The USDA recommended an increase to a fixed factor called the butterfat recovery factor, which reflects the percentage of butterfat in raw milk that is recovered during the cheesemaking process. It was traditionally set at 90 percent, but due to advancements in cheesemaking technology the USDA accepted a proposal that was made to increase it to 91 percent, acknowledging that most modern cheese plants can achieve that recovery rate. The cheese-yield factor was also increased because a larger butterfat-recovery rate means more butterfat is available in the milk to be turned into cheese, thus leading to a greater overall yield. Make-allowance increases decrease class prices, while increases in butterfat recovery and butterfat-yield factor increase class prices.

If the recommended increases in make allowances, butterfat-recovery factor and butterfat-yield factor in cheese had all been implemented from 2020 to 2023 they would have reduced prices.

• Class I prices by an average of 81 cents per hundredweight

• Class II prices by an average of 74 cents per hundredweight

• Class III prices by 89 cents per hundredweight

• Class IV prices by 74 cents per hundredweight

• That corresponds to a 3 percent to 6 percent decline in Class prices.

That change will have the largest impact, by far, on farmer prices and was opposed by the American Farm Bureau Federation, which argued that more comprehensive data was necessary to take that much money away from farmers, particularly when the current make allowances have been big enough for manufacturers to build or expand cheese plants in various regions of the country.

Base Class I skim-milk price

The skim portion of fluid milk – Class I skim milk – has been based on some combination of the values of Class III cheese and Class IV butter and powder prices. Prior to 2019, the formula to calculate base Class I skim milk was the greater of advanced Class III cheese and Class IV butter and powders skim-milk prices. The 2018 farm bill swapped the “greater-of” formula for the simple average-of advanced Class III and IV skim-milk prices, plus 74 cents.

COVID-19 pandemic-induced market conditions quickly revealed a problem with that new formula. Significant spreads between Class III and Class IV prices, paired with the delay associated with advanced Class I milk pricing, resulted in more money being paid out in Class III component values than what was collected from processing plants across all classes of milk. Worse, the inflated manufacturing milk prices meant manufacturers could avoid paying into the pool by pulling their milk out of the pool – “de-pooling” – which gutted the price of farmers whose milk stayed in the pool.

In 2020 alone, more than $700 million was lost in the revenue pool just from the reduced Class I price; those in the pool lost more as de-pooling also drained value out of the uniform price pool. During the pandemic, that imbalance was linked to a change in eating habits during the lockdown. But the losses in pool value have continued through early 2024, as cheese-milk value decreased and butter-powder values took their turn on top. Cumulative pool losses, just from reduced Class I prices and not counting depooling, have breached $1.2 billion since the formula went into effect in May 2019.

The USDA reviewed six proposals to amend the base Class I skim-milk price and recommends returning to the “greater-of” Class III or Class IV skim-milk price formulas used prior to the 2018 farm bill. Had the “greater-of” skim-milk price been in place from 2020 to 2023, average Class I prices would have increased by 64 cents per hundredweight

That return to “greater-of” was the No. 1 priority of dairy farmers who gathered in 2022 at the American Farm Bureau Federation’s Federal Milk Marketing Order Forum in Kansas City and a priority of the federation at the hearing. So that is an appreciated improvement by the USDA.

But wait! There’s more! Instead of the simple switch back to the easy to understand “greater-of,” the USDA recommends the addition of an adjuster for extended-shelf-life milk. That complicated adjustment is designed to account for differences in the timing and costs of milk used in extended-shelf-life products, which have a longer shelf life compared to other milk products. The adjuster is calculated as the rolling average of the differences between the greater-of and the average-of the advanced Class III and Class IV skim-milk pricing factors during the prior 13 to 36 months. The rolling adjuster would be computed in advance, and announced on or before the 23rd of the month 12 months in advance of its application.

Extended-shelf-life milk currently comprises about 8 percent to 10 percent of the fluid-milk market. The USDA estimated the final extended-shelf-life adjustor for each month in 2023, which, on average, increased the Class I milk price for extended-shelf-life milk by 40 cents per hundredweight The range of the adjustor varied widely, with a hypothetical 95-cent reduction to Class I extended-shelf-life milk in August 2023 and $1.18 increase to Class I extended-shelf-life milk in April 2023. The proposed adjustor adds increased complexity to an already intricate system and may not stabilize the price of extended-shelf-life milk as intended. In addition, that complicated nuisance would be made completely irrelevant if futures and options contracts for Class I milk were to be introduced. Those would provide risk-management opportunities for everyone in the market, not just extended-shelf-life processors.

Class I differentials

Class I differentials are a key part of the pricing formula for Class I beverage milk in the United States. Those differentials are fixed values, currently ranging from $1.60 to $6 per hundredweight, and are assigned to each U.S. county based on the region’s milk supply and demand characteristics. The purpose of those differentials is to account for the perishability of milk and the cost of moving it from where it is to where it’s needed to supply Class I markets, because the cows and the people aren’t always in the same place.

The current Class I differentials were established in 1998 with a 2008 update limited to the Appalachian, Florida and Southeast markets. The increasing costs of hauling milk, including inflated fuel prices, increased driver wages and other transportation expenses, mean that current differentials no longer reflect the actual cost of supplying milk to processing plants – leading to inequities in milk pricing.

