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Producer Price Differentials: The Good, The Bad and The Ugly

Producer Price Differentials: The Good, The Bad and The Ugly. Brian W. Gould Department of Agricultural and Applied Economics and Wisconsin Center for Dairy Research University of Wisconsin-Madison Wisconsin Dairy Field Representatives Conference February 9, 2005. Outline of Presentation.

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Producer Price Differentials: The Good, The Bad and The Ugly

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  1. Producer Price Differentials:The Good, The Bad and The Ugly Brian W. Gould Department of Agricultural and Applied Economics and Wisconsin Center for Dairy Research University of Wisconsin-Madison Wisconsin Dairy Field Representatives Conference February 9, 2005

  2. Outline of Presentation • Review Aspects of Federal Orders and Classified Milk Pricing • Most should be familiar with this material • Definition of Producer Price Differentials (PPD) • Exists due to Classified Pricing/Pooling • Overview of Recent PPD Experiences in UMW • Reasons for recent negative PPD’s • Implications for the Future

  3. Federal Milk Marketing Orders April 2004 - Present MCP Markets

  4. Federal Milk Marketing Orders • Regulate Handlers not producers • Objectives of the program: • Assure dairy farmers reasonable minimum milk prices • Assure consumers an adequate milk supply • Guarantee orderly marketing of fluid milk • Achieves purposes via the use of: • Classified pricing • Pooling where all producers share in the pool

  5. Classes of Milk • Class I: beverage milk • Class II: fluid cream, cottage cheese, ice cream and mixes, yogurt, infant formula, sour cream, etc. • Class III: hard cheese, cream cheese • Class IV: butter, dried milk products (SMP), evaporated and condensed milk

  6. How Are Class Prices Determined? • Based on commodity prices which are used in formulas to determine component values • NASS surveys butter, cheese, dry whey and NFDM plants each Friday for sales data • Prices and weekly sales are reported the next Friday

  7. How Are Class Prices Determined? • Class I skim milk, Class I butterfat and Class II skim milk formula prices are advanced prices • Reported on a Friday on or before the 23rd of the month prior to production month • For example, Feb. 2005 Class I price • Announced on Friday Jan. 21st • Based on NASS survey prices for weeks beginning Jan. 2nd and Jan. 9th.

  8. How Are Class Prices Determined? • Class II BF price, Class IV and Class III skim and BF prices are announced on a Friday on or before the 5th of the month following production • Prices for Feb 2005 will be announced on Friday, Mar 4th • NASS Survey Prices for weeks beginning Jan 27th, Feb 6th, Feb 13th and Feb 20th • There is a 6 or 7 week difference in timing of prices used in advanced pricing of Class I and the remaining Class prices for the same month

  9. How Are Class Prices Determined? • Minimum class prices are calculated using • NASS weekly survey prices • Assumed make allowances (plant costs) for cheese, butter, dry whey, NFDM • Assumed cwt yields of cheese, butter, dry whey and NFDM • Assumed raw milk composition • 3.5% butterfat • 2.99% true protein • 5.69% other solids • Class I and Class II prices typically higher than Class III and Class IV prices

  10. How Are Class Prices Determined? • Class III milk price= 3.5*Class III/IV butterfat value + 0.965 Class III skim milk price • Butterfat value=f(butter price) • Class III skim milk price=f(protein value, other solids value) • Protein value=f(cheese and butter price) • Other solids price=f(dry whey price)

  11. How Are Class Prices Determined? • Class IV Price= 3.5* Class III/IV butterfat value + 0.965*Class IV skim milk price • Butterfat value=f(butter price) • Class IV Skim Milk Price=f(NFDM price) • Class II Price=3.5 *Butterfat price+0.965 advanced Class II skim milk price • Butterfat value=Class IV butterfat price + $0.007 • Advanced Class II skim milk price=advanced Class IV skim milk price+$0.70

  12. How Are Class Prices Determined? • Class I Advance (higher of ) Pricing • Class I skim milk value is the higher ofadvanced Class III or Class IV skim milk price • Class I mover= (0.965 x Class I skim milk value) + 3.5 x advanced Class III/IV butterfat value • Class I price = Class I mover plus a differential • County specific Class I differential is added to Class I mover to determine min. Class I price • For Chicago area, differential is $1.80

  13. Federal Order Uniform Prices • Uniform Price (Simplified Definition): Weighted average price calculated as sum across all classes of (min. class price) x (% of milk in class) • % referred to as utilization • Actual uniform price more complicated but weighted value relatively close • With market-wide pooling all handlers share in pool and pay producers same min. uniform price (ignoring differences in milk composition, quality and plant location)

  14. Concept of Pooling Pool Handlers with milk value higher than uniform price pay into the pool Handlers with milk valuelowerthan uniform price draw from the pool Handlers Handlers pay producers the same price regardless of how milk is used Producers

