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  The percent of milk components used in the formulas has not changed in 25 years and while they are out of date, the index formulas do provide a consistent calculation.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.