Dairy Marketing Dr. Roger Ginder Econ 338 Fall 2009 Lecture # 15

CALCULATING CCC PRICE---Butter and NDM Powder The current support price is $9.90/CWT. How much would the CCC pay for butter and NDM under the current support price?

CALCULATING CCC PURCHASE PRICE FROM DERIVITIVE PRODUCTS Butter - Powder Plant (Butter Tilt) Support Price ($/cwt)$10.10___$9.90_ PlusMake allowance (Convert cwt raw milk to butter and nonfat dry milk)$ 1.32___$1.32_ Total value required for $10.10 pay price$11.42 __$11.22__ Value nonfat dry milk = ___80_¢ (established by secretary) Yield nonfat dry milk 8.13 (#/cwt milk established) Value butter = Unknown Yield of butter = 4.48 #/cwt milk Required value for $10.10 pay price$11.42__$11.22__ LessValue nonfat dry milk per cwt$ 6.50___$6.50_ ($1.05/lb x 8.13) Value of butter per cwt$ 4.92___$4.72_ Implicit value of butter per lb ($2.78/4.48#)$ 1.09___ $1.05_ CCC would support butter $1.09/lb to provide a farm pay support price of $10.10/cwt for raw milk (before deductions). At $9.90 it would support butter at $1.05/lb.

CALCULATING CCC PURCHASE PRICE FROM DERIVITIVE PRODUCTS NDM-Powder Plant Support price ($/cwt)$10.10__$9.90__ PlusMake allowance (to convert milk to$ 1.22__$1.22______ butter and nonfat dry milk) Total value required for 10.10$11.32 $11.12 Value butter = $___$.72_ (established) Yield of butter = 4.48# per cwt milk Value nonfat dry milk unknown Yield nonfat dry milk 8.13# per cwt milk Required value for $10.10 pay price$11.32__$11.12__ LessValue of butter ($.72 x 4.48# per cwt)$ 3.23__ $3.23__ Implicit value of nonfat dry milk per cwt milk$ 8.09__$7.89__ Implicit value on nonfat dry milk per lb or ($8.09/8.13# per cwt)$.996__$.97__ CCC will purchase nonfat dry $.996/lb to provide a farm pay support price of $10.10/cwt for raw milk (before deductions). At $9.90 it would support NDM at a price of $.97/ lb.

SUPPLY AND DEMAND EFFECTS OF CCC PURCHASES Supply side –Higher prices in time of surplus dampen incentive for needed supply reductions –Reduced price and income risk encourage more production –Self perpetuating surplus if price held above equilibrium market clearing level by very much Demand side –Higher prices dampen demand for milk and milk products –“Tilt” effects occur on butter and nonfat dry milk –Dampened exports due to prices being held artificially high

TWO TYPES OF “TILT” 1. Demand tilt with an increase in support of one product vs. another –One type of joint product is purchased more vigorously than the other product –The other joint product is left unchanged –The split in price effect is not distributed Product tilt –Cheese is purchased more vigorously –Butter/powder is purchased more vigorously –Market for one type of product is affected more than the other

DEMAND TILT BY CCC Assume CCC must raise price by 50¢ to maintain support price. It chooses to use butter and powder purchases to maintain the support price targeted. How much of each product will they buy?

ASSUME MILK EQUIVALENT VALUES FOR DERIVITIVE MANUFACTURED PRODUCTS Cheddar cheese9.96# Grade A butter0.238# (From whey cream) Grade AA butter4.48# (From whole milk) Grade A NDFM8.13# Dry buttermilk powder0.42#

DEMAND TILT BY CCC Case 1 50 ¢ increase in price (no tilt) ____¢ milk fat____¢ solids not fat 4.48# BF/cwt milk8.13 # SNF/cwt milk ___  4.48 = __ ¢ inc. butter___  8.13 = __ ¢ inc. SNF Case 2 50 ¢ increase in price (80% SNF tilt) ___¢ allocated to milk fat___¢ allocated to SNF market market 4.48 # BF/cwt milk8.13 # # SNF/cwt milk ___  4.48 = ____ ¢ inc. butter____  8.13 = ____ ¢ SNF price

