Financial Impact of USDA Proposed Changes to Federal Order Pricing - Part II

In the prior post, the USDA proposed changes to milk pricing in the Federal Orders were reviewed with specific analysis of Class III pricing, the largest category.   This post will cover the changes in cheese pricing in more detail and will also cover the impact of pricing for Class I and Class IV skim milk.  

CHEESE PRICING

One of the changes proposed by the USDA is to base cheese prices exclusively on Block cheese prices.  The pricing used for decades had been based on an average of Block and Barrel pricing.   For perspective, the current cheese price is $2.00 per pound.  Chart I below shows the incremental change in cheese pricing if the USDA proposal is implemented.  Ignoring the 2020 price changes during the COVID policies, the lowest price difference between pricing alternatives was -$.11 per pound in December 2019 and the highest was $.17 per pound.  

The monthly difference in the calculation processes are minimal, but can alter protein prices.  In the last 18 months, the average was a positive price per pound of cheese of just $.03 per pound.

Chart I - Cheese Wholesale Price Spread between
Block Only Prices and Block and Barrel Averaged Prices

Table I below shows the number of months each year that the proposed change would increase cheese prices.  

Table I - Months of the Year That Block Only
Prices Were Higher than the Averages of
Block and Barrel Prices 

The changes proposed have an impact of Cheddar cheese prices used to price milk protein prices in Class III milk.

CLASS I SKIM MILK PRICING

Included in the USDA proposal are changes in pricing of Class I skim milk.  For most of the last 25 years of the Federal Order pricing, Class I skim milk prices were based on the higher of the Advanced Class III or Class IV skim milk prices.   It was changed in May 2019 to "The average of both Class III and Class IV skim milk prices plus $.74 per cwt."  The new USDA proposal recommends changing it back to the original higher of Class III or Class IV.

Chart I below shows the spread between the proposed pricing vs. the current pricing.  In 2020, during the COVID mandates, pricing significantly favored the "higher of" method by $1.75 per cwt. Over the last 18 months, the proposed change would have increased prices by $.59 per cwt.  The documents in the USDA analysis used only the years 2020 and 2021 which showed a $1.58 per cwt. advantage by using the "higher of" pricing methodology.  Their analysis also ignored the $.74 adjustment in the current pricing model.

Chart I - The Pricing Spread Between the
Federal Order Proposed Pricing and the
Current Pricing.

Table II lists the number of months per year that the Class III skim price was higher than the Class IV skim price, suggesting a benefit for using the "higher of" methodology.  In 2020 after the COVID mandates were implemented there were eight consistent months of higher Class III skim milk prices, ending the year with a skim price of $20.07 per cwt.

Table II - Months of the Year that the Proposed
Change is Higher than the Current Federal Order
 Pricing Formula

The proposed change will slightly increase the price of "base" Class I skim milk, partially offsetting the increased "Make Allowances."  The base Class I skim milk index price based on the current formula is $8.29 per cwt. and with the proposed formula it would be $8.80 per cwt.

Using the current 4.1% actual component levels of butterfat, Class I milk would be worth $22.48 per cwt. with the current formulas and $22.32 per cwt. with the proposed formulas, a $.16 per cwt lower price.

CLASS IV SKIM MILK PRICING

The calculation of the Class IV skim milk price is not changed in the USDA proposal (Table III).

Table III - Class IV Milk Price Formula

However, the formula for the value of Nonfat Solids changes drastically with an increased "Make Allowance" changing from $.1678 to $.2268 per pound.  The current price of NFDM is $1 per pound.  That would lower the price of NFDM to $.94 per pound, 7%  lower (Chart IV).

Table IV - Nonfat Solids Price Formula

Using the Federal Order Index value formulas which use component levels at 3.5% butterfat, that would make Class IV milk worth $21.08 per cwt. with the current formulas and $20.33 per cwt. with the proposed formulas, a $.75 per cwt. lower price.

With the current component levels of butterfat at 4.1% butterfat, Class IV milk would be worth $23.16 per cwt. and $22.36 per cwt. with the proposed formulas, an $.80 per cwt lower price.

SUMMARY

Table V below is a summary of the impact of the proposed USDA changes to Federal Order pricing.  Class II is omitted because the size in minimal.

