The phrase “The gorilla in the room” is often used to describe something obvious but ignored.
The “gorillas” in milk marketing have become more evident due to disruptions resulting from the COVID-19 pandemic as well as a Federal Milk Marketing Ordinance (FMMO) system designed for another era.
Marin Bozic, a dairy economist at the University of Minnesota, identified these gorillas during a presentation at the 2021 Dairy Financial and Risk Management Conference, hosted by the Pennsylvania Center for Dairy Excellence. More than 100 lenders, financial consultants and others attended the September 2021 conference, held in Harrisburg, PA.
Bozic shared the results of the research conducted with Christopher Wolf, a dairy economist at Cornell University. The study, recently published in the Journal of Dairy Science, examined in depth the factors driving changes in producer price differentials (PPDs) in FMMOs.
FMMOs created at different times
“Federal orders today are not the same federal orders that were designed decades ago,” Bozic said. “Orders came in the 1930s, when the use of Class I, or the share of all pooled milk used for liquid drinks, was very high – over 70 percent. “
Bozic explained that as the use of Class I FMMO has declined, the central promise of the federal ordering system to provide a similar price to all dairy farmers in a specific order is broken. “In some parts of the country, orders are breaking down,” he said.
DPPs have been a major focal point in the blackout, particularly over the past 18 months. The research by Bozic and Wolf took an even longer perspective, highlighting the factors that have contributed to the general decline in PPD levels in all federal orders over the past 10 years.
“Often, Class I reform is blamed for the negative levels of PPD in 2020,” he said. “While Class I reform was part of it, there were far bigger issues than that. “
Factors contributing to negative PPDs
In their research, Bozic and Wolf isolated several factors that contributed to the decline in DPP. These included:
- Ongoing trends in the dairy industry, including lower use of Class I and higher protein levels among producers.
- The gap between Class III and Class IV milk prices and how this affects what is paid and paid out of the FMMO pool.
- The rallies and crashes that occur in the cheese market between the publication of advanced prices and the publication of advertised prices.
Class I use
Class I usage levels have declined significantly in many parts of the country over the past decade. In their model, Bozic and Wolf isolated the impact of this change on PPDs by maintaining all other factors – including the deviation of Class III-IV, component levels, and advanced prices from advertised prices – consistent.
Everything else being consistent, the decline in the use of Class I and the corresponding increase in the prices of other classes alone has resulted in a significant change in the PPVs that farmers receive – ranging from a drop of 48% of PPVs in the Pacific Northwest # 124 to a 23% decrease in the Southwest # 126. Without any other influence, PPD rates in Northeast No.1 would have fallen by 25%, or 47 cents per cwt (cwt) over the past 11 years, due solely to the change in class usage. I. Bozic predicts that these trends will continue over the next 10 years.
“It has nothing to do with policy changes or what happened with the virus or before any other effect related to the unrest that has occurred in the past 24 months,” he explained.
Protein modifications: two channels
Another trend influencing DPP is the increase in milk protein levels. “There are two channels in which these higher protein levels contribute to lower PPD levels,” he said.
Bozic explained that Class I handlers pay into the FMMO pool based on skim milk, which has a standardized protein test, but they take money from the pool based on the actual protein test. “So if the protein levels are higher than the standardized test, class I handlers pay the same amount but get more out now,” he explained.
He said the second channel is through accounting for Class IV pools. “A Class IV plant will pay the pool based on the price of solids non-fat, but it takes money out of the pool based on the price of protein,” he said. “So if the protein levels are higher, they take out more money than they put in.”
Class III-IV price differences
Bozic explained that as the price differential between Class III and Class IV milk widens, PPVs decrease in an almost linear relationship. Class III handlers pay into the pool based on protein and non-fat solids, but take money out of the pool based on protein prices. As the gap widens, there is less money left for PPDs.
In 2020, when demand for cheese increased due to USDA box-food purchases, Class III prices exploded. So why hasn’t all the milk been turned into cheese? Bozic explained that this was because there was no additional capacity for cheese production in the United States.
“When you run a cheese factory you want to keep it full all the time because that’s the only way to make money making basic cheese,” he said. “That’s why across the country we don’t have a lot of cheese production capacity, and that’s why when there is a huge increase in demand for cheese, it’s a huge shock to the ‘industry.”
Bozic added that FMMO’s advanced pricing schedule may also impact PPD levels. “The price of milk is determined at two different times of the month. Before the start of the month, we set the prices for the retailers, and for the manufacturers, we set the prices at the end of the month. So when there is a rise in cheese prices, PPD prices go down, ”he explained.
Finally, Bozic said the change in the price formula for Class I milk has had an impact on PPD levels. “The plan was to make it easier to cover the new channels for Class I milk, so we went from ‘highest of’ to ‘average over 74 cents’ to calculate our Class I price.
“When the industry came up with the plan, the formula was based on a revenue neutral look back,” he said. “As long as the spread [between Class III and Class IV skim milk price] was less than $ 1.48, it had a neutral to positive impact on DPP. “
What happened in 2020 was that the spread was over $ 1.48 per cwt. “The highest PPD under the new formula compared to the old one is 20 to 25 cents. But when Class III is much higher, such as in 2020, the risk of PPD falling is much greater.”
Bozic shared his research on how each of these factors influenced DPP levels, using 2010 as a benchmark. For July 2020, he showed how if all the factors were the same as in 2010, the benchmark PPD would have been $ 1.94 per cwt. The declining trends in Class I use and higher component levels that occurred between 2010 and July 2020 reduced this by 65 cents, while the gap between Class III and IV took it down. reduced by an additional $ 3.95. The rise in the price of cheese that occurred between the publication date of the advanced price and the publication of the advertised prices contributed an additional $ 1.75 to the decline, while the reform of Class I added an additional 84 cents on the decline. The resulting PPD for July 2020 was -5.46 in Northeast # 1.
“In August 2021, it was much less of a problem,” Bozic said, adding that all factors combined resulted in a PPD that was only slightly lower than it would have been in 2010.
“The gorilla in the room, however, is not what has happened before, but what we’re going to see happen in the next 10 years,” he said. “The continued decline in Class I sales will continue to drive down PPD levels, so you’ll lose an additional 25 cents over the next 10 years.
“We built the federal ordering system around a declining category – fluid milk sales – and we didn’t take into account the growing category, which is our export markets. As we think about what to do with federal orders, we have to keep in mind what to do with these exports and with these other gorillas. ”