California Milk Pricing as a Federal Order

One year ago, when California was not yet a Federal Order, a post to this blog "did the math" to show that de-pooling would probably be very significant in the California Federal Order.  A quick review of this prior post will help in understanding how de-pooling works and what is changing in California now that it is a Federal Order.  When California was not a Federal order, all milk had to be pooled.  In the Federal Orders, de-pooling is allowed except for Class I milk.  California became a Federal Order in October 2018 and data is now available for six months. The data shows that de-pooling was immediately implemented and at least one-third of the California milk is routinely being de-pooled.  With rising cheese prices, the amount of de-pooled milk could easily rise to over fifty percent.

De-pooled milk is not reported in the Federal Order statistics.  Typically, de-pooling occurs when the Producer Price Differential (PPD) goes negative.  To date, in the first six months of the California Federal Order, the PPD has not been negative.  Nevertheless, significant de-pooling has occurred.  With rising cheese prices, the California PPD could go negative and increase de-pooling. 

Chart I shows the data for the first six months of the California Federal Order.   The Data is shown as a percent of total pooled milk for November 2018 through April 2019.  Class I beverage milk in California is displayed in green in Chart I and is stable.  Class II, the yellow line, is also very stable.  However, Class III milk, the red line, was 50% de-pooled in April 2019.   Class IV milk was de-pooled by as much as 95% in December 2018 and January and February 2019.

Chart I - Percent of Milk Pooled by FMMO Class

The Upper Midwest Federal Order has typically de-pooled more than any other Federal order.  It is not unusual for the Upper Midwest to de-pool one-third of their milk.  When cheese prices are rising, the Class III price can be higher than the Class I price.  The Class I price is set weeks in advance of the Class III price and with rising cheese prices, the Class III can therefore be higher than the Class I price.  The Upper Midwest Order has over 80% of its milk utilized for cheese and very little Class IV milk.  When the Class III price is higher than the Class I, the uniform (average) price will be lower than the Class III price and thus PPD will be negative.  The negative PPD can be avoided by de-pooling and this is typically done in the Upper Midwest.

California's milk mix is very different (Chart II) than milk mix in the Upper Midwest.  For the last full year as a California based payment system, 46% of California milk went to Cheese and 33% went to Nonfat Dry Milk (NDM).  Much of that NDM is exported.  Class II milk volume is very small and Class I milk volume is also relatively small and is shrinking.  That provides a very different profile than the Upper Midwest. De-pooling in California could be much deeper and more frequent than the Upper Midwest.

Chart II - California Milk by FMMO Class for 2017

Table I shows the California Order prices for its first six months.  Producers are initially paid at the Class III price and the PPD is paid a few weeks later to ensure that all pooled producers are paid the same.  In three of these months, the Class IV price was higher than the Uniform price.  While the PPD was still positive, the Class IV price was better than the Class III plus the positive PPD.  Therefore, during December 2018 and January and February 2019, most of the Class IV milk was removed from the pool.  Those Class IV prices are highlighted for those three months in Table I below.

In March and April 2019, the Uniform price was higher than the Class III price plus the PPD.  Therefore, it made more sense for those delivering milk for Class IV use to stay in the pool.  As a result, de-pooling of Class IV milk was phased out as can be seen in Chart I above.

Table I - California Milk Prices by Class

However, the Class III price increased substantially in April and much of the Class III milk was therefore de-pooled.  With the higher Class III price of $16.38/cwt. in May, more Class III will be de-pooled.

WHAT DIFFERENCE DOES IT MAKE?  WHO CARES?

De-pooling, which is allowed under the FMMO rules, only redistributes the payment for producer milk.  It allows some producers to make more money and some make less money.  The original purpose of the PPD was to make producer milk payments the same regardless of the utilization of the milk.  However, that happens only for the milk that is pooled.  Producers producing milk for Class I cannot de-pool.  Producers producing milk for Classes II, III, IV can de-pool within certain rules.  De-pooled milk is paid at a rate established by agreement between the producer (or his cooperative) and the milk processor and it is typically paid at the FMMO price for the class of milk that was delivered for processing.

Producers supplying milk for utilization in Class III and IV, will de-pool when their class is priced higher than the Uniform price.  If they did not, they would owe money to the pool to be spread to other producers who provide milk to other Classes.  By de-pooling, their higher priced milk will not be included in the pool average price.  Therefore, other producers who remain in the pool will get a lower PPD and thereby a lower milk price.

Because California is "different" from other Federal Orders, primarily because of the large volume of milk utilized in Class IV, de-pooling will be very common.  That can happen even with a positive PPD.  When producers who de-pool for financial reasons, that means that producers remaining in the pool will make less money.

When do Class III producers de-pool?  They will de-pool when cheese prices are rising.  Cheese prices dictate the Class III price.  The Class I price is partially determined by the Advanced Class III price.  Therefore, when cheese prices are rising, the Class I price will be based on a lower cheese price and, in-turn, a lower Class III price.  The Component pricing calculations are done many weeks later than the Advanced pricing calculations.  Therefore, the Class III price may be higher than the Class I price.  In that case, producers sending their milk to cheese plants will de-pool.  In California, due to the huge Class IV volume, a lower Class IV price may also lower the average price and set the stage for Class III de-pooling.

All of these events provide an opportunity to "game" the pricing system.  Combined with the quota payment system, which is still in effect in California, significant amounts of the producer milk will be the lowest paid milk in the U.S.  (The Quota system price reduction for non-quota milk, has since October 2018, been set at $.38/cwt.  It is now being reduced to $.325/cwt. and in about one year will move to $.35/cwt.) 

The combination of de-pooling and the price reduction for non-quota milk will make some of the milk in California the lowest paid in the United States.  This could cause some significant reduction in milk production in California as some producers struggle with low revenue.