Dairy Marketing

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Dairy Marketing

• Dr. Roger Ginder
• Econ 338
• Fall 2007
• Lecture 18

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CLASSIFIED PRICING UNDER FEDERAL MILK MARKETING
ORDERS
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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

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Past
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(No Transcript)
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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)
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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
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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 1960s, 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

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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
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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

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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

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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

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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

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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

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Marketwide Pooling
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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

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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

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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
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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.

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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

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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

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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 FMMOs
  closer to Wisconsin
• Minimum percent required can be changed (within
  limits) by market administrator
• Some FMMOs have automatic qualification in
  spring if the plant had qualified in prior fall
• Coops often qualify all their plants as a unit

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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.
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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
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Example of Central Market Order Pooling
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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.
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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

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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
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Table 6.2. Computation of an example marketwide
pool (contd) 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 12.00 960,00
0 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.
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Table 6.2. Computation of an example marketwide
pool (contd) Hiland
Mid-Am Kraft Total
market Handler /cwt /cwt
/cwt /cwt Class
I 556,800 14.50 0 14.50 362,500 14.50 919,30
0 14.50 Class II 5,040 12.60 69,300 12.60 0
74,340 12.60 Class III 14,400 12.00 960,0
00 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.
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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.