1. An Overview of Milk Pricing Under Federal Orders (Milk Pricing 101) July 8, 2003 Brian W. Gould Senior Research Scientist Wisconsin Center for Dairy Research and Department of Agricultural and Applied Economics Wisconsin Center for Dairy Research

2. Summary of Presentation  Review Objectives of Federal Order System  Overview of Classified Pricing System  Review Current Milk Pricing Formulas  Work Through Example of May 2003

3. Evolution of Current Federal Order System  Enabled by Agricultural Marketing Agreement Act of 1937  Not mandatory  Dairy producers request and approve via referenda  Three main objectives:  Assure consumers adequate beverage (fluid) milk supply at reasonable price  Promote producer price stability and orderly marketing  Provide sufficient producer prices to guarantee adequate Grade A milk supply

4. Evolution of Current Federal Order System  These objectives achieved through:  Classified pricing: Minimum pay prices established for milk (and components) according to milk utilization  Pooling: Within each order, producers receive uniform milk price (based upon quality and composition), regardless of how their milk is actually used (this will not be covered today)

5. Evolution of Current Federal Order System 19601970198019902002 Orders (No.) 8062474211 Producers (No.) 189,816143,411117,490100,39763,856 Producer Deliveries (Mil. Lbs.) 44,81265,10483,998102,396125,546 Delivery/Producer (Cwt) 2,3614,5407,14910,19919,661 % of U.S. Milk: Grade A 64798077 All Milk 4359677076

6. 31 Orders11 Orders Evolution of Current Federal Order System Prior to 2000 After Jan. 2000 Note: CA, with 20% of U.S. milk production, is not part of FMMO

7. Classified Pricing of Farm Milk  Four classes of milk under Federal Orders  Class I: beverage products  Class II: soft manufactured products (e.g., ice cream, cottage cheese and creams)  Class III: hard cheese and cream cheeses  Class IV: butter and dry milk products (e.g., NDM)  Under Federal pricing system, formulas used to set monthly minimum pay prices for each class of milk  Proprietary plants  Coops should pay at-least minimum

8. Classified Pricing of Farm Milk  Class III and IV minimum prices  Friday on or before the 5 th of month following production (e.g., July ’03 prices announced on Aug. 1)  Based on product formulas relating milk component values (e.g., fat, protein, solids-not-fat) to: Wholesale dairy product prices Wholesale dairy product prices Product yield Product yield Assumed manufacturing costs Assumed manufacturing costs  Price data collected by NASS and averaged over 4-5 week period (depending on month)

9. Classified Pricing of Farm Milk  Class III and IV price/cwt: multiply component volume/cwt at standard composition by derived component values

10. Classified Pricing of Farm Milk  Class I and II minimum prices  Based on Class III and IV price formulas  Calculated over different/shorter period  Friday on or before 23 rd of month prior to production month (e.g., July 2003 Class I price and II skim milk price announced on June 20 th )  Uses most recent 2 weeks of wholesale NASS data

11. Classified Pricing of Farm Milk  Some Assumptions:  Farm Milk: 3.5% fat 3.5% fat 3.1% of skim is true protein (3.3% total protein) 3.1% of skim is true protein (3.3% total protein)  2.9915% of farm milk (3.1*.965) 82.2% of true protein is casein 82.2% of true protein is casein 5.9% other solids (8.685% total non-fat solids) 5.9% other solids (8.685% total non-fat solids)  Cheddar Cheese 90.0% fat retention, 95.9% casein retention 90.0% fat retention, 95.9% casein retention 38% moisture 38% moisture Cheese yield of 1.383/lb protein, 1.572/lb butterfat Cheese yield of 1.383/lb protein, 1.572/lb butterfat (based on Van Slyke cheese yield formula) “Gross” cheese yield of 9.685 lb/cwt (9.6615 lb/cwt net after farm-plant losses) “Gross” cheese yield of 9.685 lb/cwt (9.6615 lb/cwt net after farm-plant losses)

12. Class IV Pricing Formulas  Milk Used to Make Butter and Dry Milk Products  Based on Wholesale Butter and NDM Prices (1) Class IV (and III) Butterfat Price/lb = (NASS avg. monthly AA butter price – 0.115) X 1.20 (2) Nonfat Solids Price/lb = (NASS Monthly NDM Price – 0.14) X 0.99 (3) Class IV Skim Milk Price = 9.0 X Nonfat Solids Price (4) Class IV Price = 3.5 X Butterfat Price + 0.965 X Class IV Skim Milk Price MakeAllowance MakeAllowance Lbs. Butter Per Lb Milk fat Lbs. NDM Per Lb NF Solids Lbs. NF Solids/Cwt % Skim/100 Lbs. BF/Cwt

13. Class IV Pricing Formulas  After Substituting (1), (2), and (3) into (4): (5)Class IV Price = 4.20 x NASS Butter Price 4.20 x NASS Butter Price + 8.60 x NASS Nonfat Dry Milk Price – 1.69  A $0.10/lb change in butter price will change Class IV price by $0.42/cwt in the same direction  A $0.10/lb change in NDM price will change Class IV price by $0.86/cwt in the same direction

