Producer Price Differentials: The Good, The Bad and The Ugly Brian W. Gould Department of Agricultural and Applied Economics and Wisconsin Center for Dairy

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

Brian W. GouldBrian W. Gould

Department of Agricultural and Applied Economics Department of Agricultural and Applied Economics andand

Wisconsin Center for Dairy ResearchWisconsin Center for Dairy Research

University of Wisconsin-MadisonUniversity of Wisconsin-Madison

Wisconsin Dairy Field Wisconsin Dairy Field

Representatives ConferenceRepresentatives Conference

February 9, 2005February 9, 2005

Outline of PresentationOutline of Presentation

• Review Aspects of Federal Orders and Review Aspects of Federal Orders and Classified Milk PricingClassified Milk Pricing– Most should be familiar with this materialMost should be familiar with this material

• Definition of Producer Price Differentials (PPD)Definition of Producer Price Differentials (PPD)– Exists due to Classified Pricing/PoolingExists due to Classified Pricing/Pooling

• Overview of Recent PPD Experiences in UMWOverview of Recent PPD Experiences in UMW

– Reasons for recent negative PPD’sReasons for recent negative PPD’s

• Implications for the FutureImplications for the Future

Federal Milk Marketing OrdersFederal Milk Marketing OrdersApril 2004 - PresentApril 2004 - Present

MCP Markets

Federal Milk Marketing OrdersFederal Milk Marketing Orders

• Regulate Regulate HandlersHandlers not producers not producers

• Objectives of the program:Objectives of the program:– Assure dairy farmers reasonable Assure dairy farmers reasonable minimumminimum milk prices milk prices

– Assure consumers an adequate milk supplyAssure consumers an adequate milk supply

– Guarantee orderly marketing of fluid milkGuarantee orderly marketing of fluid milk

• Achieves purposes via the use of:Achieves purposes via the use of:– Classified pricingClassified pricing

– Pooling where all producers share in the poolPooling where all producers share in the pool

Classes of MilkClasses of Milk

• Class IClass I: beverage milk: beverage milk

• Class IIClass II: fluid cream, cottage cheese, ice cream and : fluid cream, cottage cheese, ice cream and mixes, yogurt, infant formula, sour cream, etc.mixes, yogurt, infant formula, sour cream, etc.

• Class IIIClass III: hard cheese, cream cheese: hard cheese, cream cheese

• Class IVClass IV: butter, dried milk products (SMP), : butter, dried milk products (SMP), evaporated and evaporated and condensed milk

How Are Class Prices Determined?How Are Class Prices Determined?

• Based on commodity prices which are used in Based on commodity prices which are used in formulas to determine component valuesformulas to determine component values

• NASS surveys butter, cheese, dry whey and NASS surveys butter, cheese, dry whey and NFDM plants NFDM plants each Fridayeach Friday for sales data for sales data

– Prices and weekly sales are reported the Prices and weekly sales are reported the next Fridaynext Friday


• Class I skim milk, Class I butterfat and Class II Class I skim milk, Class I butterfat and Class II skim milk formula prices are skim milk formula prices are advanced pricesadvanced prices – Reported on a Friday on or before the 23Reported on a Friday on or before the 23 rdrd of the of the

month month priorprior to production month to production month

– For example, Feb. 2005 Class I price For example, Feb. 2005 Class I price Announced on Friday Jan. 21Announced on Friday Jan. 21stst Based on NASS survey prices for weeks beginningBased on NASS survey prices for weeks beginning

Jan. 2Jan. 2ndnd and Jan. 9 and Jan. 9thth..


• Class II BF price, Class IV and Class III skim Class II BF price, Class IV and Class III skim and BF prices are announced on a Friday on or and BF prices are announced on a Friday on or before the 5before the 5thth of the month of the month following following productionproduction

– Prices for Feb 2005 will be announced on Friday, Prices for Feb 2005 will be announced on Friday, Mar 4Mar 4thth

– NASS Survey Prices for weeks beginning Jan 27NASS Survey Prices for weeks beginning Jan 27 thth, , Feb 6Feb 6thth, Feb 13, Feb 13thth and Feb 20 and Feb 20thth

