USDA’s Agricultural Marketing Service (AMS) held a rulemaking hearing late last year and early this year to consider and take evidence on 21 proposals seeking to amend the Federal Milk Marketing Order (FMMO) regulatory uniform price formula provisions. As a result of that due diligence, proposed revisions to the FMMO were adopted by USDA to modernize the pricing formulas used to determine how dairy producers are paid for their milk. There are five proposed changes that will directly impact producer milk checks with historical comparisons.

1. Milk Composition Factors:

The Class 3 and Class 4 skim milk price formulas are based on fixed component factors per hundred pounds (cwt) of skim milk. The current FMMO component factors, which were adopted in 2000, are 3.1% protein, 5.9% other solids, and 9.0% nonfat solids. The recommended decision proposes updating these factors to 3.3% protein, 6.0% other solids, and 9.3% nonfat solids.

2. Surveyed Commodity Products:

USDA administers the mandatory, audited Dairy Product Mandatory Reporting Program (DPMRP) to gather wholesale prices of four manufactured dairy products (cheese, butter, nonfat dry milk (NFDM), and dry whey for use in FMMO formulas. Currently, the cheddar cheese price used in the FMMO formulas is a sales-weighted average of the 40-pound cheddar cheese block price and the 500-pound cheddar cheese barrel price (adjusted for moisture).

The recommended decision proposes to remove the 500-pound barrel cheddar cheese price from the DPMRP survey and to rely solely on the 40-pound block cheddar cheese price to determine the monthly average cheese price used in the formulas.

3. Class 3 and Class 4 Formula Factors

End product pricing of current FMMO regulations utilizes four wholesale product prices (butter, NFDM, cheese, and dry whey) to determine the value of raw milk based on market conditions and established formulas.

Recommended changes to the Class 3 and 4 formula factors include two elements: 1.) manufacturing make allowances, and 2.) butterfat recovery percentage.

Make allowances represent the cost of converting raw milk into the four manufactured dairy products surveyed by USDA. Set in 2008 and determined using two surveys, the current make allowance levels are as follows ($/pound) – cheese: $0.2003; butter: $0.2257; NFDM: $0.1678; and dry whey: $0.1991. The recommended decision proposed to update the manufacturing allowances as follows ($/pound) – cheese: $0.2504; butter: $0.2257; NFDM: $0.2268; and dry whey: $0.2653.

The butterfat recovery factor represents the amount of butterfat in raw milk that can be recovered during the cheesemaking process. Set in 2000, the current butterfat recover assumption is 90%. The recommended decision proposes to update the butter recovery factor to 91%. Such an increase also necessitates a proposed change to the butterfat yield factor in cheese from 1.572 and 1.589.

4. Base Class I Skim Milk Price:

From 2000 to 2019, the base Class I skim milk price was determined by the higher of the advanced Class 3 or Class 4 skim milk prices (referred to as the “higher-of” formula). Currently (since May 2019), the base Class I skim milk price is determined by the average of the advanced Class 3 and Class 4 skim milk prices plus $0.74 per cwt (referred to as the “average-of” formula).

The recommended decision proposes the base Class I skim milk price to be the higher of advanced Class 3 or Class 4 skim milk prices for the month. Further, the recommended decision proposes to adopt a Class I ESL (extended shelf life) adjustment equating to a Class I price for all ESL products equal to the difference between the higher-of mover and the average-of the advanced of the Class 3 and Class 4 skim milk pricing factors, plus a 24-month rolling adjuster with a 12-month lag. The rolling monthly adjuster would be calculated as the average of the difference between the “higher-of” and the “average-of” calculations for the prior 13 to 36 months.

5. Class I and Class II Differentials:

FMMO Class I prices are calculated as the average of the advanced Class 3 and Class 4 skim milk prices, plus $0.74 plus a location-specific differential, referred to as a Class I differential. The current Class I differentials were established during Federal Order Reform in 2000, with an adjustment to Class I differentials for the Appalachian, Florida, and Southeast FMMOs, in 2008.

The recommended decision proposes to retain the current $1.60 base differential and adopt new location-specific Class I differential values to reflect current marketing conditions. Maps of the current and proposed Class I differentials may be viewed at https://www.ams.usda.gov/rules-regulations/moa/dairy/hearings/national-fmmo-pricing-hearing.

Economic Impact on Announced Prices and Producer Milk Checks

AMS conducted a “static” analysis of the recommended amendments to the FMMO pricing formulas, concluding that the overall economic impact across all FMMOs would have been beneficial over the previous five years analyzed, 2019-2023 (if the package of recommended amendments to the FMMO pricing provisions were in place at that time). The analysis accounted for the total pounds of producer milk utilized in each of the four classes across all FMMOs during the period. The results determined the impact was not consistent across the FMMOs, with most seeing a net benefit from the proposed changes except for the Upper Midwest, California, and Arizona FMMO orders.

AMS incorporates a dynamic regional econometric model which attempts to reflect future behavior regarding changes in milk pooled by order and resulting impacts. Due to the complexity of this model and the requirement to incorporate all proposed price formula changes including the Class I differential changes in each of the 3,108 counties, a static analysis was instead used to determine the price impacts of the recommended amendments if they were in place from 2019-2023. AMS built an Excel workbook designed to mimic observed pools from January 2019 through December 2023, including all component, class, and uniform prices. The parts of the pricing formula with recommended changes were updated and the resulting prices and values were recorded for comparison. All other data were held constant, and averages recorded across months are weighted averages.

Total pool value and weighted statistical uniform price (SUP) at test by FMMO were among the data analyzed by the model. Their values are included in the tables below:

Table 1: Total Pool Value by FMMO (January 2019 – December 2023)

Table 2: Weighted SUP @ Test by FMMO $/cwt (January 2019 – December 2023)

AMS concluded that because the overall impact across all FMMOs would have been beneficial over the 5-year period analyzed, the recorded amendments are likely to contribute to increases on average in producer revenue and pool values while incorporating more current costs faced by producers and processors in marketing milk. While this may be true, because the impact is not uniform across all orders it is important to understand how the recommended changes if adopted may impact your milk check and hedging strategies. In general, a higher Class I milk price will benefit all producers, although some more than others depending on Class I utilization in a particular order.

Another consideration is the potential impact to component premium received in producer milk checks. While the increased component factors for protein, other solids, and nonfat solids will raise pool value and help offset the impact from higher make allowances, they also raise the bar by which premiums for components are determined against the standard test. It is also important to understand how the proposed changes if adopted may impact hedging decisions in the future.

There is currently a 60-day comment period open following USDA’s publishing of the Recommended Decision in early July for stakeholders to submit feedback. Following this comment period, AMS will release their final recommendation 60 days after public comments close, and there will be a period of education between the final recommendation and when producers will need to vote on the proposal. A vote is currently anticipated sometime in early 2025 and if adopted, the final decision will be published in the Federal Register. It should be noted that these proposed changes to the FMMOs do not need to be part of the new Farm Bill, and thus can proceed independent of those negotiations.

Dairy producers should work with an advisor to determine how these proposed changes may impact their milk revenue specifically and incorporate that analysis into their forward hedging strategies. We will be following these developments closely and working with our clients to strategically adjust their hedging plan as appropriate.

Reach out to the CIH Dairy Team with questions about Dairy Price Risk Management.

Source Credit: Regulatory Economic Impact Analysis of the Recommended Decision to Amend Federal Milk Marketing Order Pricing Formulas – USDA/AMS, July 2024