University of Wisconsin Center for Cooperatives
Rural Cooperatives, November/December 1997, pp. 4-10
Published by the USDA Rural Business and Cooperative Development Service
How Dairy Cooperatives Impact Farm-Level Milk Prices
Both the volatility and the level of farm milk prices have frustrated many in the nation's dairy industry, including dairy marketing cooperatives and their farmer owners. Some producers have pointed the finger of blame at the National Cheese Exchange (now the Chicago Mercantile Exchange), the federal government, the failure of dairy cooperatives, dairy imports, the university extension service and others.
The following questions and answers have been compiled in the interest of creating a better understanding of industry conditions. The story they tell speaks of a resurgence in the dairy industry as it begins to adjust to life without federal government price supports and the impact of the shrinking number of federal milk marketing orders. Those who survive in the changing industry will be adapting modern technology and seeking new ways to penetrate both the domestic and export markets.
Question: Why are butter, nonfat dry milk, cheese and farm-leuel milk prices more volatile today than they use to be?
The volatility reflects the open market created by
a major change in federal dairy price support policy From 1950 until 1981,
the price of manufacturing milk was supported at between 75 percent and
90 percent of parity, or close to the market price. Supports provided stability
and an effective floor under milk prices. The Commodity Credit Corporation
(CCC) purchased butter, nonfat dry milk and cheddar cheese at specified
support prices. This enabled the average butter/powder and cheese plants
to pay the support price to dairy farmers. When these prices fell to these
specified prices, manufacturing milk plants sold to the CCC, keeping manufacturing
milk prices near the support level.
When the price increased, CCC sold these products back into the commercial market, thereby dampening the increase in milk prices as well. By purchases and sellbacks, the CCC prevented major price falls and increases while also achieving price stability.
But during the late 1970s and early l980s, the level of CCC purchases of surplus dairy products under the support program became burdensome. As a result, in 1981, the parity support program was terminated. In its place, Congress set the level of support based on the level of CCC purchases and expenditures. The support price for manufacturing milk was reduced from $13.10 per hundredweight in 1981 to $ 10.10 per hundredweight in 1990, where it remained through 1995. Provisions of the Federal Agriculture Improvement Act (FAIR) of 1996 increased the support price to $10.35 per hundredweight for 1996, but lowered it 15 cents per hundredweight per year starting in 1997 and terminated supports by the end of 1999.
A support at $ 10.10 per humdredweight is below the full cost of production of most farmers and below the cash cost of some. Therefore, since 1990, the support price has offered only a limited safety net under farm milk prices. As a result, farm level milk prices have been very volatile, but above the support price since 1991. CCC primarily purchased surplus milkfat as butter in 1991-94, but purchased virtually nothing in 1995-97. CCC stocks of butter, nonfat dry milk and cheese were eliminated. Further, there were no sales back into the commercial market to dampen price increases.
Market forces now determine milk prices, not the federal dairy price support program. Milk prices fluctuate with no real restrictions. The dairy industry at all levels, from the farm to the end-channel buyers, is facing the challenge of learning to manage this new price volatility. Tools are available, such as dairy futures and options, and new tools are being developed to manage price risks.
Q: What was the milk supply-demand situation for 1996?
Milk production for 1996 was down 0.7 percent from 1995, on a milkfat basis. Daily commercial disappearance was up 0.2 percent. So, supply and demand were in close balance in 1996.
Q: Did the U.S. in 1996 produce enough milk to meet its own needs?
While commercial disappearance was greater than total milk production in 1996, some falsely contended that the United States had a shortage of dairy products and had to rely on imports. The United States annually imports some dairy products that add to its total supply, but quotas and tariffs hold imports in check. Import levels have been about the same for many years. Meanwhile, U.S. dairy exports have exceeded dairy imports during 1991-95, with some exports impacting the commercial disappearance numbers.