• There is a There is a 6 or 7 week6 or 7 week difference in timing of difference in timing of prices used in advanced pricing of Class I and the prices used in advanced pricing of Class I and the remaining Class prices for the same monthremaining Class prices for the same month


• Minimum class prices are calculated usingMinimum class prices are calculated using– NASS weekly survey pricesNASS weekly survey prices– Assumed make allowances (plant costs) for Assumed make allowances (plant costs) for

cheese, butter, dry whey, NFDMcheese, butter, dry whey, NFDM– Assumed cwt yields of cheese, butter, dry whey Assumed cwt yields of cheese, butter, dry whey

and NFDMand NFDM– Assumed raw milk compositionAssumed raw milk composition

3.5% butterfat 3.5% butterfat 2.99% true protein2.99% true protein5.69% other solids5.69% other solids

• Class I and Class II prices typically higher Class I and Class II prices typically higher than Class III and Class IV pricesthan Class III and Class IV prices

• Class III milk price= 3.5*Class III/IV butterfat Class III milk price= 3.5*Class III/IV butterfat value + 0.965 Class III skim milk pricevalue + 0.965 Class III skim milk price– Butterfat value=f(butter price)Butterfat value=f(butter price)

– Class III skim milk price=f(protein value, other Class III skim milk price=f(protein value, other solids value)solids value) Protein value=f(cheese and butter price)Protein value=f(cheese and butter price) Other solids price=f(dry whey price)Other solids price=f(dry whey price)


• Class IV Price= 3.5* Class III/IV butterfat Class IV Price= 3.5* Class III/IV butterfat value + 0.965*Class IV skim milk pricevalue + 0.965*Class IV skim milk price– Butterfat value=f(butter price)Butterfat value=f(butter price)

– Class IV Skim Milk Price=f(NFDM price)Class IV Skim Milk Price=f(NFDM price)

• Class II Price=3.5 *Butterfat price+0.965 Class II Price=3.5 *Butterfat price+0.965 advancedadvanced Class II skim milk price Class II skim milk price– Butterfat value=Class IV butterfat price + $0.007Butterfat value=Class IV butterfat price + $0.007

– Advanced Class II skim milk price=advanced Advanced Class II skim milk price=advanced Class IV skim milk price+$0.70Class IV skim milk price+$0.70


• Class I Advance (Class I Advance (higher of higher of ) Pricing) Pricing– Class I skim milk value is the Class I skim milk value is the higher ofhigher of advancedadvanced

Class III or Class IV skim milk priceClass III or Class IV skim milk price

– Class I mover= (0.965 x Class I skim milk value) + Class I mover= (0.965 x Class I skim milk value) + 3.5 x 3.5 x advancedadvanced Class III/IV butterfat value Class III/IV butterfat value

• Class I price = Class I mover plus a differentialClass I price = Class I mover plus a differential– County specific Class I differential is added to County specific Class I differential is added to

Class I mover to determine min. Class I price Class I mover to determine min. Class I price

– For Chicago area, differential is $1.80For Chicago area, differential is $1.80


• Uniform Price (Uniform Price (Simplified DefinitionSimplified Definition)): Weighted : Weighted average price calculated as sum across all classes average price calculated as sum across all classes of (min. class price) x (% of milk in class)of (min. class price) x (% of milk in class)– % referred to as % referred to as utilizationutilization

• Actual uniform price more complicated but Actual uniform price more complicated but weighted value relatively close weighted value relatively close

• With market-wide pooling all handlers share in With market-wide pooling all handlers share in pool and pay producers same min. uniform price pool and pay producers same min. uniform price (ignoring differences in milk composition, quality (ignoring differences in milk composition, quality and plant location)and plant location)

Federal Order Uniform PricesFederal Order Uniform Prices

Concept of PoolingConcept of Pooling

PoolPool

HandlersHandlers

ProducersProducers

Handlers withmilk value higherthan uniform pricepay into the pool

Handlers withmilk value lower thanuniform price drawfrom the pool

Handlers pay producers the same price regardless of how milk is used

• Producers in 6 MCP orders (including the Producers in 6 MCP orders (including the UMW) do not receive uniform price directlyUMW) do not receive uniform price directly– Federal order payment based on value of butterfat, Federal order payment based on value of butterfat,

protein, other solids, a SCC adjustment and protein, other solids, a SCC adjustment and producer price differential (PPD)producer price differential (PPD)..