DEMAND TILT BY CCC Case 1 50 ¢ increase in price (no tilt) 25 ¢ milk fat25 ¢ solids not fat 4.48# BF/cwt milk8.13 # SNF/cwt milk 25  4.48 = 5.6 ¢ inc. butter25  8.13 = 3.0 ¢ inc. SNF Case 2 50 ¢ increase in price (80% SNF tilt) 10 ¢ allocated to milk fat40 ¢ allocated to SNF market market 4.48 # BF/cwt milk8.13 # # SNF/cwt milk 10  4.48 = 2.2 ¢ inc. butter40  8.13 = 4.8 ¢ SNF price

DEMAND TILT BY CCC Case 3 50 ¢ increase in price (100% SNF tilt) 0 ¢ allocated to milk fat50 ¢ allocated to SNF market 4.48 # BF/cwt milk8.13 #/cwt milk 0  4.48 = 0 increase50  8.13 = 6 ¢ inc. SNF No change in butter Case 4 50 ¢ increase in price (100% butter tilt) 50 ¢ allocated to milk fat0 ¢ allocated to SNF market 4.48 # BF/cwt milk8.13 #/cwt milk 50 ¢  4.48 = ¢ 0  8.13 = 0 increase increase in butterNo change in SNF price

Pre 2000 CCC MILK EQUIVALENT VALUES FOR DERIVITIVE MANUFACTURED PRODUCTS Cheddar cheese9.8# Grade A butter0.238# (From whey cream) Grade AA butter4.27# (From whole milk) Grade A NDFM8.07# Dry buttermilk powder0.42# What are the implications of these lower yield values for the support price of products purchased?

History of Tilts—1990 Farm Bill n Instructed Secretary of Ag. to use butter powder tilt to minimize government costs and authorized two changes in tilt per year n Butter was in heavy surplus at the time n Four tilts were made between 4-90 and 7-93 toward that end n Butter price used in calculation was reduced from about $1.09 to about $.65 n NDM price was increased from $.79 to about $1.03 n Butter inventories began to fall

History of Tilts—1995 & 2000 Farm Bills n Both bills reauthorized the use of two tilts per year at the discretion of the Secretary n Powder stocks were increasing steadily into the first half of 2001 n The commercial price of butter was well above the $.65 CCC price used in the calculation n Despite this disequilibrium no tilts were made until mid 2001 n By that time NDM stocks were at the 1.2 billion # level % of annual production

History of Tilts—1995 & 2000 Farm Bills n The problem was finally addressed in May of 2001 n CCC NDM purchase price of about a dollar was reduced to $.90/lb n CCC butter purchase price was increased from about $.65 to about $.85/lb n A second tilt change was made in to address the problem n CCC butter price was increased to $1.05/lb. n CCC NDM price was further reduced to $.80/lb. n These actions have began to abate the problem, but significant stocks of NDM still existed for several years

Butter Support Prices, U.S. Source: Agricultural Statistics, NASS, USDA

Nonfat Milk Support Prices, U.S. Source: Agricultural Statistics, NASS, USDA

CCC RESALES n Once purchased by CCC product may be sold back into the market when prices reach 110% of purchase support) n Occasionally this “unrestricted sales” authority is rescinded on a temporary basis n CCC dairy surplus is also made available food Domestic Foreign n Food programs are served only on an “as available” basis No targeted purchases Standby use only

How can the market price for cheese fall below the support price? n Processing and packaging standards for CCC products are different from industry standards. n Inspection and grading for CCC product is mandatory, and more stringent grading specifications result in higher rejections. n Storage and finance costs are higher because the CCC is slower to take delivery and make payment. n CCC freight allowances are inadequate to cover shipping costs on CCC sales.

