Dr. Roger Ginder Econ 338 Fall 2007 Lecture #18 Dairy Marketing Dr. Roger Ginder Econ 338 Fall 2007 Lecture #18

CLASSIFIED PRICING UNDER FEDERAL MILK MARKETING ORDERS

Classified Milk Pricing One price paid for milk in fluid uses Other prices paid for various other uses Justification for a higher fluid milk price More costly to produce grade A More costly to transport fluid milk Fluid milk has less elastic demand Need to ensure adequate supply in fall when production is down Classified pricing helps dispose of surplus milk in spring flush season by creating a lower price for manufactured products Also it helps to balance weekly bottling demands with supplies

Past

FMMO CLASSES OF MILK USAGE/PRODUCTS Class I = Fluid Products Class III = Cheese Class IV = Nonfat dry milk, Butter Class II = Everything else (e.g., cottage cheese, yogurt, ice cream)

CLASS I DIFFERENTIALS PRIOR TO 2000 * Varied from order to order but generally increased with distance away from Wisconsin * Rationale: Enables handlers located outside of Wisconsin to buy milk closer to Wisconsin at a lower price using the price savings to offset greater transport costs (assures consumers a supply, and protects producers inFMMO) * Actual Class I differentials (.15-.20/cwt/10/mi) is really less than actual transport cost

Class I Differentials Rationale for Class I Differentials Encourage production for fluid in deficit areas Pay for added transport costs to cover fluid needs in deficit areas Prior to circa 1961 Class I set by Differential above manufacturing milk price Complex economic indexes Varied from order to order - no uniformity After early 1960’s, a single basing point system was used Eau Claire, Wisconsin was base point Covered all orders east of Rocky Mountains 15¢/cwt for each 100 mi ($.0015/mi) until 1986 Class I differentials are constant and BFP is the mover of Class I and Class II price Class I differentials were amended in 1986 Approximate $.002/mi Southeast and south of Eau Claire

Class I Pricing Prior 2000 Basic formula price (2nd preceding month) + Class I differential (varies by market) Plus BFP 2nd preceding month is equal to the Class I Price (this month) + 2 month lag on BFP base favored by processors

Class I Differentials Class I differentials were amended again in 2000 Radical Change in the Basing Point mechanism, but a less radical change in the differentials paid Changed to a Multiple Basing Point System from the old Single basing point system No longer based on distance from Eau Claire Wisconsin Instead defined by county In most cases class I and II differentials were not reduced over what existed before In some cases they were increased Post 2000 Class I differentials are still constant and the BFP is still the mover of Class I and Class II price

CLASS I UTILIZATION PERCENTAGE The percent of total order milk supply (quantity) that is used in Class I products Varies greatly from order to order Generally lower in upper midwest Generally higher in east/southeast/northeast Larger Class I percentages generate larger blend prices as a rule BUT …When BFP increases rapidly and steeply an inverted price can result Inverted price less likely but still possible and has occurred under the post 2000 FMMO rules

OBSERVATIONS - CLASS I PRICING It is a type of formula pricing The Basic formula price is the “Mover” of Class I Prices and reflects competitive conditions Class I differential is fixed and does not represent competitive forces Class I differential was a single basing point pricing system with Eau Claire as the base – now multiple basing point with county prices Effectively very similar to pre 2000 pricing

Class II Differentials Rationale for Class II differential Attract sufficient Grade A milk away from manufacturing uses Covers transport costs in deficit areas At one time 10¢ was differential Later a formula price was used (complicated) --- scraped in 1995 1995-2000 used 30¢ differential After January 1, 2000 use 70¢ There was variation among orders – but not now

Class II Pricing Prior 2000 Basic Formula Price (MW for 2nd preceding month) plus 30¢ / cwt. was equal to Class II Price (this month) Effective early 1995 the Class II price was announced 5th of preceding month Advanced pricing trial to see if could work for Class I

Marketwide Pooling

Marketwide Pooling All producers receive a uniform milk price Regardless of which plant received Adjusted for transport/zone charges Assures producers share equitably in high valued end uses

CHARACTERISTICS OF FMMO AREAS Based on sales territory of competing distributing plants Based on where milk is sold not where it was produced FMMO areas have expanded as sales areas have expanded Change in distribution methods Improved transport at lower unit cost No. of FMMOs has declined to consolidations and mergers The provisions of 1995 Farm Bill (Fair Act) required even more accelerated consolidation

Region defined is typically: 1. Centered around fluid market(s) (not production areas) - milk can be pooled from anywhere - transport costs is the real issue 2. Few distribution route sales (or fluid product sales) crossing into other markets 3. A group of producers who “normally” serve that market(s) as a result of their location

POOLING REQUIREMENTS Performance or qualification provisions for participating as a pool plan Define clearly what a handler must do to become regulated or pooled on an order Ensure that Class I and Class II pricing differentials are distributed to producers who actually supply milk for fluid consumption or Class II uses Prevent plants with no commitment to fluid supply from sharing in Class I & II differentials and drawing milk from fluid suppliers.

