Why is Class III Milk Priced so Low?

The statistics below are based on the Upper Midwest March 2024 payments for milk and their 12-month Averages.  They are taken from the USDA monthly reports.  Table I below lists the value of each class of milk and the percentage of each Class.  Class I cannot be de-pooled, and Class III would not be de-pooled as it is the second lowest priced Class.  How can Class II and IV have such high values?  Obviously, most of Classes II and IV are de-pooled. 

Table II lists the percent butterfat in each Class.  Class I is at 1.96% butterfat, which is a normal blend of 3.5% butterfat (whole milk), 2% butterfat milk, 1% butterfat milk, and nonfat milk.  Class II has 20.25% butterfat, Class III. the largest Class by far, is showing just 3.99% when the average delivered milk is 4.32%.  Class IV had 37.03% butterfat in March and a higher percent in 12-month moving averages. But where did they get the butterfat?  The Classes with the most butterfat are the highest priced and are largely de-pooled.

The data below represents the pooled milk in the Upper Midwest Federal Order.  Class I is designed to be the highest priced milk.  Obviously, that is not happening.

Table I - Cwt. Prices and Percent Pooled by Class

Table II - Percent Butter Fat by Class

Details on each Class are covered below in the order of Class II, Class I, Class IV, and Class III.

CLASS II MILK

Class II milk reached 196 million pounds in 2021 (Chart I) and is now at 27 million pounds after major de-pooling.  Data is based on 12-month moving averages. Butterfat prices are high and butterfat has been transferred primarily from Class I milk.  Butterfat is priced differently in Class I and Class II. but the prices are similar.

Chart I - Pounds of Class II Milk

The 12-month average butterfat percent for Class II reached 18.9% in March.   No cow gives a butterfat content that high.  Most of that butter is coming from Class I milk.  Most of the value in Class II that is not de-pooled is getting its value from the butterfat.  For the month of March 2024, 66% of the Class II value comes from butterfat.

Chart II - Class II Butterfat Percent

CLASS I MILK

Class I milk continues its long-term decrease (Chart III).  Over the five plus years in this chart, volume has dropped from 245 million pounds to 160 million pounds, a 35% decline.  Class I cannot be de-pooled.  

Chart III - Pounds of Class II Milk

The average percent butterfat used for Class I is about 2% which is a blend of the four fluid milk products (Chart IV).  The butterfat percent of the incoming milk is over 4%.  The unused butterfat is transferred primarily to Class II pooled milk.

Chart IV - Class I Butterfat Percent

CLASS IV MILK

Class IV milk volume is showing a very significant volume drop, as around 90% is being de-pooled since mid 2022.  Milk is de-pooled when it is above the estimated uniform price (Chart V).

Chart V - Pounds of Class IV Milk

The Class IV 12-month average of butterfat is at 50% (Chart VII)!  Class IV has the highest percent butterfat and gets 95% of its value from butterfat.  Obviously, most of the butterfat is coming from another Class.  In this case it is coming primarily from Class III pooled milk.

Chart VI - Class IV Butterfat Percent

CLASS III MILK

Class III milk took a big drop in 2021 as COVID protocols continued in place, driving higher prices and significant de-pooling.  Class III milk prices are now the second lowest and none is de-pooled.

Chart VII - Pounds of Class III Milk

The butterfat percent used in Class III milk increased with the overall growth of milk components.  When butterfat prices are high they provide a good Class III price.  Currently, the butterfat percent has dropped.  The incoming milk is 4.12% and currently the 12-month average butterfat percent has dropped to 3.9%.  With less high-priced butterfat, the Class III value has declined.

Chart IX - Class III Butterfat Percent

Chart X follows the protein/butterfat ratio.  Cheese making needs enough protein to coagulate and retain the butterfat.  Butterfat volume has been growing faster than protein volume.  Butterfat is expensive and a smaller amount has a cost advantage for processors.  Rather than increasing protein levels, butterfat is removed.  The amount of butterfat removed is now around 140 million pounds per month!  

Chart X - Class III Butterfat/Protein Ratio

So why is Class III milk so low priced?  There are a number of reasons:

1. The formula for calculating the price of milk protein in Class III reduces the value of milk protein when the butterfat price increases.  Due to the high butterfat pries, milk protein has lost value.  For details see this prior post.
2. De-pooling moves money around.  When a milk Class is de-pooled it is done to keep the milk value high but that means a lower Uniform price.  The Upper Midwest has very flexible rules for de-pooling, so it can be implemented month-by-month.   (California's rules for de-pooling are similar.)  The Northeast Federal Order rules for de-pooling make it more difficult to de-pool.  In the April 2, 2024 post to this blog, the Northeast Federal Order had the highest Uniform (average) price among the Federal Orders paid on the Class and Component system.  The Upper Midwest and California had the lowest Uniform prices.
3. With high-priced butterfat and low-priced cheese, the financial impact is to put the most effort and money behind higher butterfat levels and less effort and money behind protein levels.  But by the Federal Order guidelines, this forces butterfat to be removed from Class III and added to Class IV.  With less butterfat in Class III, the value will be lower.

