Producer Price Differentials:
The Good, The Bad and The Ugly
Brian W. Gould
Department of Agricultural and Applied Economics
and
Wisconsin Center for Dairy Research
University of Wisconsin-Madison
Wisconsin Dairy Field
Representatives Conference
February 9, 2005
Outline of Presentation
• Review Aspects of Federal Orders and
Classified Milk Pricing
– Most should be familiar with this material
• Definition of Producer Price Differentials (PPD)
– Exists due to Classified Pricing/Pooling
• Overview of Recent PPD Experiences in UMW
– Reasons for recent negative PPD’s
• Implications for the Future
Federal Milk Marketing Orders
April 2004 - Present
MCP Markets
Federal Milk Marketing Orders
• Regulate Handlers not producers
• Objectives of the program:
– Assure dairy farmers reasonable minimum milk prices
– Assure consumers an adequate milk supply
– Guarantee orderly marketing of fluid milk
• Achieves purposes via the use of:
– Classified pricing
– Pooling where all producers share in the pool
Classes of Milk
•
Class I: beverage milk
•
Class II: fluid cream, cottage cheese, ice cream
and mixes, yogurt, infant formula, sour cream, etc.
•
Class III: hard cheese, cream cheese
•
Class IV: butter, dried milk products (SMP),
evaporated and condensed milk
How Are Class Prices Determined?
• Based on commodity prices which are used in
formulas to determine component values
• NASS surveys butter, cheese, dry whey and
NFDM plants each Friday for sales data
– Prices and weekly sales are reported the next Friday
How Are Class Prices Determined?
• Class I skim milk, Class I butterfat and Class II
skim milk formula prices are advanced prices
– Reported on a Friday on or before the 23rd of the
month prior to production month
– For example, Feb. 2005 Class I price
 Announced on Friday Jan. 21st
 Based on NASS survey prices for weeks beginning
Jan. 2nd and Jan. 9th.
How Are Class Prices Determined?
•
Class II BF price, Class IV and Class III skim
and BF prices are announced on a Friday on or
before the 5th of the month following production
– Prices for Feb 2005 will be announced on Friday,
Mar 4th
– NASS Survey Prices for weeks beginning Jan 27th,
Feb 6th, Feb 13th and Feb 20th
•
There is a 6 or 7 week difference in timing of
prices used in advanced pricing of Class I and the
remaining Class prices for the same month
How Are Class Prices Determined?
• Minimum class prices are calculated using
– NASS weekly survey prices
– Assumed make allowances (plant costs) for
cheese, butter, dry whey, NFDM
– Assumed cwt yields of cheese, butter, dry whey
and NFDM
– Assumed raw milk composition
3.5% butterfat
2.99% true protein
5.69% other solids
• Class I and Class II prices typically higher than
Class III and Class IV prices
How Are Class Prices Determined?
• Class III milk price= 3.5*Class III/IV butterfat
value + 0.965 Class III skim milk price
– Butterfat value=f(butter price)
– Class III skim milk price=f(protein value, other
solids value)
 Protein value=f(cheese and butter price)
 Other solids price=f(dry whey price)
How Are Class Prices Determined?
• Class IV Price= 3.5* Class III/IV butterfat
value + 0.965*Class IV skim milk price
– Butterfat value=f(butter price)
– Class IV Skim Milk Price=f(NFDM price)
• Class II Price=3.5 *Butterfat price+0.965
advanced Class II skim milk price
– Butterfat value=Class IV butterfat price + $0.007
– Advanced Class II skim milk price=advanced
Class IV skim milk price+$0.70
How Are Class Prices Determined?
• Class I Advance (higher of ) Pricing
– Class I skim milk value is the higher of advanced
Class III or Class IV skim milk price
– Class I mover= (0.965 x Class I skim milk value) +
3.5 x advanced Class III/IV butterfat value
• Class I price = Class I mover plus a differential
– County specific Class I differential is added to
Class I mover to determine min. Class I price
– For Chicago area, differential is $1.80
Federal Order Uniform Prices
•
Uniform Price (Simplified Definition): Weighted
average price calculated as sum across all classes
of (min. class price) x (% of milk in class)
– % referred to as utilization
•
•
Actual uniform price more complicated but
weighted value relatively close
With market-wide pooling all handlers share in
pool and pay producers same min. uniform price
(ignoring differences in milk composition, quality
and plant location)
Concept of Pooling
Handlers with
milk value higher
than uniform price
pay into the pool
Pool
Handlers
Handlers pay
producers the same
price regardless of
how milk is used
Producers
Handlers with
milk value lower than
uniform price draw
from the pool
Producer Price Differential
• Producers in 6 MCP orders (including the
UMW) do not receive uniform price directly
– Federal order payment based on value of butterfat,
protein, other solids, a SCC adjustment and
producer price differential (PPD).
