1. History, Function & Future of Federal Milk Marketing Orders Bob Cropp Dairy Marketing & Policy Specialist University of Wisconsin-Madison April 2001

2. Dairy cooperatives initially attempted to improve milk prices to dairy farmers. 1810 first U.S. dairy cooperative 1822 dairy cooperatives involved in: * retail fluid milk distribution * wholesale milk distribution * bargaining 1920 dairy cooperatives attempted to replace “flat pricing” with “classified pricing” and “pooling”. * Milk buyers had been refusing to pay one high flat price for all milk (milk in excess of fluid needs)

3. Cooperative voluntary classified pricing and pooling had only limited success. Not all milk buyers participated. There were advantages to milk buyers to stay outside of the voluntary arrangement. * Milk buyer that was 100% fluid could pay “directly” to farmers a higher price than the pooled (average) price and yet buy milk cheaper. * Example Fluid price = $6.00 X 50% fluid = $3.00 Surplus price = $4.00 X 50% surplus = $2.00 Average price paid to dairy farmer = $5.00 Fluid Milk buyer “outside” could pay directly to farmers $5.50

4. Cooperative activity continued to grow: By 1935: * 2,270 dairy cooperatives that represented 16% of the dairy farmers but 45% of all milk marketed by farmers. * 110 dairy cooperatives were bottling milk, but represented just 5% of the fluid sales. * 87 bargaining cooperatives * Several cooperatives making butter and cheese

5. Federal legislation to assist dairy farmers with milk pricing: Agricultural Adjustment Act of 1933: - Established program of licenses - All milk dealers in a given market required to pay dairy farmers classified pricing and pooling 1935 Agricultural Act: - Set more specific terms and provisions and called the programs “marketing orders” rather than licenses

6. Agricultural Marketing Agreement Act of 1937 Refined the marketing order provisions that are used today. This is enabling legislation---that is, dairy farmers may request and approve a federal milk marketing order; orders are not mandatory; they require dairy farmer (producer) approval.

7. Purposes of federal milk marketing orders (FMMOs) To provide for orderly marketing To assure reasonable prices to bother dairy farmers and to consumers To assure an adequate supply of wholesome beverage milk to consumers

8. FMMOs continued: FMMOs price only Grade A milk Procedure to get an FMMO: 1. Dairy farmers (producers), dairy cooperatives request the Secretary of Agriculture to hold a hearing to provide information for the need for an order. 2. Upon evidence submitted at the hearing, the Secretary issues a recommended decision. 3. Producers and milk plants (handlers) make submit comments 4. Secretary issues a final decision 5. Producer referendum --if two-thirds of dairy producers voting approve the final decision, the order becomes effective

9. Dairy cooperatives may “bloc vote”. The board of directors of a dairy cooperative may decide on behalf of the entire dairy-farmer membership whether to cast a vote of approval. If 500 members, the cooperative casts 500 yes or no votes.

10. FMMOs continued: Milk plants that handle Grade A milk for fluid (Class I) purposes are called “Handlers”. * Bottlers * Supply plants * Dairy cooperatives Dairy farmers who markets their milk to a handler is called a “Producer” Handlers are regulated, not dairy producers

11. FMMOs continued: Handlers are regulated by being required to pay at least minimum class prices into a pool. Class prices are established by the FMMO Initially three classes: 1. Class I beverage milk products 2. Class II soft manufactured dairy products- ice cream, yogurt, evaporated & condensed milk, cream products 3. Class III cheese, butter and dry milk powder Since the purpose of FMMOs is to assure consumers of beverage milk, Class I is the highest price.

12. How classified pricing and pooling works: Let’s assume the following class prices and milk utilization: Class I $12.00/Cwt. 50% = $6.00 Class II $11.00/Cwt. 10% = $1.00 Class III $10.00/Cwt. 40% = $4.00 Weighted average price = $11.00 (blend price) All milk handlers pay dairy producers at least this blend price of $11.00/Cwt. So all producers receive the same base blend price regardless of where they sell their milk.

13. Pooling: ( a producer settlement fund) Lets assume two handlers in the market, Handler A, a bottler, and Handler B, a cheese plant (supply plant) Handler A has: Class I $12.00 X 90% = $10.80 Class II $11.00 X 10% = $ 1.10 Class III $10.00 X 0% = $ 0.00 Average milk value = $11.90 Handler A pays its producers the $11.00 blend price and pays INTO the pool the difference of $11.90 - $11.00 or $0.90/Cwt. on all milk handled

14. Handler B has: Class I $12.00 X 10% = $ 1.20 Class II $11.00 X 0% = $ 0.00 Class III $10.00 X 90% = $ 9.00 Average milk value = $10.20 Handler B pays its dairy producers the $11.00 blend price a draws OUT of the pool the difference between $11.00 - $10.20 or $0.80

15. Dairy cooperatives are obligated to the pool prices, but are not obligated to paying producers the blend price. Dairy cooperatives re-blend when paying their member producers. Dairy cooperatives manufacture dairy products, sell raw milk to different handlers in different markets and take all milk revenues generated to divide among dairy producers. Dairy cooperatives return at the end of the year profits earned to members--patronage refund

16. Each FMMO has a “market area”: The market area is the geographic area where milk is consumed; not necessarily produced. All handlers serving those same consumers ought to have the same raw milk cost. Location of handler or producer does not determine which FMMO a handler is regulated under; but rather where does the handler’s Class I sales go.