TYPES OF FMMO MILK PLANTS (BUYERS OR HANDLERS) 1. By activity a. Distributing plant is a fluid handler, bottler, or processor b. Supply plant is a plant which ships a minimum amount of its milk to a distributing plant (1) Butter/powder or cheese plant (2) Reload or receiving stations 2. By regulation status a. Regulated plant is the same as pooled or also called qualified (Must follow FMMO provisions) b. Nonpool (unregulated) plant Not affected by FMMO provisions Class III and Class IV

POOLING REQUIREMENTS FOR A DISTRIBUTING PLANT 1. Use minimum percent of Grade A milk in Class I 2. Use minimum percent of Grade A milk in Class I sales within that FMMO area Regulated under order where its Class I sales are the largest Most become regulated automatically No real choice in the matter

POOLING REQUIREMENTS FOR A SUPPLY PLANT Ship minimum percent of Grade A milk to pooled distributing plant Shipping a minimum percent of milk to a distribution plant (requirements are usually higher in fall) The minimum percent is usually lower for FMMO’s closer to Wisconsin Minimum percent required can be changed (within limits) by market administrator Some FMMO’s have automatic qualification in spring if the plant had qualified in prior fall Coops often qualify all their plants as a unit

Alternative Pooling Procedures 1. Stricter shipping requirements, call provisions + Those who share in Class I sales are those who “perform” - May result in uneconomic shipments 2. Individual handler pooling + Class I sales shared only with those who serve Class I market + Little incentive for supply area to expand beyond that which is needed for Class I sales - Unequal price treatment of producers 3. Supply balancing or standby pool payments (use part of Class I differential for payment) 4. Abandon intraorder Class I differentials. Assess all Class I purchases an amount equal to actual transportation costs.

Producer Blend Price is the Weighted Average Price to be paid to producers. To calculate it: Class I percent utilization x Price of Class I Plus Class II percent utilization x Price of Class II Plus Class III percent utilization x Price of Class III

Example of Central Market Order Pooling

Table 6.4. Computation of the July 1994 uniform blend price for the Southwest Plains marketing area Utilization Receipts Price Value (%) (cwt) ($/cwt) ($) Class I 37.03 1,226,392 14.28 17,512,878 Class II 16.53 547,406 10.35 5,665,652 Class III 40.01 1,325,177 11.41 15,120,274 Class IIIa 6.43 213,099 10.13 2,158,689 Weighted average price 12.21 40,474,189 Add location adjustment 867,858 Add 1/2 ending fund reserve 166,587 Less new reserve .04252 140,830 Uniform blend price at 3.5% butterfat 12.49 41,367,804 Source: Market Administrator, Southwest Plains Marketing Order.

Producer Settlement Fund A fund that is used to collect and disburse funds to handlers to equalize blend price paid to farmers and the classified value of milk used Fluid distributing plants typically pay into the fund Higher fraction of milk bought has class one value (above blend price) Lower fraction in Class II, III and IV Other supply plants may pay into or draw from the fund depending on product mix and fluid provided Pay in if fluid and Class II uses are high Draw out if Class I & II are low relative to Class III & IIIa Cooperative association plants typically draw from the pool Handle large quantities of milk Perform balancing function Process more Class III and IIIa products Cooperatives typically have lower performance requirements in recognition that They are farmer owned patronage organizations They perform balancing functions in the market when supplies are high

Table 6.2. Computation of an example marketwide pool Hiland Mid-Am Kraft Total market Handler (cwt) (%) (cwt) (%) (cwt) (%) (cwt) (%) Producer receipts Class I 38,400 96 0 0 25,000 50 63,400 36 Class II 400 1 5,500 6 0 0 5,900 3 Class III 1,200 3 80,000 90 25,000 50 106,200 59 Class IIIa 0 0 3,500 4 0 0 3,500 2 Total 40,000 100 89,000 100 50,000 100 179,000 100

Table 6.2. Computation of an example marketwide pool (cont’d) Hiland Mid-Am Kraft Total market Handler $ $/cwt $ $/cwt $ $/cwt $ $/cwt Class I 556,800 14.50 0 14.50 362,500 14.50 919,300 14.50 Class II 5,040 12.60 69,300 12.60 0 74,340 12.60 Class III 14,400 12.00 960,000 12.00 300,000 12.01 1,274,400 12.00 Class IIIa 0 36,750 10.50 0 36,750 10.50 Total Amt. Paid $ 576,240 40K $ 1,066,050 89K $662,500 50K $2,304,790 179K Average classified value 14.41 11.98 13.25 12.88 Note: Classified prices ($/cwt) used in this analysis are as follows: Class I: $14.50; Class II; $12.60; Class III: $12.00; and Class IIIa: $10.50.

Table 6.2. Computation of an example marketwide pool (cont’d) Hiland Mid-Am Kraft Total market Handler $ $/cwt $ $/cwt $ $/cwt $ $/cwt Class I 556,800 14.50 0 14.50 362,500 14.50 919,300 14.50 Class II 5,040 12.60 69,300 12.60 0 74,340 12.60 Class III 14,400 12.00 960,000 12.00 300,000 12.01 1,274,400 12.00 Class IIIa 0 36,750 10.50 0 36,750 10.50 Total 576,240 40K 1,066,050 89K 662,500 50K 2,304,790 179K Average classified value 14.41 11.98 13.25 12.88 Note: Classified prices ($/cwt) used in this analysis are as follows: Class I: $14.50; Class II; $12.60; Class III: $12.00; and Class IIIa: $10.50.

Payments made into the fund by handlers whose pool obligation is greater than the blend Price to be received by the farmers and handlers who supply it. Producer Settlement Fund Payments received from the fund by handlers whose pool obligation is less than blend Price to be received by the farmers and handlers who supply it.