ProActive Price Risk Management: Chapter 1 Milk Pricing Fundamentals

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ProActive Price Risk ManagementChapter 1 - Milk
Pricing Fundamentals
Study Guide Users Guide to Pricing Milk in
Multiple Component Markets With Application to
the Mideast Area Federal Order 33. Updated
2003. By Cameron S. Thraen / OSU State Dairy
Marketing Specialist
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How is Your Milk Price Determined?

• Federal Milk Marketing Orders and Multiple
  Component Pricing
• How Component Values are established
• Deriving the Class III price
• Mailbox price versus the Class III price
• Producer Price Differential

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Federal Milk Marketing Orders January 1, 2000
84 Of Federal Order Milk Under MCP50 Under
Somatic Cell Count16 Skim Butterfat Only
Courtesy of Ken Bailey, Penn State Univ.
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Components Of MilkStandardized Milk for
purposes of calculating Class Prices
Courtesy of Ken Bailey, Penn State Univ.
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Butterfat
Protein
Other Solids
SCC
PPD
MCP
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Step 1 Summarize NASS Survey Prices

• Cheese
• Butter
• Nonfat dry milk
• Whey Protein Concentrate
• Compute two-week average (For Class I and Class
  II prices - announced in advance of the month to
  which they apply)
• Compute monthly average (for Class III and IV
  prices announced after the month to which they
  apply)

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Release Dates for NASS Prices
2004 release dates
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Collect the NASS official prices
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Step 2 Convert commodity prices to component
prices .butter to butterfat.
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Convert commodity prices to component
pricescheese to protein.
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Convert commodity prices to component
pricescheese to protein.
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Step 3 Compute Class Prices

• Class I Class I Mover Class I Differential
  Location adjustment Class I Butterfat
• Mover is greater of advanced Class III or IV
  Skim Price
• Class II Adv Class IV Skim Milk Price 0.70
  Class II Butterfat

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Step 3 Compute Class Prices

• Class III f(Class III butterfat, protein, other
  solids)
• Class IV f(Class IV butterfat, nonfat solids)

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Calculate Class Price from Component Prices
Class III
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Table 10 continued...
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Calculate Class Price from Component Prices
Class I Table 14.
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Table 14.
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Step 4Compute Class I-IV Revenue Pool
ValuePool Value gt Component Value most of the
time!

• Class I Value (Skim Milk and Butterfat )
• Class II Value (Nonfat Solids and Butterfat)
• Class III Value (Class III Fat, Protein, and
  Other Solids)
• Class IV Value (Class IV Fat and Nonfat Solids)
• /- Somatic Cell Count Adjustment (for Class
  II-IV)
• Total Value of Producer Milk

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Step 5Compute Producer Price Differential

• Total Pool Value
• - Fat, Protein, and Other Solids Payments made to
  producers
• - SCC Adjustments paid to producers
• - Transportation and Assembly credits
• /- Other adjustments
• Total Value of Milk in excess of Class III Value
• Divided by total milk equals PPD

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Whats the PPD?
Uniform Price PPD Class III Value or, PPD
Uniform Price Class III Value
Pool Values are reported each month by each
Federal Milk Marketing Administrator
Office http//www.fmmaclev.com/
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Facts on the FO33 PPD

• Correlation between the Uniform Price and the C3
  price is 0.90
• Correlation between the C3 price and the PPD is
  0.6
• Average value of the FO33 PPD is declining
• 2000 2.34
• 2001 1.42
• 2002 1.15
• 2003 0.54
• 2004 0.05

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PPD can become a deduction from the milk check
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Class III Price Versus Mailbox Price
Class III _at_ 3.5 bf
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Variation in Milk Composition Affects Producer
Milk Value
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How are producer prices related to the Class
prices?

• Federal order producer payments for a given month
  are the sum of the following (For orders with
  component pricing)
• Butterfat pounds X butterfat price
• Protein pounds X protein price
• Other solids pounds X other solids price
• Total hundredweight milk X Producer Price
  Differential
• Total hundredweight milk X somatic cell
  adjustment
• Federal order portion of the producer milk
  check

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The first three elements represent the total
monthly value of the Class III components.

• If your milk tested exactly the same as the
  standard composition milk used to derive the
  Class III price (3.5 butterfat, 2.99 true
  protein and 5.69 other solids) you could divide
  the sum of the first three elements by your
  monthly milk marketings in cwt. and come up with
  the Class III price.
• However, it is unlikely that your milk
  composition is the same and it probably varies
  from month to month.

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Milk pooled on Federal Order 33
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Components do vary by producer