The Federal Order pricing protocols developed before the year 2000 are now leading to moving milk processing out of Federal Order control by de-pooling.  De-pooling leads to lower Uniform prices.  Once de-pooled, the pricing is negotiated with the buyer, but not under the control of the Federal Order pricing.  

What should a producer do?  Higher protein and butterfat levels are key.  When reviewing revenue, remember that the Uniform Price and the Producer Price Differential are the real revenue.

How do the Producers Maintain Class III Revenue?

The Upper Midwest Federal Milk Order used 30.5 trillion pounds of Class III milk for cheese in 2023.  This is far above the volume of any other Federal Order.  The Upper Midwest is and has been "all about cheese" for a very long time.  There is a lot of press about the current low Class III prices, usually using the Agricultural Marketing Service (AMS) Class III index parameters.  The index is based on 3% milk protein and 3.5% butterfat.  The Upper Midwest Class III milk in March is at 3.31% milk protein and 3.99% butterfat.  It makes a big difference.

Data used below is based on 12-month moving averages to reduce monthly volatility.  The raw data is from the USDA monthly statistics for the Upper Midwest.

Chart I shows the Class III protein revenue by month in the Upper Midwest Federal Order.  With the current low price for protein the contribution to revenue has declined by more than 50% in the last three years.  The reason for the decline is a low price for cheese and a very high price for butterfat.  For an explanation of the impact of high butterfat prices on protein prices, click here.

Chart I - Upper Midwest Revenue per Cwt. of Milk
From Protein

Chart II shows the Upper Midwest butterfat revenue by month.  The recent butterfat prices have escalated as high as double the lowest prior price on the Chart.  Butterfat revenue per cwt. reached a high in October 2022.  Can butterfat revenue offset the low protein prices?

Chart II - Upper Midwest Revenue per Cwt. of Milk
From Butterfat

Chart III show the combined revenue per cwt. for both protein and butterfat.  The range from high to low is 19%.  If the total value included Other Solids, the Class III value would be $18.31 per cwt.  Not a great price, but not a horrible price.

Chart III - Upper Midwest Revenue per Cwt. of Milk
From Protein and Butterfat

How were producers in the Upper Midwest able to get this decent price per cwt.?  A lot has to do with increasing component levels.  Protein percent (Chart IV) has increased from 3.13% to $3.25 in the last five years.  This is contributing an additional $.35 per cwt. of milk.

Chart IV - Protein Percent by Month

Butterfat component levels (Chart V) have increased from 3.71% to a 3.90% high in December 2022.  The current $3.90 price is contributing $.57 per cwt. more than in the beginning of 2019.   Combined, the protein and butterfat component increases are adding $.92 per cwt. of milk compared to five years ago.

In the last 12 months, the butterfat percent in Class III has slightly dropped (Chart V) and as a result, the butterfat revenue in Chart II above has also fallen.  This is unusual as butterfat prices are currently reaching new highs.  If the butterfat percent in Class III had continued to increase, the impact would be significantly more.

(The butterfat delivery in the Upper Midwest is greater than that reported in their monthly USDA statistical statements.  The butterfat test as delivered by the handlers for the Upper Midwest is 4.3%.  Class I and Class III make up 99% of the milk used in the USDA monthly Federal Order report for the Upper Midwest.  Class I is reported to have 2% butterfat and Class III is reported to have 4%.  Where is the rest of the butterfat that was delivered?  Who gets paid for the butterfat delivered to the Federal Order and that is not included in the monthly reports and what is the price?  More on this will be covered in the next post to this blog.)

Chart V - Butterfat Percent by Month

Compared to the index prices using 3% protein and 3.5% butterfat, the current revenue is $1.62 per cwt. of milk greater.   The index prices used by the USDA formulas for Class III milk are based on the protein and butterfat levels in 1999.

Current prices for milk protein are very low.  This is largely impacted by the out-of-date USDA price formula for milk protein.  The is no current effort to change this formula.   

Producers in the Upper Midwest have worked to maintain decent prices through the tough times.

Are Commodity Inventories Impacting Producer Milk Prices?

