Economic Update: Formula change has added to market disorder

Update Highlights

One factor cited in the historical negative producer price differentials (PPDs) across Federal Milk Marketing Orders (FMMOs) this year is a change made to the formula to calculate the Class I milk price mover. A recent article by John Newton, chief economist with the American Farm Bureau Federation (AFBF), analyzes the two Class I milk price formulas and the multimillion dollar impact the change – coupled with COVID-19-related volatility in dairy markets – has had on dairy farmers supplying the Class I (fluid milk) market.

Read: Impact of the Farm Bill Change to the Class I Milk Price on Dairy Farm Income.

The change to the milk pricing rules did not move through a formal FMMO rule-making process, but rather was approved by Congress in the 2018 Farm Bill. It was implemented in May 2019.

Prior to the change, the formula used to calculate Class I milk price mover was based on the “higher-of” the advanced Class III and Class IV skim milk price. The 2018 Farm Bill eliminated the higher-of component of the formula and replaced it with a formula based on the simple average of the monthly Class III and Class IV advanced prices, plus 74 cents.

At the time, the change was expected to have little impact on prices paid to dairy farmers and was seen as a benefit to milk processors challenged by a declining fluid milk market and unable to fully hedge fluid milk costs using the Chicago Mercantile Exchange (CME) futures market.

After implementation in May 2019 and prior to COVID-19 milk market disruptions, Class I prices calculated under both old and new formulas were similar, with an average of just 9 cents per hundredweight (cwt) in the dairy producer’s favor, according to Newton’s analysis. During nine of the 12 months the new pricing formula was in place, the new Class I milk price was greater than it would have been under the higher-of formula.

Then, COVID-19 hit. From late February to late April, when the May Class I milk price was announced, and late May, when the June Class I milk price was announced, advanced Class III and Class IV milk prices collapsed. The advanced Class I milk price fell by 15% and 36%, respectively, from March to May and March to June. The advanced Class IV milk price fell by 27% and 38%, respectively, during these same periods. Despite that collapse, the June Class I advanced price was 38 cents per cwt higher than it would have been under the pre-farm bill formula, Newton wrote.

Following government intervention in cheese markets and cooperative-led supply reduction programs, cheese prices rallied sharply while nonfat dry milk prices rallied only marginally. From June to July, the advanced Class III price rose by nearly 100%, and from June to August the price change had reached 171%. Meanwhile, during these same periods, the advanced Class IV milk price rose by 8% and 19%, respectively.

As a direct result of no longer including the higher-of in the milk price formula, the Class I milk price never fully captured the rally in Class III milk prices. Instead, the new Class I milk price was as much as $4.57 per cwt below the higher-of formula price in August and $4.26 lower in September. Had the higher-of formula still been in place, the Class I mover would have exceeded $24 per cwt in August, even before Class I location adjustments are added. In South Florida, for example, the Class I milk price would have been more than $30 per cwt in August 2020.

From May-October 2020, the average difference between the old and new Class I milk prices was $2.04 per cwt in favor of the beverage milk processor. Going back to May 2019, the Class I milk price is 62 cents per cwt lower than the pre-farm bill formula. Cumulatively, since the Class I milk price formula was modified, the pooled value of Class I milk is $403 million lower than it would have been under the higher-of formula eliminated in the 2018 Farm Bill.

Going forward, any time the Class III and IV advanced prices differ by more than $1.48 per cwt, the Class I milk price will be lower than the higher-of formula and the likelihood of negative PPDs and depooling incentives will increase.

The new Class I milk price formula remains in place through April 2021, unless modified by an amendment to the FMMO – either as an act of Congress or administratively through an FMMO hearing.

Read Newton’s full article and other background material here.

Following up on a previous report indicating U.S. per capita dairy consumption had moved to a 60-year high in 2019, the USDA released additional information specific to per capita cheese consumption. The good news: 2019 consumption of natural cheeses was up more than a quarter pound from 2018 to a record 38.59 pounds per person.

It marked the 11th consecutive year per capita cheese consumption has increased from the previous year; consumption has now increased more than 9 pounds per person over the past two decades.