• PPD accounts for difference between Class I,
II, and IV prices and Class III price
– Except for some minor adjustments:
PPD approx. = uniform price - Class III price
Producer Price Differential
• Producers are paid via the following:
Producer Payment =
Butterfat Lbs/Cwt x Class III Butterfat Value
+ Protein Lbs/Cwt Class III Protein Value
+ Other Solids Lbs/Cwt x Class III Other Solids
Value
+ PPD
+ SCC adjustment
Producer Price Differential
• Class III price reflects total value of protein,
butterfat and other solids in producer’s total cwt of
marketed milk
• PPD is the added value per cwt of that portion of
an Order’s milk used for Class I, II and IV.
• In approximate terms, for each 6 MCP orders :
PPD = % Class I x (Class I price – Class III price)
+ % Class II x (Class II price – Class III price)
+ % Class IV x (Class IV price – Class III price)
Producer Price Differential
• What has been recent experience of uniform
prices and the PPD in the Upper Midwest
(UMW) Order?
Uniform Price and PPD's:
Upper Midwest Federal Order ($/cwt)
Class III/Uniform
PPD
20.00
16.00
12.00
8.00
4.00
Uniform Price
Class III
Actual PPD
0 PPD
4
l-0
Ju
04
Ja
n-
3
l-0
Ju
03
Ja
n-
2
l-0
Ju
02
Ja
n-
1
l-0
Ju
01
Ja
n-
0
l-0
Ju
Ja
n-
00
0.00
6.50
5.50
4.50
3.50
2.50
1.50
0.50
-0.50
-1.50
-2.50
-3.50
-4.50
Uniform and Class III Price
Upper Midwest Federal Order
$/cwt
20.00
Uniform Price
Class III
18.00
= Neg. PPD month
16.00
14.00
12.00
10.00
4
l-0
Ju
04
Ja
n-
3
l-0
Ju
03
Ja
n-
2
l-0
Ju
02
Ja
n-
1
l-0
Ju
01
Ja
n-
0
l-0
Ju
Ja
n-
00
8.00
April 2004 PPD
Milk Class
Class I
Pricing Time
Period
Announced
Date
Price
Class Price
– Class III
2/29 - 3/13
3/19/04
$15.44
-$4.22
4/30/04
$15.21
-$4.45
Class II
Skim
Fat
2/29-3/13
3/28-4/24
Class III
3/28-4/24
4/30/04
$19.66
-----
Class IV
3/28-4/24
4/30/04
$14.57
-$5.09
Note: The Class I price is the Class I mover plus the differential for
Cook County, IL
April 2004 PPD
• Negative $4.11 Upper Midwest PPD
• Over the Mar. 19-Apr 30 period there was a
significant increase in cheese price
– Two-week avg. cheese price for advanced Class I
calc.: $1.4582/lb
– Monthly avg. cheese price for Class III calc.:
$2.0520/lb, $0.5938 higher than advance value
April 2004 PPD
Class Price Factor
Advanced Announced % Change
Class III Skim Milk ($/cwt)
$5.64
$11.30
100.4
Class IV Skim Milk ($/cwt)
$5.96
$2.2525
$6.03
$2.5013
1.2
11.0
Average Product Price
Butter ($/lb) $1.9921
2.1994
NFDM ($/lb) $0.8090
0.8171
Cheese ($/lb) $1.4582
2.0520
10.4
1.0
40.7
Butterfat Price ($/lb)
Dry Whey ($/lb)
$0.1706
0.2602
52.5
Why The Negative April 2004 PPD?
• Steep run-up in cheese prices between advance
and Class III announcement periods
– Created an inverse relationship between normally
higher Class I and Class III price
• Price inversion occurs if:
– The monthly Class III price is higher than the
Class I Mover by more than the Class I differential
Why The Negative April 2004 PPD?
• Besides difference in Class III and Class I,
April Class II and IV prices were well below
Class III
– Value of milk used for butter and NFDM well
below milk value used for cheese
– Substantially reduced value of components for
Class II and IV milk
Why The Negative April 2004 PPD?
•
•
•
•
•
Changes in class utilization due to depooling
added to size of negative PPD
Manufacturing plants can depool from an order
prior to release of monthly classified prices
Bottling plants are not allowed to depool
To understand why a plant depools or not:
– Relationship among class prices and timing of
Federal Order price announcements
– Obligation of pooled handlers to producer
settlement fund
Lets compare April 2003 and April 2004
Why The Negative April 2004 PPD?
April 2003 Upper Midwest Order
Class
Price
Utilization
% Mil lb.
Class I $11.44 18.2 338.1
Class II $10.44 2.8
52.8
Class III $9.41 76.8 1,430.9
Class IV $9.73 2.2
41.0
Weighted Average Pool Value
Actual Uniform Price
PPD= $0.46
Value
$2.08
$0.29
$7.73
$0.21
$9.81
$9.87
Why The Negative April 2004 PPD?
• Class III and IV plants have economic incentive to pool
Class I price
• Class I handler pays into pool $1.63: $11.44 - $9.87
Class II price
Uniform price
• Class II handler pays into pool $0.63: $10.44 - $9.87
Uniform price
Uniform price
• Class III handler draws out of pool $0.46: $9.87 - $9.41
Uniform price
Class III price
• Class IV handler draws out of pool $0.14: $9.87 - $9.73
Class IV price
Why The Negative April 2004 PPD?
