New ‘cost of processing’ report could boost make allowances by almost $1.00 per cwt

By Sherry Bunting

WASHINGTON, D.C. — The USDA released the long-anticipated study on milk price ‘make allowances’ recently. These are embedded in the end-product pricing formulas.

Make allowances are processor credits for transforming raw milk into the four base commodities – cheddar, butter, nonfat dry milk and dry whey that are used in end-product pricing formulas for Federal Milk Marketing Order (FMMO) Class and Component prices as well as the Class I Mover price.

During ADC’s Future of Federal Milk Pricing Forum Feb. 15, set make allowances were cited by panelist Mike McCully as margin guarantees that “encourage commodity production and deter innovation.”

He believes ‘value-added’ products are the path to return more dollars to farmers in the future for all classes, including Class I fluid milk.

“If (FMMO) end-product pricing continues, then the make allowances will have to be raised, and this will come at a cost to producers,” said McCully, referencing the Cost of Processing study commissioned in 2019 by USDA and completed in 2022 by Dr. Mark Stephenson, dairy economics professor at University of Wisconsin-Madison.

In a USDA AMS webinar Feb. 23, Dr. Stephenson talked about the report as well as previous reports in 2006-08 when make allowances were last raised. He observed that today’s plants are more complex with a wider range of products and innovations. Therefore, isolating the costs for the four basic commodities was more difficult this time.

He said 80% of the data came from participation by processing plants owned by cooperatives. Many proprietary plants chose not to participate.

The Class III make allowances for cheese and whey currently total $3.17 per hundredweight, and the Class IV make allowances for butter and nonfat dry milk total $2.17, according to Dr. John Newton, chief economist for the U.S. Senate Agriculture Committee Republicans.

Newton said the new Cost of Processing report shows these make allowances could go up to $4.00 for Class III and $3.12 for Class IV, which represents a nearly $1.00 impact in Federal Order minimum class price reductions if implemented.

“The ultimate result is a reduction in farm milk checks,” said Newton speaking virtually to Kentucky dairy producers at their annual Dairy Partners conference Wed., Feb. 23 in Bowling Green.

“The make allowances are designed to cover the costs of taking raw milk and converting it to these products, where the component value is captured in end-product pricing,” said Newton, observing that they haven’t been raised for more than 10 years, but this hasn’t stopped explosive growth in product production and significant re-blending of farm milk prices in recent years.

“Processors have opportunities to add value in the many other product streams outside of the make allowance and end-product pricing formula, already,” said Newton, noting some of the cumulative numbers and describing this as “effectively a subsidy from farmers to processors to process their milk.”

“This will be a very tough debate, and hopefully farmers are at the table as this debate happens,” he said.

Future of Federal Milk Pricing Forum got ‘wheels turning’

‘We need to figure out a way to get farmers’ voices incorporated into this discussion’

Table I reflects a decade of change in FMMO participation as total U.S. milk production grew 13.3% from 2011 to 2021, and the percentage of milk pooled on FMMOs fell from 82% in 2011 to 60.5% in 2021. California became an FMMO in 2018 after previously being a state order, so California’s production is not included in the 2011 pooling comparison so the pooling percentages are relative to production in FMMO and unregulated regions. Class I pounds as a percent of total production fell from 28.7% in 2011 to 18.6% in 2021. Figures for 2021 are shown both ways, including and excluding California to compare to 10 years ago when the number one dairy state had its own state order with different pooling and classification rules and incomplete data, but the percent of change is nonetheless eye-opening. Chart compiled by S. Bunting 

By Sherry Bunting, published in Farmshine, Feb. 18 and 25, 2022

GREEN BAY, Wis. — Do dairy farmers want to save the baby, save the bathwater, change the flow of the bathwater, or tighten the plug on the drain before the bathwater drains to the point of taking baby with it?

That’s a brutal take after 90 minutes and a lot of information, starting with the basics and hearing perspectives and questions during the American Dairy Coalition’s Future of Federal Milk Pricing Forum on Feb. 15.

It was a first step in what ADC sees as a continuing conversation and effort to engage dairy farmers to lead the process. They said the next forum will be in March.

Geared specifically for dairy farmers, the forum attracted 160 participants from across the country, representing every element of the dairy industry — including dairy farmers.

The virtual format was moderated by Dave Natzke, markets and policy editor with Progressive Dairy magazine. Featured presenters were Calvin Covington, retired co-op COO with 45 years of experience in federal and state marketing orders; Frank Doll, a third generation Illinois dairy farmer involved in American Farm Bureau’s dairy policy committee, and Mike McCully, industry consultant on the IDFA dairy ingredients board and economic policy committee.

Included were comments presented by attendees, who pre-registered for three-minute slots. Others typed into the queue.

“This is complicated, and many people say it can’t be fixed, but we have a great amount of expertise and value here. We covered a lot,” said Laurie Fischer, CEO of ADC at the end of the forum. “We can’t just let this drop. We need to continue to move forward.”

“We heard a lot of good information that has everyone’s wheels turning,” added ADC president Walt Moore of Walmoore Holsteins, Chester County, Pa. He encouraged producers to reach out and engage to tackle the hard topics.

The goal of this initial forum was to inform dairy producers on the Federal Milk Marketing Orders (FMMO) and pricing process to become engaged and have a greater voice in guiding future policies.

For its part, American Farm Bureau Federation spent the past couple years going through a similar working group with policy recommendations coming from states to national and back to states. 

Several commenters concurred with the position of ADC, Farm Bureau and other organizations that Class I pricing should return to the ‘higher of’ method until future policies can go through what could be a long hearing process of potential revision for the future.

In fact, one eye opener during the Forum was Doll’s confirmation that Farm Bureau policy now includes support for going back to the ‘higher of’ — plus adding 74 cents — in the calculation of the Class I mover price, while remaining open to other ideas.

Doll said consensus was hard to find in the Farm Bureau working group of 13 members from across the country due to regional differences in the makeup of processing. But general recommendations found agreement, including the reference to Class I as well as modified bloc voting where co-ops can vote for their members on Federal Orders, but farmers can cast their own votes and be encouraged to do so.

Several attendees cited the need for a vehicle for producers to have real input without fear of retribution, that farmers should collectively ask questions of their cooperatives, seek better representation and together, hold their cooperatives accountable to represent their interests. 

“We need to figure out a way to get farmers’ voices incorporated into this discussion. I hear from producers all the time, but there is fear of retribution, the threat that your milk is not going to get picked up. If you are on a board and speak up, you’re not there very long,” said Kim Bremmer, representing Venture Co-op in Wisconsin, a third-party ‘testing co-op’ qualified by USDA.

She addressed bloc voting, saying: “What’s the point of having a hearing if producers can’t vote? We don’t have great representation from some of the groups that say they represent us.”

Bottomline, said Bremmer: “We have to address how to get more of the producer voice and not just the processor voice — because they’re not the same.”

She asked: “Is it a conflict of interest if you’re a processor and you’re marketing milk and you’re also advocating for producers? I think that’s an important question that needs to be answered. We need to stay engaged in this and be able to ask the tough questions and demand some answers.”

ADC’s Fischer said the organization wants to work with farmers and their state and national organizations to provide a vehicle to bring farmers together and compose a list of pricing policy items to explore further with experts.

One clear change in the dairy industry formed the crux of the discussion: The growth of milk production in the U.S. — in concert with growing export sales and declining fluid milk sales — put export sales volume above Class I volume as a percentage of total milk solids in 2021.

McCully described this as “a seismic change.”

Covington confirmed that Class I sales — as a percentage of total milk production — fell below 20% in 2021. The percentage of Class I milk within the 137 billion pounds pooled on 11 FMMOs in 2021 was about 30%.

Contrary to the widely held belief that FMMOs regulate a majority of the milk, they simply do not. Covington confirmed that the 137 billion pounds of milk pooled on 11 FMMOs in 2021 represents only about 60% of U.S. milk production.

The FMMOs aren’t designed for this direction that the dairy industry is going toward global markets, according to McCully.

He said the world will look to the U.S. as the “go-to market,” claiming New Zealand and the EU are maxed out. He described the “white gallon jug” as being the most prime example of a low-margin commodity and predicted ‘value-added’ products will return more dollars to farmers in the future. These are recurrent themes heard from speakers at winter meetings this year.

(Author’s note: In contrast, current industry-wide discussion on the ‘sustainability’ side is for a ‘stable’ U.S. cattle herd to be an indicator of dairy’s climate neutrality. If exports grow, and the U.S. herd remains ‘stable’, then export milk will have to come from growth in output per cow and displacement of Class I production. One can see how geographic camps can set up, since fresh fluid milk sales are vital to the viability of dairy farms in areas outside of the earmarked growth areas for dairy manufacturing in the Central U.S. — the question is how to bridge it.)