Within the cheese category, per capita Italian cheese consumption was 15.87 pounds in 2019, up about 0.2 pound from 2018. Mozzarella consumption averaged 12.48 pounds per person, with consumption of other Italian cheeses at 3.4 pounds, down slightly from 2016-18.

In 2019, per capita consumption of American-type cheese totaled 15.54 pounds, the eighth straight year of growth. Within the American cheese category, per capita cheddar consumption was 10.9 pounds, down from previous annual averages in 2015-19. However, that was offset by increased consumption of other American-type cheeses (colby, washed curd, stirred curd and Monterey Jack) at 5.45 pounds.

Among other types of cheeses, consumption of Swiss, Muenster, Hispanic and cream/Neufchatel varieties all posted small gains in 2019, while consumption of blue and brick cheeses held steady with the prior year.

Lower consumption of process cheese was mostly offset by an increase in cold pack, cheese foods and spreads.

Thanks to the growth in cheese consumption, 2019 U.S. per capita consumption of dairy products (on a milk-equivalent, milkfat basis) increased 7 pounds from the 2018’s estimate to 653 pounds.

The disruption of 2020 holiday family plans due to the coronavirus pandemic and concerns over unemployment and a weaker economy cloud the dairy product sales picture in the fourth quarter of the year, according to Blimling’s Phil Plourd and Kathleen Wolfley. They shared insights and interviews in the latest Dairy Download podcast, produced by the International Dairy Foods Association (IDFA) and Blimling and Associates.

Other segments of the Dairy Download podcast include:

  • A discussion regarding the return of the iconic “Got Milk?” campaign, with MilkPEP CEO Yin Woon Rani
  • Michael Flood, president and CEO of the Los Angeles Regional Food Bank, discusses how demand at Los Angeles food banks is “through the roof” due COVID-19’s drag on the economy, and distribution of dairy products is up nearly tenfold from pre-COVID-19 levels.
  • Finally, Patti Montague, CEO of the School Nutrition Association, talks about how the loss of sales and subsidies due to reduced in-school meal programs are causing financial stress on many school districts. She shares how the nation’s school meals professionals are using creative methods to get milk and other healthy foods to students.

The index of Global Dairy Trade (GDT) dairy product prices rose 2.2% in the latest auction, held Oct. 6.

A price summary of individual product categories follows:

  • Skim milk powder was up 0.9% to $2,865 per metric ton (MT).
  • Butter was up 8.4% to $3,561 per MT.
  • Whole milk powder was up 1.7% to $3,041 per MT.
  • Cheddar cheese was up 0.4% to $3,694 per MT.

The Purdue University/CME Group “Ag Economy Barometer” provides a monthly snapshot of farmer sentiment regarding the state of the agricultural economy. In addition, it reveals producer insights into other topics impacting their businesses.

The latest survey was conducted Sept. 21-25, shortly after the USDA announced a second round of Coronavirus Food Assistance Program (CFAP 2) payments and during a period fall-harvested crop prices were improving.

In general, survey results revealed a brighter outlook for both current and future economic conditions. However, that optimism did not completely carry over into perspectives toward the future of U.S. agriculture’s trade. Compared to a month earlier, a lower percentage of respondents said they expect agriculture exports to increase over the next five years. Less than half of the respondents indicated they expect China to fulfill its Phase I trade agreement commitment to import food and ag products from the U.S.

Based on the September survey, producers were more confident about making large investments in their farming operations than they were in August. Also, compared to the August survey, fewer producers said they planned to reduce their machinery purchases compared to a year earlier.

With many educational events and programs transitioning to online delivery, farmers were asked whether they have attended an online program and, if so, what aspects they liked and disliked. Twenty-two percent of respondents to the September survey said they attended an online educational program or field day this year. Respondents said they liked the flexible timing of attending and viewing the programs (27%) and the ability to choose topics of interest (21%). However, respondents overwhelmingly pointed to the lack of interaction with other attendees (40%), poor broadband connection (18%) and difficulty in asking questions (17%) as the top reasons they disliked these programs.

The monthly survey collects responses from 400 producers whose annual market value of production is equal to or exceeds $500,000. Minimum targets by enterprise are as follows: 53% corn/soybeans, 14% wheat, 3% cotton, 19% beef cattle, 5% dairy and 6% hogs.  end mark

Dave Natzke

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