Tuesday, February 25, 2014

How is Nonfat Dry Milk Driving the Market?

This post will be devoted solely to the current and unusual situation that is causing the international price of Nonfat Dry Milk (NDM)/Skim Milk Powder (SMP) to significantly influence U.S. producer milk prices. The pricing process is complex, which requires a fairly long post to adequately demonstrate the impact of NDM prices on producer prices.


As discussed in the prior post, U.S. NDM pricing is being driven by exports.  In 2013, 58% of NDM produced was exported.  The international demand has been very strong and international pricing has increased as a result.  The chart below shows the comparative prices for NDM/SMP in Europe, Oceania, and the USA.  The prices show the impact of international competition and the escalating price for NDM/SMP.

The USA pricing is still the lowest and there is a growing demand.


The Federal Milk Marketing Order (FMMO) system establishes producer milk prices for the majority of the milk in the U.S.  These prices are formula driven based on the wholesale price of cheddar cheese, butter, dry whey, and NDM as determined by the National Agricultural Statistical Survey (NASS) .

Four Classes of Milk are recognized in the FMMOs.

Class I: Grade A milk used in all beverage milks.
Class II: Grade A milk used in fluid cream products, yogurts, or perishable manufactured products (ice cream, cottage cheese, and others).
Class III: Grade A milk used to produce cream cheese and hard manufactured cheese.
Class IV: Grade A milk used to produce butter and any milk in dried form.

Most (55% of the U.S. Milk in 2012) is paid on three components, protein, fat, and other solids.  The prices are calculated at the end of the producer's month.  This is referred to as the component pricing system.

The other Federal Order producers (10% of the U.S. Milk in 2012) are paid based on the weight of skim milk and the butterfat content.  These prices are calculated based on the wholesale prices of the products mentioned above for the two weeks preceding the producer's month.

The California milk payment system is similar, with a few differences.  The inputs for payment are based on block cheddar cheese and butter prices at the Chicago Mercantile Exchange, Western dry whey as reported by the Dairy Market News, and NDF as reported by the California Department of Food and Agricultural.  All milk is paid on two components, fat and solids not fat.  There is no specific payment for protein in the California system.

The financial impact of the increase in NDM prices is different in each system.  Due to the geographic proximity of ports to ship to the Oceania markets, California has the majority of the NDM market.  The chart below shows Class IV (and the equivalent for California - Class 4a) for the FMMOs and California.  California has the majority with 52%.


Producers paid by the FMMO component system are initially paid at the Class III price.  Nonfat dry milk pricing does not affect the Class III price in any way.  However, it does impact the payment to producers paid on the Class III component basis, which is the majority of U.S. dairy producers.  This apparent contradiction is explained via the formulas below.  The simple answer is that all producers in these FMMOs receive a payment approximately 2 weeks after the close of the month called the Producer Price Differential (PPD).  This is the difference between the weighted average of all four classes of milk (the "Uniform Price") and the Class III price.  The high NDM is now driving the Class I, III, and IV milk prices up, so this is positively influencing the PPD.

Nonfat dry milk is the basis of the Class IV milk price.  

Class IV Skim Milk Price = Nonfat Solids Price x 9 

Nonfat solids pricing is calculated from the nonfat dry milk price as shown below.

Nonfat Solids Price = (Nonfat Dry Milk - 0.1678) x 0.99 

The formula for the Class I Skim Milk price is based on the higher of the Advanced Class III or IV price, so when the Advanced Class IV price is higher, which it currently is, the advanced Class IV price will really determine the the Class I price.

Base Skim Milk Price for Class I = Higher of Advanced Class III or IV Skim Milk Pricing 

The Class II Skim Milk price is always determined by the Advanced Class IV price.

Class II Skim Milk Price = Advanced Class IV Skim Milk Pricing + $.70

The bottom line impact is that the nonfat dry milk price is now driving the Class I, II, and IV milk prices to higher levels, which in-turn drive the PPD higher.   This impact varies by FMMO and those with the most Class I, II, and IV milk are benefiting the most.


Milk in the four FMMOs that pay on the Advanced system are paid at the Uniform milk price.  This is dominated by Class I milk which is paid on a skim milk + butterfat formula.

The Class I price is announced in Advance of the month.  The price of Class I Skim Milk is based on the higher of the Advanced Class III or IV Skim Milk Pricing.  The majority of the time, the Advanced Class III is the higher.  However, this changed starting in March 2013.  

By December 2013, the differential between the advanced Class III and IV was $1.49/cwt., a clear advantage for Class I milk pricing.  Who does this impact the most?  The four Federal Orders paid on the advanced pricing system include Florida, Southeast, Appalachian, and Arizona - Las Vegas Federal Milk Orders.  These Orders get the advantage of the higher Class I price.  Arizona - Las Vegas also has the benefit of having a significant Class IV NDM business, produced primarily for export.

Class II skim milk in the Advanced payment system is based on the Advanced Class IV price plus $.70.  
Class II Skim Milk Price = Advanced Class IV Skim Milk Pricing Factor + 0.70 

The high NDM prices have therefore increased the value of Classes I, II, and IV, bringing a significant benefit to the producers in the four FMMO paid on the advanced system.


California uses 5 different categories of milk.

Class 1: Milk used in fluid products, including whole, reduced fat, low-fat, and nonfat milks. 
Class 2: Milk used in heavy cream, cottage cheese, yogurt, and condensed products. 
Class 3: Milk used in ice cream and other frozen products. 
Class 4a: Milk used in butter and dry milk products, such as nonfat dry milk. 
Class 4b: Milk used in cheese, other than cottage cheese, and whey products. 

In all classes, only components are recognized as having value and only two components are recognized, Fat and Solids Not Fat (SNF).

Formulas are used to calculate the prices for each class of milk.  For Classes 2, 3, and 4a, the value of SNF is based on the NDM price.  The Class 1 price for SNF is based on the higher of two formulas, one based on a cheese type valuation and the other based on a NDM valuation.  The NDM valuation is currently higher, so Class I SNF price is based on the NDM price.  Only the Class 4b price for SNF is NOT based on NDM.  In 2012, the Class 4b milk represented 44% of the California milk usage, so the 56% majority of milk in California IS influenced by the NDM price.


This analysis is intended to show the huge impact of international prices on U.S. milk prices.  Although this post is not an in-depth analysis of U.S. diary prices, it is intended to show the growing international influence on dairy producer pricing.

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