Policies, Politics and the
Way We Price Milk
Mark Stephenson
Director of Dairy Policy Analysis
What Is Special About Milk?
It’s perishable
It’s bulky
It’s produced and must be sold 365 days a year
Specialized assets for production
Many more sellers than buyers
Relatively inelastic demand for products
Historically led to “destructive competition”
Federal Milk Marketing Orders
Cooperatives had modest success in policing the
marketplace
Federal government instituted Marketing Agreements
Shortly thereafter, Marketing Agreements became
Marketing Orders
Marketing Orders act like a traffic cop in the market
They regulate the terms of trade
They measure
They assure compliance
Classified Pricing
Class I — generally highest price
Class II
Class III
Class IV — generally lowest price
What is consistent with this ordering?
These are minimum prices to be paid!
Pooling
Processors contribute differently to the Federal Order
Pool, but producers receive the blended value.
Regulating Minimum Prices
Price
Supply
Over-Order
Premiums will get
you back here.
Pd
Pm
Ps
Demand
Quantity
Qm
Qs
Qd
Benefits of FMMO for Producers
Classified pricing can improve producer returns but it
is not a price support—Markets must still clear.
Pooling is about equity—sharing in those higher returns
Sharing a pool comes at a cost—qualification and
performance
Plants are audited
Prices are coordinated across markets (efficiency in
transportation)
Benefits for Processors
Plants know that their competitors are paying at least
the minimum class price.
Manufacturing plants get a “pool draw” to pay their
producers the same uniform or blend price.
Both producers and processors benefit from federal
order data
Testing
Audited milk production
Transportation, etc.
How would you price milk?
Ingredient & Product Streams
Ingredients
Cheese
Milk
Sweet
Cream
Let’s survey the market
price for these products
and back into a milk
We want to price this.
price.
Whey
Dried Whey
Whey
Cream
WPC
Permeate
Butter
Lactose
Product Price Formulas
Based on weekly AMS surveys of product sold
Product Price Formulas
Butterfat Price = (Butter price - 0.1715) x 1.211
Make Allowance - What does it cost you to
transform milk into 1 pound of butter?
Yield Factor - How many pounds of butter
can you make from 1 pound of butterfat?
Product Price Formulas
Dairy producers want a small make allowance and a
large yield factor
Dairy processors want a large make allowance and a
small yield factor
How do you determine the correct parameter values?
The Issue of Make Allowance
45
Who’s price?
40
Highest
Lowest
Average
35
30
25
20
15
10
5
0
12¢
13¢
14¢
15¢
16¢
17¢
18¢
19¢
Minimum Milk Price to Producers
Pounds of Butterfat
Pounds of Protein
Pounds of Other Solids (lactose + minerals)
Quality (Somatic Cell)
Total Pounds of Milk
Premiums often paid (over order)
Quality (somatic cell, bacteria)
Volume
Protein
Plant or Market
Hauling subsidies
New Policy?
Use policy to fix problems that the market or an
individual can’t
Standards of identity
FMMOs
Price Support Program
Policy fails when it does too little or too much
Eg. Price Support Program
Policy does not determine the end result—only the path
that the market takes
Today’s Issues
Price Volatility
Much discussion since about 2006
Refundable Assessments (Milk Producers’ Council, 2007)
Mandatory CWT (Dairy Farmers Working Together, 2007)
Growth Management Plan (Milk Producer’s Council, 2009)
Dairy Growth Management Initiative (DFA, 2009)
Marginal Milk Pricing (Agri-Mark, 2010)
Dairy Market Stabilization Program (NMPF, 2010)
Farm Savings Accounts (discussed by DIAC, 2010)
Margin Insurance Programs (NMPF’s DPMPP and discussed by DIAC, 2010-11)
Market Cow Bonus Program (DPAC, 2011)
Farm Savings Accounts (again, processor groups, 2011)
Peterson Discussion Draft (July 2011; modified DMSP)
Dairy Security Act of 2011 (September 2011)
Federal Milk Marketing Improvement Act of 2011 (Casey, October 2011)
Rural Economic Farm and Ranch Sustainability and Hunger Act of 2011 (October 2011)
Most have focused on supply correction (temporary quota, cull cow)
Some have focused on self-help (better LGM-D, FSA, etc.)
