Impact of Proposed Changes to the Class I Price Formula

Proposed Changes to the Class I Price Formula: What Could the Impact Be?

BY GARY LATTA

As of late June, the U.S. Department of Agriculture had not yet received a formal hearing request to address modifying fluid milk price formulas under the Federal Milk Marketing Orders. At this time, three very different proposals have surfaced from cooperative groups. We will take a brief look at them here.

The current formula, implemented in May 2019, is the simple average of the announced Advanced Class III and IV prices plus 74 cents. The intent of this new formula was to help minimize much of the uncertainty that existed under the previous “higher-of” formula and maintain revenue-neutrality. The benefits of improved forward planning and hedging for producers and processors under the new formula were embraced by both the International Dairy Foods Association and National Milk Producers Association. The formula change was authorized by Congress in the Farm Bill signed in late-December 2018.

The new formula worked as intended until COVID-19 ravaged the dairy marketplace and pushed it into the perfect storm. In March 2020, Class III and IV prices collapsed, as the country went into lockdown. In many areas, milk was being dumped, and cooperatives implemented internal supply management programs. In mid-April 2020, the USDA announced the Coronavirus Food Assistance Program, which directs support to farmers and ranchers, as well as the Farmers to Families Food Box program. Cheese exports were strong to begin with due to previous commitments, and the attractiveness of the low U.S. price for a short time on the international market further increased sales. Within weeks, cheese prices rocketed to record highs. The spread between Class III and IV widened. At times, monthly Class III prices were higher than previously announced Class I prices. High Class III prices incentivized depooling and helped generate negative producer price differentials through 2020.

In February 2021, the National Milk Producers Federation began releasing comments and ideas to address what it felt was a $725 million shortfall in Class I revenues attributable to the use of the new “average of +$0.74” price formula that was agreed on and implemented in May 2019. NMPF feels that if the older formula (“the higher of”) was still in place, at least $725 million more Class I revenue would have been realized. In other words, all the rise in Class III was not captured under the newer formula, which simply averaged Class III and IV. Had the previous “higher of” formula been in place, Class III cheese would have been the primary driver of Class I fluid and would have increased revenues for producers.

NMPF’s plan is to increase the Class I skim milk price mover from the present 74 cents per cwt to $1.63 per cwt for a two-year period to recoup much of the $725 million from the marketplace. We can assume that raising the mover to $1.63, an increase of 89 cents per cwt, will likely increase retail prices at least 8 cents per gallon. According to a NMPF release, the Class I increment (add-on) would be adjusted based on a moving average of the difference between the “average of” and the “higher of” the advanced Class III and IV skim milk pricing factors over the prior 24 months of May through April. Increment adjustments would take place only once every two years based on this moving average, and the adjustment would remain in place for the following 24 months. The increment would not be lower than 74 cents per cwt nor increased if the calculated adjustment were less than 5 cents per cwt. So far, NMPF has not formally submitted its proposal to the USDA.

Following NMPF’s idea, two more cooperative Class I formula proposals have stepped forward in the past few months. The simplest of the two is FarmFirst’s proposal to return to the “higher of” formula for calculating Class I fluid prices. FarmFirst Dairy Cooperative is headquartered in Madison, Wisconsin, and represents producers in Wisconsin, Indiana, Illinois, Iowa, Michigan, South Dakota and Minnesota. The

$6

$5 Cumulative USDA Farmers to Families Food Box Program Funds Dollars in Billions (estimate)

$4

$3

$2

$1

$0

ROUND 1 (May 15-June 30)

ROUND 2 (July 1-Aug. 31)

ROUND 3 (Sept. 1-Oct. 31)

ROUND 4 (Nov. 1-Dec. 31)

ROUND 5 (Jan. 19-April 30)

Source: USDA

cooperative feels the old formula worked well with few problems for nearly two decades and was fully vetted in a national hearing two decades ago.

FarmFirst believes that none of the current suggested proposals will eliminate negative PPDs, but going back to the “higher of” formula will net better performance than experienced during the pandemic. FarmFirst also believes use of the “higher of” will lessen the occurrence of depooling. FarmFirst admits there are many changes dairy stakeholders would like to address, however, negative PPDs are the priority.

According to FarmFirst’s General Manager Jeff Lyons, “Returning to the higher of Class III or IV will get us back to the original intent to create favorable milk prices for farmers. Minimizing negative PPDs will provide more stability in milk prices, which will set the stage for additional order reform in the future.”

FarmFirst has indicated that it is ready to submit its proposal for consideration to the USDA when the NMPF submits its own.