U.S. dairy imports changed little from 1994 to 1996. When domestic prices are relatively high compared to world prices, imports are attracted to the United States; our nation's dairy products are less competitive on the world market, and our dairy exports decline. Further, with record high cheese prices, nonfat dry milk was used to make cheese in 1996 and not exported under the Dairy Export Incentive Program (DEIP), as in 1995.
In 1996, the supply and demand for milk was essentially in balance. Significant CCC purchases of surplus dairy products occurred annually from 1979 to 1989. In 1985, the CCC purchased 9.4 percent of all milk marketed by dairy farmers, at a cost of more than $2 billion. Congress struggled with these large surpluses and associated costs. Supply management programs (the Dairy Diversion and Dairy Termination Programs), a 1988 drought, and a significant reduction in the support level from 1981 to 1990 slowed the growth in milk production. This, along with relatively good commercial sales, solved the milk surplus problem in the l990s.
Q: Given reduced milk production, why did cheese and butter prices and the Basic Formula Price (BFP) decline sharply during the last quarter of 1996?
Although total milk production was down in 1996, the United States produced about 4 percent more total cheese—American cheese production increased 5 percent and Italian by 4 percent. That had a significant impact on the market. Sales of American cheese were up just 2.7 percent and sales of other varieties climbed just 2 percent. Higher retail prices dampened sales during the last quarter of 1996. Both 1996 cheese stocks and prices were much higher than in 1995.
Record cheese prices in the fall were hard to justify, based on cheese production, sales and stocks. On Oct. 18 (Black Friday) cheese prices tumbled. Butter prices fell relatively more. So, August and September cheese and butter prices were higher than anticipated, or could be justified with existing supply and demand conditions.
Q: Then why were cheese prices at these levels?
A variety of circumstances created the situation: poor first crop hay and delayed plantings for grain, historically low U.S. and world grain stocks at the start of the year, questionable corn crop and higher grain prices in 1995-96 meant less milk. Milk production had been running below a year earlier, and cheese buyers aggressively built inventories in anticipation of tight supplies and even higher prices.
Q: Why did October and November cheese and butter prices drop more than expected ?
Principal among the reasons were: USDA announced a record corn crop, lower grain and soybean prices meant more milk, cheese stocks increased, milk production began to recover in the West and Southwest, and cheese buyers—in anticipation of adequate supplies and lower prices—purchased cheese only on an as needed basis for customers.
Some other factors affected 1996 and set the stage for 1997: California increased cheese production by more than 100 million pounds, a 10 percent increase. That state's cheese production exceeded 1-billion pounds for the first time, or more than 50 percent of Wisconsin's cheese production.
Q: But how did the United States increase total cheese production 4 percent when total milk production was down?
More of the existing milk supply was diverted from butter/powder production and into higher-valued cheese. California and Idaho, in particular, followed this practice. But Wisconsin, which does not make much nonfat dry milk and was already allocating about 87 percent of its milk for cheese production, could not make this switch. Further, inexpensive, nonfat dry milk was used to produce cheese, a common industry practice. Sales of nonfat dry milk increased 8.2 percent in 1996, but DEIP exports of it dropped from 130 metric tons in 1995 to just 43 metric tons in 1996.
Table 1 - Stocks of Dairy Products, July 31, 1997 vs 1996
Table 2 - Percentage Milk Production Change, 1997 vs 1996 (Selected
Q: What kept prices at low levels for the first half of 1997?
There are a number of important reasons. First, total milk production was well above 1995 and 1996 levels. The decline in milk cow numbers has slowed and there are some signs that farmers are rebuilding dairy herds. But the major reason is more milk per cow, up 4 to 5 percent, during the spring and early summer months. Milk production has been particularly strong in the West and Southwest. August production climbed 11.4 percent in California,7.5 percent in Idaho, 6.3 percent in Arizona and 8.7 percent in New Mexico. Even Wisconsin's August milk production was up 3.4 percent at a time when milk cow numbers were down. Significantly, in August, California produced nearly 2.4 billion pounds of milk, 423 million more pounds (or 21.6 percent more) than Wisconsin's 1.9 billion pounds.
