Proposed Change to FMMO Milk Price Formulas: Updated 12/4/2017

There is currently a proposal to change the method of calculation for Class I milk.  Class I milk is the second largest milk category with Class III being the largest.  Therefore any change in the method of calculating the Class I price will have a significant impact on producer milk prices.

Chart I - Milk Production by Utilization Class

Currently, the Class I base price is based on the higher of Class III or Class IV milk.  The proposal under consideration would average the higher one with the lower one and add an adjustment to minic the current Class I price

Chart II below shows 17 years of of Class III and Class IV prices.  Obviously, the Class III and Class IV price move in a similar pattern.  In  the first half of 2017,  the Class III price was not high, but the global glut of nonfat dry milk has kept the Class IV price lower than the Class III price.

Chart II - Class III and Class IV Milk Prices

The rationale for this is that it would allow processors to more precisely hedge the price paid for Class I milk because the current hedging tools require processors to choose between hedging with  Class III or Class IV prices.  If they choose the wrong one, the hedge may not precisely fit the final price.  If the processor choses to hedge using the Class III price, and international events drove up the price of nonfat dry milk which would increase the Class IV price,  their hedge would be lower than the actual price.

For producers, the same can be said, but there are very few producers who use hedging tools.  Most all processors do use hedging to minimize fluctuations in cash flow and profits.  Those that use hedging (primarily processors) would benefit from a simplified method of hedging.

The rationale is that more processors would be willing to produce fluid milk products if they could accurately hedge the price of milk and minimize they risk of inaccurate hedging.  In that way, more Class I milk would be produced and producers would gain by having a greater market for Class I milk.

It's not hard to see the folly in the logic of the above paragraph.  Milk consumption is not constrained by processing capacity.  The decrease in per capita consumption of fluid milk has been going on for nearly a century.  It is influenced primarily by competition from the many other choices in available drinks.  Because consumption decreases every year, processing capacity is more an issue of which processing plants should be closed, than what new ones should be built.  There are no grocery stores in the U.S. that do not carry milk because of a lack of processing capacity.  See a recent post to this blog covering U.S. consumption of dairy products.

How would this change impact producer prices?  The most impacted Federal Order would be Florida.  Their milk is primarily Class I fluid milk.  A formula change that would change the price of Class I milk would simply change the producer income.  This would be true of the other three orders paid on the "Advanced" pricing system, although the impact would be less.

For the six Federal Orders paid on the component system, the proposal would be seen in a changed producer price differentials.  The impact will be minimal for Orders like the Upper Midwest, where fluid milk makes up a very small part of milk usage.  It would be greater in areas like the Northeast Federal Order, where a significant part of overall milk usage is Class I.

In 2018, California will likely become a Federal Order paid on components. If the new Class I pricing formula is approved, the proposed formula change could influence the upcoming vote of California producers and their cooperatives.

It is frankly surprising that the Farm Bureau is supporting this change.  There is no obvious improvement for producers.  One would expect them to protect farmers.  I encourage the staff of the Farm Bureau and the Farm Journal's publishers of "Skimmed Milk" to add comments to this blog to defend their positions or debate this analysis.  What has been published is certainly not “fair and balanced.”

ADDENDUM

On October 12, Dr. John Newton, Director, Market Intelligence for the American Farm Bureau Federation asked that an addendum by added to this blog.  He stated that "The Farm Bureau has not taken a position on the proposal to change the FMMO Class I formula."  He also stated that "The proposal is currently under evaluation by the Farm Bureau."