1. Policies, Politics and the Way We Price Milk Mark Stephenson Director of Dairy Policy Analysis

2. What Is Special About Milk? It’s perishable It’s bulky It’s produced and must be sold 365 days a year Specialized assets for production Many more sellers than buyers Relatively inelastic demand for products Historically led to “destructive competition”

3. Federal Milk Marketing Orders Cooperatives had modest success in policing the marketplace Federal government instituted Marketing Agreements Shortly thereafter, Marketing Agreements became Marketing Orders Marketing Orders act like a traffic cop in the market They regulate the terms of trade They measure They assure compliance

4. Classified Pricing Class I — generally highest price Class II Class III Class IV — generally lowest price What is consistent with this ordering? These are minimum prices to be paid!

5. Pooling Processors contribute differently to the Federal Order Pool, but producers receive the blended value.

6. Regulating Minimum Prices Price Quantity Demand Supply PmPm QmQm PsPs QdQd QsQs PdPd Over-Order Premiums will get you back here.

7. Benefits of FMMO for Producers Classified pricing can improve producer returns but it is not a price support—Markets must still clear. Pooling is about equity—sharing in those higher returns Sharing a pool comes at a cost—qualification and performance Plants are audited Prices are coordinated across markets (efficiency in transportation)

8. Benefits for Processors Plants know that their competitors are paying at least the minimum class price. Manufacturing plants get a “pool draw” to pay their producers the same uniform or blend price. Both producers and processors benefit from federal order data Testing Audited milk production Transportation, etc.

9. How would you price milk?

10. Ingredient & Product Streams Milk Sweet Cream Ingredients Whey Cheese Dried Whey Whey Cream WPC Permeate Lactose Butter We want to price this. Let’s survey the market price for these products and back into a milk price.

11. Product Price Formulas Based on weekly AMS surveys of product sold

12. Product Price Formulas Butterfat Price = (Butter price - 0.1715) x 1.211 Make Allowance Make Allowance - What does it cost you to transform milk into 1 pound of butter? Yield Factor - How many pounds of butter can you make from 1 pound of butterfat?

13. Product Price Formulas Dairy producers want a small make allowance and a large yield factor Dairy processors want a large make allowance and a small yield factor How do you determine the correct parameter values?

14. The Issue of Make Allowance Who’s price? Highest Lowest Average

15. Minimum Milk Price to Producers Pounds of Butterfat Pounds of Protein Pounds of Other Solids (lactose + minerals) Quality (Somatic Cell) Total Pounds of Milk

16. Premiums often paid (over order) Quality (somatic cell, bacteria) Volume Protein Plant or Market Hauling subsidies

17. Use policy to fix problems that the market or an individual can’t Standards of identity FMMOs Price Support Program Policy fails when it does too little or too much Eg. Price Support Program Policy does not determine the end result—only the path that the market takes New Policy?

18. Price Volatility Much discussion since about 2006 Refundable Assessments (Milk Producers’ Council, 2007) Mandatory CWT (Dairy Farmers Working Together, 2007) Growth Management Plan (Milk Producer’s Council, 2009) Dairy Growth Management Initiative (DFA, 2009) Marginal Milk Pricing (Agri-Mark, 2010) Dairy Market Stabilization Program (NMPF, 2010) Farm Savings Accounts (discussed by DIAC, 2010) Margin Insurance Programs (NMPF’s DPMPP and discussed by DIAC, 2010-11) Market Cow Bonus Program (DPAC, 2011) Farm Savings Accounts (again, processor groups, 2011) Peterson Discussion Draft (July 2011; modified DMSP) Dairy Security Act of 2011 (September 2011) Federal Milk Marketing Improvement Act of 2011 (Casey, October 2011) Rural Economic Farm and Ranch Sustainability and Hunger Act of 2011 (October 2011) Most have focused on supply correction (temporary quota, cull cow) Some have focused on self-help (better LGM-D, FSA, etc.) Today’s Issues

19. Price Risk! U.S. All Milk Price

20. We Have Four Cycles There appears to be a 9 month cycle There appears to be an annual cycle There appears to be a 26 month cycle There appears to be a 36 month cycle

21. Spectral Decomposition

22. Volatility in Inputs Too NASS Dairy Feed Ration

23. Some Variation of the The Dairy Security Act of 2011 is the Starting Point Cost savings by repeal of MILC, DPPSP & DEIP New safety net with margin protection insurance Reduce milk price volatility with temporary reductions in milk supply

24. Points to Consider The program is voluntary. Margin Insurance and the Market Stabilization are linked—you can’t have one without the other. You would have several months to make a decision to register after the bill is enacted. If you register, you will need to make a decision at that time about the level of insurance and the percent of milk.

25. The Margin NASS All Milk Price Minus Ration Value NASS corn, NASS alfalfa hay, AMS Soybean Meal

26. Dairy Producer Margin Protection Program $4 base margin coverage is free Partially subsidized premiums for supplemental coverage (25%–90% of base) Run by FSA Calculated as 2 month pairs Jan-Feb, Mar-Apr, etc.

27. Historic Trigger Values

28. Margin Protection Details If you register, your historic base will be highest annual production in the previous three years. New producers can register within 180 days of first milk production. Will prorate annual production. You get margin protection on 80% of this historic base for free. Your annual production history is updated every year.

29. Margin Protection Details If you want to protect more than free margin base, you can buy up in 50¢ increments You can protect from 25% to 90 % of your production base. This election is made at the time you register and continues throughout the life of the bill but the levels of supplemental insurance can be changed each year. Annual premiums must be paid by Jan 15 or in 2 installments.

30. Example Margin Protection Your historic base is 20 million pounds You choose a $5.50 margin protection level at 75% of your production Two years later you have grown to 30 million pounds.

31. Example Margin Protection If margin is calculated as $3.50 average for two months. Indemnity is triggered You are paid $4.00 - $3.50 = 50¢ on your historic base = 50¢ * (200,000cwt / 6 ) * 80% = $13,333 You receive a supplemental payment of $5.50 - $4.00 = $1.50 on your production base = $1.50 * (300,000cwt / 6) * 75% = $56,250 Total 2 month payment = $13,333 + $56,250= $69,583

32. Dairy Market Stabilization Program Uses same margin trigger calculation The average trigger value is based on consecutive two- month periods E.g., Jan-Feb, Feb-Mar, Mar-Apr, etc. Different milk production base Most recent 3-month average Same month from previous year Can select which base calculation each year by Jan 15

33. Dairy Market Stabilization Program Triggers if 2-month average margin is below $6 $5—$6, no payment on milk over 2% of base to 6% of current marketings $4—$5, no payment on milk over 3% of base to 7% of current marketings Triggers if 1-month average margin is below $4 Under $4, no payment on milk over 4% of base to 8% of current marketings

34. Dairy Market Stabilization Program Triggers can increase For example, if you were in a $6 trigger event and next month’s calculated 2-month average is now below $5, the more restrictive trigger is active. It appears as though if it is a long trigger event, a rolling 3-month base can incorporate your reduced marketings. Program is suspended when 2-month average is above $6 or U.S. price for cheddar or NFDM is more than 20% higher than world prices.

35. Modeling the DSA Need many assumptions about participation Look at Baseline and 2 scenarios High participation, 50% of producers register in each of 4 farm size categories and choose to protect 60% of their milk at a $6 margin. Low Participation differs by farm size: 10%, 5%, 2.5% and 1% of S, M, L, XL protect 50% of milk at $5.

36. All Milk Price

37. Government Expenditures

38. NFOI for Representative Medium Farm