  15. Producer Price Differential • Producers in 6 MCP orders (including the UMW) do not receive uniform price directly • Federal order payment based on value of butterfat, protein, other solids, a SCC adjustment and producer price differential (PPD). • PPD accounts for difference between Class I, II, and IV prices and Class III price • Except for some minor adjustments: PPD approx. = uniform price - Class III price

  16. Producer Price Differential • Producers are paid via the following: ProducerPayment = Butterfat Lbs/Cwt x Class III Butterfat Value + Protein Lbs/Cwt Class III Protein Value + Other Solids Lbs/Cwt x Class III Other Solids Value + PPD + SCC adjustment

  17. Producer Price Differential • Class III price reflects total value of protein, butterfat and other solids in producer’s total cwt of marketed milk • PPD is the added value per cwt of that portion of an Order’s milk used for Class I, II and IV. • In approximate terms, for each 6 MCP orders : PPD = % Class I x (Class I price – Class III price) + % Class II x (Class II price – Class III price) + % Class IV x (Class IV price – Class III price)

  18. Producer Price Differential • What has been recent experience of uniform prices and the PPD in the Upper Midwest (UMW) Order?

  19. = Neg. PPD month

  20. April 2004 PPD Note: The Class I price is the Class I mover plus the differential for Cook County, IL

  21. April 2004 PPD • Negative $4.11 Upper Midwest PPD • Over the Mar. 19-Apr 30 period there was a significant increase in cheese price • Two-week avg. cheese price for advanced Class I calc.: $1.4582/lb • Monthly avg. cheese price for Class III calc.: $2.0520/lb, $0.5938 higher than advance value

  22. April 2004 PPD

  23. Why The Negative April 2004 PPD? • Steep run-up in cheese prices between advance and Class III announcement periods • Created an inverse relationship between normally higher Class I and Class III price • Price inversion occurs if: • The monthly Class III price is higher than the Class I Mover by more than the Class I differential

  24. Why The Negative April 2004 PPD? • Besides difference in Class III and Class I, April Class II and IV prices were well below Class III • Value of milk used for butter and NFDM well below milk value used for cheese • Substantially reduced value of components for Class II and IV milk

  25. Why The Negative April 2004 PPD? • Changes in class utilization due to depooling added to size of negative PPD • Manufacturing plants can depool from an order prior to release of monthly classified prices • Bottling plants are not allowed to depool • To understand why a plant depools or not: • Relationship among class prices and timing of Federal Order price announcements • Obligation of pooled handlers to producer settlement fund • Lets compare April 2003 and April 2004

  26. Why The Negative April 2004 PPD? April 2003 Upper Midwest Order PPD= $0.46

  27. Why The Negative April 2004 PPD? • Class III and IV plants have economic incentive to pool • Class I handler pays into pool $1.63: $11.44 - $9.87 • Class II handler pays into pool $0.63: $10.44 - $9.87 • Class III handler draws out of pool $0.46: $9.87 - $9.41 • Class IV handler draws out of pool $0.14: $9.87 - $9.73 Class I price Uniform price Class II price Uniform price Uniform price Uniform price Class III price Class IV price

  28. Why The Negative April 2004 PPD? April 2004 Upper Midwest Order PPD = -$4.11

  29. Why The Negative April 2004 PPD? • Class III plants have economic incentive to depool as they would have to pay into the pool • 1.4 Bil. lbs. Class III milk in April 2003, 11.0 Mil. in 2004 • Class III milk pays into pool $4.11 ($19.66-$15.55) • Class I handlers have no choice but to pool • Draw from the pool $0.11 ($15.55-15.44) • Class II and Class IV handlers have incentive to pool because they draw out of the pool. • Class II milk draw out of the pool, $0.34, Class IV milk subject to a draw of $0.98

  30. Why The Negative April 2004 PPD? →If had more typical pooling patterns in April 2004, the PPD would have been close to -$1.00 vs. -$4.11

  31. Dec 2004 Pooling and Class Prices PPD = -$0.95

  32. Dec 2004 Pooling and Class Prices →If more typical pooling patterns in Dec 2004, PPD would have been close to -$.35 vs. -$0.95

  33. UMW Utilization Patterns: 2003-2004

  34. Summary • Why the negative PPD’s? • Advanced pricing system for Class I milk • 6-7 week delay until Class III price set • Easy for Class III plants to depool one month and pool the next • What does it mean for 2005? • What is happening in the cheese markets? • Any changes in pooling policy?

  35. Summary • If you want more detail • access the publications section of the University of Wisconsin Dairy Marketing Website • www.aae.wisc.edu/future • Feel free to contact me anytime: • gould@aae.wisc.edu

  36. Thank You!!

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