Dairy Products purchased under the Dairy Price Support Program (Effective 2008).80 Nonfat Dry Milk (Non- Fortified): Cheddar Cheese: 40-60# Blocks 500# Barrels 1.05Butter Market Price $/Lb. ( ) CCC Price $/Lb.Product

SUMMARY OF FEDERAL POLICY Pre 2000 n The government used several policy instruments to conduct dairy policy prior to 2000 including price supports n Initially (1940’s to 1980) Price supports were used to increase producer income---But that caused increased production and very high government cost n Later ( ) price supports were used to place a floor under the price of milk while transitioning to a competitive market n For much of that period price supports have been falling and at the end of the period were well below the cost of production n By the end of the period ( ) price supports were not much more an attempt to blunt the effects of temporary downside price volatility inherent in a market for a perishable product

PsPs Q s SoSo Pric e Quantity PePe Q d Q e Economics of Using Supports Above Equilibrium to Increase Producer Price DoDo Producers will supply Consumers will Buy

SUMMARY OF FEDERAL POLICY PRE n Several policies attempted to reduce supply or shift the supply curve upward and to the left –Across the board producer Assessments were instituted to hold government costs down –Across the board diversion payments were made to those who reduced production –Across the board whole herd buyouts were initiated

P1P1 Q1Q1 SoSo Price Quantity DoDo S1S1 PEPE QEQE Factors that can shift supply: 1. New technology 2. Changes in input costs 3. Raw material or resource availability 4. Legal or government program constraints on production 5.Per Unit Production Taxes

SUMMARY OF FEDERAL POLICY PRE-2000 n Several policies were designed to increase consumption of dairy products –Free distribution policies for cheese –Subsidized school milk program –Promotion of dairy products financed by producers

PoPo QoQo SoSo Pric e Quantity D1D1 P1P1 Q1Q1 Factors that can shift demand: 1. Change in tastes or preferences 2. Change in income 3. Change in population level 4. Change in the price of substitute or complement products DoDo

CCC PURCHASES IN MILK EQUIVALENT n Gradual decline from late 1980’s and early 1990’s ( ) billion # n Peak year billion # (Approx. 14%) n Average Percent of production 4.2% milk fat basis n Average Percent of production 6.4% solids basis n More recently much less than 0.5% on a solids basis

CCC Net Removals as a Percent of Total U.S. Milk Production (milk equivalent, milkfat basis) Source: Based on statistics from Dairy Yearbook, ERS, 10/21/94, 6/23/95, & 6/21/96 Dairy Outlook, ERS, 8/98 Livestock, Dairy and Poultry Situation and Outlook Report, ERS, & Agricultural Statistics, NASS

Source: 10/21/94, 6/23/95, 6/21/96 Dairy Outlook, ERS & 8/98 Livestock, Dairy and Poultry Situation and Outlook Report, ERS CCC Net Removals (milk equivalent, milkfat basis)

SUMMARY OF FEDERAL POLICY PRE-2000 n Current support is a low level safety net –Below cost for many producers –Generally the price for manufacturing milk been higher than support in recent times –Greater price volatility upside/downside has resulted as government retreats –Price can fall below cash costs and force insolvency for marginal producers –Some believe an over-adjustment in supply could result and lead to exaggerated price increases in future-People don’t move in and out of dairy farming –Others believe large low cost operations will fill the gap –Legislation of higher prices will be very difficult in the absence of extreme conditions –Significant structural implications and consequences will likely occur over the next decade

FEDERAL POLICY POST n Less Emphasis on Supporting Milk Prices ( Until Recently) n Movement to Countercyclical Payments That Are More Directed to Producers n Continued Promotion Programs n Continued Export Enhancement

2002 Farm Bill: Dairy Title n $9.90 support price extended through December 31, n Dairy “counter-cyclical” payment program authorized from December 2001 through September 2005 (Market Income Loss Contracts – MILC!!). n Dairy Export Incentive continued unchanged from 1996 bill.

2002 Farm Bill: Dairy Title (Continued) n Continued processor fluid milk promotion program and requires importers to pay an assessment equivalent to $0.15 per hundredweight NDPR check-off. n Authorized (without appropriations) Johnes research program.

2008 Farm Bill n Retains MILC with changes n Changes Dairy Price Support to Dairy Product Price Support. n If still supported milk at parity---100% parity is $47.40; What would happen if we had milk prices this high?