April 2004 Upper Midwest Order
Class
Price Utilization Value
($/cwt) % Mil lb. ($/cwt)
Class I $15.44 62.8 381.8 $9.70
Class II $15.21 15.8
96.3 $2.40
Class III $19.66 1.8
11.0 $0.35
Class IV $14.57 19.6 119.0 $2.86
Weighted Average Pool Value $15.31
Actual Uniform Price $15.55
PPD = -$4.11
Why The Negative April 2004 PPD?
•
•
•
Class III plants have economic incentive to
depool as they would have to pay into the pool
– 1.4 Bil. lbs. Class III milk in April 2003, 11.0 Mil. in 2004
– Class III milk pays into pool $4.11 ($19.66-$15.55)
Class I handlers have no choice but to pool
– Draw from the pool $0.11 ($15.55-15.44)
Class II and Class IV handlers have incentive to
pool because they draw out of the pool.
– Class II milk draw out of the pool, $0.34, Class IV milk
subject to a draw of $0.98
Why The Negative April 2004 PPD?
2004
2003
Simulated
Utilization
Value
Class
Price
(%)
($/cwt)
($/cwt)
Class I $15.44
18.2
$2.81
Class II $15.21
2.8
$0.43
Class III $19.66
76.8
$15.10
Class IV $14.57
2.2
$0.32
Simulated Average Pool Value $18.66
Actual Weighted Avg. Pool Value $15.31
→ If had more typical pooling patterns in April 2004,
the PPD would have been close to -$1.00 vs. -$4.11
Dec 2004 Pooling and Class Prices
Class Price Factor
Class III Skim Milk ($/cwt)
Advanced Announced
$8.12
$9.34
Class IV Skim Milk ($/cwt) $6.37
$6.52
Butterfat Price ($/lb) $1.8834 $2.0366
Average Product Price
Butter ($/lb) $1.6845 1.8122
NFDM ($/lb) $0.8553 0.8713
Cheese ($/lb) $1.5481 1.7146
Dry Whey ($/lb) $0.2338 0.2423
PPD = -$0.95
%
Change
15.0
2.4
8.1
7.6
1.8
10.8
4.1
Dec 2004 Pooling and Class Prices
Dec
Dec
Dec
2004
2003
2004
2004
2003
Value Simulated
Class
Util.
Util. ($/cwt)
Value
Price
(%)
(%)
($/cwt)
($/cwt)
Class I $16.23
59.3
18.1
$9.62
$2.94
Class II $13.98
15.2
5.2
$2.12
$0.73
Class III $16.14
5.3
68.5
$0.80 $11.06
Class IV $13.42
20.2
8.2
$2.71
$1.10
Simulated Average Pool Value $15.25 $15.83
Uniform Price $15.19
----→ If more typical pooling patterns in Dec 2004,
PPD would have been close to -$.35 vs. -$0.95
UMW Utilization Patterns: 2003-2004
2003 % Class Utilization
I
II
III
IV
2004 % Class Utilization
I
II
III
IV
PPD
PPD
Jan
19.7
2.3
76.0
2.0
0.58
Jan
17.8
5.5
68.9
7.8
0.37
Feb
18.5
2.4
74.2
4.9
0.47
Feb
18.3
4.3
74.4
3.0
0.47
Mar
17.5
2.7
77.3
2.5
0.54
Mar
58.7 11.2
12.3
17.8
0.21
Apr
18.2
2.8
76.8
2.2
0.46
Apr
62.8 15.8
1.8
19.6 (4.11)
May
17.9
2.5
77.9
1.7
0.40
May
53.2 17.5
4.6
24.7 (1.97)
Jun
15.6
2.7
77.4
4.3
0.38
Jun
15.9
6.3
69.8
8.1
0.30
Jul
49.7 15.9
11.6
22.8 (0.41)
Jul
16.1
5.8
70.8
7.3
0.72
Aug
50.6 18.4
8.4
22.6 (1.58)
Aug
18.0
6.6
68.2
7.3
0.22
Sep
54.0 17.6
5.7
22.7 (1.07)
Sep
29.1
8.9
51.9
10.1
0.13
Oct
55.2 17.0
4.8
23.0 (0.88)
Oct
18.9
5.7
68.6
6.7
0.31
Nov
35.6 11.0
36.2
17.2 (0.07)
Nov
40.6 11.7
35.7 12.0
0.13
Dec
18.1
68.5
Dec
59.3 15.2
5.2
8.2
0.54
5.3
20.2
(0.95)
Summary
• Why the negative PPD’s?
–
Advanced pricing system for Class I milk

–
6-7 week delay until Class III price set
Easy for Class III plants to depool one month
and pool the next
• What does it mean for 2005?
–
–
What is happening in the cheese markets?
Any changes in pooling policy?
Summary
• If you want more detail
–
access the publications section of the University
of Wisconsin Dairy Marketing Website
 www.aae.wisc.edu/future
– Feel free to contact me anytime:
 gould@aae.wisc.edu
Thank You!!