At the same time, dragging feet doesn’t seem to be much of an option.

If dairy policy remains ‘status quo,’ leaving the FMMOs ‘as-is,’ they could eventually cover less and less milk and potentially collapse, according to McCully.

Covington also addressed this, noting that FMMOs “were designed for fluid milk, but today, fluid milk is a minority use. People used to drink their milk, now they are eating their milk.”

McCully noted the need for dairy innovation. He said make allowances have facilitated large-scale commodity plant construction supplied by large-scale farms, suggesting it is these built-in make allowance ‘margins’ that favor commodity production and deter innovation. 

“If end-product pricing continues, the make allowances will have to be raised,” he said, citing a new make allowance study “fresh off the press.”

In 2019, USDA commissioned Dr. Mark Stephenson, dairy economist at University of Wisconsin-Madison, to do the study. Stephenson recently announced it is complete and will soon be released by USDA. McCully’s glimpse at the report shows make allowance calculations to be “significantly higher” than the amounts embedded currently in end-product pricing formulas.

Western Pennsylvania dairy nutritionist Harry Stugart offered his concise, data-driven argument that the make allowances be removed from the formula for the ‘advance’ Class I mover price because these make allowances do not pertain to fluid milk. In January 2022, he said they amounted to $2.67 per hundredweight.

Another crucial part of the discussion was how FMMOs actually work and what they do, besides pricing.

Covington gave attendees a primer of key points to think about as discussions move forward. What he shared may be old news to some, but it’s surprising how many people do not know these facts:

— FMMOs are not required by law, they are simply “enabled” to exist by law. This means producers vote to have them (California in 2018) or to terminate them (Idaho 2004).

— Only Class I fluid milk plants are required to be regulated under FMMOs.

— Class II, III and IV plants participate voluntarily, and they tend to do so “when it’s economically feasible.” Rules of participation vary from Order to Order.

— FMMOs establish other things besides minimum pricing for regulated plants. This includes setting payment terms, providing market information and market services such as testing and auditing.

— The last FMMO reform (2000) was complicated and took four years. It was a combination of legislation (1995 Farm Bill) and an administrative rulemaking process.

— Today, there are four classes of milk, but that was not always the case.

— Today, the Class I mover (base price), as well as the Class II, III and IV prices are established to be the same in all FMMOs, but in the past different FMMOs had different mechanisms.

— Cooperatives are not required to pay FMMO minimum prices even if they own regulated Class I plants because cooperatives are viewed by the FMMOs as one big producer and can make their own decisions about distributing the revenue received to their farmer-members.

— Today, over half of the Class I fluid milk plants in the U.S. are either owned by cooperatives or by large retail supermarkets. Over the past 60 years of consolidation, FMMOs have gone from regulating 2250 fluid milk plants in 1960 to just 225 in 2021.

— Cooperatives balance the Class I market at a cost. Excess milk can go to unregulated buyers at a price that is several dollars below the minimum price. Some co-ops run their own balancing plants. These costs can result in paying farmers below minimum price.

“Milk pricing should return a fair cost to producers, processors and retailers. A chain is only as strong as its weakest link,” said Sherry Bunting, speaking on behalf of the Grassroots PA Dairy Advisory Committee. She also highlighted the Whole Milk for Healthy Kids Act, H.R. 1861, explaining how support for this legislation is essential — no matter how milk is priced.

“In the process of working on this legislation, our (Grassroots PA) committee has identified other concerns. It is hard for producers to advocate when even such a simple and good thing as whole milk in schools is rebuked,” said Bunting. “Farmers hear from leaders and inspectors: ‘If we sell whole milk in schools, do you think we can just stop making cheese and other products?’ Or ‘All you are doing is disrupting markets and creating a butterfat shortage.’ Or ‘Be careful what you wish for.’ These are veiled threats.”

Bunting highlighted the need for greater competition, accountability, transparency and timeliness of price reporting. 

“Dairy farmers have farms to run, cows to care for, and they become paralyzed by the complexity and lack of transparency in the system and their milk checks. They become overwhelmed and unconfident, even fearing retribution,” she said.

Bremmer specifically addressed milk check transparency.

“We have members with attorneys that cannot interpret their milk checks. That has to stop,” said Bremmer. “Why wouldn’t processors want to show farmers what they are paying them? What is the reason? To have attorneys and others looking at it and they can’t figure it out, that’s a real problem. We think they’re probably re-blending some things to make another ‘make allowance’. We know these things are happening all across the United States.”

Payment terms are critical in this conversation. Even the best-made plans for risk management mean nothing if farmers don’t receive timely and consistent payments for their milk due to the high capital costs and cash flow needs of running a dairy farm. 

One commenter said farmers want their income to come from consumers, not from the federal government. He wondered why Federal Milk Marketing Orders (FMMOs) are even needed to guarantee payment.

“Why? So you get paid,” replied panelist Covington. “The FMMOs all establish dates when advance and final payments are made. Having been a co-op manager working with fluid milk plants, I can’t emphasize enough how important this is.”

He also pointed out the important auditing, weights and measures, and market information the FMMOs provide.

McCully said these other services provided by FMMOs are “something we need more of going forward. We need less (price) regulation and more (market) information,” he added. “What’s not working is the milk pricing.”

Here’s where the crux comes into play: The FMMOs are not set up to regulate a global product market, and the industry has set its sights on exporting even more. This is leading the dairy industry to look at how other countries price milk as it relates to the U.S. pricing system and its ability to “be globally competitive.”

As the percentage of Class I sales have declined in relation to growth of U.S. milk production over the past decade, the percentage of milk pooled on FMMOs has also declined from 82% in 2011 to 60% in 2021 (See Table I).

Covington explained how pooling plays out within the FMMO system: “A regulated plant is required to pay its direct shippers and any co-op supplying milk a minimum blend or uniform price. Each Order takes the revenue from each class at the minimum price and pulls it together into one pool to come up with the uniform price.”

He said Class I differentials “have two purposes, to move milk to fluid use and to gain additional revenue for dairy farmers.” They range from $1.60/cwt in the extreme northern U.S. to $6.00/cwt in Miami, Florida and are added to the base Class I mover price. 

The regulated Class I plants pay the difference between the uniform price and the Class I minimum price into the FMMO. Other class plants voluntarily participate to take a draw from the FMMO to add to what they pay their producers. That’s how it has worked most of the time – until now.

Diminished Class I sales as a percentage of total milk flip this switch, and the 2018 Farm Bill change to averaging Class III and IV skim plus 74 cents — instead of the ‘higher of’ — along with the advance pricing element, have increased the de-pooling pressure on this system, especially during times of volatility.

When asked about wide price inversions that occurred in some months over the past two years, both Covington and McCully observed the impact on bottlers paying above minimum prices to attract milk away from then higher-value Class III.

In thinking about the future, Covington reminded attendees of the past. He said at one time some Orders had individual handler pools — not marketwide pools — a nod to the idea of how FMMOs could continue to regulate Class I, if handlers in the other classes lose interest in participation.

Back when California was a state order, virtually all milk was pooled. Plants had to make decisions about pooling annually by January 1. 

McCully contended that this scenario led to dumping of milk and inefficient transport to other areas. According to his analysis, the idea of making the pooling rules more restrictive and uniform across all FMMOs would lead processors to completely leave the system, and they can do that because their participation is voluntary, except for Class I.

Risk management was on the mind of several commenters, including Doll. He pointed out how the ‘holes’ in the Class I pricing change were exposed by the pandemic volatility. (Significant losses to Class I value are occurring again in the February and March 2022 Class I price.)

Joining Doll as a fellow Illinois dairy farmer was Bryan Henrichs. He said the class price inversions during the pandemic left many farmers on the losing end of what they thought were ‘safe’ $18 Class III forward contracts. The up to $9 negative PPDs kept them from achieving that price when the Class III price exceeded the contract level, but the farmer didn’t receive that price in the milk check — a double whammy.

Henrichs and others noted that milk should be priced competitively and simplified. Henrichs mentioned the idea of pricing milk at one price — no matter what it is used for — allowing market participants, including farmers, to manage risk and trade location basis, like for corn.

Arden Tewksbury’s comments from Progressive Agriculture Organization based in Meshoppen, Pennsylvania were presented by Carol Sullivan — highlighting the need for cost of production in the pricing equation, along with a realistic supply management program. 

Annual FMMO pooling decisions (instead of in and out), and his longtime support for whole milk in schools were other key points offered by Tewksbury.