• PPD accounts for difference between Class I, PPD accounts for difference between Class I, II, and IV prices and Class III priceII, and IV prices and Class III price– Except for some minor adjustments:Except for some minor adjustments:

PPD approx. = uniform price - Class III pricePPD approx. = uniform price - Class III price

Producer Price DifferentialProducer Price Differential


• Producers are paid via the following:Producers are paid via the following:

ProducerProducer Payment =Payment =

Butterfat Lbs/Cwt x Class III Butterfat Value Butterfat Lbs/Cwt x Class III Butterfat Value

+ Protein Lbs/Cwt Class III Protein Value+ Protein Lbs/Cwt Class III Protein Value

+ Other Solids Lbs/Cwt x Class III Other Solids + Other Solids Lbs/Cwt x Class III Other Solids ValueValue

+ + PPDPPD

++ SCC adjustment SCC adjustment


• Class III price reflects total value of protein, Class III price reflects total value of protein, butterfat and other solids in producer’s total cwt of butterfat and other solids in producer’s total cwt of marketed milkmarketed milk

• PPD is the PPD is the added value per cwtadded value per cwt of that portion of of that portion of an Order’s milk used for Class I, II and IV.an Order’s milk used for Class I, II and IV.

• In approximate terms, for each 6 MCP orders :In approximate terms, for each 6 MCP orders :PPDPPD = % Class I x (Class I price – Class III price) = % Class I x (Class I price – Class III price)

+ % Class II x (Class II price – Class III price)+ % Class II x (Class II price – Class III price) + % Class IV x (Class IV price – Class III price)+ % Class IV x (Class IV price – Class III price)


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

Uniform Price and PPD's: Upper Midwest Federal Order ($/cwt)

0.00

4.00

8.00

12.00

16.00

20.00

Class III/Uniform

-4.50-3.50-2.50-1.50-0.500.501.502.503.504.505.506.50PPD

Uniform Price Class III

Actual PPD 0 PPD

Uniform and Class III Price Upper Midwest Federal Order

8.00

10.00

12.00

14.00

16.00

18.00

20.00

$/cwt

Uniform Price Class III

= Neg. PPD month

April 2004 PPDApril 2004 PPD

Milk ClassMilk Class

Pricing Time Pricing Time PeriodPeriod

Announced Announced DateDate

PricePrice Class Price Class Price – Class III– Class III

Class I Class I 2/29 - 3/132/29 - 3/13 3/19/043/19/04 $15.44$15.44 -$4.22-$4.22

Class II Class II

SkimSkim

FatFat

2/29-3/13 2/29-3/13

3/28-4/243/28-4/24

4/30/044/30/04 $15.21$15.21 -$4.45-$4.45

Class IIIClass III 3/28-4/243/28-4/24 4/30/044/30/04 $19.66$19.66 ----------

Class IVClass IV 3/28-4/243/28-4/24 4/30/044/30/04 $14.57$14.57 -$5.09-$5.09

Note: The Class I price is the Class I mover plus the differential for Note: The Class I price is the Class I mover plus the differential for Cook County, ILCook County, IL


• NegativeNegative $4.11 Upper Midwest PPD $4.11 Upper Midwest PPD

• Over the Mar. 19-Apr 30 period there was a Over the Mar. 19-Apr 30 period there was a significant increase in cheese pricesignificant increase in cheese price– Two-weekTwo-week avg. cheese price for advanced Class I avg. cheese price for advanced Class I

calc.: $1.4582/lbcalc.: $1.4582/lb

– MonthlyMonthly avg. cheese price for Class III calc.: avg. cheese price for Class III calc.: $2.0520/lb, $2.0520/lb, $0.5938 higher$0.5938 higher than advance value than advance value


Class Price FactorClass Price Factor AdvancedAdvanced AnnouncedAnnounced % Change% Change

Class III Skim Milk ($/cwt)Class III Skim Milk ($/cwt) $5.64$5.64 $11.30$11.30 100.4100.4

