Weekly Dairy Market Outlook

By Ken Bailey

Penn State University

March 3, 2006

Headline: Coops Offer Revised Pricing Formulas

· Plan still lowers Class III and IV prices

· Class I and II, however, remain unchanged

· Still lowers farm prices in all orders

There is new proposal to change make allowances for processors in federal milk marketing orders. This proposal is a direct outcome from the January 24-27, 2006 USDA hearing (URL: http://www.ams.usda.gov/dairy/proposals/classIII_IV_make_all.htm ). This time the idea is to “decouple” Class I and II pricing formulas from the major changes that were earlier proposed for Class III and IV. The idea would be to allow cheese, butter and powder plants to pay farmers less for their milk (by increasing the make allowance), but to leave the fluid, ice cream, and yogurt plants unchanged.

In a letter directed to Dana Coale, Deputy Administrator of Dairy Programs at USDA, five major U.S. dairy cooperatives are requesting an emergency Federal Order Hearing to change those pricing formulas that affect how dairy farmers are paid. Cooperatives have complained that rising energy and labor costs have left them with processing losses. Therefore they are requesting that make allowance--those parts of the pricing formulas that cover processing costs--be increased. But the current proposal only covers Class III and IV milk. In other words, only processors of butter, nonfat dry milk, cheese and dry whey would be directly affected. Fluid plants and processors of Class II products (yogurt, ice cream, and cream cheese) would be left untouched.

I did a very simple analysis. I developed a monthly spreadsheet for 2006 and forecasted monthly federal order prices (using my old price forecasts). I then compared the monthly and annual changes suggested in the proposal to this baseline. What I found was that the new proposal would leave Class I and II prices unchanged, but Class III and IV prices would fall $0.54 and $0.65 per cwt, respectively (Table 1). In other words, processors of only Class III and IV products would pay farmers less for their milk.

This proposal would have very uneven consequences for federal order pools. Those orders that have a very heavy Class I market would be relatively unscathed in the short run, whereas markets with heavy Class III and IV markets would be directly affected. In a market like the Northeast order, where there is a very good mix of all four classes, the proposed decoupling plan would reduce farm milk prices in 2006 by $0.19 per cwt. But prices in the Upper Midwest would fall by $0.37 per cwt. Thus, there would be an equity issue at stake which could cause regional frictions.

One of the unintended consequences of this decoupling proposal is that relative federal order prices would be distorted. The ratio of Class I to Class III milk prices would rise by $0.54 per cwt (Table 2). This represents a dramatic increase. One of the consequences of such a change could be greater pressures to pool distance Class III milk supplies on Class I pools in the east coast(so-called paper pooling). Also, the ratio of Class II to Class IV prices would rise by $0.65 per cwt. Class II processors would then have an economic incentive to substitute some fresh milk with powdered milk. The point is, this decoupling proposal could create new unintended economic disincentives.

The fact remains that market conditions have changed dramatically in recent weeks. I am forecasting that the all-milk price could fall by as much as $2.90 per cwt in 2006 from the previous year. Thus any proposal for a Federal Order Hearing that could possibly result in even lower farm-gate milk prices will likely face strong challenges from dairy farmers.

Table 1. Analysis of 2006 Impact of Price Decoupling of Class I & II from Class III and IV and using Revised Make Allowances 1/
	2006	Decoupling
	Baseline	Proposal	Change
Federal Order Prices:
Class I mover	13.42	13.42	0.00
Class II price	12.75	12.75	0.00
Class III price	13.40	12.86	-0.54
Class IV price	11.98	11.33	-0.65
Federal Order Uniform Blend Prices:
Northeast	14.67	14.48	-0.19
Appalachian	15.34	15.25	-0.09
Southeast	15.19	15.05	-0.14
Florida	16.71	16.67	-0.04
Mideast	14.03	13.80	-0.23
Upper Midwest	13.69	13.32	-0.37
Central	13.91	13.63	-0.28
Southwest	14.46	14.23	-0.23
Arizona-Las Vegas	13.84	13.50	-0.34
Pacific Northwest	13.50	13.13	-0.36
All markets	14.31	14.06	-0.24
1/ Table 4 of Agri-Mark's testimony at the January USDA hearing.

Table 2. Impact of Price Decoupling on Relative Prices for 2006
		Decoupling
	Baseline	Proposal	change
Ratio of Class I to Class III milk prices	2.67	3.21	0.54
Ratio of Class II to Class IV milk prices	0.77	1.42	0.65
Note: The Class I price used in this analysis was the forecasted Class I mover plus a U.S. average differential of $2.65/cwt.

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