The Impact of De-pooling and the Impact of Changing Consumption Trends on the Producer Price Differential

Producer Price Differentials (PPDs) are complicated and confusing. They also have a major impact on milk payments to producers. The prior two posts covered the negative PPDs in California and the five reasons for negative PPDs.  One of the difficulties in understanding fluctuations and negative PPDs is that there are five factors at work all moving in different directions at different times.  Based on comments from the post on the five reasons for negative PPDs, the explanations for two were difficult to understand and will be further explained in this post.  They are the following:

• A significant amount of Class III is being de-pooled.  That increases the amount of a negative PPD and lowers a positive PPD.   When Class IV is de-pooled, it lowers a positive PPD.

• As less fluid milk is consumed, there is a smaller percentage of Class I milk in the mix.  Because Class I pricing is formulated to be the highest paid milk, when there is a smaller percentage, the "Uniform" or average price will be lower.

Class I milk cannot be de-pooled and Class II milk is small enough to be inconsequential.  Therefore, the de-pooling examples deal only with de-pooling of Class III and Class IV milk.

The Class III milk price paid to a producer is based on the value of milk protein, butterfat, and Other Solids in the delivered milk.  That is the basis for the initial payment to producers in a Class and Component Federal Order.  At the end of a month when the receipts are complete, a weighted average of the four Classes at their specific pricing formulas is calculated.  This is known as the Uniform price.  The PPD is the difference between the Uniform price and the initial payment based on components.

To better explain the reasons for the two events listed above that can lower a negative PPD, examples have been prepared below.  In these examples, only one variable is changed at a time.  All other variables are held constant to better understand the impact of each event.  In the examples below Class III milk is de-pooled when it is high, and Class IV is de-pooled when it is high.  Milk is de-pooled to avoid paying a negative PPD.

DE-POOLING WHEN CLASS III PRICE IS HIGHER THAN THE UNIFORM PRICE

Table I below shows the base case. In this example The Class III price is lower than the Uniform price causing a negative PPD.  This happens when the Class IV milk is significantly lower than the Class III.

Table I - Negative PPD for base case

Table II shows what happens as all the Class III milk in this example is de-pooled.  The negative PPD doubles, going from -$.31 to -$.60 per cwt.  While the Class III milk that was de-pooled has avoided the negative PPD, the balance is made up by those that are still in the pool.

Table II - Impact of de-pooling Class III milk

LONG-TERM IMPACT OF PPD WITH CHANGING CONSUMER CONSUMPTION

Table III shows the long-term impact of changing domestic consumption.  Fluid milk, Class I, is declining by about 2 percent annually.  Cheese consumption, Class III milk, is increasing by about two percent annually.  This table shows the impact of these changing consumer patterns on PPDs over five years.  Class I milk has gone from making up 24 percent (Table I) to making up just 21 percent (Table III).  During these five years, the Class III milk has increased from 48 percent to 52 percent of the total milk.  With less of the high-priced Class I milk, the negative PPD has increased from -$.30 to -$.35.  In this example, nothing has changed except for the mix of the four milk Classes.

This is perhaps a small factor, but as the consumption trends of less fluid milk continue, that will continue to lower the Uniform price of milk and thereby make negative PPDs larger and positive PPDs smaller.

Table III - impact of changes in Domestic Consumption

DE-POOLING WHEN CLASS IV PRICE IS HIGHER THAN THE UNIFORM PRICE

Occasionally, the Class IV milk price may be higher than the Class III milk price.  In this case, some Class IV milk would likely be de-pooled to avoid the paying a negative PPD.  In this example, it is assumed than all of the Class IV milk is de-pooled. Table IV shows the base case with no de-pooling and Table V shows the impact of de-pooling.

Table IV - Class IV milk is priced above Class III milk

De-pooling the higher priced Class IV milk has reduced the Uniform price and thereby has reduced the positive PPD from $2.09 per cwt. to $1.89/ cwt.

Table V - Impact of de-pooling Class IV milk

SUMMARY

Everything about the PPD is both complicated and confusing, but it is also very impactful on producer pricing. The chances of a high positive PPD are slim under the existing conditions.  The short-term issue is the significantly lower price of Class IV milk compared to Class III milk.  This is not likely to change in the short-term.  

The driver of a long-term mix with less Class I fluid milk and more Class III milk for cheese will also have a negative impact on PPDs.  This is also not likely to change in the short-term and will become more impactful in the long-term.