One attendee stated that if processors are looking to raise their ‘make allowances,’ why not add a ‘make allowance’ for producers?

On cost of production, McCully pointed out that the range is wide between a 50,000-cow dairy in western Kansas and a 40-cow dairy in northern Vermont, for example. He said interstate movement of milk and the fact that FMMO participation is voluntary for over 80% of the milk outside of Class I creates issues for using a blanket national average cost of production.

McCully said ‘cost-plus’ contracts are being used today by some processors and producers, but this is only for milk sold outside of the FMMO system.

As confirmed by Covington, 40% of the U.S. milk supply was priced outside of the FMMOs in 2021. He said this could increase as Class I becomes a smaller slice of the growing pie, especially in areas of the country where Class I is already quite small.

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March Class I mover higher, but marks second straight month of value loss under current formula

Weekly MARKET MOOS, by Sherry Bunting, Farmshine, Feb. 18, 2022

March Class I ‘mover’ $22.88 instead of $23.67

The March Class I base price, or ‘mover’, was announced Wed., Feb. 16 at $22.88. This is $1.24 higher than the Feb. Class I ‘mover’ and $7.60 higher than a year ago. This marks the 6th consecutive month of Class I mover gains.

However, for the second consecutive month, the Class I mover is at a level lower than it would have been under the previous ‘higher of’ formula. Announced at $22.88 for March 2022 using the average-plus method, this is 79 cents lower than the $23.67 it would have been under the previous ‘higher of’ formula.

As shown above, the net loss in Class I value since the new formula was implemented in May 2019 is over $738 million. This could continue for the foreseeable future if this week’s futures markets are an indication.

Near term futures diverge by $2 to $3; 12-mo. Cl. III avg. $21.34, IV $23.28

Class III milk contracts came under pressure at midweek while Class IV surged solidly higher. This created more divergence between the two this week — to spreads beyond the $1.48 ‘magic number’ for all but three of the next 12 month contracts. ($1.48 is the point when the Class I price set by the current average-plus method becomes a loss compared to the previous ‘higher of’ method.)

We already saw this occur for the February and March 2022 Class I mover (above).
But the good news is the overall price levels are the highest in 8 years for most of these months — just not as much higher as they would have been using the ‘higher of’ method.

The average spread between the two milk contracts for the next 12 months Feb. 2022 through Jan. 2023 stands at $1.94/cwt this week.

Class III milk futures averaged $21.34 for the next 12 months, 8 cents lower than the average a week ago.

Class IV futures averaged $23.28 for the next 12 months, gaining 47 cents on top of last week’s 67-cent gain, now up fully $2.00 compared with a month ago.

CME spot dairy products all higher, except whey slips a penny

CME spot dairy prices moved higher on all products this week, except whey slipped another penny. Butter made the biggest gains, followed by block cheddar.

On Wed., Feb. 16, butter was pegged at $2.80/lb with 7 loads trading. This is up a whopping 27 cents compared with a week ago but 7 cents below the high for the week at 2.87/lb on the previous day.

Grade A nonfat dry milk (NFDM) hit $1.90 this week, then lost a penny Wed., Feb. 16, pegged at $1.89/lb — still a 2 1/2 cent gain over a week ago with a single load changing hands.

On the Class III side of the ledger Wed., Feb. 16, 40-lb Cheddar blocks were pegged at $1.9825/lb, up 8 cents from the previous Wednesday with 3 loads trading; 500-lb barrels at $1.92 are up 6 cents from a week ago with 3 loads trading.

The spot market for dry whey lost another penny this week, but remains above the 80-cent mark. On Wed., Feb. 16, a single load traded and the price was pegged at 81 cents/lb.

Jan. blend up $1.50-$2.00: Class IV tops Class I in all 7 MCP Orders

January’s uniform prices announced in each of the 11 Federal Milk Marketing Orders (FMMO) over the past several days were $1.50 to $2.00 higher across the board for the third consecutive month. In the 7 multiple component pricing (MCP) FMMOs, the Class IV price topped the Class I minimums (including differentials) and in some FMMOs, the Class I minimums were the lowest class price.

Statistical reports show the spreads incentivized some de-pooling of Class II and IV milk. In the Northeast FMMO for January, Class IV and Class II, combined, accounted for 40% of utilization and Class I accounted for 31%, contributing to a blend price that was $2.36 above the Class III price. PPDs were positive throughout all MCP Orders because Class III was the lowest price. (PPD = blend price minus Class III.)

January’s uniform prices moved higher for the third straight month — across the board — as follows:

FMMO 1 (Northeast) SUP $22.74 PPD +$2.36
FMMO 33 (Mideast) SUP $20.38 PPD +$0.96
FMMO 32 (Central) SUP $21.09 PPD +$0.71
FMMO 30 (UpperMW) SUP $20.59 PPD +$0.21
FMMO 126 (So. West) SUP $21.63 PPD +$1.25
FMMO 124 (Pacific NW) SUP $21.49 PPD +$1.11
FMMO 51 (California) SUP $21.25 PPD +$0.87
FMMO 5 (Appalachian) uniform price $23.72
FMMO 7 (Southeast) uniform price $22.28
FMMO 6 (Florida) uniform price $25.49
FMMO 131 (Arizona) uniform price $24.17

Your milk check and fairness in contracts: Dr. Bozic urges transparency

Dr. Marin Bozic of Bozic LLC talked about his Milk Check Transparency Report at Pennsylvania Dairy Summit in Lancaster on Feb. 2. S.Bunting photo

By Sherry Bunting, published in Farmshine, Feb. 18, 2022

LANCASTER, Pa. — Aside from Federal Milk Marketing Order modifications, Dr. Marin Bozic talked about two other key pillars of reform during his keynote presentation at the Pennsylvania Dairy Summit February 2: Milk check transparency and fairness in milk contracts.

“Everyone prices milk differently depending on what they want you to do,” he said, showing a scattergram of milk check data from various coops and buyers. 

“It’s impossible to compare it,” Bozic declared, noting that in Australia, all milk pricing data are public so anyone can see how everyone compares in payment by region. In Ireland something similar is also done, where each buyer’s protein and butterfat price is published as well as a price for the liquid portion.

“They see what different processors pay. They don’t have Federal Orders. This transparency keeps everyone honest,” said Bozic. 

He knows about pricing around the world because — in addition to being an associate professor of applied economics at the University of Minnesota — Bozic is founder and CEO of Bozic LLC, a global provider of technology for commodity markets analytics and risk management, with around 100 clients on four continents. He is also an advisor to several dairy trade associations.

“While it’s not easy to switch (milk markets) today, milk check transparency would allow producers to hold boards accountable and hold management accountable,” said Bozic. “Having this information, seeing the patterns, a producer can ask the question: Are you doing everything you can to make sure I am successful?”

Bozic announced his new Milk Check Transparency Report, which he said will be a monthly report generated from producers submitting their milk checks to him. The purpose is to make milk checks easier to understand and to benchmark across processors to improve price discovery.

He has been working on this project with 12 processors, mainly in Wisconsin, so far. The first report is due out in the next few weeks, and the goal is to gain more input covering more buyers in more regions.

He said he hopes to have 90 to 95% of the processors included within the next six months to be able to generate a national Milk Check Transparency Report every month.

Specifically, all data is collected from producers’ milk check statements. The collaboration is confidential and a non-disclosure agreement is signed protecting the producer. Bozic and an assistant input the data. No one else sees the individual milk check submissions.

Once enough data are collected to have a high degree of confidence in the estimates, processors are contacted to offer them the opportunity to validate or comment before publishing.

Bozic has a multi-step process for standardizing the information at national average component levels (4.0F and 3.3P). He appreciates having a document describing how premiums are set by the milk buyer. Representative hauling is also incorporated and other formulas so price discovery comparisons can be made.

“Then we can work with any milk check,” said Bozic.

He said a large number of farms from Washington to Florida and from California to New York are or will be participating in this project, and he urged producers to get involved by writing to him at marin@bozic.io

Bozic was quick to point out there are other considerations and benefits a cooperative or private milk market may provide that go outside the scope of the report. He said the Milk Check Transparency Report is not meant for ranking. Instead, it is a way to look comparatively, so producers can have better market price discovery, input and accountability.

Another goal of the report is to eventually have a calculator option, where a producer can slide the pounds of volume or components, even milk quality, and see how it changes the pricing outcome.

“We are then better able to design risk management,” said Bozic, whose proprietary company owns the intellectual property he developed as the infrastructure behind risk management programs like Dairy Revenue Protection (DRP).

