The Amazing Success of Organic Milk

This post will look at the success of organic milk.  Is it a niche dairy product?  How does it financially compare to conventional milk?  Who is making money with organic milk?  The retail price of organic milk is more than double the price of conventional milk.  However, even with this huge pricing difference, consumption of organic milk is growing while consumption of conventional milk is shrinking.  See the recent analysis of fluid milk sales in this recent post.

Organic milk currently makes up about 6.3 percent of total milk consumption.  It has grown from 5.6 percent at the beginning of 2018.  The growth rate appears to be accelerating (Chart I). 

Chart I - Growth of Organic Milk as a Percent of Total Milk

Chart II and Table I below compare the retail prices of conventional and organic milk.  The data covers the years 2018, 2019, 2020 and the first months of 2021.  Organic milk has an average retail price of $8.12 per gallon during this time.  The price has been very consistent with no visible trends.  There is almost no price difference between whole and two percent milk.

By comparison, conventional milk has an average retail price of $3.40 per gallon for whole milk and an average price of $3.34 per gallon for two percent milk.  The lower price for two percent milk has been consistent.  Conventional milk is selling for just 42 percent of the price of organic milk.

Chart II - Retail Prices of Conventional and Organic Milk

Table I - Retail Prices of Conventional and Organic Milk

CONVENTIONAL MILK PRICING

Conventional milk is a commodity.  It is purchased from producers, processed, packaged, delivered, and sold as a commodity.  Chart III and Table II below compare the retail price of conventional milk to the producer price for Class I milk.  Chart III adds the weighted average primary Class I differential to the Class I base price to better compare what the processor pays for this milk vs. the retail price it is sold for.

The average producer price is 41 percent of the final selling price.  That leave 59 percent for pasteurizing, homogenizing, packaging, delivering the milk to grocery stores, and the grocer's retail markup.  Overall, the whole process is very indicative of a commodity with low margins through the entire process. 

Chart III - Retail and Producer Prices for Conventional Milk

Table II - Retail and Producer Prices for Conventional Milk

ORGANIC MILK PRICING

Chart IV and Table III compare organic milk retail pricing and producer Class I milk pricing.  In this case, the producer price is not strictly the Class I price.  Organic producers do receive a higher price because of the costs to get certified and produce the milk to organic standards.  The amount of the higher price is not public, but those in the business discuss the bonuses as originally around 50 percent but decreasing over time to about 30 percent.  The chart and table below use these amounts in the comparison.

All in the chain benefit from the higher prices.  However, the greatest beneficiaries are the processors who have taken a strong marketing stance based on the popularity of organic products.  With organic milk, whole milk and two percent milk are closely priced.  This is not true of conventional milk.

Chart IV - Retail and Producer Prices for Organic Milk

Table III - Retail and Producer Prices for Organic Milk

The spread between the retail prices and the producer prices are very different for conventional milk and organic milk.  The spread between retail and producer prices for conventional whole milk is $2.01 per gallon.  The spread for organic whole milk using the 30 percent producer organic up-charge is $6.00 per gallon.  Over time the significant organic spread between retail and producer prices will likely decrease with competition.

Over time, niche products can become commodities.  Currently, that is not the case with organic milk as the retail prices have remained stable.  That does appear to be happening to the producer prices as more organic producers have added to the available supply of certified organic milk.

Organic Valley has done an excellent job of promoting and getting placement for their organic milk with a strong brand name.  However, as success comes, so does competition.  Other brands are showing up in stores like Safeway, Costco, Walmart, and Target.  They are selling their own branded organic milk.  It's hard to tell for how long organic milk will be a niche product with high prices. For now, the store brand organic pricing is in line with the organic prices quoted in this blog. However, over time, organic milk will likely become more commoditized and prices will likely drop. 

What is Really Happening to Producer Milk Prices? What can be Done to Improve Income and Cash Flow?

Much of the present dairy news discusses gains and losses of the Class III milk price.  The general conclusion is that they are "OK."  They are not as high as the peaks but are better than the prices in 2018 and 2019.  Chart I below shows the history of Class III milk prices. They are currently around $16 per cwt.

Chart I - Class III Milk Prices Over 21 Years

For those producers paid on the Class and Component system, Class III prices are the basis for the initial producer payment for milk delivered.  But unfortunately, that is not where the story ends.  The second payment that follows is based on the Producer Price Differential (PPD).  The PPD balances the payment to all by calculating the difference between the Class III price and the weighted average of the four classes. Due to changes over the 21 year history of the Federal Order payment system, the second "payment" has been coming out as a bill, not a check for most producers.

