended products as well as cellular agriculture and bio-engineered analog proteins, none of which are included in the FMMO pricing structure.

Wills brought home the reality for rural communities when small and mid-sized farms are lost. Near the end of the hearing, he responded to a question from Senator Roger Marshall (R-Kansas) asking what are his farmers’ biggest concerns, what do they talk about when he sits down with them for coffee at a restaurant?

“My farmers tend to be smaller producers,” said Wills, president of two Wisconsin cheese companies supplied by 28 dairy farms. “They are concerned about having continued access to markets as the industry continues to consolidate. Even in Wisconsin, where we have more competition than most places, it is hard to find homes for those dairies that are cut loose from big plants.”

As consolidation accelerates, he said, there is a trend toward plants not wanting to make multiple stops. “The impact of losing all of those producers … that 10% per year loss (over time) just hollows out our communities. There’s not a restaurant in town anymore to have coffee at,” said Wills. “We lost our hardware store, our grocery store. A lot of it has to do with our rural communities being hollowed out. The ability to maintain those small farms is also important for our communities.”

On program safety nets and risk management tools, Dr. Wolf noted that the Dairy Margin Coverage program has a very positive impact on small producers vs. large producers, and that the Dairy Revenue Protection and Livestock Gross Margin are aimed at bigger farms. He said farms with those programs in place were “in a better place” last year.

However, elsewhere in his testimony and in that of others, the risk management difficulties during the unusual price inversions were also mentioned, when the Class I pricing change was exacerbated by pandemic disruptions creating those misaligned conditions.

As for simply nationalizing the FMMO pooling rules or making them more rigid, Zuiderveen said this would lead to more processors staying out of the pool, and Wills said de-pooling is the pressure relief valve processors need.

With a nod to pricing delays that affect the transparency in sending market signals through the FMMO system, Wills said he found out that week (Sept. 13) what he will be paying for the milk he bought on August 1, and his producers who sold that milk to him were also just finding out what they would be paid. That’s six weeks after shipping the milk.

Wills said this kind of inefficiency makes it difficult to plan and compete in business.

Another positive to come out of the hearing was when Davenport brought up legalizing whole milk in schools, to which Chairwoman Gillibrand, Senator Marshall, a doctor, and a few other members of the Senate Subcommittee gave hearty verbal support.  

Here is the link to the recorded Senate Ag subcommittee hearing https://www.agriculture.senate.gov/hearings/milk-pricing-areas-for-improvement-and-reform

Look for more in a future Farmshine.

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Hot topic: Understanding milk pricing basics and PPD

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Gratitude to Blimling and Associates for this flow chart illustrating the complexity of USDA milk pricing

By Sherry Bunting, Farmshine, March 26, 2021

I challenge anyone to find a pricing system on anything in the universe as complicated as the pricing of a hundred pounds of milk (See Fig. 1).

The Federal Milk Marketing Order (FMMO) system goes back to the 1930s Ag Marketing Law.  In 2000, changes were made to use end-product pricing formulas for four base commodities – Cheese (block and barrel Cheddar average), Butter, Nonfat dry milk (NDFM) and Dry Whey.

Today, these four commodities trade daily on the spot cash market at the Chicago Mercantile Exchange (CME), where less than 1% of volume, closer to 2% on butter, is sold. Since 2018, this 10-minute daily spot auction is done completely as an electronic auction.

The CME spot market sets the pace for actual sales reported weekly to USDA by around 100 processors. From these weekly-reported prices, a weighted average for each of the four commodities is calculated by USDA. The weighted averages are used in formulas that account for yield and deduct specific “make allowances” (See Table 1) to then calculate Class and Component prices.

But first, these weighted price averages for just the first two weeks of each month are plugged into a multi-step formula to determine an Advanced Skim Pricing Factor for Class III (cheese/whey) and Class IV (butter, NFDM). The adjusted butter price is also used to calculate the Advanced Butterfat Pricing Factor.

Effective May 2019 — as a result of a change agreed to by National Milk Producers Federation and International Dairy Foods Association and then passed by Congress in the 2018 Farm Bill — the 2-week Class III and IV Advanced Skim Pricing Factors are averaged together, plus 74 cents to calculate the Base Skim Price.

Prior to May 2019, the Base Skim Price was simply the “higher of” either the Class III or the Class IV Advanced Skim Pricing Factor.

(Author’s Note #1: The previous ‘higher of’ method was the way the FMMOs could make sure Class I always brought the highest price to fulfill the purpose of the Federal Orders – assuring fresh milk supplies – and to keep other handlers invested in pooling their milk. We can’t lose sight of the fact that the fluid milk sales (Class I) have no market transparency as to their value – at all. In some states there are loss-leader laws or minimum pricing provisions, but in most states, Class I fluid milk sales are treated as a base commodity by large retailers like Walmart and Kroger. They loss-lead the retail consumer price of fluid milk to extreme low levels, even as low as $1 per gallon, to win shoppers. They do this because supermarket data show fresh fluid milk is in over 94% of consumer shopping carts! Because it is treated as a loss-leader in some states, and regulated with minimum pricing in other states, it’s impossible to know the real market value of Class I fluid milk apart from the value of its components in making other products.)