He believes with better information, even the Dairy Margin Coverage can be improved, and the calculators and sliders could allow producers to see how they are paid against a national index allowing them to make changes that would improve profitability and better inform how to manage the price risk they have.

Negative PPDs (producer price differentials) made headlines the past two years, Bozic acknowledged. 

“There’s an impression that all this milk was de-pooled and a feeling that processors could have their cake and eat it too,” he said. “The Milk Check Transparency Report puts everyone on notice that whether differentials are positive or negative, they are in there.”

In this way, he said, the report can “promote good behavior in an unregulated way.”

On the variation in how producers are paid, Bozic said a big problem is lack of clarity on how farmers can achieve a better price.

“It’s astonishing to me that processors do not have brochures detailing how their incentives are based so farmers know how to meet them,” said Bozic.

The Milk Check Transparency Report is something Bozic is doing, for free, on his own time. He is not relying on the University of Minnesota. He said he knows he’ll get some ‘hate mail’ but believes it is important. 

When asked why he is doing this, Bozic brought his reply to a personal level. He mentioned his mother, who is ailing, saying that she inspired him all his life to help people. He said it is hard for anyone to do this, but that he is fortunate to have built a technology company over the years and believes he is in a position to do something good.

On contract fairness, Bozic noted that Australia has required structures in their milk contracts, but they do not have regulated pricing.

“It’s their contracts that put them on an even keel,” he said. 

For example, no cooperative or milk buyer should be able to prohibit their producers from doing third-party milk weight and test samples. Contracts should protect farmers from being ‘failed’ in inspections simply because they are ‘prickly’ or ‘vocal’ producers.

He also noted that in countries, like Australia, milk buyers or cooperatives are not allowed to require exclusivity while also doing two-tiered pricing for base and over-base milk at the same time. 

“It’s one or the other,” said Bozic. “When those two lanes cross at the same time, we have a traffic accident.”

“Organizations like ADC and Edge are fighting for some of these interests of farmers, but they need more voices,” said Bozic.

He pointed out that the combination of exclusivity and base programs in the East may be insulating against production growth and surplus.

“That ‘insulation’ may be fine right now,” said Bozic. “But what about 10 years from now?”

What happens to dairy in the Northeast, for example, when processing has been built up everywhere else where production is being allowed, even encouraged, to grow?

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Covington: Southeast blend price forecast $3.50 higher for 2022

Industry trends explored at Georgia Dairy Conference

Calvin Covington gives Southeast Dairy Outlook at Georgia Dairy Conference in January. S.Bunting photo

By Sherry Bunting, published in Farmshine, Feb. 11, 2022

SAVANNAH, Ga. – “Everything is going up, and quickly. Class IV is driving milk prices, with good demand for both butter and powder, especially for exporting,” said Calvin Covington as he presented the Southeast dairy outlook during the 2022 Georgia Dairy Conference, attended by around 300 dairy producers and industry members in Savannah in January.

He forecast the 2022 Federal Order blend price average (not mailbox price) for the Southeast region will be up $3.50, with most of that increase on higher butterfat, predicted to average $2.54/lb.

Covington’s 2022 blend price projections range from $23.01 in the Appalachian Order 5 and $23.05 in the Southeast Order 7 to $24.81 in Florida Order 6.

He noted that the market beat his conservative 2021 projections by 50 cents to the good. 

“I’m still on the conservative side this year because prices can decrease as quickly as they increase,” Covinton said. “A small change in supply or demand makes a larger change – up or down – in your milk price.”

Covington went through the numbers for 2021, noting reduced milk production, reduced product inventories, reduced Class I sales, a narrowing of the Southeast milk deficit, expanded exports, and expanded domestic demand as trends that are expected to persist into 2022 – especially on the milk production side as supply programs, production cost increases and limits on available labor keep a lid on milk growth nationwide, even worldwide.

Come 2023-24, Covington sees production “jumping up” because of new cheese capacity coming on line in the next two to three years. 

“Texas and the I-29 corridor (Central Plains) are bringing cows to where the plants are growing. We can see this in the production numbers,” he said.

As the milk supply in 2022 is likely to be restrained, Covington looks to the signs that domestic and export demand will continue strong, but questioned how inflation will affect consumer buying power.

The availability and consistency of labor also continues to challenge the dairy supply chain and its customers on the foodservice side.

Be prepared for the unexpected, he cautioned, reminding producers that 2020 was forecast to be a good year, and then the unexpected happened – Coronavirus – so all bets were off.

Exports play bigger role in milk price

“Export demand has become very important to your milk price,” said Covington. “We are seeing the strongest demand yet… and look how dependent the industry is on the export market, sending a record 17.1% of supply overseas — up from 15.8% in 2020.”

Using the available figures for the first 11 months of 2021 to gauge it, Covington said overall export demand is up 11.5% for 2021. Over the past decade, the year over year export demand gains averaged 4.3% by comparison.

Add to this the increase in domestic demand, up 1.4% in 2021, and the net gain in dairy demand for 2021 is more than 3% — almost double the 10-year average year over year demand increase of 1.7%.

Unfortunately, on the fluid milk side, USDA reports sales are down over 4% in 2021 vs. 2020, according to Covington.

“Exports are having a bigger part in your milk price,” he said, noting that global milk production in major dairy exporting countries is flat to lower, pushing global dairy prices higher. “Our prices are well below the world prices, making us very competitive. We’re exporting twice as much butter, and 75% of our nonfat dry milk is being exported.”

That’s positive for the skim price, and the doubling of butterfat exports along with domestic demand push the other side of the fat/skim equation higher.

Milk production trends

Even though 2021 milk production will clock in at around 1% over 2020, Covington honed into the production and cow losses on the back half of the year, using July through November data.

Cow losses at 124,000 head in those five months “are the biggest drop since 2009,” he said.

At the same time, milk per cow had been increasing the first part of the year but flattened in the second half as cost of production caught up to milk prices.

“Production is lower now because of less milk per cow and fewer cows,” said Covington.

Looking at just the back half of 2021, Covington broke the 24 monthly milk reporting states into thirds and showed the geographic shifts (Table 1, above): 8 states were up more than 1% in production, 8 states had reduced production and 8 states were in between.

Significant in the gaining top-third is Georgia, with July through November 2021 production up 3.2% over the same period in 2020.

“Georgia added more cows and increased milk per cow,” said Covington. He said as Florida is losing production, Georgia is gaining and getting closer to Florida.

On the bottom third, the back half 2021 milk production decreases were 4.6% in Florida and 3% in Virginia.

“Florida lost 6000 head and Virginia 3000,” said Covington. “This tells me people are going out of business.”

Looking at the three major milk states of the Southeast region for the year, Covington noted that Florida is down 4.8%, Virginia down 3.3% and Georgia up 1.1%. The other seven states of the Southeast are collectively down about a billion pounds over the past few years.

In the Northeast, Covington’s chart showed New York’s production for those months was up 1.1%, barely putting it in the gaining third, while Pennsylvania’s production was 2.3% lower and Ohio of 1.1%.

In the West, the chart showed Texas up 3.9%, but New Mexico down 9.9%; Wisconsin and Minnesota up 3.2 and 2.7% and Illinois down 1.4%; South Dakota continues as the largest percentage gainer, up 16.7% on the back half of 2021.

“South Dakota tops the list with expansion in cheese capacity,” said Covington. “Cheese expansion is also underway in Texas, and milk production is growing there too.”

Dairy inventories and commodity production are down

Dairy inventories are down. “One of the best barometers for milk prices is looking at inventories, to see if they are building or declining,” said Covington. They are declining with butter inventory down 16%, powder down 21%, whey down almost 9%.

Cheese inventories are up 9.6%, which isn’t bad, according to Covington.

“We’re going into 2022 with really no challenge of inventory,” he said.

On the commodity production side, Covington observed that, “We do not have excess cream. Butter production is lower and powder production is lower. Fluid milk consumption is lower, but the fat percentage is higher, decreasing the cream supply. Demand for other cream products has also been good.”

With cheese production up 1.3% overall, Covington said the real positive here is Italian cheese production up 5.6% is the bulk of the increase. 

“This tells you the product is moving,” he said, “because it’s the fresh cheese production that is higher. They don’t usually make Italian cheese without a sale for it.”

Southeast fluid milk changes

Together, all three southeastern FMMOs had 4.2% less milk going into Class I in 2021. (Table 2, above)

“2021 was a poor year for Class I in the Southeast, but we are comparing to when the food box program was in effect, and that program gave quite a lift to fluid milk in 2020,” said Covington. This loss translates to about one million pounds per day.