14. Class IV Pricing Formulas NASS Grade A Butter Price Butterfat Price ($/lb) Class IV Price ($/cwt) NASS NDM Price ($/lb) Nonfat Solids Price ($/lb) Class IV Skim Price ($/cwt) (1) x 3.5 x 0.965 (2)x 9.0 Note: The numbers in parentheses identify product price formula

15. Class III Pricing Formulas  Milk Used to Make Cream Cheese and Hard Cheeses (1) Class IV/III Butterfat Price/Lb. = (NASS monthly AA butter price – 0.115) x 1.20 (6) Other Solids Price/Lb. = (NASS Monthly Dry Whey Price – 0.159) x 1.03 (7) Protein Price/Lb. = (NASS Monthly Cheese Price – 0.165) x 1.383 + {[(NASS Monthly Cheese Price – 0.165) x 1.572] – 0.9 x Butterfat Price} x 1.17 MakeAllowance Lbs. Butter Per Lb Milk fat MakeAllowance Lbs. OS Per Lb OS MakeAllowance Protein-Based Yield Fat-Based Yield Fat-Protein Ratio Fat Retention

16. Class III Pricing Formulas (8) Class III Skim Milk Price = 3.1 x Protein Price + 5.9 x Other Solids Price 5.9 x Other Solids Price (9) Class III Price = 3.5 x Class IV/III Butterfat Price + 0.965 x Class III Skim Milk Price Assumed Composition/Cwt Lbs. Fat/Cwt % Skim/100

17. Class III Pricing Formulas  After Substituting (1), (6), (7), and (8) into (9): (10) Class III Price = (10) Class III Price = 9.64 x NASS Cheese Price 9.64 x NASS Cheese Price + 0.42 x NASS Butter Price + 5.86 x NASS Dry Whey Price - 2.57  $0.10 increase in cheese, butter, and dry-whey prices will increase Class III price $0.964, $0.042 and $0.586 per cwt, respectively

18. Class III Pricing Formulas NASS Grade A Butter Price Butterfat Price ($/lb) Class III Price ($/cwt) NASS Dry Whey Price ($/lb) Other Solids Price ($/lb) Class III Skim Price ($/cwt) (1) x 3.5 x 0.965 (6) x 5.9 Note: The numbers in parentheses identify product price formula NASS Cheese Price ($/lb) Protein Price ($/lb) x 3.1 (7)

19. Class II Pricing Formulas  Minimum price for Class II skim milk portion announced in advance of production month (11) Advanced Nonfat Solids Price/Lb. = (11) Advanced Nonfat Solids Price/Lb. = (NASS Two-Week NDM price - 0.14) x 0.99 (12) Advanced Class IV Skim Milk Price Factor/Cwt. = 9.0 x Advanced Nonfat Solids Price (13) Class II Skim Milk Price/Cwt. = Advanced Class IV Skim Milk Price Factor + $0.70 (14) Class II Nonfat Solids Price/Lb. = Class II Skim Milk Price/Cwt. ÷ 9.0 Lbs. NDM Per Lb NF Solids MakeAllowance Lbs. NF Solids/Cwt Differential

20. Class II Pricing Formulas  Minimum price for Class II butterfat determined as Class III/IV butterfat price plus differential (e.g., announced by 5 th of the month following production) (15) Class II Butterfat Price/Lb. = Class IV/III Butterfat Price + $0.007  Total Class II price combines advanced skim milk and butterfat value (16) Class II Price/Cwt. = 0.965 x Class II Advanced Skim Milk Price + 3.5 x Class II Butterfat Price Differential Lbs. Fat/Cwt % Skim/100

21. Class I Pricing Formulas  Unlike Class II, both skim and butterfat portions of Class I are advanced-priced  Skim milk value based on higher of advanced Class III or IV skim pricing factors  Eq. (11) and (12) show advanced Class IV milk pricing factor  Butterfat value based on Class III/IV formula (Eq. 1)

22. Class I Pricing Formulas  Advanced Class III skim milk pricing factor based on skim milk pricing factor used in Class III calculation except for use of 2-week price data  Similar to eq. (1): (17) Class III Advanced Butterfat Price/Lb. = (NASS 2-Week AA Butter Price – 0.115) x 1.20  Similar to eq. (7): (18) Class III Advanced Protein Price/Lb. = (NASS 2-Week Cheese Price – 0.165) x 1.383 + {[(NASS 2-Week Cheese Price – 0.165) x 1.572] – 0.9 X Advanced Butterfat Price} x 1.17 MakeAllowance MakeAllowance Protein-Based Yield Fat-Based Yield Fat-Protein Ratio Fat Retention Lbs. Butter Per Lb Milk fat

