What is the impact of De-pooling and Shrinking Class I Utilization?

In the prior post, the California Federal Milk Marketing Order (FMMO) de-pooling was covered.  Up to 99 percent of Class III milk was being de-pooled in California. In the October 2021 post to this blog, de-pooling in all FMMOs was reviewed.  This post will look at U.S. de-pooling currently.   The Upper Midwest FMMO has become the champion de-pooler, de-pooling up to 75 percent of the Order's total milk, and up to 89 percent of Class III milk.  In total in 2021, only 60 percent of U.S. milk was paid based on Federal Order pricing.

In early 2021, the Upper Midwest de-pooled more pounds of milk than any other FMMO and de-pooled the largest percent of any FMMO (Charts I and II).  What was being de-pooled in 2021 was high priced Class III milk.  The Upper Midwest produces more Class III milk for cheese than any other FMMO.

Chart I - Percent of milk De-pooled

Chart II - Million pounds of milk De-pooled

How much milk is being de-pooled from the Federal Orders?  In the early part of 2021, up to 29 percent of Federal Order milk was being de-pooled.  Toward the end of 2021 and continuing in 2022, de-pooling dropped to a range of 18 to 25 percent (Chart III).

Chart III - Total De-pooling in the Federal Orders

What caused the swing in de-pooling?  Chart IV below partially answers that question.  When Class III milk is higher priced than Class IV milk, a lot of Class III milk will be de-pooled, because it is likely that the Producer Price Differential will be negative.  Class IV milk is now heavily weighted in the Uniform (average) price because it is always included in the Class I pricing, and it is also used for Class II pricing.  

Currently, the Class IV price is $3.27 per cwt. higher than the Class III price.  This has slowed the Class III de-pooling, but a significant amount is still being de-pooled.

Chart IV - Class III and Class IV Milk Prices

When milk is de-pooled it is no longer under the protection of Federal Order pricing.  While the payment for butterfat, milk protein, and "all other" solids may be the same as Federal Order pricing, there is no requirement to keep them based on the Federal Order pricing.

As shown in Chart I, de-pooling is not just based on changes in Class III and IV milk pricing.  There is a significant and constant level of de-pooling regardless of Federal Order milk prices.  Payment is likely tailored to the needs of the processor.

Impact of changes in Class I milk

Class I milk is designed to be the most expensive milk.  When producers are first paid based on their butterfat, protein, and "other solids," a higher Class I price should bring a positive Producer Price Differential.  As less Class I milk is included in the "Uniform" (average) price the lower the Uniform price will be and the chances of a lower or negative Producer Price Differential increases.

Chart V shows the Class I percent of milk in the FMMOs over time.  In 1947, 66 percent of the milk was Class I. By 2021, that had dropped to 31 percent.  Class I milk cannot be de-pooled but all other Classes of milk can be de-pooled.  If the de-pooled milk was included in the FMMO, the percent of Class I would be significantly less.  By extrapolation, in 10 years Class I milk could be close to just 20 percent of the pooled FMMO milk.

Chart V - Percent of Class I in Federal Order Volumes

Which Federal Orders are impacted the most by declining Class I Milk?  In the Upper Midwest, comparing the first half of 2021 to the first half of 2022, the percent of Class I milk in the FMMO decreased by 3.8 percent.  With less Class I milk in the mix there is a likely chance of negative Producer Price Differentials.  As a result, it is likely that more Class III milk will be permanently de-pooled.  Class III milk now makes up over 90 percent of the pooled milk in the Upper Midwest FMMO.

Chart VI - Changes in Class I Percent by Orders Paid
on the Class and Component system

The Federal Orders paid on the Advanced system have a large volume of Class I milk.  Florida is almost strictly Class I milk and it grew Class I volumes by 3.6 percent.  Florida is having a significant population growth that may be at least partially the reason for the increase.

Chart VII - Changes in Class I percent by Orders Paid
 on the Advanced System 

PUTTING IT ALL TOGETHER

What does all this mean for the FMMO system?  The amount of de-pooling is very significant and a lot of it is permanent.  Without the FMMO framework, processors want the least costly milk that serves their needs.  

• Class I producers want plentiful butterfat because they can sell what is not used in drinking milk.  The do care about Somatic Cell Count, but not about protein.  

• Class II milk is a small category and mixed.  Butterfat for ice cream is vital.  Butterfat not used in low fat yogurt can be sold.  Protein content is not that important for Class II.

• Class III for cheese needs milk high in milk protein and butterfat and with a low Somatic Cell Count.  This is by far the largest Class of milk and continues to grow at about two percent annually.

• Class IV for butter needs high butterfat but has little need for high protein.  Skimmed milk powder does require a minimum level of milk protein, but the U.S. does not make much skimmed milk powder.

If the FMMO payment systems are not revised, the FMMOs will likely shrink.  This could be a slow death for FMMOs.