Utilization percentage has remained about the same at a little over 72% across the three FMMOs. As Class I sales have declined (4.2%), Southeast production has also declined (3%), so there is little change in utilization percent.

The structure of Class I pool distributing plant ownership has also changed in the Southeast, post-Dean, with 9 of the 44 plants supermarket owned and 19 cooperative owned.

The Southeast region is producing 103 pounds of milk per capita annually, down 20 pounds while fluid milk sales per capita, at 134 pounds, are off by 7 pounds – putting Southeast per capita production 31 pounds below fluid milk per capita consumption.

“The size of the deficit gap is smaller than it was in 2010 due to sales declining more than the production declines over the past decade,” said Covington.

Looking ahead to questions asked about FMMO reform and the Class I mover calculation, Covington said he “would hope we can get back to the ‘higher of’ – realizing what it costs to serve a fluid milk market.”

He shared concern about what happens to orderly marketing when Class I is underpriced vs. the other milk classes.

“Fuel cost estimates are a big concern, and there are other costs,” said Covington. “The cost to serve Class I markets keeps going up. The biggest issue is the FMMO system started when fluid milk was king, and now it is becoming a minority, especially in some areas of the country where processors will wonder, why be in the Federal Order?”

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PA Dairy Summit tackles milk pricing: Bozic digs into Class I, FMMO system

Dr. Marin Bozic at the PA Dairy Summit Feb. 2

By Sherry Bunting, published in Farmshine, Feb. 11, 2022

LANCASTER, Pa. — “The Federal Milk Marketing Order (FMMO) system is built around Class I fluid milk… if no changes are made, they can just collapse, west of the Mississippi,” said Dr. Marin Bozic, a University of Minnesota associate professor of applied economics speaking to over 300 farm and industry attendees of the Pennsylvania Dairy Summit in Lancaster on Feb. 2.

Dr. Bozic showed how the U.S. is now exporting more milk on a solids basis than is being sold in the domestic beverage category. This development is sending shockwaves through a Federal Milk Marketing Order system in which only Class I fluid milk handlers are required to participate.

Fluid milk sales are declining and being overtaken by the increasing export category — leading processors to lose interest in FMMO participation, he said.

Class I fluid milk handlers are the only ones required to participate in FMMOs. It is voluntary for all others.

As markets shift, Bozic predicts continued reductions in producer price differentials, forecasting the average Northeast PPD to decline by more than 20% over the next eight years. 

He also cited the impact of inefficient milk movement stimulated by FMMO pool access provisions. This could also apply to state-regulated over-order premiums. Location-based Class I premiums can fuel inefficient movement of packaged fluid milk from more distant lower-cost-of-production areas. (When local milk is displaced, hauling costs go up.)

“What can we do to give FMMOs a new lease on life?” Bozic asked, observing that future reforms should prepare them to survive in a time when the U.S. is increasingly exporting more milk on a solids basis than in the beverage category.

Bozic said national hearings on FMMO changes could happen after the midterm elections but may not happen until after the 2023 Farm Bill, and NMPF and IDFA are working on their positions.

He referenced a working paper about modernizing U.S. milk pricing and how pricing is done in other countries. Bozic authored the paper together with Blimling and Associates, and it was released at the IDFA convention in January. It is available and anticipating feedback at https://www.idfa.org/wordpress/wp-content/uploads/2022/01/Modernizing_US_Milk_Pricing_Working_Paper_012522.pdf

Right now, he said, “Milk is being priced like it’s 1999, but it’s 2022.”

For starters, he said, the standard component test should be raised to reflect current national averages that are higher than in 1999. Butterfat, for example, stands at an average 4.0, but standard test is still 3.5. 

Bozic also predicted that over the next two years, the embedded make allowances in the pricing formulas will be increased. He said processors are already re-blending pay prices to accomplish a higher ‘make allowance’ internally. He cited New Zealand’s system that frequently updates manufacturing costs used to determine producer prices.

He was quick to point out that when make allowances are adjusted, it would be tools like the monthly Milk Check Transparency Report that Bozic is working on — along with some ideas for contract fairness — that would put processors on notice that they can’t just re-blend their pay prices on top of a make allowance adjustment. That would be double-dipping.

Answering questions about producer ‘cost of production’ and ‘cost-plus’ pricing, Bozic explained that in the UK, retailers are starting to use a ‘Fairness for Farmers’ label by doing a cost-plus contract model where they use accountants to measure dairy farm costs of production, along with a consumer price index, to price milk three months at a time. 

One key difference, however, is the interstate commerce clause in the U.S. Constitution makes it impossible to keep milk from areas with a lower cost of production from moving to undercut price structures in areas with a higher cost of production. Feed cost could be used, which is a bit more universal, but still varies by region. 

With dairy farms in the UK similarly sized with similar cost structures to farms in the Class I markets of the eastern U.S., such ideas are worth exploring, he said, noting that fluid milk prices in the UK are more stable.

This slide from a working paper co-authored by Dr. Marin Bozic and Blimling and Associates was discussed at the PA Dairy Summit. Dairy farmer Nelson Troutman noticed the fluid milk consumption graph showed the UK (lighter blue line under gray line) doing much better in per-capita fluid milk trends the past 15 years compared with the U.S. (red line), and he asked about it. Australia (gray line) is also doing better.

Referencing Bozic’s graph showing fluid milk consumption trends for various countries, Berks County dairy farmer Nelson Troutman asked about the notably different trend in the UK compared with the U.S. 

“Why is their fluid milk not going down like here?” Troutman asked. “Over there, they talk about ‘the blue milk’ (a reference to the package color of whole milk in the UK). Is it because their whole milk is higher fat than ours? They don’t take it down to 3.25%, and I think their schools can still serve it. It’s no wonder fluid milk sales are falling here.”

Bozic responded to say he thinks “it’s atrocious that we make school kids drink milk without fat,” going on to mention new technology that can convert the lactose into a dietary fiber. 

“If that is successful,” said Bozic, “Then flavored milk (for schools) can be developed to have no additional calories (even with the full fat).”

In that aspect, Bozic talked about how to stimulate fluid milk brand innovation, promotion, and packaging investment in a regulated Class I pricing environment.

“We cling to the FMMO structure because we think that without it, milk pricing will be like the Wild West,” said Bozic.

“There’s some truth to that,” he acknowledged, noting that farms with fewer than 3000 cows are not sure if processors will want to work with them in the future, and the regulated pricing affords some structure for those small and mid-sized farms “to feel safe.”

In reality, however, Bozic said the Wild West is already happening, and it starts at the retail level, which then pushes losses through the system and milk all over the map.

He explained that the Class I price announcements give retailers a price in advance, and these pricing structures show them the costs of bottling, so they know how hard they can squeeze those bottlers, and they are squeezing them.

It’s within this context that Bozic put forth the idea of a fluid milk innovation premium or credit, where the Class I price could be lifted, maybe $2 per hundredweight, and processors could get this premium back — IF they innovate their brand packaging, marketing and promotion.

A key part of this concept is the cost of innovation would be within the Class I price. It would have to be earned, but would be protected from the retailer price squeeze.

“This could encourage fluid milk bottlers to do brand innovation and promotion, to invest in packaging, while making it not so easy for retailers to squeeze them to where they can’t do it,” said Bozic.

“Consumers would pay a little more for milk, but that’s fine,” he explained, citing research that shows the demand reaction to promotion is much larger than the demand reaction to price.

Outside of Pennsylvania, the 99-cent and $1.25, $1.50 gallons seen in supermarkets reflect Class I value loss that is not being borne solely by those discounting retailers. The losses are pushed back through the system, especially now that there is more cooperative ownership of Class I bottling plants, post-Dean. 

Cooperatives are not required to pay Class I minimums to their milk suppliers the way that private milk buyers must.

One attendee asked about the roughly $2.50 in make allowance equivalents that are, by default, subtracted from the Class I price. Could this money be used for innovation and promotion credits since Class I bottlers are not making cheese, butter, nonfat dry milk and whey that the make allowances pertain to?

Bozic replied that the make allowances aren’t extractable because they are “embedded” in the FMMO formulas that currently determine the value of milk components.

For producers in regulated Class I areas — namely the Northeast and Southeast — Bozic said it will be important for them to “lead the way” in an open debate on how fluid milk prices can be stabilized and how the other benefits of FMMOs in payment timeliness, weights and measures, price benchmarking and such can be preserved.

When asked specifically about going back to the ‘higher of’ for calculating the Class I base price, Bozic said: “In the Northeast and Southeast, Class I is still a big deal. If you want it, and if IDFA can’t make a strong argument against it, then go for it.”