Second, milk production improved greatly during the spring and summer of 1997 in the South and Southeast. A year ago, these states were experiencing significant decreases and are now showing increases. This means they need to bring in less Grade A milk from other states to make up for local shortages of milk for fluid (beverage) needs.
Consequently, shipments from Wisconsin to the Southeast declined, but that surplus supply was used for increased cheese production.
Third, much of the increased milk production is going into cheese production. Total cheese production in July (1997) was 6 percent higher than in 1996. California increased production of American cheese 21 percent between August 1996 to 1997. By comparison, production of American and Mozzarella cheese were down 2 percent for the same period.
Fourth, sales of milk and dairy products were sluggish for the first half of the year. For the period January through June of 1997 vs 1996, commercial disappearance of all dairy products on a daily basis was up just 0.6 percent. Sales of butter were down 7.4 percent, sales of American cheese up just 1.1 percent, other cheese sales increased 3.2 percent, nonfat dry milk sales were down 19.7 percent, and fluid (beverage) milk sales declined 0.3 percent. Sales of nonfat dry milk were down because lower cheese prices were not attracting nonfat dry milk for cheese production the way it did in 1996. The softer sales of dairy products is partially due to relatively high retail prices that existed in late fall of 1996 and the winter of 1997.
Fifth, with cheese production up much more than sales, the stocks of cheese were much higher than in 1996. As of July 31, 1997, stocks of Natural American cheese were up 16.8 percent from a year earlier and up 28.5 percent from two years earlier.
Sixth, the CCC has resumed purchases of surplus dairy products under the dairy prices support program. From Oct. 1, 1996 through Sept. 12,1997, the CCC purchased 1.9 million pounds of cheese, compared with none for the same period a year earlier, and 27.7 million pounds of nonfat dry milk, also compared with none for the same period the previous year.
Q: What are the prospects for milk prices for the next five years?
Without a change in federal dairy policy from the existing market orientation approach to a higher support price (safety net), predictions are for fairly flat prices from year-to-year (average all milk prices for the year in the high $12 to low $13 per hundredweight range), but with continual volatility within the year ($1.50 to $2.50 price range). With NAFTA and GATT agreements and the trend towards globalization of agriculture and increased international trade in dairy products, it would be difficult and relatively costly to return to significantly higher support prices for dairy, but that is up to Congress.
Q: How can milk prices stay in this relatively low range when dairy farmers are exiting the dairy industry at an accelerated rate and the cost of production keeps going up?
While it's true that the number of dairy farmers
exiting the dairy business is accelerating, particularly in the Upper Midwest,
at the same time considerable dairy expansion is under way and new dairy
operations are being built. Milk production continues to increase in the
Southwest, West and Northwest. With expansion and new operations, milk
production will continue to expand. This expansion and the new operations
are being made assuming average milk prices will be in the $12 per hundredweight
range. Other dairy farmers are reducing operating costs by rotational grazing,
sharing operating equipment with their neighbors or other means. The market-oriented
federal dairy policy is forcing adjustments on the farm. Milk will be produced
in areas with the least cost. Those who can produce at the lowest cost
and weather price uncertainties will be profitable.
Q: But don't dairy farmers in the Southwest, West and Northwest receive more for their milk than those in the Upper Midwest?
No, those outside the Upper Midwest actually receive a lower price. When considering mailbox prices, Upper Midwest farmers receive higher milk prices. Mailbox price is the net pay price received by farmers marketing milk to handlers who are regulated under the federal milk order. It includes all payments received for milk sold and all associated marketing costs. Prices are reported at the market average bufferfat test.
Figure 1 compares mailbox prices to the federal order blend prices. Wisconsin and Minnesota dairy farmers receive higher mailbox prices because the dairy cooperatives and other buyers are paying dairy farmers premiums well above the federal order regulated blend price (Chicago Regional and Upper Midwest Orders). In fact, mailbox prices are actually below the federal order blend prices in milk orders such as those in the Pacific Northwest, New Mexico-West Texas, the Great Basin, Southwest Idaho-Eastem Oregon and Texas.