All three milk classes will decline in value.  The largest decrease is also the largest category.  Class III milk for cheese uses over 50% of the U.S. milk.  The main reason for the decline in the value of milk protein.  

The prices used in Table V are based on June 2024 data.  Month to month, the values can vary, but the numbers do represent the impact on producer prices as listed in the USDA proposal.

Table V - Summary of Proposed Changes on
Producer Milk Prices

Financial Impact of USDA Proposed Changes to Federal Order Pricing

                          

The USDA is proposing changes in the formulas used to price producer milk.  This post will analyze the impact of these changes on producer milk prices.

The most major change is in processor "Make Allowances" (Table I).  "Make Allowances" represent the cost to convert milk to commodities (eg, the cost to make cheese from milk).  Table I below lists the current and proposed changes to the "Make Allowances."  The changes are HUGE.  They range from 25% to 35% increases.  

With increases in the "Make Allowances" what happens?  Producers get less money for their milk and processors get more money. 

Table I - Proposed Changes in Make Allowances

The Agricultural Marketing Service (AMS) uses the formulas developed and approved by the USDA to calculate an index price for the different Classes of milk.  The index is used to measure changes in producer milk prices based on consistent calculations.  The percent of milk components used in the formulas has not changed in 25 years and while they are out of date, the index formulas do provide a consistent calculation.  

No one gets paid by the index milk prices.  They are only for comparison and are used to follow the value of producer milk prices as wholesale commodity prices change.

This post will cover the impact of the proposed changes on Class III milk prices.  Class III milk for cheese is the largest category utilizing over 50% of milk produced.

Table II below shows the proposed changes in milk solids content used in calculating the index prices.  The percent of protein in skimmed milk is increased from 3.1% to 3.3%.  Strangely, there is no percent change in butterfat percent.  Butterfat milk solids have increased much more than milk protein increases.  That leaves a mystery as why an index formula is changed after 25 years and why are three component percents increased and one is not?   Changes in the percent of components will make comparisons to historical calculations of index numbers non-comparable.

Is it an attempt to show that Class III skim index price for producer milk is not drastically lower with the new higher "Make Allowances?"  See more on this later in this blog.

Table II - Changes in Component Percents
used in Pricing Formulas

Table III shows the comparison between the current Class III skim milk formula and the proposed Class III skim milk formula.  Both of these unusual changes will increase the index price compared to the historic formula calculations and will make the proposed producer value of milk appear larger.  

Table III - Current and Proposed Formulas
for Class III Skim Milk

There are two additional pricing changes that impact the currently low prices for milk protein.  The changes are highlighted in Table IV along with the changes in the "Make Allowance".  

The proposed butterfat prices will be based on Block prices only, instead of an average of Block and Barrel prices.  On the average, Block prices are higher than Barrel prices.  This will increase butterfat prices on the average.  The conversion of butterfat usage in cheese is increased from .90 to .91.  Both changes will increase the negative butterfat pricing in the protein formula and will decrease the protein prices which are already very low.  

The first two lines of the formulas below are based on the wholesale price of Cheddar cheese.  The higher  "Make Allowances" will significantly lower the value of milk protein.  

The butterfat price, the third line of the formulas will also decrease with a higher "Make Allowance" offset somewhat by the increase in butterfat price when calculated with Block prices only.  The increased butterfat content (current is .90 and proposed is .91) will increase the value of the third line.  The net result will lower protein prices.

Table IV - Changes in Calculating Protein Value

Below are the formulas (Table V) for Class III skim milk.  The Class III milk formula (Table VI) stays the same as there is no change in the percent of skim milk and butterfat. 

Table V - Class III Skim Milk Formulas

Table VI - Class III Formula

The index values in Chart VII use current commodity prices.  Skim milk will be worth $.41 less per cwt. and butterfat will be worth $.06 less per pound.  Class III milk will be worth $.62 less per cwt., which is 3%  lower.  The index values do change with the new formulas.    

