Dairy farmers are pleased with the rise in dairy commodity prices, particularly that for butter and cheese. The wholesale price of Grade AA butter at the Chicago Mercantile Exchange (CME) rose from $1.1450 per pound in January and peaked at $2.81 on September 4. While it has since declined to $2.25 per pound by October 30, it has added considerably to farmers milk checks by raising the butterfat differential which pays farmers on the basis of pounds of milkfat. The September butterfat differential was $0.325.
Cheese prices have also risen. The wholesale price of 40-pound block cheese at the CME rose from a low of $1.18 per pound on May 1 to $1.8450 on October 30. This price is critical to a farmers base milk price since it affects the value of the Basic Formula Price, or BFP. The BFP is the value of milk used for manufacturing purposes (corrected to 3.5 percent milkfat). It also affects other prices under federal orders. Thus the higher the BFP, generally speaking, the higher a farmer’s milk check.
Many farmers feel that they have not seen all of the rapid rise in dairy commodity prices in their milk check. There are complaints that farm gate milk prices are not keeping up with the strong growth in butter, cheese and even nonfat dry milk prices. Thus some farmers are asking critical questions: where is all the money going?
The answer is that there are tremendous lags built into our current federal order pricing system. This system was not designed to be immediately responsive to week-to-week changes in wholesale dairy commodity prices. Thus farmers will see the real benefits of higher commodity prices in November and December milk checks. The major sources of delays in farm gate milk prices are in the computation of the Class I price and the BFP.
Class I Price
The biggest lag in the federal order pricing system is the computation of the minimum price of milk used for fluid purposes, or the
Class I price. That price is equal to the BFP lagged two months plus the Class I differential. Fluid milk processors like the lag since it
allows them to advance price their product to retail stores. For example, the September Class I price for fluid milk in the Upper
Midwest was $15.97. It was based on the July BFP of $14.77 plus the Class I differential of $1.20 per cwt. Since the July BFP was
announced on August 5, fluid processors in the Upper Midwest knew that day what the announced minimum price of fluid milk was
for September.
The problem is, farmers expected a higher price for their milk used for fluid purposes in September. The September BFP announced on October 5 was $15.10. That higher price won’t end up in farmers milk checks until November. Thus it is the lag in the system that is resulting in lower than expected farm gate milk prices. Farmers in a region with a heavy Class I use will see and even lower than expected milk price. Fluid prices will catch up, however, in November and December. For example, the September Class I price in order 46 for Louisville-Lexington-Evansville was $16.88. The announced Class I price for November for this order was $17.21.
BFP
Another lag is reflected in the computation of the Basic Formula Price. The BFP is calculated by USDA each month and is announced
on the 5th of the following month. It is based on two parts: a competitive pay price for the preceding month, and a product price
formula that is updated for the current month. The competitive pay price, called the base month price, is based on a survey of
processors in the Upper Midwest who purchase Grade B milk and manufacture mainly cheese and some butter/nonfat dry milk. This
is called a competitive pay price since the price of Grade B milk is unregulated and is supposedly determined by market forces. The
problem with using this competitive pay price survey is that it is based on the preceding month. In other words, a September BFP
announced on October 5 will use a base month survey price from August. It just takes time to do this survey!
The base month price is then updated using a product formula that looks at the change in butter, nonfat dry milk and cheese prices since the preceding month. In other words, the September BFP uses a formula to update the August base month price. Thus, if prices for cheese and butter rise in September relative to August, farmers will receive a higher BFP. That is what happened in September. The August base month price was $14.69. The value for the update formula was a positive $0.41. Thus the September BFP was $15.10 for milk corrected to 3.5 percent milk fat. In some months the value of the update formula will be positive, and in other months it could be negative.
There is a new lag, however, built into the update formula. That’s because the cheese price variable used in the formula is no longer based on a single market price. Previously it was based on a monthly average for 40-pound block Cheddar cheese from the National Cheese Exchange. Those weekly announced prices were used immediately in the computation of the BFP. Trading on the NCE, however, stopped on April 25. Weekly trading for cheese moved to the Chicago Mercantile Exchange (CME). In fact, there is now daily trading for 40-pound block Cheddar cheese in Chicago. USDA, however, decided to not use the CME price and instead use a new national survey of 40-pound block cheese reported weekly by the National Agricultural Statistics Service (NASS). Some farmers insisted the Secretary of Agriculture develop a new survey that was not based on a single market price. It was thought this would be less biased.
The new NASS survey covers all transactions during a week and is based on a survey of cheese manufacturing plants throughout the country. It concludes on Friday and is published on Friday of the following week. To compute the monthly average NASS survey cheese price, only those weekly averages that have been published by the scheduled release of the BFP are used. In other words, the monthly average of the NASS survey used in the calculation of the BFP is now a week behind compared to using the old NCE prices. This is illustrated in Table 1 below.
Weekly NASS cheese prices, which reflect a national survey, are reported for the weeks ending in September. The weighted average of those prices is $1.6556. This is the September price that was used on the computation of the BFP. The weekly average wholesale price of 40-pound cheddar cheese in Chicago is also reported in Table 1. The simple monthly average of the CME prices for September is $1.7026, much higher than the monthly average NASS survey price. There are two reasons for this. First, there is that one week lag in the NASS survey price. Second, the NASS survey price appears to be lower than the CME price once the weeks are aligned.