23. Class I Pricing Formulas  Similar to Eq. (6): (19) Class III Advanced Other Solids Price/Lb. = (NASS 2-Week Dry Whey Price – 0.159) x 1.03  Similar to Eq. (8): (20) Advanced Class III Skim Milk Price Factor = 3.1 x Class III Advanced Protein Price + 5.9 x Class III Advanced Other Solids Price MakeAllowance Lbs. OS Per Lb OS Assumed Composition/Cwt

24. Class I Pricing Formulas (21) Class I Skim Milk Price = Higher of: Advanced Class III or Class IV Skim Milk Price + Class I Differential

26. Class I Pricing Formulas (22) Class I Butterfat Price/Lb. =Advanced Butterfat Price + (Class I Differential ÷ 100) (23) Class I Price/Cwt. = 0.965 x Class I Skim Milk Price + 3.5 x Class I Butterfat Price Lbs. Fat/Cwt % Skim/100

27. Example of Class Price Calculations Average NASS Survey Prices Commodity May Advanced Pricing May Class Prices May Class Prices April 18, 2003 April 18, 2003 (Avg. for Apr. 5 th & 12 th May 30, 2003 (Avg. for 4 weeks ending May 25) Butter1.07021.0743 NDM0.80320.8040 Cheese1.08421.1394 Dry Whey 0.15890.1450

28. Example of Class Price Calculations Component Price Eq. No. EquationValue Advanced Butterfat ($/Lb) 17 (1.0702 – 0.115) X 1.20 1.1462 Class III Advanced Protein ($/Lb) 18 (1.0842 – 0.165) X 1.383 + {[(1.0842 – 0.165) X 1.582] – 0.9 X 1.1462} X 1.17 1.7549 Class III Advanced Other Solids ($/Lb) 19 (0.1589 – 0.159) X 1.03 -0.0001 Advanced Nonfat Milk Solids ($/Lb) 11 (0.8032 – 0.14) X 0.99 0.6566 Calculation of May ’03 Advanced Prices Note: With Class III pricing formula effective April 2003, Other Solids price is not snubbed at zero and is negative whenever NASS dry-whey price is less than $0.159/lb. (green: NASS data, yellow: calculated value)

29. Example of Class Price Calculations Component/Class Price Eq. No. EquationValue Class IV Skim Milk Price Factor ($/Cwt) 12 9.0 X 0.6566 5.91 Class II Skim Milk ($/Cwt) 13 5.91 + 0.70 6.61 Class II Nonfat Solids ($/Lb) 14 6.61 ÷ 9.0 0.7344 Class III Skim Milk Price Factor ($/Cwt) 20 3.1 x 1.7549 + 5.9 x (-.0001) 5.44 Class I Skim Milk ($/Cwt) 21 5.91 + 1.80 (@ Base Zone) 7.71 Class I Butterfat ($/Cwt) 22 1.1462 + (1.80 ÷ 100) 1.1642 Class I @ Test ($/Cwt) 23 (0.965 x 7.71) + (3.5 x 1.1642) 11.51 Calculation of May ’03 Advanced Prices yellow: calculated value

30. Example of Class Price Calculations Calculation of May ’03 Class Prices Component Value Eq. No. EquationValue Butterfat ($/Lb) 1 (1.0743– 0.115) x 1.20 1.1512 Protein ($/Lb) 7 (1.1394 – 0.165) x 1.383 + {[(1.1394 – 0.165) x 1.582] – 0.9 x 1.1512} x 1.17 1.9275 Other Solids ($/Lb)* 6 (0.1450 – 0.159) x 1.03 -0.0144 Nonfat Milk Solids ($/Lb) 2 (0.8040 – 0.14) x 0.99 0.6574

31. Example of Class Price Calculations Calculation of May ’03 Class Prices Class Price Eq. No. EquationValue Class IV Skim Milk ($/Cwt) 3 9.0 x 0.6574 5.92 Class IV Milk ($/Cwt) 4 (3.5 X 1.1512) + (0.965 x 5.92) 9.74 Class III Skim Milk ($/Cwt) 8 (3.1 X 1.9275) + (5.9 x (-0.0144)) 5.89 Class III Milk ($/Cwt) 9 (3.5 X 1.1512) + (0.965 x 5.89) 9.71 Class II Butterfat Price ($/Lb) 15 1.1512 + 0.007 1.1582 Class II Milk ($/Cwt) 16 (0.965 x 6.61) + (3.5 x 1.1582) (0.965 x 6.61) + (3.5 x 1.1582)10.43 yellow: calculated, red: correction from your handout

32. Where Can You Obtain Dairy Marketing Information?  Univ. of Wisconsin Dairy Marketing Website (www.aae.wisc.edu/future)  Basic Milk Pricing Concepts for Dairy Farmers by Ed Jesse and Bob Cropp, Univ. of Wisconsin Extension Publication, July 2003  Brian W. Gould Wisconsin Center for Dairy Research Wisconsin Center for Dairy Research (608)263-3212 (608)263-3212 gould@aae.wisc.edu gould@aae.wisc.edu