More importantly, he said: “We need to build a grand coalition. Transparency is part of that. If building a broader coalition brings us back to discussion about the ‘higher of’, then maybe that’s part of it.”

But the bigger issue he alluded to is this: Doing nothing, and letting it all just happen, could lead to Federal Orders collapsing in other parts of the country, without enough Class I to keep them together, and the system could begin to unravel, anyway, without producer input as to what functions should be saved and how to save them.

Look for part two next week on other aspects of the milk pricing discussion, and more details about what Bozic is doing on Milk Check Transparency, including how producers can participate by writing to him at marin@bozic.io

Last week’s Farmshine (Feb. 4, 2022) had a brief overview of the discussion. Check it out here

Milk pricing reform preview? Bozic unveils bold ideas, new transparency report at PA Dairy Summit

By Sherry Bunting, published in Farmshine, Feb. 4, 2022

LANCASTER, Pa. – “The optimum level of tension is not zero,” said Dr. Marin Bozic. While he is an assistant professor of applied economics at the University of Minnesota, it his independent work that he spoke of during a 90-minute reveal of bold ideas for the future of milk pricing.

Bozic was the keynote speaker for the 2022 Pennsylvania Dairy Summit in Lancaster this week. His first public presentation of what he has been working on for months fueled questions and applause from the over 300 attending dairy producers and industry members.

He laid out three “pillars” of milk pricing reform: milk check transparency, fairness in contracting, and Federal Milk Marketing Order modifications.

The first is something he has already begun bringing to fruition. Receiving milk checks from producers in some parts of the country, so far, his goal is to start publishing a Milk Check Transparency Report that would allow producers in a region, or nationally, to see how they are paid — to make milk checks more comparable, and work toward a way for producers to plug in their volume and components and be able to see how decisions affect their price.

He urged dairy producers to consider providing milk checks for this purpose with the goal to cover all regions and buyers. Only Bozic and his assistant see the milk checks, and they are destroyed once the data is entered.

“Making milk checks more comparable brings accountability,” said Bozic. “Transparency is empowering. It gives perspective, and we can have those meaningful conversations.”

While acknowledging that the conversations could get “loud,” and this could get “messy” for a while, he said again, “The optimum level of tension is not zero.”

This new Milk Check Transparency Report will be a way to introduce accountability and competitiveness into the system, said Bozic.

On the milk contracting side, he laid out several ways that producers can have a more level playing field. Key among them is that milk buyers should not be allowed to limit a farm’s production and require exclusivity at the same time.

“Those are two separate lanes, and when they cross, we have traffic accidents,” said Bozic. In other words, a milk buyer or co-op should not require a patron farm to sell only to them while at the same time having a two-tiered pricing scheme — putting limits on how much they will buy at a non-penalty price.

Bozic talked about tweaking the FMMO system to “reinvigorate” fluid milk. He had ideas for a processor premium — raising the price of fluid milk with a premium that, for example, processors can earn back through innovation of packaging and promotion that improves fluid milk marketing.

He also discussed having an open debate about how to price Class I differently for more stability. So much important ground was covered. Look for details in a future Farmshine.

Part One published in Farmshine, Feb. 11, 2022

Check back for Part Two

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Milk solids seen as foundation for optimism in 2022

By Sherry Bunting, Farmshine, December 24, 2021

NEW HOLLAND, Pa. — “Milk pricing is backward, but look forward, and focus on components,” said Dr. Normand St-Pierre of Perdue Agribusiness speaking at Homestead Nutrition’s December Dairy Seminar in New Holland, Pennsylvania, where 200 dairy farmers heard from experts about the markets and the all-important goals of modifying milk price by improving components, and improving the milk margin by feeding healthy cows.

St-Pierre urged producers to be smart as they look at their costs — to not cut costs that sacrifice early lactation milk yield. He also pointed out how these higher prices for all components make feeding for components a continued area of focus to help the dairy in the face of milk check deductions related to cuts in base allotments and balancing.

Earlier in the program, Dr. Mike Van Amburgh shared Cornell University research on how to feed cows in a way that optimizes component yield by percentage, not just in total volume pounds. Total component pounds have historically been a function of total milk volume, but today, percentage counts because of per-hundredweight milk check deductions and over-base penalties.

“Milk volume is being discouraged in many regions of the country,” said Van Amburgh. “So the opportunity for producers here is to enhance their milk components, to make components a primary strategy, while still making your milk volume.”

St-Pierre noted that the next six months will be better than the last six months with a better milk price, and the futures markets certainly confirm this — moving even higher over the past four weeks. Global milk production is down 1% year-to-date, global skim milk powder stocks are low, butter production has been down for three months, stocks are low, and the world is getting short on butterfat, he said.

He observed that the Class III price was averaging over $19 and Class IV over $20 looking out six to 12 months in the futures markets. (That was the case on December 8, and now Class III is averaging over $20 and Class IV over $21.)

He sees the milk check butterfat price averaging $2.30 over the next six months; however, he said he believes this average could actually go higher, while protein should average $2.80. 

Another positive he mentioned is the ‘solids nonfat’ are being priced higher, and the ‘other solids’ are priced at almost double the historical average, driven by robust whey sales.

Even the USDA World Supply and Demand Estimates (WASDE) report the day after this meeting (Dec. 9, 2021) revised forecasts higher for butter, cheese and whey with NFDM forecasted at steady prices in 2022. As pointed out by St-Pierre, the current trends suggest this report could revise upward again in January, although much hinges on consumer responses to inflationary pressure in their buying habits.

The 2021 All Milk price average was increased in the WASDE report to $18.60, buoyed by yearend strength, and the 2022 All-Milk price forecast was revised upward to $20.75.

If current futures market levels are realized, these higher trending milk prices should help dairies keep pace with rising input costs, although experts calculate feed costs to be up by around $2.50/cwt for 2022 vs. 2021 and all costs combined could be up by almost $3.50/cwt for 2022 vs. 2021.

St-Pierre dug into this from a milk pricing standpoint, and he shared the good news that negative producer price differentials (PPD) from 2020 and the first half of 2021 have “quieted down.” 

Negative PPDs eat into location adjustments and change the way components are ultimately valued when massive de-pooling of milk occurs in Federal Milk Marketing Orders.

“We have positive PPDs right now because Class III and IV are trading closer together,” he said, noting that the new Class I formula averages the two manufacturing classes and adds 74 cents, so when they trade farther apart, the producer sees the hit in Class I also, dragging down the blend price and leaving smaller or negative producer price differentials (PPD).

The Class I pricing change and negative PPDs are issues St-Pierre has written about.

“Now they are asking the people who made the mess to fix it. That escapes me,” he said, noting the Federal Milk Marketing Orders (FMMO) were created in the 1930s and designed at a time when there were hundreds of cooperatives and milk did not move all over the country and the world.

St-Pierre said FMMOs exist for “orderly marketing,” but the government made a ‘fix’ that is like fixing an old horse. “He’s fixed but not running very fast and may be at the point where the horse has had enough.”

FMMOs were also created at a time when people drank more milk. Today, he said, they eat more cheese.

Showing a graph of per-capita fluid milk sales from 1980 (234 pounds per capita annually) to 2018 (146 pounds per capita annually), St-Pierre asked: “Does that look to you like an area of growth? If that marketer worked for Coca-Cola, he would have long been unemployed.”

While he acknowledged fluid milk has been disadvantaged by “lazy marketing,” he also said promoting milk is very hard because “we are not in the same world as in 1980. We are competing against water — with food in a bottle that we have to keep refrigerated. Cheese is easier to sell.”

The per-capita rise in cheese consumption since 1980 reflects this.

In the past, said St-Pierre, the FMMOs were designed to put the highest price in the bottle because that was the most perishable product. Today, as for the past 20 years, the prices are still based on the surveys of four products at wholesale – cheddar, butter, nonfat dry milk, and whey.

It was designed to have those prices for Classes 1 through 4 go in that order, he explained. “But it doesn’t work that way anymore.”

“As the butter price goes up, just make more butter, right?” he asks. “But it’s hard to make butter in a cheese plant and vice versa.”

“If I’m a processor, and I built a big cheese plant, and it cost me $150 million, I make a lot of cheese,” St-Pierre quipped.

Plus the built-in make allowances encourage single-product, single-class production plants running at full capacity, regardless of what the market is doing.

“It will take a while to change that dynamic,” he said.

“All milk is paid on components, but handlers don’t pay for components in the same way in the (FMMO) pool,” said St-Pierre. He explained that milk handlers pay for components according to how the milk is used, what “class” of products the milk was utilized in.

