Should usda be setting milk prices?
March 22, 2022
Apple growers have three markets for their product: 1) the domestic market for fresh apples, 2) processing for apple juice, cider, and sauce, and 3) exports. The fresh market returns the highest price, but not all apples can be sold into this market. And market prices change from year to year. Growers understand they can’t influence the price. The job of the coop manager is to find markets for their growers that will return the highest price, to staff and manage receiving and processing facilities, net out all expenses from sales, and return the balance to the members of the coop.
Most agricultural cooperatives in the U.S. operate this way. Managers face different markets with prices that are set by supply and demand. They can control their costs to some extent. But plants must be kept open, truck drivers paid, etc. These costs are less volatile than market prices, but must be paid before farmers receive their share of the proceeds. When market prices are high, everyone wins. Since processing and handling costs are pretty much fixed, most of the higher revenue from sales is passed on to the farmers (some may be retained as capital for the coop).
But dairy cooperatives don’t work this way. Their cost and sales price are set by someone else. Like apple growers, dairy coop managers face market prices that are completely out of their control. Dairy prices are set by market supply and demand, with a domestic market and an export market. If the manager charges too much for the product, they end up selling nothing. But dairy coop managers also face a cost for milk components that is set each month by USDA. Sure, they can depool their plants, and yes coops can adjust the monthly pool price if they need to (called “rebalancing”). But most coop managers think long and hard before deducting anything from the milk check that isn’t set by USDA.
So here is the problem. If the market sets the sales price, and USDA determines the cost of milk components, the difference (the gross margin) could easily be upside down. How so? Let’s provide an example. Suppose our manager makes a cheese export sale in August, produces the product in September, and loads the cheese onto a container ship in October. The price will be set in August based on global markets, but the “cost” will be determined by USDA in September. There is a timing difference, and a difference between domestic and international prices. Plus, to calculate the cost of milk components, USDA uses a manufacturing allowance that was last changed in 2008. So yes, the finance department may inform the coop manager that the export sale lost money, even though it was the marginally highest value sale for that product. Of course our manager may be able in some months to use the futures market to lock in costs ahead of time, and domestic and international market prices could converge in some months.
The critical question today is why would farmers, who own the cooperatives and hire the managers, agree to such a system for products that they export? Why would they allow USDA, via a lengthy and expensive hearing process, to set formulas that are used to calculate their farm-gate milk prices? Few countries price their milk this way today.
Well, the answer goes way back in time. First, farmers don’t always know how milk prices are determined. Today the sheer complexity of milk pricing fuels that distrust, including negative PPD’s. Where does this price come from? How was it calculated? Is it fair? Having USDA in the middle provides a lot of comfort to many dairy farmers. Second, having USDA assist in setting and measuring the standards for weights and testing of milk deliveries also provides farmers a lot of comfort. Third, back in the day, milk was pretty much based on fluid milk and manufacturing. Two basic classes of milk. When federal order reform was implemented in 2000, only 5% of milk was exported. So having a system based on four classes of milk (two fresh, two manufacturing) with most milk centered in the East (fluid markets) and Midwest (cheese) made sense back then.
Today is a different story. Processors are making many more products from a bucket of milk. The export market is exploding, providing the U.S. with substantial opportunities. There are lots of value-added products that can be made from fat and protein. The size and importance of the fluid milk market continues to decline each year, and milk prices are much more volatile than in 2000. Also, the number of farms and plants have shrunk in numbers and increased in size since 2000. Dairy board members and coop managers today are very business oriented and know how to deal with millions of dollars. They understand the market, risk and opportunities. So it’s a very different world today.
Having USDA set the cost of all milk used in the system may not be desirable. More and more milk is being exported. That product may be out of sync with domestic price surveys. And the products being exported are not your typical surveyed commodities. So, providing the coop manager with greater discretion in determining the cost of milk for Class III and IV products may have the advantage of unleashing more investments in processing plants, and more exports of value-added dairy products. Wouldn’t that be good for farmers? But today a coop manager has to think long and hard before investing in more infrastructure. How can they generate a positive stream of future earnings from this investment if they aren’t in control of either the sales price or cost of the milk? Gaining control of the cost side may in the long run steer future investments towards higher value and potentially more profitable options. That would improve the incremental value of milk and put more money in the pockets of dairy farmers.