Policies, Politics and the Way We Price Milk

Mark StephensonDirector of Dairy Policy Analysis

What Is Special About Milk?

It’s perishableIt’s bulkyIt’s produced and must be sold 365 days a yearSpecialized assets for productionMany more sellers than buyersRelatively inelastic demand for productsHistorically led to “destructive competition”

Federal Milk Marketing Orders

Cooperatives had modest success in policing the marketplaceFederal government instituted Marketing AgreementsShortly thereafter, Marketing Agreements became Marketing OrdersMarketing Orders act like a traffic cop in the market

They regulate the terms of tradeThey measureThey assure compliance

Classified PricingClass I — generally highest priceClass IIClass IIIClass IV — generally lowest price

What is consistent with this ordering?

These are minimum prices to be paid!

PoolingProcessors contribute differently to the Federal Order Pool, but producers receive the blended value.

Regulating Minimum Prices

Price

Quantity

Demand

Supply

Pm

Qm

Ps

QdQs

Pd

Over-Order Premiums will get you back

here.

Benefits of FMMO for Producers

Classified pricing can improve producer returns but it is not a price support—Markets must still clear.Pooling is about equity—sharing in those higher returns

Sharing a pool comes at a cost—qualification and performance

Plants are auditedPrices are coordinated across markets (efficiency in transportation)

Benefits for ProcessorsPlants know that their competitors are paying at least the minimum class price.Manufacturing plants get a “pool draw” to pay their producers the same uniform or blend price.

Both producers and processors benefit from federal order data

TestingAudited milk productionTransportation, etc.

How would you price milk?

Ingredient & Product Streams

Milk

Sweet Cream

Ingredients

Whey

Cheese

Dried Whey

Whey Cream

WPC

Permeate

LactoseButter

We want to price this.

Let’s survey the market price for these products and back into a milk price.

Product Price FormulasBased on weekly AMS surveys of product sold

Product Price FormulasButterfat Price = (Butter price - 0.1715) x 1.211

Make Allowance - What does it cost you to transform milk into 1 pound of butter?

Yield Factor - How many pounds of butter can you make from 1 pound of butterfat?

Product Price FormulasDairy producers want a small make allowance and a large yield factorDairy processors want a large make allowance and a small yield factor

How do you determine the correct parameter values?

The Issue of Make Allowance

12¢ 13¢ 14¢ 15¢ 16¢ 17¢ 18¢ 19¢0

5

10

15

20

25

30

35

40

45

Who’s price?

HighestLowestAverage

Minimum Milk Price to Producers

Pounds of ButterfatPounds of ProteinPounds of Other Solids (lactose + minerals)Quality (Somatic Cell)Total Pounds of Milk

Premiums often paid (over order)

Quality (somatic cell, bacteria)VolumeProteinPlant or MarketHauling subsidies

Use policy to fix problems that the market or an individual can’t

Standards of identityFMMOsPrice Support Program

Policy fails when it does too little or too muchEg. Price Support Program

Policy does not determine the end result—only the path that the market takes

New Policy?

Price VolatilityMuch discussion since about 2006

Refundable Assessments (Milk Producers’ Council, 2007)Mandatory CWT (Dairy Farmers Working Together, 2007) Growth Management Plan (Milk Producer’s Council, 2009)Dairy Growth Management Initiative (DFA, 2009)Marginal Milk Pricing (Agri-Mark, 2010)Dairy Market Stabilization Program (NMPF, 2010)Farm Savings Accounts (discussed by DIAC, 2010)Margin Insurance Programs (NMPF’s DPMPP and discussed by DIAC, 2010-11)Market Cow Bonus Program (DPAC, 2011)Farm Savings Accounts (again, processor groups, 2011)Peterson Discussion Draft (July 2011; modified DMSP)Dairy Security Act of 2011 (September 2011)Federal Milk Marketing Improvement Act of 2011 (Casey, October 2011)Rural Economic Farm and Ranch Sustainability and Hunger Act of 2011 (October 2011)

Most have focused on supply correction (temporary quota, cull cow)Some have focused on self-help (better LGM-D, FSA, etc.)