Class I price is based on butterfat and skim, Class II on butterfat and nonfat solids. Class III, which is 55% of the milk utilization, pays mainly on protein and other solids with an adjustment for butterfat because cheese production also uses a lot of fat. Class IV pays on butterfat and nonfat solids.

“We price things backward. Tell me one thing that you can go out and buy and drive out of the store and a month later tell that store what you will pay for it,” St-Pierre said, noting this is essentially what milk buyers do through the FMMO system, month after month, year after year.

He encouraged producers to be looking ahead three months, which he admitted is hard to do when the pricing for their product is so far behind the transaction. Still, he said following the markets gives a good indication, and there is more reliability in the 3-month window than 6 to 12 months out in the futures markets. 

The Class III price is normally higher than Class IV, but for the next few months, even through the next year, it looks to be flip-flopped.

Using an ‘imaginary’ FMMO, he divided all four classes as 25% utilization, which in reality is not too far off what the Northeast Order can come close to. In that four-class FMMO, the different ways different classes pay for components cause the books to be out of balance after producers are paid their advance check based on protein. Knowing each class pays differently, the class price differences and utilization become the key to how that PPD is either positive, flat or negative.

When Class IV was $6 below Class III, cooperatives and processors de-pooled a lot of milk, St-Pierre observed: “They could just pay 20 cents over that $13.80 price to get the milk and then sell it back at the $20 (Class III) price. That makes the co-op look good but the producer gets shafted,” said St-Pierre.

In FMMO 30, where most of the utilization is already Class III, processors made a lot of cheese in 2020-21, but they didn’t pool a lot of that milk, and they got it cheaper, he explained.

Bottom line, said St-Pierre, the Federal Orders were never designed to operate this way. Then along came the “little change” in the Class I price. In the past, the FMMOs used the ‘higher of’ Class III or IV as the way to set the Class I base.

“If I am a bottler, I don’t like that (higher of) because I don’t know how to hedge it,” said St-Pierre. “I know my price ahead of time anyway (through advance Class I pricing), but I still don’t like the ‘higher of’ so I go and tell Congress to average it and add 74 cents. Then Covid-19 hits, and producers lose over $750 million.”

St-Pierre notes that the industry is trying to fix the system, backwards.

He confirmed that where the negative PPDs kick Northeast producers is in the location adjustments. A smaller than normal positive PPD is a loss, and when it goes negative, it eats into the location adjustment, which is also supposed to be positive.

Working through all of these thoughts about pricing and consumption pattern, St-Pierre left dairy farmers with the good news that for the foreseeable future, the PPDs should be positive, although smaller than normal in some months, and Class III and IV prices are both on the rise. 

Production has slowed, and demand is good, including for milk powders and whey. These positive supply and demand factors are confirmed in the dairy product production and cold storage reports.

With the very reasonable expectation of good prices for milk components, in the face of base penalties, balancing assessments, and other milk check deductions that a dairy producer encounters, the best way to navigate is focusing on component yield because the deductions are a flat amount per hundredweight of total volume, whereas component yield becomes a percentage increase in the value of those milk hundredweights.

Look for more on other interesting nutrition topics and milk quality award winners as this article continues in a future Farmshine.

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What’s up with the $350 mil. in PMVAP payments to dairy farms announced last August?

Just some of the criteria for PMVAP are listed on this slide. There is no generally-applied formula per-cow or per-cwt for how producers will receive these USDA program funds via their handlers or cooperatives. The PMVAP payments are milk handler-specific. Criteria were explained in a USDA webinar and during a recent Center for Dairy Excellence industry call.

Producer payments will vary by handler eligibility, specific Federal Order data, how producers were paid during the covered time period, and are delayed to Q1 2022. Only those handlers and cooperatives that pooled any portion of their milk on a Federal Milk Marketing Order at any point during the July-Dec. 2020 time period are eligible.

By Sherry Bunting

WASHINGTON, D.C. – Dairy farmers are wondering about the PMVAP payments. They were expecting to see roughly $350 million in Pandemic Market Volatility Assistance Program funds disbursed by USDA through eligible milk handlers by the end of 2021.

According to Erin Taylor at USDA AMS Dairy Programs, those payments will be delayed until the end of January or into February or even March because of the unique and complicated handler-specific internal clearing process being used.

During a recent Center for Dairy Excellence dairy industry call, Taylor said USDA has been working diligently with eligible handlers and cooperatives since the program was announced on August 19, 2021.

It is a complex process of USDA AMS dairy program staff meeting with milk handlers and cooperatives that pooled any milk on any Federal Milk Marketing Order at any point from July through December 2020 to formulate specific payment agreements on an individual handler basis that include the calculated lump sum to the handler and specify how the producers affiliated with that handler are to be paid.

“We have started sending out these agreements and expect to get them all out to handlers for signing and returning by early January,” said Taylor. “Once approved, we will distribute payment dollars to those handlers. Then, they have 30 days to disburse the funds to their eligible producers.”

In short, she said, USDA is striving to get the money sent to handlers in early 2022. Later this spring, she said, USDA will audit handlers to verify these payments were made correctly, in full, to their producers.

It is important to know that not all handlers and cooperatives are eligible to participate, not all eligible handlers will choose to participate, and therefore, not all producers will receive PMVAP payments.

Who is eligible for PMVAP payments?

Only those milk handlers and cooperatives that participated in a Federal Order system during some or all of the July through December 2020 time period are eligible, according to Taylor.

Eligible handlers must also obtain from each producer the verification of meeting the Adjusted Gross Income (AGI) limits USDA has for its farm programs.

“You should have been contacted by your handler by now, if you are eligible, because they need to verify that you meet the AGI requirements,” said Taylor, noting that any producer who has not been contacted by their handler but thinks they are eligible for PMVAP can contact their handler and directly ask if they are participating.

“If that doesn’t work, or if you would rather ask USDA, then email pmvap@usda.gov or call 202.384.3417. Tell us who your handler is, and we can look it up,” she added. These email and phone contacts can also be used by producers who have other questions about the PMVAP.

During the Center for Dairy Excellence call, producers asked if there was a formula for how they can expect to be paid per cow or per hundredweight. Taylor explained there is no general formula for many reasons.

First, she said, there are requirements in this program that will be met differently by different handlers according to their Federal Milk Marketing Order data.

Also, payments to producers are limited to payment of 80% of losses on up to 5 million pounds of production and only on milk that was pooled or in cases of non-pooled producers who were paid by their handlers based on the pooled volume – together with the pooled producers.

“Each factor is different for every handler,” said Taylor. “We are working with handlers to ensure the milk pounds to be paid on and the methodology for payment are correct according to the program.”

She said doing it this way was deemed “the easiest way to do it through handlers that have this payment relationship with (dairy farmers), to get the money out quickly and with USDA oversight.”

In short, these are targeted payments based on Federal Order pooling fund losses as reflected by a much lower Class I base price under the new average-plus formula compared with the old ‘higher of’ formula for the July through December 2020 time period.

“A lot of these factors differ by handler in terms of how producers were paid in aggregate,” she said. “In the FMMOs, handlers don’t have to pool all of their milk. Some don’t pool any, and those that didn’t pool any milk are not eligible.”

For other handlers, the payments are based on the pooled portion, but if they paid all their producers the same way (pooled and non-pooled), then their payments to their producers will be done in the same way over all the milk in aggregate, not just the pooled milk.

“Otherwise, it would be the luck of the draw because a producer is not the one who decides on what milk is pooled and what milk is not pooled,” Taylor explained. “We compute the payment rate (for each handler) in a way that ensures fairness and equity in how the payments are distributed (based on how the producers were originally paid) for those months.”

Taylor said each eligible handler will have received workbooks pre-done by USDA with their approved data for covered milk pounds and the payment methodology so they can simply do the calculations and distribute the payments to their producers accordingly.

FMMO staff will audit and verify with handlers after these payments are made, according to Taylor.

The eligible and participating milk handlers will be reimbursed to administer these payments, which includes providing an educational component for their producers. These funds do not come out of the producer payments but are calculated separately.

She noted that handlers do not receive their administration reimbursement until after USDA verifies producers have been paid in full and the educational component is met.

When asked what percentage of U.S. milk production will be covered by PMVAP payments, Taylor said it depends on the percentage of handlers pooling milk and choosing to participate in the PMVAP. Normally, she said, about 70% of U.S. milk production is pooled on Federal Orders, but in 2020 this percentage was lower (due to massive de-pooling of milk in many Federal Orders in the face of severely negative PPDs).

Producers also asked if there is any chance that a Class III producer that was not paid that higher Class III price during the July-Dec 2020 period may be able to receive PMVAP payments.