The USDA’s recommended decision proposes increases to all Class I differentials, except for two counties in southwest Oklahoma. The largest increases are proposed in three West Virginia counties, with a recommendation to lift their current $2.20 differential to $4.80. The USDA’s proposal would lift Class I differentials the most in the Southeast order, the Appalachian order, the southern-Mideast order and the Northeast order. Orders in the West would see smaller increases. On average, Class I differentials would be lifted by $1.25 across the country, with the greatest average increase in the Appalachian order and smallest increase in the Arizona order.

Those adjustments are overdue, and we trust that the USDA, by beginning with the results of a relatively unbiased economic model, has largely captured the relative location value of milk across the country.

Putting it all together

One of the key elements of the Federal Milk Marketing Orders system is its pooling mechanism, which ensures that farmers receive a uniform price for their milk regardless of what it is used for. The intention is to ensure handlers in a similar location and who produce similar products pay the same minimum classified price for the raw milk – and that farmers producing milk in the same area receive the same price. Each month the total Class values of milk within an order are aggregated, and an average uniform price is calculated. The contributions of different Class prices to the pool can vary significantly depending on the supply and demand conditions within an order. Consequently the effects of adjustments to Class-price formulas on individual orders are best understood once differences in Class utilization and production volumes are accounted for.

Figure 3 illustrates the annual impact of each of USDA’s recommended amendments on the total pool value for each order – using an average across 2020-2023 pricing data. In that analysis, each adjustment was made separately and then layered to isolate the effect of each recommendation. But it’s important to note that interactions between different formula factors within the Class price equations were not considered, so the combined effects of those adjustments in real-world scenarios might differ.

Most apparent, the proposed increases in make allowances have significant negative impacts to order pool values, ranging from a pool-value impact of -$19.84 million in the Florida order to -$223 million in the Upper Midwest order. All other adjustments positively impact pool values. Composition-factor updates contributed to a one-year increase of $220 million across all orders, a benefit that would be inaccessible for the first year due to the proposed implementation delay. The proposed extended-shelf-life adjustment for the base Class I price was not included as the overall impact on pool values was too minor to visualize.

Figure 4 combines the effects of the USDA’s Federal Milk Marketing Orders recommendations and shows the net impact on each order. The proposed increases in make allowances would significantly offset the benefits in several orders, reducing the total pool value by

• $78 million in the California order,

• $75 million in the Upper Midwest order,

• $64 million in the Southwest order, and

• $17 million in the Pacific Northwest order.

If those changes had been implemented in 2020 through 2023, dairy farmers in those four orders would have received smaller prices than under the current Federal Milk Marketing Orders system. Those orders have greater Class III and IV utilization, making them more vulnerable to the negative effects of increased make allowances. In contrast, orders with increased Class I utilization, such as the Appalachian and Mideast orders, would see an increase in pool value from the proposed changes. Arizona and the Central orders would experience a small but positive benefit. The proposed make-allowance increases create disparities among dairy farmers based on their physical location – an outcome that the Federal Milk Marketing Orders system is designed to prevent.

What’s missing?

The American Farm Bureau Federation supported some other changes that the USDA hasn’t recommended. Those include

• an increased minimum Class I differential, in line with the increased cost of supplying Grade A milk;

• the elimination of advanced pricing for Class I milk and for Class II skim milk, which would reduce the misalignment of prices each month and so reduced the risk of depooling;

• adding 640-pound cheddar blocks to the survey, to make the price collection more robust because the larger blocks are gradually replacing the 40-pound blocks;

• adding unsalted butter to the survey, to make that price collection more robust as that volume grows and unsalted butter is increasingly seen as a production substitute for salted butter; and

• an 86-cent increase in the Class II differential, an update based on the exact logic that the USDA applied when they first established the Class II differential 25 years ago.

Rulemaking process

The release of the recommended decisions marks the ninth step in the 12-step Federal Milk Marketing Orders rulemaking process. Following the comment period, the USDA will spend the next 60 days reviewing and analyzing the feedback before issuing a final rule, anticipated at about mid-November. Once the final rule is published, the USDA will organize a referendum, allowing dairy farmers and cooperatives to vote on whether to accept or reject the proposed amendments within each order, ultimately determining the future of the Federal Milk Marketing Orders system.

Conclusion

The USDA’s proposed amendments to the 11 Federal Milk Marketing Orders carry potential benefits for many dairy farmers and significant concerns for others. While a switch back to the “greater-of” Class I base price, elimination of the barrel cheese price, and increases in composition factors and Class I differentials are designed to better reflect current market realities and improve overall pricing for farmers, the recommended make-allowance increase is so large that it would wipe out those gains, particularly in regions with greater Class III and IV utilization. They also raise concerns about creating regional disparities among dairy farmers.

The delay in implementing composition-factor updates and the added complexity of the extended-shelf-life milk adjuster further complicate the potential outcomes, leaving many dairy farmers uncertain about whether the changes will ultimately work in their favor.

Visit www.fb.org/market-intel for more information.