This post will cover some of the reasons why the second check is minimal or negative and, without change, will remain so in the future.  Data in this post will be displayed for the last 21 years with trend lines that will reflect the long-term changes in the PPD.  There are at least four factors that will keep the PPDs low or negative.

1. The amount of Class I beverage milk, the highest paid milk, is decreasing as domestic consumption continues to fall.
2. The price of NDM is used to price skim Class II and Class IV milk and partially price skim Class I milk. The value of NDM has decreased overtime as increasing amounts must be exported as there is not sufficient domestic demand.  See this recent post for details.
3. The May 2019 change in the Class I base milk price has put more emphasis on NDM.   The price of NDM is now always included in the Class I calculation.  Because the price of NDM is lower than it has been in the past, the Class I price is also lower.
   
4. De-pooling from the Federal Orders has significantly increased as higher priced Class III milk is often removed from the pool to avoid negative PPDs.  This leaves a lesser volume of milk to absorb negative PPDs and the size of negative PPDs will therefore increase for those remaining in the pool.

The system as originally configured in 1999 was based on a value system that placed the price of Class III milk below the price of most other Classes of milk.  Class I was the largest Class and was the highest paid Class of milk.  That is no longer true.  Chart II shows the base price of Class I milk minus Class III milk.  Originally, the base Class I price was always higher than the Class III price.   The trend line has been constantly falling.  The May 2019 formula change used to calculate the Class I price has accelerated the trend.

The Class I base price is used in this comparison because the Class I differentials are different in every Federal Order.  The differentials stay the same overtime, so the chart below accurately expresses the long-term trend. 

Chart II - Class I Milk Price Minus the Class III Price

Chart III shows the progression of each Class of milk over 21 years.  Because Chart III is a chart with over 1000 data points, it is hard to discern differences and trends.  For that reason, only the trend lines are shown in Chart IV.  This analysis will focus on Chart IV.

Chart III - Milk Prices for each Class of Milk for 21 years

In the early years of the Federal Order Pricing, Class IV skim milk (the red trend line below) was typically worth more than Class III skim milk (the blue line below).   Therefore, Class I and Class II were based on Class IV prices and were worth more than Class III milk.  Class III milk was the lowest paid milk. As a result, in the first three years of the new Federal Order pricing, PPDs were always 100 percent positive.  But 21 years later, in 2020, Class III skim milk was worth more than any other Class of milk.  As a result, from mid 2020 to the present, PPDs were mostly all negative.  

Chart IV - Trend lines for each Class of Milk for 21 years

A review of the PPD for four of the largest Federal Orders is shown in Charts V through VIII.  Overtime, the PPD has steadily decreased as Class I milk became a smaller part of the overall mix.  The formula changed in May of 2019 to always include Class IV skim prices. Previously Class I was based on the higher of Class III or Class IV.  The Class IV price has deteriorated as it has become more and more of an export item with excess inventories.   See the prior post to this blog.

The four Federal Orders chosen have very different profiles.  The Northeast Order has a very balanced mix of the four classes of milk.  The Southwest Order has grown significantly since 2000.  The Upper Midwest Order is dominated by Class III milk for cheese.  California is new to the Federal Order system and has a huge volume of Class IV milk.

All Federal Orders have seen a decline in the PPD over the life of the current pricing system as can be seen in the trend lines.

Chart V - PPD of the Northeast Federal Order.

Chart VI - PPD of the southwest Federal Order

Chart VII - PPD of the Upper Midwest Federal Order

Chart VIII - PPD oof the California Federal Order

Below are two tables of the PPDs for the Federal Orders shown above.  Table I lists the PPDs for the first 26 months beginning in the year 2000.  There are no negative PPDs.  

Table I - PPD for the First 26 Months

Table II lists the most recent 26 months beginning in 2019.  It is easy to see the red negative PPDs, many of which are very significant. 

Table II - PPDs for the Current 26 Months

WHAT SHOULD A PRODUCER DO IN THIS PRICING CLIMATE?

Payment in the Federal Orders is primarily based on the volume of butterfat and milk protein.  The only way to maximize income and cash flow is to produce maximum butterfat and milk protein.  Milk protein is the most valuable.  The science exists to maximize these components.  Every effort should be made to maximize butterfat and milk protein.

There are some in the dairy industry that expect the PPD to magically return to the levels of prior years.  That is not going to happen.  To stay solvent, the components that are the most valuable need to have a high priority of attention.