Price Risk!
U.S. All Milk Price
We Have Four Cycles
There appears to be a 9 month cycle
There appears to be an annual cycle
There appears to be a 26 month cycle
There appears to be a 36 month cycle
Spectral Decomposition
Volatility in Inputs Too
NASS Dairy Feed Ration
Some Variation of the The Dairy Security
Act of 2011 is the Starting Point
Cost savings by repeal of MILC, DPPSP & DEIP
New safety net with margin protection insurance
Reduce milk price volatility with temporary reductions in milk
supply
Points to Consider
The program is voluntary.
Margin Insurance and the Market Stabilization are
linked—you can’t have one without the other.
You would have several months to make a decision to
register after the bill is enacted.
If you register, you will need to make a decision at that
time about the level of insurance and the percent of
milk.
The Margin
NASS All Milk Price
Minus
Ration Value
NASS corn, NASS alfalfa hay, AMS Soybean Meal
Dairy Producer Margin Protection
Program
$4 base margin coverage is free
Partially subsidized premiums for supplemental coverage (25%–90%
of base)
Run by FSA
Calculated as
2 month pairs
Jan-Feb,
Mar-Apr,
etc.
Historic Trigger Values
Margin Protection Details
If you register, your historic base will be highest annual
production in the previous three years.
New producers can register within 180 days of first milk
production. Will prorate annual production.
You get margin protection on 80% of this historic base
for free.
Your annual production history is updated every year.
Margin Protection Details
If you want to protect more than free margin base, you
can buy up in 50¢ increments
You can protect from 25% to 90 % of your production
base.
This election is made at the time you register and
continues throughout the life of the bill but the levels
of supplemental insurance can be changed each year.
Annual premiums must be paid by Jan 15 or in 2
installments.
Example Margin Protection
Your historic base is 20 million pounds
You choose a $5.50 margin protection level at 75% of
your production
Two years later you have grown to 30 million pounds.
Example Margin Protection
If margin is calculated as $3.50 average for two months.
Indemnity is triggered
You are paid $4.00 - $3.50 = 50¢ on your historic base =
50¢ * (200,000cwt / 6 ) * 80% = $13,333
You receive a supplemental payment of
$5.50 $4.00 = $1.50 on your production base =
$1.50 *
(300,000cwt / 6) * 75% = $56,250
Total 2 month payment = $13,333 + $56,250= $69,583
Dairy Market Stabilization
Program
Uses same margin trigger calculation
The average trigger value is based on consecutive twomonth periods
E.g., Jan-Feb, Feb-Mar, Mar-Apr, etc.
Different milk production base
Most recent 3-month average
Same month from previous year
Can select which base calculation each year by Jan 15
Dairy Market Stabilization
Program
Triggers if 2-month average margin is below $6
$5—$6, no payment on milk over 2% of base to 6% of
current marketings
$4—$5, no payment on milk over 3% of base to 7% of
current marketings
Triggers if 1-month average margin is below $4
Under $4, no payment on milk over 4% of base to 8%
of current marketings
Dairy Market Stabilization
Program
Triggers can increase
For example, if you were in a $6 trigger event and next
month’s calculated 2-month average is now below $5,
the more restrictive trigger is active.
It appears as though if it is a long trigger event, a rolling
3-month base can incorporate your reduced marketings.
Program is suspended when 2-month average is above
$6 or U.S. price for cheddar or NFDM is more than
20% higher than world prices.
Modeling the DSA
Need many assumptions about participation
Look at Baseline and 2 scenarios
High participation, 50% of producers register in each of 4 farm
size categories and choose to protect 60% of their milk at a $6
margin.
Low Participation differs by farm size: 10%, 5%, 2.5% and 1% of
S, M, L, XL protect 50% of milk at $5.
All Milk Price
Government Expenditures
NFOI for Representative Medium
Farm