The most important commodities for pricing producer milk are butter and cheese.  Butter prices are very high.  Cheese prices are stable, trading within a close range.  Butter prices since the start of 2018 have ranged from $1.51 to $2.87 per pound, a 90% difference.  Cheese prices have ranged from $1.51 to $2.12 per pound, a 40% difference.  Wholesale inventory levels are key to the Agricultural Marketing Service (AMS) prices used to value producer milk.  (See this post for information on the pricing formulas).

This post will review the impact of inventory levels on pricing.  All data used in this post is based on 12-month moving averages to reduce monthly volatility.

BUTTER

The wholesale price of butter has varied tremendously (Chart I). The prices in 2018 and 2019 were very stable around $2.30 per pound.  In 2020 and 2021, with COVID protocols in place, prices dropped by one third.  In 2022, prices rose peaking at $2.87 per pound.  Retail sales dropped with these high prices and inventories increased. Sales recovered in 2023 as prices declined but remained relatively high.  In 2023 and 2024 YTD, butter prices dropped by about 8% and remained at near historical highs.

Chart II shows the wholesale inventories expressed in days of supply.  Chart II is the mirror image of Chart I on butter prices.   As inventory levels increase, prices go down and as inventory levels decrease, prices go up.  The current inventory levels are in the range of 2019 levels, but the prices are significantly higher. 

Chart I - AMS Butter Price per Pound

Chart II - Wholesale Inventory Levels

Chart III below shows the total inventory levels.   They follow the pattern of Chart II but show increasing inventory levels in 2023 and YTD 2024, higher than those in 2018 and 2019.  

The higher inventory levels have not reduced prices because as shown in Chart IV below, domestic disappearance has increased significantly as consumption of butter has recovered.  Domestic disappearance has increased by 18% compared to 2018 and retail consumption has increased by 15%.

Butter inventory levels and domestic disappearance have very strong annual fluctuations with inventories building during the Spring and Summer months and demand increases in November and December due to the year-end holidays.  To minimize monthly volatility, this data is presented in 12-month moving averages.

Chart III - Butter Inventory Stocks

Chart IV - Domestic Disappearance

Exports and imports are a small factor compared to domestic demand.  The lack of domestic inventories keeps exports low, and a combination of competitive brands and domestic needs has increased imports to 6% of domestic production.   The net of imports and exports is shown in Chart V and current amount of imports exceeds imports by  5.2 million pounds.

Chart V - Net Exports of Butter

CHEESE

The prices and supply of Cheddar cheese are shown below in Charts VI and VII.  Analyzing changes in cheese prices in more complicated than butter because cheese is composed of both butterfat and milk protein.  The AMS price of cheese is based on Cheddar cheese only but wholesale inventories levels are not publicly available for Cheddar cheese.  This section is partially based on American cheese inventory data as it are consistently composed of about 70% Cheddar cheese. 

The charts below on cheese prices and inventories are not the exact mirror of each other as the butter charts above are.  Currently the days of supply is in a midrange position and the price of cheese is also in a midrange.

Chart VI - Wholesale Cheddar Cheese Price per Pound

Chart VII - Days Inventory of Wholesale American Cheese

Production of American cheese has grown nicely over the span of these charts to meet demand, but the growth has recently slowed as shown in Chart VIII.  Cheese consumption fell by 6% in 2022 causing a pause in the growth of American cheese production.

Chart VIII - Production of American Cheese 

With the reduction in production in 2022, American cheese inventories fell (Chart IX) causing AMS cheese prices to escalate (Chart VI above).  The lower production is keeping inventories beneath their peak in 2022 (Chart IX).

Chart IX - Wholesale Inventories of American Cheese

American cheese domestic disappearance (Chart X) has flattened out to compensate for the drop in consumption in 2022 and bring the days of supply (Chart VII above) in balance.

Chart X - American Cheese Wholesale
Domestic Disappearance

As with butter above, American cheese exports are minimal.  Exports are currently just 4% of domestic disappearance and imports are less than 1% of domestic disappearance.

Chart XI - American Cheese Net Exports

WHAT DOES IT ALL MEAN?

It's very clear that wholesale butter prices move with the wholesale supply of butter.  Butter domestic consumption is growing and the dependence on imports indicate that domestic inventories will remain tight.  Therefore, butter and butterfat prices will remain high and will likely continue to grow.

Cheese prices fluctuate with changes in butterfat prices and milk protein prices.  As has been covered in prior posts to this blog, as butterfat price rise, milk protein prices decline.  The days of supply of American cheese is not high or low and prices of cheese should remain stable.