Class IV Skim Milk ($/cwt)Class IV Skim Milk ($/cwt) $5.96$5.96 $6.03$6.03 1.21.2

Butterfat Price ($/lb)Butterfat Price ($/lb) $2.2525$2.2525 $2.5013$2.5013 11.011.0

Average Product PriceAverage Product Price

Butter ($/lb)Butter ($/lb) $1.9921$1.9921 2.19942.1994 10.410.4

NFDM ($/lb)NFDM ($/lb) $0.8090$0.8090 0.81710.8171 1.01.0

Cheese ($/lb)Cheese ($/lb) $1.4582$1.4582 2.05202.0520 40.740.7

Dry Whey ($/lb)Dry Whey ($/lb) $0.1706$0.1706 0.26020.2602 52.552.5

Why The Negative April 2004 PPD?Why The Negative April 2004 PPD?

• Steep run-up in cheese prices between advance Steep run-up in cheese prices between advance and Class III announcement periodsand Class III announcement periods– Created an inverse relationship between normally Created an inverse relationship between normally

higher Class I and Class III pricehigher Class I and Class III price

• Price inversion occurs if:Price inversion occurs if:– The The monthly Class IIImonthly Class III price is higher than the price is higher than the

Class I MoverClass I Mover by more than the Class I differential by more than the Class I differential


• Besides difference in Class III and Class I, Besides difference in Class III and Class I, April Class II and IV prices were well below April Class II and IV prices were well below Class IIIClass III– Value of milk used for butter and NFDM well Value of milk used for butter and NFDM well

below milk value used for cheesebelow milk value used for cheese

– Substantially reduced value of components for Substantially reduced value of components for Class II and IV milkClass II and IV milk


• Changes in class utilization due to Changes in class utilization due to depooling depooling added to size of negative PPDadded to size of negative PPD

• Manufacturing plants can depool from an order Manufacturing plants can depool from an order prior to release of monthly classified pricesprior to release of monthly classified prices

• Bottling plants are not allowed to depoolBottling plants are not allowed to depool• To understand why a plant depools or not:To understand why a plant depools or not:

– Relationship among class prices and timing of Relationship among class prices and timing of Federal Order price announcementsFederal Order price announcements

– Obligation of pooled handlers to producer Obligation of pooled handlers to producer settlement fundsettlement fund

• Lets compare April 2003 and April 2004Lets compare April 2003 and April 2004

ClassClass PricePrice UtilizationUtilization ValueValue

%% Mil lb.Mil lb.

Class IClass I $11.44$11.44 18.218.2 338.1338.1 $2.08$2.08

Class IIClass II $10.44$10.44 2.82.8 52.852.8 $0.29$0.29

Class IIIClass III $9.41$9.41 76.876.8 1,430.91,430.9 $7.73$7.73

Class IVClass IV $9.73$9.73 2.22.2 41.041.0 $0.21$0.21

Weighted Average Pool ValueWeighted Average Pool Value $9.81$9.81

Actual Uniform PriceActual Uniform Price $9.87$9.87PPD= $0.46PPD= $0.46

April 2003 Upper Midwest OrderApril 2003 Upper Midwest Order


• Class III and IV plants have economic incentive to poolClass III and IV plants have economic incentive to pool

• Class I handler pays into pool $1.63: $11.44 - $9.87Class I handler pays into pool $1.63: $11.44 - $9.87

• Class II handler pays into pool $0.63: $10.44 - $9.87Class II handler pays into pool $0.63: $10.44 - $9.87

• Class III handler draws out of pool $0.46: $9.87 - $9.41Class III handler draws out of pool $0.46: $9.87 - $9.41

• Class IV handler draws out of pool $0.14: $9.87 - $9.73Class IV handler draws out of pool $0.14: $9.87 - $9.73

Class I priceClass I price

Uniform priceUniform priceClass II priceClass II price

Uniform priceUniform priceUniform priceUniform price

Class III priceClass III priceUniform priceUniform price

Class IV priceClass IV price


ClassClass PricePrice

($/cwt)($/cwt)

UtilizationUtilization ValueValue

($/cwt)($/cwt)%% Mil lb.Mil lb.

