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Looking forward to a milk price

Ben Yale Published on 12 April 2010

Roller Coaster photo

New rear-mounted cameras and strategically located convex mirrors aid us in backing up. They provide us a wider, clearer and less obstructed view of the rear. Even then, these improvements in seeing behind us are insufficient to replace driving full speed down a highway looking forward through the windshield at what is ahead.

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It is not just that they are not useful going forward, they tend to distort the view of what we see. The pole that seems six feet away is six inches. Thus the warnings, “Objects are closer than they appear.”

As producers ride the wild roller coaster of commodity prices, they are denied a forward view. Producers harvest the milk during one month and receive price and payment the next. Knowing after the fact denies any ability to make changes in response to market conditions. The pricing system does not tell the producer what the milk will be worth, but all too often this delayed pricing is the basis for producers thinking what the milk will be worth next month. The pricing signal to producers, both good and bad, are delayed by two months or more. Moving forward in a business this way is like seeing the pothole for the first time in the rearview mirror – feeling it came first.

There was a time when prices changed little from month to month. From 1980 through 1999, the two decades immediately before FMMO reform, the Class III price based on competitive pricing varied from one month to the next less than 50 cents more than three out of four times and less than a dollar nine out of ten. Even the two-month difference was generally mild with less than 50-cent changes almost a third of the time. Thus producers who got used to using last month’s pay price to estimate the next month’s milk price did so with limited risk. Anyone can drive down a straight highway looking in the rear-view mirror.

Not so today. Only 35 percent of the changes from month to month are less than 50 cents since 2000. Some have been extremely high, as high as $5.17. In the price change from December 2008 to January 2009, the drop was $4.50. Those who used their December milk check price received in January to estimate February 2009 were off by a third, as the Class III price dropped $4.73 between December and February. For those who waited until March when they got the check for February milk, the bottom had already fallen out of the bucket. It was like looking into a mirror seeing the open throat of a monster – the warning “Objects are closer than they appear!” hanging from the vibrating uvula.

Riding a roller coaster has its thrills and chills, but it’s something altogether to ride a roller coaster looking out the rear. Seeing the valley you just left or the heights from which you just dropped provide no warning as to what will happen next. The ride is a lot easier to take, if you know in advance they will be climbing up or falling down, twisting right or twisting left, sitting up or dangling upside down as the bottom falls out.

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But not knowing also allows you to make it up! Dairy farmers can continue to produce milk this month even with a low milk price for last month because they can believe that next month’s will be good enough. Always the optimists, the muted, convoluted and delayed signals they do get can be ignored. When the virtual roller coaster car is jerked into reality, the pain is even greater.

While producers need to develop programs to see milk pricing coming through the windshield driving forward, not through a rear-view mirror or even fancy rear camera, current pricing rules make it difficult to see this month’s milk price before the end of the month. There are no less than 66 (77 in five-week months) variables that go into the official FMMO class prices. California’s is simpler because it does not use weighted averages as does USDA. Variations from month to month in utilization and location differentials add further complications in coming to a blend price. Then there is the producer basis that further adjusts that price.

Twenty-two of the Federal variables are announced on the Friday just before or on the 23rd of the month in advance of the shipping month. From these, USDA computes the Class I skim and butterfat and Class II solids-not-fat for the next month. With the exception of the Upper Midwest, these price elements constitute from one-third to 85 percent of the next month’s official producer milk price. California announces by the 10th Class 1 prices for the next month and every other month the Class 2 and 3 prices for the next two months. These three price elements represent less than 30 percent of that state’s official producer milk price. Depending on where you market your milk, some portion of your milk check value can be known in advance.

The remaining 44 to 55 variables are announced each Friday as the month progresses. California uses the average of the daily announced CME prices for butter and cheese. In both cases the month’s milk check can be built as the month progresses. Week-to-week changes are less volatile than month-to-month. As a result, very early in the month, a close estimate of the final milk price can be made.

To know the value of your milk as early on as possible you will have to estimate a basis using prior differences between your milk check and the announced blend prices. Basis is a complex, widely varying mix of different class utilizations, location differentials, premiums/discounts in the market, cooperative reblends and other pluses and minuses. Tracking the rest of the milk price will at least show you the general direction your prices are going as you look forward.

Several websites provide milk marketing price calculators to assist you in the process. University of Wisconsin’s Understanding Dairy Markets has a calculator that computes the milk price based upon the weekly changes in the NASS prices ( http://future.aae.wisc.edu/docs/excel.html#1 ). Besides computing the price, it even has a page that will estimate the differential for your farm ( http://future.aae.wisc.edu/docs/excel.html#4 ). The producer trade groups in California weekly estimate upcoming quota and overbase prices. Because the NASS price correlates to the CME prices with a one- to two-week lag, average CME prices for the week fairly well predict NASS prices the next week. This means the whole estimation process can be moved a week earlier. This information is available at the Wisconsin website mentioned above as well as in Dairy Market News, published by USDA each week on Fridays ( http://www.ams.usda.gov/AMSv1.0/dairy ).

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Even if you do not use futures or options as part of risk management, seeing what the market is expecting can give you greater foresight of future milk prices. Futures markets, particularly the close months, are good predictors of the coming month’s milk price. Penn State each month in its market outlook has a website that computes the Pennsylvania all-milk price using the closing futures markets.

Having said all of that, and believing producers should be looking towards their milk price, these are still estimates, not actual prices. In times of tight, even nonexistent, margins, there is little room for error. Truly knowing what the price is can only come when producers and processors together negotiate prices that provide both profits. That cannot be fully done today.

The reason that producers and processors cannot look forward to the milk price, but have the confusing pricing system they have, is because producers asked for it. The FMMO was to give producers some assurance of sustainable prices. Certainly 2009 should dispel any belief that the FMMO price system assures in anyway sustainable producer prices, or ever will.

This is not because of any ill intent on the part of government administrators. Rather it is the result, intended or not, when government is asked to fix minimum prices. Neither USDA nor CDFA nor any other state agency is going to compel plants to pay more for milk than it believes plants can afford, with emphasis on believe. In short, these minimum prices are designed to assure plants a potential for profit, not a guarantee but a potential. The complex pricing formulas and mixed timing are designed to reduce processor risk that raw milk prices exceed the selling price of their product. The advance pricing of Class I and II milk allows bottlers to fix their sales prices in advance. Cheese is generally priced at make. Matching the value of the raw milk with the sales price again assures potential for profit but demands that the milk price not be set until after the month it was sold.

It is a trade-off in exchange for giving up knowing what their milk price is worth ahead of time, with the belief the system will produce an adequate price guaranteed by the government. In all of the discussions of changes to the system of milk pricing, so long as the government is involved, there will be no change to this exchange. Looking to the government to fix prices is not looking forward to a price for milk. It means producers will always be looking backward so plants can stand still. They are enhancements of the rear- view mirror, fancy and sophisticated in some cases, but still rear-looking. Seeing close-up and in color the saliva dripping from the uvula of a monster about to make a meal of us is not progress.

The answer lies in developing systems that provide producers and processors the ability to fairly and competitively establish prices and volumes for those sales, offset the risks of those prices and both obtain a profit. Together they look forward to what is good for both of them. That’s a price to look forward to. PD

Ben Yale
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