17. Market area: Initially rather small geographic area But as modern processing, packaging and transportation technologies developed packaged beverage milk products could be economically distributed in greater geographic areas. The result, FMMOs were consolidated

18. History and Scope of Federal Milk Orders

19. Minimum class prices: Prior to 1960 the different FMMOs used different formulas for establishing minimum class prices. By 1960, it was recognized that butter, cheese and dry milk powder were marketed nationally and that beverage milk products had a much larger geographic area of distribution. Uniform class pricing formulas were established.

20. Uniform pricing formulas: The majority of milk in Minnesota and Wisconsin was used for butter, powder and cheese and accounted for a major share of national production. The Minnesota-Wisconsin Price Series (M-W) was adopted as the base price for Class III in all FMMOs and as the “mover” of Class II and Class I prices. The M-W was the weighted average price paid by Minnesota and Wisconsin butter, milk powder and cheese plants for Grade B milk.

21. Class differentials: A differential was added to the M-W for the Class II price. A differential that varied by FMMO was added to the M-W for the Class I price. Eau Clare, Wisconsin was the starting point; the Class I differential increased with distance from Eau Clare. Wisconsin was considered as the major reserve of Grade A milk for Class I use.

22. The Class I differential reflected: The added cost to dairy producers to produce Grade A rather than Grade B milk The transport cost of moving raw Grade A milk to the market. A more inelastic price demand for Class I products

23. Connection between the federal dairy price support program and federal orders: The federal dairy price support program implemented in 1950 supports the price of milk to dairy producers by setting a support price for milk used for manufactured dairy products. The support price is converted into a price per pound of cheese, butter and nonfat dry milk. If surplus milk is produced and commercial prices of cheese, butter and nonfat dry milk fall below the purchase prices, the CCC stands ready to purchase these products. This CCC purchase activity supports the price of Grade B milk which supports the M-W price which supports the Class prices in FMMOs.

24. The M-W as the base price and mover came into question in the 1980s. The quantity of Grade B milk in Wisconsin and Minnesota was declining as dairy farmers converted to Grade A production. Other regions of the country were producing significant shares of manufactured products--NE and West

25. However, no change until 1995. A change in how the base price was determined was made. The M-W was based entirely on a survey of milk plants. A survey of plants for the previous month pay prices retained but this was adjusted based on what had happened to the price of cheese, butter and milk powder during the current month. The M-W was changed to the Basic Formula Price (BFP)

26. By 1990, the Upper Midwest began questioning the increase in Class I differentials from Eau Clare, Wisconsin Grade A milk production was increasing in the South, South West and West. - Modern production technology was enabling these regions to build large dairy operations and produce milk at very competitive prices. - Modern transportation enable the transport of raw Grade A milk greater distances to serve deficit Grade A milk areas. - No longer was Wisconsin the sole area for reserve Grade A milk production.

28. The Secretary of Agriculture received a request to hold a national hearing on Class I pricing. A national hearing was held in 1990 The Upper Midwest was the only region that offered information on the out-dated Eau Clare, Wisconsin basing point for Class I differentials. Result, no major changes in Class I differentials Minnesota Milk Producers sued the Secretary of Agriculture for this decision charging that the 1937 Act was not being implemented properly. The lawsuit drew national attention to the problems of FMMOs, but any change was denied.

29. 1996 Farm Bill included changes for FMMOs. Directed the Secretary of Agriculture to consolidate the existing 33 federal orders to between 10 and 14; California could be included if dairy producer so requested. The Secretary was authorized to visit the various pricing provisions of FMMOs. Consolidation of orders and pricing changes were to be implemented on or before April 4, 1999. A Northeast Dairy Compact was authorized for a period up until federal order reform was implemented ( on or before April 4, 1999)

30. The Secretary of Agriculture recommendations: Consolidate to 11 FMMOs. Replace the BFP with multiple component pricing formulas Establish four classes of milk Flatten the Class I differential pricing surface Establish a separate mover of Class I

31. U.S. Congress intervened: Accepted the consolidation of orders, but reversed the flattening of Class I differentials. Extended the Northeast Compact until September 30, 2001. Allowed implementation of federal order reform January 1, 2000, but instructed the Secretary to review the multiple component pricing formulas.

