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NMPF considering Class I price formula change proposal

Progressive Dairyman Editor Dave Natzke Published on 24 October 2017

The National Milk Producers Federation (NMPF) officers have endorsed a proposal to change how federal milk marketing order (FMMO) Class I base prices are calculated. The proposal will be reviewed and voted on by the full NMPF board on Oct. 30, meeting in Anaheim, California, in conjunction with the joint annual meeting of NMPF, the National Dairy Board and the United Dairy Industry Association (UDIA).

The proposal was developed by a task force of NMPF members, meeting with members of the International Dairy Foods Association (IDFA), according to Chris Galen, NMPF senior vice president of communications. The producer and processor organizations sought to find a mutually acceptable approach to determine monthly FMMO Class I (fluid) milk prices, with a goal of reducing price risks for Class I buyers while preserving the farm-level revenue the formula generates for producers’ milk checks.

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The current classified pricing system, established in 2000, uses the “higher of” the Class III or IV price in each month to calculate the monthly Class I base price. Location-specific differentials are then added to the base and would remain under the current proposal.

“Use of the ‘higher of’ makes it difficult for Class I milk handlers to hedge risk because they don’t know which class will be the mover for a particular month,” Galen said. “However, the ‘higher of’ calculation as the Class I mover has benefited dairy producers since its implementation, and NMPF task force members made clear that value would have to be reflected in any alternative pricing formula going forward.”

Under the terms of the proposal, the Class I price formula would be adjusted using the simple average of monthly Class III and Class IV prices. To keep the proposal revenue-neutral, the proposal would boost Class I differentials by 74 cents per hundredweight (cwt) in each federal milk marketing order.

That premium represents the average value of the “higher of” system dating back to 2000. With the additional premium, dairy farmers  would not see lower average milk prices, Galen said.

“The larger differential is needed so that moving to an average of the two market-determined manufacturing class prices does not diminish the contribution to the blend price provided by Class I revenue,” Galen said.

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Analysis by John Newton, market Intelligence director with the American Farm Bureau Federation (AFBF), indicates the unpredictability of pricing beverage milk has increased risks for processors attempting to hedge Class I milk prices using Class III and Class IV futures. Read Newton's article and analysis: “Proposed Changes to Fluid Milk Pricing, And Why Farmers Need to Care.”

Read also: Could FMMO Class I price formula changes reduce risk, fluid milk slide?

Historically, from 2001 to 2017, the basis risk when using the Class III milk futures contract to cross-hedge Class I milk averaged 47 cents per cwt and ranged from a low of minus 78 cents to plus $4.64 per cwt. During this same time, the basis risk when using the Class IV milk futures contract averaged 90 cents per cwt and ranged from a low of minus 77 cents to a high of plus $6.68 per cwt.

“The agreement creates a positive outcome for farmers and processors because it addresses fluid bottlers’ desire for improved risk management, while protecting the integrity of federal milk marketing orders and locking in the value that the ‘higher of’ has provided,” Galen said.

Reaching an agreement on this issue could also score political points, signifying policy unity between NMPF and IDFA. That could be important for other dairy sections of the 2018 Farm Bill, which is also expected to contain improvements in the Margin Protection Program for Dairy (MPP-Dairy).

“Given the ongoing federal budget challenges in developing a new farm bill, a unified dairy industry will be critically important to legislative success,” Galen said.

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While the path of the proposal is currently being steered through Congress, dairy economists contacted by Progressive Dairyman questioned whether it should instead go through the FMMO hearing process administered by USDA.

“Although well within congressional authority, I think this level of legislation qualifies as micromanagement and risks undermining the very deliberative process of determining a regulation ‘in the public interest’,” said Andrew Novakovic, Cornell University dairy economist. His sentiments were shared by Mark Stephenson, director of dairy policy analysis with the University of Wisconsin – Madison.

“I oppose Congress making changes in federal order regulations,” said Cal Covington, retired dairy cooperative CEO. “Congress provided the enabling legislation. The specific regulations should go through the administrative hearing process. This process is open, structured, transparent and allows all interested parties to speak for or against any proposed change, under oath and subject to cross-examination. Yes, it is slow, but it is fair. Congress making federal order changes opens the door for any entity with political power and money and the loudest voice to make changes. I remember the Class I differential shouting matches in the halls of Congress. That is no way to make changes in federal orders.”  end mark

Dave Natzke
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