Class IClass I $15.44$15.44 62.862.8 381.8381.8 $9.70$9.70

Class IIClass II $15.21$15.21 15.815.8 96.396.3 $2.40$2.40

Class IIIClass III $19.66$19.66 1.81.8 11.011.0 $0.35$0.35

Class IVClass IV $14.57$14.57 19.619.6 119.0119.0 $2.86$2.86

Weighted Average Pool ValueWeighted Average Pool Value $15.31$15.31

Actual Uniform PriceActual Uniform Price $15.55$15.55PPD = -$4.11PPD = -$4.11

April 2004 Upper Midwest OrderApril 2004 Upper Midwest OrderWhy The Negative April 2004 PPD?Why The Negative April 2004 PPD?

• Class III plants have economic incentive to Class III plants have economic incentive to depooldepool as they would have to pay into the pool as they would have to pay into the pool– 1.4 1.4 BilBil. lbs. Class III milk in April 2003, 11.0 . lbs. Class III milk in April 2003, 11.0 Mil.Mil. in 2004 in 2004

– Class III milk pays into pool $4.11 ($19.66-$15.55)Class III milk pays into pool $4.11 ($19.66-$15.55)

• Class I handlers have no choice but to poolClass I handlers have no choice but to pool– Draw from the pool $0.11 ($15.55-15.44)Draw from the pool $0.11 ($15.55-15.44)

• Class II and Class IV handlers have incentive to Class II and Class IV handlers have incentive to pool because they draw out of the pool.pool because they draw out of the pool.– Class II milk draw out of the pool, $0.34, Class IV milk Class II milk draw out of the pool, $0.34, Class IV milk

subject to a draw of $0.98 subject to a draw of $0.98


ClassClass

20042004

PricePrice

($/cwt)($/cwt)

2003 2003 Utilization Utilization

(%)(%)

Simulated Simulated ValueValue

($/cwt)($/cwt)

Class IClass I $15.44$15.44 18.218.2 $2.81$2.81

Class IIClass II $15.21$15.21 2.82.8 $0.43$0.43

Class IIIClass III $19.66$19.66 76.876.8 $15.10$15.10

Class IVClass IV $14.57$14.57 2.22.2 $0.32$0.32

Simulated Average Pool ValueSimulated Average Pool Value $18.66$18.66

Actual Weighted Avg. Pool ValueActual Weighted Avg. Pool Value $15.31$15.31

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


Dec 2004 Pooling and Class PricesDec 2004 Pooling and Class PricesClass Price FactorClass Price Factor AdvancedAdvanced AnnouncedAnnounced % %

ChangeChange

Class III Skim Milk ($/cwt)Class III Skim Milk ($/cwt) $8.12$8.12 $9.34$9.34 15.015.0

Class IV Skim Milk ($/cwt)Class IV Skim Milk ($/cwt) $6.37$6.37 $6.52$6.52 2.42.4

Butterfat Price ($/lb)Butterfat Price ($/lb) $1.8834$1.8834 $2.0366$2.0366 8.18.1

Average Product PriceAverage Product Price

Butter ($/lb)Butter ($/lb) $1.6845$1.6845 1.81221.8122 7.67.6

NFDM ($/lb)NFDM ($/lb) $0.8553$0.8553 0.87130.8713 1.81.8

Cheese ($/lb)Cheese ($/lb) $1.5481$1.5481 1.71461.7146 10.810.8

Dry Whey ($/lb)Dry Whey ($/lb) $0.2338$0.2338 0.24230.2423 4.14.1

PPD = PPD = -$0.95-$0.95

ClassClass

Dec Dec 20042004

PricePrice

($/cwt)($/cwt)

Dec Dec 2004 2004 Util.Util.

(%)(%)

Dec Dec 2003 2003 Util.Util.

