Dairy Excel: Milk pricing issue requires attention

“Leahy’s proposal disconnects the price the dairy producer receives from the
price consumers use to make decisions. If we have learned one hard lesson in
dairy policy over the last 30 years, it is that this is a dangerous proposition.”

* * *

As the 2001 marketing year draws to a close, there is an important milk pricing
and an important dairy policy issue to which we need to pay very close attention.

If implemented, either of these changes could have important financial impacts
on your dairy farm cash-flow in the future. The first of these potential changes
is new proposed pricing rules for Class III and Class IV in federal milk marketing
orders, and the second is the inclusion of the Leahy version of the Sanders/Obey
amendment in the Senate farm bill.

Number one. With the publishing of the Oct. 25 “Federal Register,” the
USDA Agricultural Marketing Service announced new proposed pricing formulae
for all Federal Order marketing areas.

These new rules are in response to a Congressional mandate included in the Consolidated
Appropriations Act 2000, which directed the Secretary of Agriculture to review
the Class III and Class IV pricing formulae put forth in the federal order reform
tentative final decision issued Nov. 29, 2000.

First of all, the tentative final rule which specified a separate butterfat
price calculation for butter and cheese has been scrapped permanently. The other
changes are:

Grade AA butter to butterfat calculation: Unchanged from current rules in effect.

Cheddar cheese to protein calculation: No change in the make allowances but
only 90 percent of the butterfat price is deducted and the adjustment factor
is lowered from 1.28 to 1.17.

Dry whey to other solids calculation: The make allowance is increased from 14
cents per pound to 15.9 cents per pound and the “snubber” is eliminated. (The
snubber keeps the other solids price from being calculated as anything other
than zero when the dry whey price is below the make allowance.)

Current OS formula: Other Solids Price = (NASS Dry Whey Price – 0.14)/0.968

Proposed OS formula: Other Solids Price = (NASS Dry Whey Price – 0.159)/0.968

Impact. So what does this mean for the Class III price component of
your milk check? More dollars in the milk check if the experience from 2001
is any guide.

The table shows the prices that would have been calculated each month during
2001 IF these Class III and Class IV pricing rules had been adopted beginning
January 2001.

The Class III price would have averaged 55 cents higher under the new proposed
rules. (Almost enough to makeup for the pool riding cost per hundredweight in
the Mideast Federal Order!)

What’s pushing increase?

So why do the new proposed rules increase the Class III price? The answer lies
in the fact that the new rules would create a significant change in the relationship
between butter prices, butterfat price and the protein price calculation.

Under the current rule, a higher butter price, other prices unchanged, gets
translated into a lower Class III price. The net effect is that a 10 cent per
pound rise in the butter price, all other prices held fixed, results in a 4
cent drop in the Class III price.

With the new proposed rule this relationship is completely altered so that a
10 cent per pound rise in the butter price increases the Class III price by
4+ cents.

If this were not enough, the protein price derived from the cheese price is
higher for any level of cheese prices with the new proposed protein pricing
rule because of the lower deduction for butterfat.

Timetable. So, when will these new rules take effect and begin to show
up in producers’ milk check? The comment period holds until Nov. 26. After that
time the USDA/AMS will review the comments and issue a final (final??) decision.


It is always a guess as to when this will occur but I am willing to bet that
with low milk prices in the next couple of months there will be significant
pressure on the USDA/AMS to make this change as quickly as possible.

It would be a real nice holiday present if they could accomplish this by January
2002.

Debate. Is there total agreement in the industry on these proposed changes?
Of course not – dairy producers earn a higher price – cheese manufacturers have
to pay a higher price.

Remember the general rule: 10 cents on the cheese price is $1 on the milk price.
Increasing the average Class III price by 55 cents means cheese must bring an
additional 5.5 cents on average per pound. This may not seem like a lot of money
but it is 33 percent of the cheese make allowance of 16.5 cents per pound.

There is also an issue of creating a pricing disparity for cheese milk between
cheese manufactures in the near west such as Idaho and the far west – California.

Number two. Sanders/Obey Amendment and New Regional Milk Supply Management
Districts. The expiration of the Northeast Interstate Dairy Compact Sept. 30
ushered in new attempt to establish a national compact-style milk pricing program.


Although a version offered by Rep. Bernie Sanders, I-Vt., during the House farm
bill debate was defeated, Sen. Patrick Leahy, D-Vt., has now taken the lead
in circulating a similar amendment in the Senate.