A third proposal to modify the fl uid milk formula emerged in late April from another Midwest dairy group. This concept is being put forth by the Dairy Business Association in Wisconsin, the Edge Dairy Farmer Cooperative, also in Wisconsin; the Minnesota Milk Producers Association and the Nebraska State Dairy Association. This group has retained the services of Assistant Professor Marin Bozic, Ph.D., of the Department of Agricultural and Applied Economics, University of WisconsinMadison, to help develop its Class III Plus idea.

Class III Plus proposes that Class I skim milk prices be calculated as the Class III skim milk price + a Class I skim milk price adjuster. In all FMMOs, advanced prices will be replaced with announced prices. This includes the advanced Class II skim price. There would no longer be advanced prices. The Class I skim price adjuster, to be updated annually, would be equal to the average monthly differences between the “higher-of” Class III and IV skim milk prices and the Class III skim milk price over the prior 36 months of August through July.

Proponents of the Class III Plus concept believe that tying Class I skim prices to Class III skim, along with annual adjuster updates, ensures a greater probability that Class I will be the highest price among the four announced classes. Proponents also feel that by tying Class III to Class I, there will be less incentive for Class III plants to depool. The group feels that eliminating advanced prices and replacing them with announced prices, reduces the occurrence of negative PPDs.

The Class III Plus group points out that, unlike the NMPF proposal that reviews the adjuster every two years, it requires the USDA to revise the Class I skim price adjuster each September for the forthcoming year to better refl ect more recent conditions. Since Class III Plus requires USDA to modify the adjuster based on 36 months of data versus NMPF’s 24 months, it would tend to better smooth price shocks. The Class I skim adjuster would not be lower than 36 cents per cwt for 2021 through 2025 to recapture some of the revenue absent in the FMMO pool in year 2020. CONTINUED ON NEXT PAGE ►

Class III Plus group consultant Bozic is featured in online webinars that describe in detail the mechanics and logic of the plan. Bozic is not shy in sharing his critical opinion of the NMPF proposal, which he describes as a narrow-focused “clawback” of revenue. Bozic claims Class III Plus is a “gentler” claw-back than the NMPF proposal. If there is a sudden price shock, like in 2020, it is paid back over a three-year period, which would smooth out discrepancies and be easier on producers, processors and consumers.

Government intervention in dairy was unprecedented in 2020 through the Farmers to Families Food Box Program, the Coronavirus Food Assistance Program, the Paycheck Protection Program and EIDL Loans/Advances. According to the USDA’s website, contractors have delivered 173,699,775 boxes, estimated to total near $5.5 billion, in five rounds of the Farmers to Families Food Box Program that formally ended April 2021. Cheese and other dairy products were required to be included in every box.

The NMPF noted that The Farmers to Families Food Box program has delivered approximately $1 billion worth of dairy products — including fresh fluid milk, various cheeses, yogurt, sour cream and more — to needy Americans since this spring. According to Supermarket News, dairy makes up at least one-quarter of all products included in the boxes.

And, according to The Hill, Food Box purchases distorted prices by concentrating purchases among a few selected items like cheese. Even the dairy industry, one of the primary beneficiaries of the program, had advocated changes to the program to provide a better mix of dairy products to avoid market distortions.

In late October 2020, NMPF applauded the USDA for continuing to fund the Food Box Program that had delivered $1 billion worth of dairy products to date. “The Farmers to Families Food Box program has proven to be an effective benefit both for families needing assistance and for dairy farmers and processors providing high-quality products to those families via food boxes,” said Jim Mulhern, president and CEO of the NMPF.

Bozic raised the question, “What if USDA, the SBA and other governmental agencies had not intervened in 2020?” Perhaps then the spread between Class III and IV would have been narrower and the current “average-of” formula might have worked better. Sure, prices would have been lower, but maybe Class III and IV would have been sufficiently close to say the current formula worked adequately as intended. Which world would producers have rather lived in? One absent government intervention, or one with considerable intervention as experienced in 2020?

As this is written, none of these proposals have formally been submitted to the USDA. Once a proposal is submitted, the USDA has 30 days to respond with an action plan to hold a hearing, request additional information, deny the request or hold a pre-hearing information session with interested parties to gather more information.

At a Senate Appropriations Committee hearing on June 15, U.S. Secretary of Agriculture Tom Vilsack said, “We are creating a program to help reduce the differential that occurred between Class I and Class III milk pricing because of a disproportionate number of purchases of cheese during the Food Box effort.” We will have to wait and see exactly what Vilsack means by this as it develops.

In the meantime, we are anxiously waiting to see if agricultural experts in academia will do some computer modeling to determine the impact of these proposals on producers, processors and fluid milk consumers.

Gary Latta is a dairy product specialist consultant for the Northeast Dairy Foods Association, Inc. He has more than 30 years of experience in providing economic analysis, statistics and information to the dairy processing industry.