Table VII - Value of Skim Class III and Class III
Based on the Current and Proposed Formulas

REALITY

Enough about Index values because no one gets paid by the prices of the Index values.  The section below will cover the impact of the changes in formulas with the current actual component levels which are used to pay producers for their milk.  The actual current levels of butterfat and milk protein in producer milk are 4.14% and 3.23%.  The producer payments based on the current and proposed formula changes would be $2.08 per cwt. lower which is 9% lower.

Table VIII - Value of Skim Class III and Class III
at Current Component Levels

The index formulas are tuned to show only a 3% decrease in producer payments while the actual payments will decrease by 9%.

This post covered the impact of the USDA proposed changes on Class III pricing.  The next post will cover the impact on Class I and Class IV pricing.

Butterfat Continues Price Increases

Butterfat continues to increase in price.  How much longer will this continue?  Chart I below lists the record setting prices of butterfat over 25 years.  Record highs for butterfat have been reached 23 times over these 25 years.  Nineteen of these records have occurred at the beginning and end of these 25 years.  During the first two years of the Class and Component pricing, there were 13 record high prices.  For the next 12 years there were no significant record price increases.  In 2014 there were three new high price records set.  Following that there were another eight years with no new record price increases.  In the most recent three years there have been six new record highs set.

Chart I - Record Highs for Butterfat Prices

The moving 12-month averages are shown in Chart II.  Butterfat production is cyclical, and prices are volatile and are therefore shown as 12-month moving averages.  The 12-month moving averages do not show the full impact of the most recent record setting prices for butterfat. 

In 2020 and 2021 butterfat prices were low during COVID "stay at home" mandates.  The butterfat prices reached a high in late 2022 and dropped in 2023.  With the new record high prices in 2024, the moving averages began to increase.

Chart II - AMS Butterfat Prices

With higher butterfat prices, producers and their nutritionists worked hard to increase butterfat in milk.  Over the five plus years in Chart III, the average butterfat level increased from 3.9% to 4.2%.  That is an 8% increase in butterfat levels or about 1.5% increase per year!  Yes, money talks.

Chart III - Butterfat Percent in Milk by Month

Charts IV through VI below show the butterfat levels in three of the largest Federal Orders.  The increases in butterfat levels are nearly identical and consistent with the average for the U.S.

Chart IV - Butterfat Percent in the
 California FMMO

Chart V - Butterfat Percent in the
Upper Midwest FMMO

Chart VI - Butterfat Percent in the Southwest FMMO

What is the impact of increased butterfat levels, increased prices, and increased milk per cow on producer revenue?  This data is also reported on 12-month moving averages and do not show the full impact on the latest reporting month.  The most recent month reported, May 2024, will be compared to the 12-month moving average at the end of this post.

Chart VII shows the revenue per cow for U.S. milk.  While 2023 revenue dropped with lower butterfat prices, it has in 2024 reached a record level in the latest reporting month.

Chart VII - Butterfat Revenue per Cow in the U.S.

Charts VIII through X follow the revenue per cow for three of the major dairy states.  Chart VIII, California, has the lowest current revenue of the three states at $266 per month per cow.  The price paid for butterfat is the same and the component levels are the same for all three states, but California does have a lower milk per cow factor.

Chart VIII - Butterfat Revenue per Cow in California

Wisconsin and Texas data in Charts IX and X are very similar as their milk per cow is similar.  Both Wisconsin and Texas are showing record levels of revenue per cow.

Chart IX - Butterfat Revenue per Cow in Wisconsin

Chart X - Butterfat Revenue per Cow in Texas

To see the full impact of the most recent butterfat prices and butterfat component levels, Table I below compares the May 2024 12-month average revenue to the May 2024 revenue.  The actual monthly revenue is significantly higher than the 12-month average due to rapidly increasing butterfat prices.

Table I - Revenue per Month per Cow for May 2024

It seems obvious that producers and nutritionists and anyone else involved in changes to increase butterfat should go full steam.  To maximize revenue per cow, it is also important to increase milk per cow and the amount of milk protein.   Cheese uses over half of the U.S. milk produced and cheese continues to increase annually.  Cheese makers need high levels of milk protein to efficiently make cheese.  The ability to increase revenue and profitability are established technologies.

The USDA is about to enact increases in the make allowances that will move money from producers to processors.  Improving butterfat and milk protein is key for producers to survive.