On Nov. 15 the Senate Agricultural Committee passed the Senate farm bill on
to the full Senate and this included these key provisions of the Leahy/Sanders/Obey
proposal:

* Establishes a minimum Class I price mover of $14.25 to which the Class I differential
must be added in all 48 contiguous states;

* Requires all milk processors, each month, to place the difference between
the $14.25 mover and the actual Class I price mover for all beverage milk purchased
into a federal trust fund for dairy farmers nationwide;

* Assesses fluid milk processors up to 5 cents per hundredweight on all beverage
milk sold to cover new administrative costs-this would have cost fluid milk
processors $28 million in the year 2000;

* Requires the Secretary of Agriculture to add up to $300 million a year in
federal dollars to the trust fund for direct payments to all U.S. dairy farmers
– the amount to be added each month is 25 percent of the difference between
the actual Class III price (milk used to make cheese) and a target price of
$13 times the volume of national eligible Class II, III and IV production;

* Distributes the trust fund’s national ‘pool’ of money (from the two forms
of payments into the pool noted above) to dairy farmers in the 48 states according
to the amount of milk they produce each month;

* Limits the amount of trust fund money that can be received by any single dairy
farm – payments are only made on a farm’s first 500,000 pounds of monthly milk
production, the equivalent of about a 250- to 350-cow farm, depending on each
farm’s output per cow;

* Establishes 11 regional supply management boards that administer payments
to farmers and are authorized to prevent production increases from occurring
as a result of higher prices paid to farmers; and

* Requires the Secretary to use trust fund revenues to reimburse the Commodity
Credit Corporation for added costs under the Dairy Price Support Program, and
the WIC and school meals programs for higher costs resulting from the legislation.

Analyses. At this time, there have been two in-depth analyses of the
potential long-term impacts of this legislation. The Food and Agricultural Policy
Research Institute, University of Missouri, a think tank that conducts agricultural
policy analysis for the U.S. Congress, has looked at the long-term impacts over
the period 2002 through 2010.

Assuming the payment limitation rules are in effect, a review of the FAPRI analysis
leads to these conclusions:

* Drive up beverage milk prices by 10 percent or about 26 cents per gallon for
milk,

* Reduce consumer demand for beverage milk by an average 3 percent per year,

* Drive down the all milk price by an average of 98 cents per year,

* Drive down the Class III milk price by an average of 60 cents per year,

* Drive down the Class IV milk price by an average of $1.05 per year.

* Returns an average $1.33 from the trust fund to each producer,

* Returns a net increase in the all milk price of 33 cents per hundredweight
to each producer (net of the lower milk price plus trust fund payment).

A related analysis by the Agricultural and Food Policy Center located at Texas
A&M University has estimated the impact of the counter-cyclical payments provision
on individual dairy farms by size of milking operation.

The conclusions reached by the center are:

* All dairy farms experience a drop in market prices and therefore net cash
farm income derived from the market (just as in the research institute’s analysis);

* All dairy farms, irrespective of size, benefit if there is no binding payment
limit. The larger the milking operation the greater the benefit. For example
a modest 85-cow dairy could experience an increase in average net cash farm
income of $7,800 and a 2,100-cow dairy $196,000 over the program period of 2002-2010;

* If there are binding payment constraints ($500,000 or equivalently 250-350
milking cows) then the larger dairy operations experience substantial average
annual declines in net cash farm income.

The addition of the counter-cyclical payment to the market milk price is more
than offset by the loss of cash income as a result of drop in market milk prices
resulting from the program.

For example, the 85-cow dairy may experience an average annual increase of $17,000
with a binding payment limitation while a larger dairy operation may experience
an average annual loss ranging from $285,000 (Idaho dairy) to $938,000 (New
Mexico dairy).

A large 1,200-cow dairy located in the Federal Order 33 milkshed could experience
a loss as great as $135,000 per year! With binding payment limitations there
will be substantial incentives to reorganize the structure of the larger dairy
farms to take advantage of the counter-cyclical payments.

On the surface, this program appears to be beneficial to medium to small dairy
farms. The lure of counter-cyclical payments and a floor under Class I milk
price is very attractive.

Who could be against a national trust fund that promises to allow all to share
in Class I revenues? Before we jump ahead, let’s take a closer look.

Concern. A serious concern that I have about this program is that it
disconnects the price that the dairy producer receives from the price that is
effective in the market and the price that consumers use to make decisions.


If we have learned one hard lesson in dairy policy over the last 30 years it
is that this is a dangerous proposition.

A program that stimulates milk production, drives down market prices, reduces
consumption of beverage milk, distorts incentives to adopt and maintain efficient
scale of operations, pits the well-being of small dairy farms against that of
large dairy farms, places overall dairy farm economic well-being at the mercy
of the federal budget process, and disconnects critical economic decision making
at the dairy farm level from the realities of the market place is indeed a siren’s
song of a program.

I cannot find merit in such a program and do not believe that it is in the long-term
best interest of our dairy producers.

As always I am interested in your view on this subject.

(You can e-mail Cameron Thraen at thraen.1@osu.edu.
Or write to Cameron Thraen, OSUE State Specialist, Dairy Markets and Policy,
2120 Fyffe Road #325, Columbus, Ohio 43210-1099.)