“This program pays on pooled milk and depending on if the handler pooled any milk at all will determine if that handler’s producers get a payment,” Taylor replied. “Those that didn’t pool any milk during those months are not eligible under the current program rules.”

While these PMVAP payments are meant to assist against the losses influenced by pandemic volatility in 2020 exacerbating issues with the Class I formula change, the payments will be received by producers in 2022, and it will be considered earned income for that tax year, according to Taylor. Handlers will be sending 2022 Form 1099 Misc. Income statements to producers receiving these payments.

The educational component of the PMVAP requires handlers to outline their plans and to verify they have met them. USDA AMS has provided links at the special website with educational resources on an array of federal dairy policy topics that meet the requirement. Handlers can also choose to use other resources to provide education on one or more areas that include dairy markets, risk management, how FMMOs work, how marketwide pooling works, Dairy Margin Coverage and other topics via a variety of methods, including in-person meetings, webinars, newsletters, emails distributions and mailers.

USDA has a special website devoted to the PMVAP program that includes explanations, webinars, resources and contacts at https://www.ams.usda.gov/services/pandemic-market-volatility-assistance-program

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Ag Secretary says ‘Dairy will change’, economist digs into how, why

Using a graphic pulled from the September 10, 2021 edition of Farmshine in which a follow up story ran about Danone dropping 89 organic dairy farms from its Horizon brand — all of its Horizon farms in the Northeast — Bozic explained that the ‘social mission’ of cooperatives is to market all of their members’ milk. He said the “primary function of the future” for the Federal Milk Marketing Orders — as an extension of the cooperatives — is to ensure market access for dairy farms. “Market Orders are there to ensure orderly consolidation at a humane pace,” he declared.

By Sherry Bunting, Farmshine, Sept. 24, 2021

HARRISBURG, Pa. – ‘Turning the page’ was the theme for the annual Financial and Risk Management Conference where key takeaways about a changing dairy industry were presented.

The conference was hosted by the Center for Dairy Excellence Sept. 21 in Harrisburg.

Pennsylvania Secretary of Agriculture Russell Redding summarized his own thoughts: “I am still very positive about dairy, but dairy will change. It is changing,” he said.

The Center’s risk management educator Zach Myers set the stage for attending lenders, vendors, producers and industry talking about Dairy Margin Coverage and Dairy Revenue Protection and how these programs have worked (more on that in a separate article.)

Digging into the stress — the ‘change’ — was Marin Bozic, University of Minnesota associate professor of applied economics and dairy foods marketing, who also serves as facilitator for the Midwest Dairy Growth Alliance. He dug right into how and why, discussing some of the Federal Milk Marketing Order complexities, industry trends and pricing relationships. He made the case that more flexibility, competition and innovation are needed in the Federal Orders for a “level playing field” so winners and losers can “self-select.”

Bringing up the 89 organic producers Danone will drop from Horizon next year, Bozic said it is an example that, “One new farm in Indiana replaced 89 or 90 farms in the Northeast, and they can do that. There is nothing illegal about it. They could say they have a fiduciary responsibility to stakeholders and are minding their bottom line, but none of that helps you if 90 producers get dumped in a year.”

He pointed out the “social mission” of the cooperatives is to leave no member behind, so remaining an independent producer carries more risk today than in the past.

Bozic connected the dots to say the “primary function of the future for Federal Milk Marketing Orders — as an extension of the milk cooperatives — is to ensure market access for dairy producers.

“Market orders are there to ensure orderly consolidation at a humane pace,” he declared.

That’s a change from the central promise of the FMMOs today, which Bozic described earlier as “broken.”

“To navigate our businesses over the next year and longer,” said Bozic, “we have to count the passes and see the gorilla” — a nod to the visual exercise he had the audience participate in.

Bozic mentioned a few gorillas in milk. Gorillas in the FMMOs, in risk management, in dairy markets and in the macroeconomic situation – what else is going on in the world.

He showed graphs of what Producer Price Differentials (PPDs) looked like for the Northeast in 2020, the $4 and $5 negatives that represented cash flow bleeding, equity bleeding.

While the futures show the view out to the horizon over the next 6, 12, 15 months that would suggest there won’t be a repeat of that carnage, Bozic cited some of these risks, or gorillas, in the market and in world events that could represent shocks that can make the whole thing “go haywire again.”

Observing that the FMMOs are not the same today as when they were designed many decades ago, Bozic stepped conference attendees through the various long- and short-term impacts that reduce PPD, such as declining Class I utilization compared with increasing Class IV utilization and production.

“Orders were designed around the assumption that there would be plenty of fluid milk usage (as a percentage of total production), and we can just take it and designate it to be the highest and use those funds to make everyone whole,” said Bozic.

“The central promise of the FMMOs is that if your milk is as good as your neighbor’s, you get paid the same, so one farmer does not bid against another for market access and a good price,” he asserted. “That promise is now getting broken, not as much here, the East Coast FMMOs still have Class I.”

The next effect in the Northeast is the rise of protein tests. This impact comes through two channels where higher protein reduces PPD, the economist explained.

“Envision FMMOs as all processors paying into the pool and then taking from the pool. First they pay to the pool with classified pricing based on their respective milk solids. Class I pays on pounds of skim milk as volume, not on protein pounds,” he explained. “Even if sales are the same and the only thing that changes is protein, those (Class I) processors would pay the same amount (on skim) into the pool and take more money out (on protein) so there is less money remaining and a lower PPD.”

The second way higher protein production affects PPD is when the value of protein is lower in the powder than it is in the cheese. The butter/powder plant pays to the pool on nonfat solids price but takes money from the pool on protein price, “so that spread between the value of protein in cheese and powder also leaves less money for PPD,” said Bozic.

He explained the Class III price as an index of butterfat, protein and solids, in a straight formula that equals the class price. “When Class III price is higher than Class IV price, the predicted PPD for the Northeast Order declines,” said Bozic. “It’s almost linear.”

Conversely, when IV is above III, PPD goes up. “This has to do with paying the pool based on protein and nonfat solids, but when handlers take money out of the pool for components, everyone takes protein price leaving less money in the pool for PPD.

Bozic explained the demand shock to this system when the Food Box program “focused on smaller packages of cheese to put in every box. They didn’t take bulk powder and butter. So we went from a record low cheese price on the CME to a record high and no one expected this.”

The pull of 5% of the cheese supply for immediate delivery had everyone scrambling, said Bozic.

The amount of spare cheese available was not as high a volume as the government wanted to buy so cheese went from being long to short, and the price skyrocketed. This translated to an historically higher gap between Class III and IV prices as wide as $10 apart.

So why not just send more milk to make cheese? Bozic maintains that Class IV processing is accustomed to “balancing” fluid milk seasonality so there is extra capacity in that system.

Not so with Class III because those plants already run at capacity. “That’s the only way processors of commodity cheese make margin is to run at capacity, so when the demand shock came, and spare product was used up, there was no spare capacity and the price went higher. That was the main driver of negative PPD in 2020,” said Bozic.

Will it happen again? Bozic doesn’t foresee Food box programs with the same intensity in the future, but, “yes, it can happen, but I would say you need to have a pandemic in an election year. Don’t count on a program like this.”

The industry did ask USDA back in the 2008-09 recession to buy consumer packaged cheese instead of bulk commodities, so it could move instead of being stored to overhang the market later. That wasn’t working either.

“Now we understand that this other method disturbs PPDs so the dairy industry is united behind a more balanced approach,” said Bozic, describing the next iteration of purchases through the Dairy Donation Program will not be as aggressive in moving the markets by three orders of magnitude.”

Bozic said quick rallies and crashes impact PPDs also because of advance pricing on Class I based on the first two weeks of the prior month and announced pricing for the other classes at the end of the month.

Bozic explained why the change in Class I pricing was made: “The dairy industry wants to attract new distributors like Starbucks and McDonalds that are used to hedging their input costs. They don’t want to change prices every month. They want it to be what it is for a year, so the industry wants stable, predictable milk price costs to win favor with new distribution channels by making it easier for them to hedge.”

He said the new average plus 74 cents was designed to be revenue neutral. Looking forward, when Classes III and IV have less than $1.48/cwt spread, PPD under the new system is higher than under the old. But the most it can be higher is by 74 cents on Class I, which translates to 20 cents on the blend price.

The best case scenario is to add 20 cents to the blend price, but when Classes III and IV are far apart “the PPD can go haywire. Bottom line, the upside benefit of the averaging method with 74-cent adjuster is limited but the downside risk is big,” said Bozic.