Next, the Base Skim Price is multiplied by a yield factor of 0.965 and the Advanced Butterfat Pricing Factor is multiplied by a yield factor of 3.5 and then added together to become the Base Class I Price. This price, known as the Class I ‘mover,’ is announced before the 23rd of each month but is used in the following month.

The various location differentials throughout the 11 FMMOs are next added to this Base Class I Price.

Whew! Now back to those weekly-reported commodity prices, yield factors and make allowances… Announced around the 5th of the next month, the other class prices are a function of the component values based on average weekly prices for the four commodities for four weeks: Component Value = Yield x (Commodity Price – Make Allowance).

In Multiple Component Pricing FMMOs like the Northeast (FMMO 1) and Mideast (FMMO 33), a Statistical Uniform Price (SUP) is calculated from these Class and Component prices according to how the milk in the FMMO was utilized. The SUP is announced around the 11th of the next month before settlement checks are paid for the previous month’s milk.

(Author’s Note#2: Another wrinkle… did you know that an uptrending cheese and butter price can leave producers with a lower protein price? It happened in March 2021. Every end-product — butter, cheddar, nonfat dry milk and dry whey — was higher in March than February, and Class III, IV and II pricing were also higher, but the uptrending butterfat portion of the cheese price creates a ‘snubbing’ effect on the ability of protein to rise within the skim portion. Yes, it’s complicated, and the answer from USDA is a story of its own in the future.)

The FMMO SUPs are based on a 3.5% Butterfat test, but the FMMOs also report for information purposes a uniform price based on the average actual fat test. Your price will differ in your milk check based on your fat, protein, and other factors. In general, producing protein and butterfat above the statistical level nets a higher price, under normal conditions. Lately this has not held out because of negative PPDs.

What are PPDs? Along with the SUP, the FMMO calculates a Producer Price Differential (PPD). This shows how money remaining in the producer settlement fund is divided across the qualified hundredweights of milk, after all components are paid. Sometimes this is a negative number, meaning there was not enough money in the producer settlement fund to pay all of the actual component value after the location differentials on Class I were paid. A negative PPD represents spreading the shortfall across qualified milk in the pool. Severely negative PPDs represent unpaid component value.

The PPD is calculated by subtracting the Class III price from the average of all classes together: PPD = SUP – Class III. In the Northeast and Mideast FMMOs, this PPD has typically been a positive number but has been shrinking in recent years and has been negative for 13 of the past 23 months.

Negative PPDs happen for any or all of four main reasons:

1) When a rapid rise in commodity price(s) is not captured in the 2-week Advanced Pricing Factors.

2) When Class II and IV are far below Class III.

3) When Class I price falls below Class III because of the new averaging method when the spread between III and IV is greater than $1.48/cwt. Half of the months from May 2019 through December 2020 had a lower Class I Base price under the new method, representing a net loss of over $700 million on Class I pounds across all FMMOs. (See Table 2)

4) When handlers de-pool Class III milk because it is higher — to avoid paying into the pool.

Only Class I handlers are required to pool all of their milk. Other handlers can choose what non-Class I milk to pool or not pool based on what is financially advantageous. De-pooling is more likely when multiple months have negative PPDs because of wait times to re-qualify milk for the pool. Some FMMO pool-qualifying requirements are more stringent than others, and the rules have been loosening in recent years because handlers say they need more flexibility to meet fluctuating fluid milk needs.

Occasionally, when cooperatives or plants de-pool Class III milk, some will pass the higher value they withheld from the pool directly to their own producers. In most cases, however, this did not happen in 2020. Additionally, the severity of negative PPDs across FMMOs varied and this created a wide range of milk check pricing of $8 to $10 from top to bottom, when normally this range is $2 to $3, maybe $4. USDA relates that the value is still in the marketplace, so even when the PPD goes negative, some of that value is attributed to the All Milk price used in Dairy Margin Coverage margins because the value is in the market even if it is not in the “pool.”

In addition, for Pennsylvania dairy producers, all Class I milk from Pennsylvania farms that is bottled in Pennsylvania and sold in Pennsylvania stores receives the Pa. Milk Marketing Board (PMMB) over-order premium, which currently stands at $1.00/cwt. Processors can reduce this obligation by selling and sourcing milk from in and out of state as well as other methods.

Cooperatives are producers under the Pennsylvania law, so they collectively receive this premium also, where applicable, and have the ability to disburse the premium to members as they see fit.

Every farm’s mailbox price is further affected by premiums, such as quality bonuses, and deductions, such as trucking cost and marketing fees, which all vary across cooperatives and milk buyers.

This ‘primer’ just scratches the surface of current milk pricing issues. A related topic affecting many producers since May 2019 is how the new Class I pricing method, and the negative PPDs and depooling that can result when Class III and IV are so divergent, affect the way price risk management tools work, creating additional losses in many cases.

(Author’s Note #3: This article has been updated since it was previously published in R&J Dairy Consulting’s customer newsletter.)

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