Table 1. Comparison of NASS Survey and CME Cheese Prices
40# block cheese
---------NASS Survey--------- CME
Week Ending: Price Volume Price 1/
---------------------------------------------------------------
Sept. 4 1.6403 5,605,607 1.6575
Sept. 11 1.6430 5,755,932 1.6750
Sept. 18 1.6597 6,118,433 1.7195
Sept. 25 1.6806 5,295,418 1.7585
Total/Avg 1.6556 22,775,390 1.7026
1/ Weekly average block CME cheese prices.
It is important to illustrate how this new NASS cheese price is used on the computation of the BFP. This calculation is made in Table
2 below using the methodology published by Gould and Cropp. The cheese prices used for August and September are the NASS
survey cheese prices (see Table 1 for September 1998). Other market prices used are for butter, nonfat dry milk (NFDM), and dry
buttermilk. The economic formulas for August and September use yield factors (in bold) and the market prices to approximate the
gross value of milk. The changes in these values are then computed for cheese and butter/nonfat dry milk for the months of August
and September. These changes in values are then weighted between cheese and butter/nonfat dry milk based on how much milk was
used in cheese plants in the Upper Midwest versus how much milk was used in butter/nonfat dry milk plants. This is approximated
using milk equivalent conversions based on cheese and nonfat dry milk production.
The weighted average of the change in the value of cheese and butter/nonfat dry milk prices is $0.41 per cwt. That change is then
added to the August base month price to determine the September BFP.
Table 2. Calculation of the September BFP using NASS Cheese Price
August 1998 September 1998
---------------------------------------------------------------------
Grade AA CME Butter Price $2.1730 $2.7566
Equivalent Grade A
CME Butter Price 2.0830 2.6666
NASS Cheese Price (40-lb block) 1.6320 1.6556
NFDM, Western States,
Low/Med Heat 1.0425 1.0944
Dry Buttermilk, Western States 0.9574 0.9914
---------------------------------------------------------------------
August Values
---------------------------------------------------------------------
Cheese (9.87 X 1.6320) + (0.238 X 21.0830) = 16.6036
Butter/NFDM (4.27 X 2.1730) + (8.07 X 1.0425) +
(0.42 X 0.9574) = 18.0938
---------------------------------------------------------------------
September Values
Cheese (9.87 X 1.6556) + (0.238 X 2.6666) = 16.9754
Butter/NFDM (4.27 X 2.7566) + (8.07 X 1.0944) +
(0.42 X 0.9914) = 21.0189
---------------------------------------------------------------------
Change in Values Cheese | NFDM
16.9754 - 16.6036 = | 21.0189 - 18.0938 =
0.3718 | 2.9251
---------------------------------------------------------------------
Production: Milk Equivalents August Product Shares
(1000 CWTs)
Cheese (1000 lbs)
119,060/9.87 12,062.8 98.6%
NFDM (1000 lbs)
1,361/8.07 168.65 1.4%
Total 12,231.5 100%
---------------------------------------------------------------------
Update Values
---------------------------------------------------------------------
Cheese (98.6/100) X 0.3718 = 0.3666
Butter/NFDM (1.4/100) X 2.9251 = 0.0410
Total Change in Value 0.3666 + 0.0410 = 0.4076 rounded to $0.41
August Base Month Price 14.69
BFP-September 14.69 + 0.41 = 15.10
It should be apparent from Table 2 that the value of the NASS cheese price survey has a significant impact on the BFP. Approximately 95-98 percent of the change in dairy commodity prices used to update the BFP is from the value of cheese. Thus a one week lag in the NASS cheese price survey will effectively result in a lag in the value of the BFP. When cheese prices are rising, as they have been recently, one would expect some of the increase will result in a higher BFP in later months.
Conclusions
The analysis above indicates that farmers are not being cheated from rising dairy commodity values. The present computation of class
prices and the BFP is resulting in a lag between the time that dairy commodity prices rise and dairy farmers receive this higher value
in their milk check.
One way around this lag is to eliminate the cause: federal milk marketing orders. In particular, classified pricing is the culprit. Farmers receive one price for fluid milk and other prices for milk used for manufacturing purposes. These classified prices have lags built in as already discussed. One could simply replace the whole federal order system with a market-based multiple component pricing system that only paid farmers for the pounds of butterfat, protein and other solids delivered. This system could theoretically pay farmers weekly based on cash market prices for cheese, butter, nonfat dry milk and buttermilk. These cash prices would determine minimum component values. This system would not have any lags since there would be no need for surveys, class I calculations, blend pricing and pooling, etc.
Farmers and their legislators, however, have voted overwhelmingly for keeping federal orders. Secretary Glickman was instructed by the Congress to modernize federal milk marketing orders. He has suggested using multiple component pricing in more orders, reducing the number of federal orders, and instituted new class price formulas based on market prices. This proposed system, however, will also have lags. For example, it calls for a 6-month declining average formula for calculating Class I milk prices. The idea here is to add stability to Class I milk prices.
Thus farmers cannot have it both ways. They can either opt for immediate price signals with inherent market instability, or artificial pricing formulas with lags and greater price stability.
1 Agricultural Marketing Service, USDA. Dairy Market News. Vol. 64, Report no. 19. Week of May 5-9, 1997, p. 13.
2 Agricultural Marketing Service, USDA. Dairy Market News. Vol. 64, Report no. 24. Week of June 9-13, 1997, p. 8.
3 Gould, Brian W. and Bob Cropp. "The Basic Formula Price: Has the Value of NASS Cheese Prices Changed Its Value?" Marketing and Policy Briefing Paper
No. 58. September 1997.