(%)(%)

2004 2004 ValueValue

($/cwt)($/cwt)

2003 2003 Simulated Simulated

ValueValue

($/cwt)($/cwt)

Class IClass I $16.23$16.23 59.359.3 18.118.1 $9.62$9.62 $2.94$2.94

Class IIClass II $13.98$13.98 15.215.2 5.25.2 $2.12$2.12 $0.73$0.73

Class IIIClass III $16.14$16.14 5.35.3 68.568.5 $0.80$0.80 $11.06$11.06

Class IVClass IV $13.42$13.42 20.220.2 8.28.2 $2.71$2.71 $1.10$1.10

Simulated Average Pool ValueSimulated Average Pool Value $15.25$15.25 $15.83$15.83

Uniform PriceUniform Price $15.19$15.19 ----------→→ If more typical pooling patterns in Dec 2004, If more typical pooling patterns in Dec 2004, PPD would have been close to -$.35 vs. -$0.95PPD would have been close to -$.35 vs. -$0.95

Dec 2004 Pooling and Class PricesDec 2004 Pooling and Class Prices

2003 % Class 2003 % Class UtilizationUtilization

PPDPPD

2004 % Class 2004 % Class UtilizationUtilization

PPDPPDII IIII IIIIII IVIV II IIII IIIIII IVIV

JanJan 19.719.7 2.32.3 76.076.0 2.02.0 0.58 0.58 JanJan 17.817.8 5.55.5 68.968.9 7.87.8 0.37 0.37

FebFeb 18.518.5 2.42.4 74.274.2 4.94.9 0.47 0.47 FebFeb 18.318.3 4.34.3 74.474.4 3.03.0 0.47 0.47

MarMar 17.517.5 2.72.7 77.377.3 2.52.5 0.54 0.54 MarMar 58.758.7 11.211.2 12.312.3 17.817.8 0.21 0.21

AprApr 18.218.2 2.82.8 76.876.8 2.22.2 0.46 0.46 AprApr 62.862.8 15.815.8 1.81.8 19.619.6 (4.11)(4.11)

MayMay 17.917.9 2.52.5 77.977.9 1.71.7 0.40 0.40 MayMay 53.253.2 17.517.5 4.64.6 24.724.7 (1.97)(1.97)

JunJun 15.615.6 2.72.7 77.477.4 4.34.3 0.38 0.38 JunJun 15.915.9 6.36.3 69.869.8 8.18.1 0.30 0.30

JulJul 49.749.7 15.915.9 11.611.6 22.822.8 (0.41)(0.41) JulJul 16.116.1 5.85.8 70.870.8 7.37.3 0.72 0.72

AugAug 50.650.6 18.418.4 8.48.4 22.622.6 (1.58)(1.58) AugAug 18.018.0 6.66.6 68.268.2 7.37.3 0.22 0.22

SepSep 54.054.0 17.617.6 5.75.7 22.722.7 (1.07)(1.07) SepSep 29.129.1 8.98.9 51.951.9 10.110.1 0.13 0.13

OctOct 55.255.2 17.017.0 4.84.8 23.023.0 (0.88)(0.88) OctOct 18.918.9 5.75.7 68.668.6 6.76.7 0.31 0.31

NovNov 35.635.6 11.011.0 36.236.2 17.217.2 (0.07)(0.07) NovNov 40.640.6 11.711.7 35.735.7 12.0 12.0 0.130.13

DecDec 18.118.1 5.25.2 68.568.5 8.28.2 0.54 0.54 DecDec 59.359.3 15.215.2 5.35.3 20.2 20.2 (0.95)(0.95)

UMW Utilization Patterns: 2003-2004

SummarySummary

• Why the negative PPD’s?Why the negative PPD’s?– Advanced pricing system for Class I milkAdvanced pricing system for Class I milk

6-7 week delay until Class III price set6-7 week delay until Class III price set

– Easy for Class III plants to depool one month Easy for Class III plants to depool one month and pool the nextand pool the next

• What does it mean for 2005?What does it mean for 2005?

– What is happening in the cheese markets? What is happening in the cheese markets?

– Any changes in pooling policy?Any changes in pooling policy?

SummarySummary

• If you want more detail If you want more detail – access the publications section of the access the publications section of the University University

of Wisconsin Dairy Marketing Websiteof Wisconsin Dairy Marketing Website www.aae.wisc.edu/futurewww.aae.wisc.edu/future

– Feel free to contact me anytime:Feel free to contact me anytime: [email protected]@aae.wisc.edu

Thank You!!Thank You!!

Documents

Producer Price Differentials: The Good, The Bad and The Ugly Brian W. Gould Department of Agricultural and Applied Economics and Wisconsin Center for Dairy