Today’s Issues

Price Risk!U.S. All Milk Price

We Have Four CyclesThere appears to be a 9 month cycle

There appears to be an annual cycle

There appears to be a 26 month cycle

There appears to be a 36 month cycle

Spectral Decomposition

Volatility in Inputs TooNASS Dairy Feed Ration

Some Variation of the The Dairy Security Act of 2011 is the Starting Point

Cost savings by repeal of MILC, DPPSP & DEIP

New safety net with margin protection insurance

Reduce milk price volatility with temporary reductions in milk supply

Points to ConsiderThe program is voluntary.Margin Insurance and the Market Stabilization are linked—you can’t have one without the other.You would have several months to make a decision to register after the bill is enacted.If you register, you will need to make a decision at that time about the level of insurance and the percent of milk.

The MarginNASS All Milk Price

Minus

Ration ValueNASS corn, NASS alfalfa hay, AMS Soybean Meal

Dairy Producer Margin Protection Program

$4 base margin coverage is freePartially subsidized premiums for supplemental coverage (25%–90% of base)Run by FSACalculated as2 month pairsJan-Feb, Mar-Apr,etc.

Historic Trigger Values

Margin Protection Details

If you register, your historic base will be highest annual production in the previous three years.

New producers can register within 180 days of first milk production. Will prorate annual production.

You get margin protection on 80% of this historic base for free.Your annual production history is updated every year.

Margin Protection Details

If you want to protect more than free margin base, you can buy up in 50¢ incrementsYou can protect from 25% to 90 % of your production base.This election is made at the time you register and continues throughout the life of the bill but the levels of supplemental insurance can be changed each year.Annual premiums must be paid by Jan 15 or in 2 installments.

Example Margin Protection

Your historic base is 20 million poundsYou choose a $5.50 margin protection level at 75% of your productionTwo years later you have grown to 30 million pounds.

Example Margin Protection

If margin is calculated as $3.50 average for two months.

Indemnity is triggeredYou are paid $4.00 - $3.50 = 50¢ on your historic base = 50¢ * (200,000cwt / 6 ) * 80% = $13,333You receive a supplemental payment of $5.50 - $4.00 = $1.50 on your production base = $1.50 * (300,000cwt / 6) * 75% = $56,250Total 2 month payment = $13,333 + $56,250= $69,583

Dairy Market Stabilization ProgramUses same margin trigger calculationThe average trigger value is based on consecutive two-month periods

E.g., Jan-Feb, Feb-Mar, Mar-Apr, etc.

Different milk production baseMost recent 3-month averageSame month from previous yearCan select which base calculation each year by Jan 15

Dairy Market Stabilization ProgramTriggers if 2-month average margin is below $6

$5—$6, no payment on milk over 2% of base to 6% of current marketings$4—$5, no payment on milk over 3% of base to 7% of current marketings

Triggers if 1-month average margin is below $4

Under $4, no payment on milk over 4% of base to 8% of current marketings

Dairy Market Stabilization ProgramTriggers can increase

For example, if you were in a $6 trigger event and next month’s calculated 2-month average is now below $5, the more restrictive trigger is active.It appears as though if it is a long trigger event, a rolling 3-month base can incorporate your reduced marketings.Program is suspended when 2-month average is above $6 or U.S. price for cheddar or NFDM is more than 20% higher than world prices.

Modeling the DSANeed many assumptions about participationLook at Baseline and 2 scenarios

High participation, 50% of producers register in each of 4 farm size categories and choose to protect 60% of their milk at a $6 margin.Low Participation differs by farm size: 10%, 5%, 2.5% and 1% of S, M, L, XL protect 50% of milk at $5.

All Milk Price

Government Expenditures

NFOI for Representative Medium Farm