32. Secretary of Agriculture held a hearing May 2000 Secretary December 2000 issued a tentative decision that made some changes in the multiple component pricing formulas; ask the cooperatives for approval and approval of dairy producers not associated with cooperatives. Implementation of changes January 1, 2001, but industry had until February 5, 2001 to submit comments. The Secretary will review the comments and issue a final decision which will require producer approval for implementation. A lawsuit challenged a change in calculating the value of butterfat in Class III (cheese); the result is an injunction against implementation of that change.

33. Federal Milk Marketing Orders 31 Orders11 Orders

35. Classes of milk: Class I: Milk used for beverage milk products. Class II: Milk used for soft manufactured products, ice cream, cream products, yogurt, condensed milk Class III: Milk used for cheese Class IV: Milk used for butter and dry milk products

36. The Class III price: Butterfat price per pound: (NASS monthly AA butter price - 0.115)/0.82 NASS is the USDA National Agricultural Statistical Reporting Service survey of selling prices of manufacturing plants. 0.115 is the “make allowance” 0.82, is the yield factor for butter

37. Class III continued: Other solids price per pound: (NASS monthly dry whey price - 0.14)/0.968 0.14 is make allowance 0.968 is the yield factor of dry whey

38. Class III price continued: Protein price per pound: (NASS monthly cheese price - 0.165) X 1.405 + {[(NASS monthly cheese price - 0.165) X 1.582] - butterfat price} X 1.28 The first line represents the net value of protein in cheese. 0.165 is make allowance; 1.405 is yield of cheese per pound of protein The second line accounts for the value of butterfat in cheese in excess of its value in butter.

39. Class III continued: Class III skim milk value per hundredweight: 3.1 X protein price + 5.9 X other solids price Class III price per hundredweight: 3.5 X butterfat price X 0.965 X Class III skim milk price

40. Class IV price: Butterfat price per pound: The same as Class III butterfat price Nonfat solids price per pound: (NASS monthly nonfat dry milk price - 0.14) 0.14 ism the make allowance

41. Class IV continued: Skim milk price per hundredweight: 9.0 X nonfat solids price Class IV price per hundredweight: 3.5 X butterfat price + 0.965 X skim milk price

42. Class II price: An advanced Class IV skim milk price is determined ( example, the April Class II price is announced on or before March 23rd.) To this advanced Class IV price a $0.70 per hundredweight differential is added. Class II butterfat price: The Class IV butterfat price + $0.007 Class II price per hundredweight: 0.965 X Class II advanced skim milk price + 3.5 X butterfat price.

43. Class I price: Base price: The “higher of” an advanced Class III or Class IV per hundredweight price. The skim milk and butterfat values of the “higher of” are used. Class I differential is added to the base price: This differential varies for each county in the U.S. and ranges from $1.60 per hundredweight to $4.30 per hundredweight. The appropriate differential is where the milk plant is located

45. How dairy producers are paid: Seven of the eleven orders pay dairy producers on a milk component basis. Four orders that are primarily Class I markets pay producers under a butterfat and skim milk basis.

46. How producers are paid under orders with multiple component pricing: All producers receive the following in their monthly milk check: Butterfat price X pounds of butterfat marketed + Protein price X pounds of protein marketed + Other solids X pounds of other solids marketed + Producer price differential X total hundredweight's of milk marketed + Somatic cell adjustment X total hundredweight's of milk marketed = Federal order portion of the producer’s milk check Milk plants may pay dairy producers more than the federal order price.

47. The Producer Price Differential: (PPD) The PPD represents the value of total market utilization in Class I, Class II, and Class IV relative to Class III value. Example: (Class I $15.00 - Class III $11.00) X 40% Class I = $1.60 (Class II $11.90 - Class III $11.00) X 10% Class II = $0.09 (Class IV $11.20 - Class III $11.00)X 15% Class IV = $0.02 PPD = $1.71 The PPD can also be easily calculate by Blend Price minus Class III price.

48. Somatic cell adjustment: SCC is an adjustment for milk somatic cell count relative to a base of 350,000. A rate per 1,000 cell count above and below the base is specified each month by: NASS monthly cheese price used in the Class III protein formula X 0.0005

49. Future of Federal Milk Marketing Orders FMMOs are difficult to change because: 1. Only producers within an order can vote on their order. 2. U.S. Congress votes based on people not cows or milk volume. Congress over rules the Secretary’s decision. 3. Legal--different interpretations of 1937 Act; also politics So it appears that FMMOs will stay for sometime.

50. Remaining Federal Order Issues: The higher of mover for Class I Isolates Class I prices from cheese prices. Milk supply/demand adjustments fall heavily upon Class III markets. Pooling Milk can be pooled in any order regardless of need for milk Milk in California is pooled in the Upper Midwest order Butter/powder tilt A price support issue but impacts the Class IV price & mover