Pooling and De-Pooling in the California FMMO

Getting California's dairy payment system into a Federal Order has been a long process.  It is now a done deal to be implemented before the end of 2018.  Will there be some unexpected impacts of this change?  This post will explore how the Producer Price Differential (PPD) may influence pooling and de-pooling. Under the CDFA payment system, de-pooling was not allowed.  As a Federal Order it will be allowed for milk Classes II, III, and IV.  De-pooling allows members to drop out of the FMMO temporarily when there is a financial penalty for staying in the pool.   The PPD can create that penalty.

The PPD and its impact on the California FMMO were initially discussed in the second half of the May 27, 2017 post to this blog.  It was covered in more detail in the September 2017 article in Progressive Dairyman.  That was one year ago, and the probable dynamics have changed.

In a Federal Milk Marketing Order paid on the component system, milk is valued by the amount of butterfat, milk protein, and other solids delivered to the processor.  The milk delivered is evaluated and a check will be issued for the volume of components via the Class III formula.  At the end of the month, a "uniform" price is calculated for the order by calculating a weighted average of the four Classes of milk.  This methodology was developed when fluid milk was the main use of milk.  Class I fluid milk is paid the highest, and the "Uniform" price was consistently higher than the Class III milk price.  A producer was then paid for the calculated difference between the Uniform price and the Class III price.  This PPD brought his milk payment to the average for the FMMO

The Class I price is determined in advance of the month and the Class III is calculated at the end of the month.  Therefore, when cheese prices are increasing, the Class III price may be higher than the Class I price.  This can cause the "Uniform" price to be lower than the Class III price.  When this happens, the PPD can become negative.  That would require the producer to pay money to the FMMO fund.  However, a producer or his agent can elect to drop out of the pool (de-pool) and not be a part of the FMMO to avoid that payment.  Class I milk is not allowed to de-pool.  All other classes can de-pool.  In the case of California, the vast volume of Class IV milk and the shrinking Class I volume can also make the PPD become negative.

In March 2018, the Agricultural Marketing Service issued a 33 page paper entitled "Regulatory Economic Impact Analysis of the Final Decision to Establish a California Federal Milk Marketing Order."  The final analysis is based on establishing the California FMMO just like all the other FMMOs paid on the component system.  In the analysis, the impact discusses the similarities between the Upper Midwest FMMO and the California FMMO.  In reality, the two orders are very different.

Below in Chart I, is the Class mix of milk for 2017 for the Upper Midwest, as reported by the FMMO.  Class III, milk for cheese makes up 76% of the total milk usage.  Class IV, milk used for butter and skimmed milk, is only 4% of the Upper Midwest volume.

Chart I - Milk Usage by Class for the Upper Midwest

Chart II below is a fabricated chart, which attempts to include all the milk in the Upper Midwest that was "de-pooled."  This milk is not considered to be FMMO milk and is not reported in FMMO numbers.  How much was de-pooled?  Nearly one third of all the Upper Midwest milk was de-pooled in 2017!  In reality, 81% of the milk produced was used for cheese. 

Chart II - Milk Usage by Class for the Upper Midwest with De-Pooled Milk Added in

Chart III below shows the California milk usage by FMMO classifications.  There will be some slight modifications when the exact definitions used by the FMMOs are in place, but it will not significantly alter the numbers in Chart III.  The really big difference between the Upper Midwest FMMO and the California FMMO is the vast production of Class IV milk in California.  Only 4 percent of the milk in the Upper Midwest goes to Class IV usage while 33 percent of California milk goes to Class IV usage!  That is a huge difference that will impact California as an FMMO.  Class IV prices are very low with no change in sight.  That will significantly reduce the Class IV price.

Chart III - Milk Usage by California by FMMO Classifications

What do we know about the trends in milk usage that will further influence the PPD?  Class I, the high priced milk is rapidly declining in domestic consumption.  See the recent post to this blog for details.  The price of Class IV milk is declining as the consumption of butter increases and that leaves excess skimmed milk available globally.  Excess skimmed milk means lower Class IV prices.  In the case of California, Class IV is significantly bigger than Class I, and that volume difference will continue to grow in favor of the Class IV volume. 

Based on the 2017 milk volumes in California, the PPD for the California FMMO would have been negative in 15 of the most recent 17 months comprising 2017 and 2018 YTD.  In 2018, it has so far been negative every month.  As the consumption trends continue, will the California PPD ever be positive?  If one third of the Upper Midwest was de-pooled in 2017, how much of the California milk will be de-pooled? 

The de-pooling rules are a bit complex and will likely change many things including the storage requirements of the processors.  Pooled and de-pooled milk must not be arbitrarily mingled.  More on de-pooling will be covered in a future post to this blog.  The PPD "game" will bring real change to the California dairy system.