Q: Why are mailbox prices higher in Wisconsin and Minnesota?
Dairy cooperatives and milk plants in these states pay a higher price for Grade A milk that goes into cheese than in any other state—about 70 to 90 cents above the BFP. Further, dairy cooperatives and the Wisconsin National Farmers Organization, through a common marketing agency, Central Milk Producers Cooperative (CMPC), negotiate over-order premiums on Class I milk sold in federal orders. These premiums average about $2 per hundredweight. Mailbox prices are higher only in the very high class I use markets in the South and Southeast.
Q: But won't the federal milk order reform required by the 1996 FAIR Act (farm bill), to be implemented on or before April 1, 1999, improve milk prices paid to Wisconsin and Minnesota dairy farmers?
The 1996 FAIR Act requires the U.S. secretary of agriculture to consolidate the number of existing federal milk marketing orders down from 31 to 14. The act authorizes the secretary to consider federal order pricing issues. The process is under way.
While federal order reform is important, it won't result in large milk price increases for dairy farmers in Wisconsin and Minnesota. Price enhancement and stability are more a function of the dairy price support program, which is being phased out. Classified pricing and pooling provisions of federal orders do provide some price enhancement and price stability. But the base price and mover of all class prices under federal orders is the BFP, which is determined under competitive conditions. Some dairy farmers are pushing for a higher BFP, perhaps including the cost of production or placing a floor under the BFP or Class I prices. This would change some of the objectives of federal orders to more of a price support function.
Further, California operates outside the federal order system. Its state order results in prices being paid to farmers that are considerably lower for milk going into manufactured products than those paid by milk plants elsewhere. In California, the price of milk going into cheese averages about $1 per hundredweight less than what Wisconsin cheese plants pay. But, because California is the leading producer of milk, the second largest producer of cheese and the largest producer of nonfat dry milk and butter, it is difficult to change the pricing provisions of federal orders that would force milk plants outside of California to pay substantially more for milk than do California plants. Keep in mind that butter, milk powder and cheese are sold on a national market.
Q: Why don't Wisconsin and Minnesota form a dairy compact, similar to the one that exists in the Northeast?
A dairy compact won't work for Wisconsin and Minnesota
because most of their milk goes into cheese and other manufactured products
which must be sold on
Q: Why can some non-cooperative dairy companies "pick off" some of the larger dairy farmers by paying substantially more for milk than the dairy cooperatives offer?
The answer is complex, and may best be explained through the following example involving the Chicago regional federal milk marketing order, a common marketing agency of dairy cooperatives, and the Wisconsin National Farmers Organization, which negotiates with Class I milk handlers (bottlers) that serve the Chicago market to establish an "over-order premium" on Class I milk. They operate as the Central Milk Producers Cooperative (CMPC). Its members supply about 90 percent of the milk for fluid use in the Chicago market. These premiums have been significant —running about $2 per hundredweight.
Dairy cooperatives provide a number of marketwide services that benefit all dairy producers, such as balancing Class I supply with demand on a weekly and seasonal basis, buying milk from producers, transporting bulk milk to processors, etc. It costs the cooperatives to provide these marketing services. Therefore, part of the over-order premium is needed to cover some of these costs.
Assume that an over-order premium of $1.75 per hundredweight
is negotiated, that about 20 percent of the CMPC cooperatives' milk is
Class 1, and that 35 cents of the premium is needed to cover market service
costs. A $1.40 net payment would be returned to the dairy farmers. Spreading
the $1.40 over all member's milk leaves a net of 28 cents per hundredweight.
Assume one buyer has a 90 percent Class I utilization. The buyer goes directly to the dairy farmers and avoids paying CMPC's over-order premium. Other Class I buyers obtain their milk for Class I use from CMPC cooperatives and pay the $1.75 premium.
Q: What is the cost difference for Class I milk for the buyer who does not buy from CMPC and other buyers who do?
The Class I buyers who buy from CMPC achieve some
savings from not having to provide the marketing services covered by CMPC.
If purchased from the CMPC cooperatives, the price is:
If purchased directly from dairy farmers:
The buyer who wants to attract farmers away from the dairy cooperative will need to pay the farmers some premium to beat the cooperative's pay price. SO, what can the dairy cooperative pay farmers?
Q: What do those who do not buy milk from CMPC need to pay dairy farmers to attract them away from the cooperative?
The Class I buyer must outpay the cooperative. If
the Class I buyer offered dairy farmers a $1.25 per hundredweight premium,
its pay price would be:
Q: How can the Class I buyer who is outpaying the dairy cooperative by $0.97 per cwt be actually buying milk cheaper than if it bought milk from CMPC cooperatives?
Total cost of milk if bought from CMPC cooperatives:
Total cost of milk if bought directly from dairy farmers:
While this illustration assumed the Class I buyer had just Class I and Class $11.285 III milk use and no Class II or Class III- $.280 A, it does not change the point being made. $11.565/Cwt
Q: Under this scenario, what happens in the long run?
The Class I buyer who deals directly with dairy farmers has a lower cost for its Class I milk than those who buy from the CMPC cooperatives. As a result, it can offer package fluid milk to its customers (store accounts, school milk programs) at a lower price (about 2.8 cents per gallon less) than the other buyers. The other buyers will lose customer accounts to this Class I buyer if they keep paying the $1.75 over order premium.
It hurts the CMPC cooperatives if their buyers lose accounts and don't need milk. So, the CMPC cooperatives are forced to either lower the over-order premium or rebate a "competitive credit" to their buyers so they can still compete with this other Class I buyer for customer accounts. This process sets up a cycle that results in lower prices for dairy farmers.
In the short run, those dairy farmers who switch from the dairy cooperative to a Class I buyer, who offers a higher pay price than the cooperative, gain in the short term. But in the long term, over order premiums are reduced and this Class I buyer no longer needs to pay as high a premium to outpay the cooperatives.
Therefore, in the long run, all dairy farmers lose with lower milk prices. If all dairy farmers would market together through their cooperatives, all producers could benefit in both the short and long term rather than just those who benefit in the short run by making a special deal with a Class I buyer attempting to break the bargaining power of cooperatives.
Q: Why can't dairy cooperatives or a group of organized dairy farmers bargain for higher milk prices?
They can under provisions of the Capper Volstead Act of 1922. It gives farmers the legal right to organize for the purpose of bargaining and marketing. Dairy cooperatives fall under the law as do bargaining organizations such as the National Farmers Organization. To achieve success, both parties at the bargaining table need to gain something. The CMPC example shows that it's possible to negotiate a premium on milk by offering a supply along with some marketwide services that also benefit the buyer of CMPC milk. But the CMPC example shows there is a need for supply control. While CMPC has about 90 percent of the market, the special deals made by the other 10 percent breaks down the bargaining power of CMPC.
It appears that some farmers are always willing to accept special deals for "short-run" gains and not stick together in a bargaining effort. But supply control is much more than this. Bargaining won't be effective if prices are enhanced and dairy farmers respond with increased milk production at a level greater than the market will clear at that price.
And since dairy markets are national, one part of the country can't in the long run achieve significant bargaining power without a similar effort and supply control in other parts of the country. Higher U.S. prices may also trigger increased imports of dairy products into the U.S. market. Reduced exports may also occur with existing GATT provisions.
This situation is rather like that of the auto industry. Manufacturers set the price of cars, but then make only the number of cars that they can sell at that price. Sometimes they overproduce cars and offer special deals to move excess inventory. And, finally, the concentration of market power among buyers of milk and dairy products from dairy cooperatives and the concentration of power among the final distributors of food products to consumers complicates the ability to push farm-level price increases through the food system. These buyers and sellers of food products are all competing for an increased share of the consumer dollar by being the lowest cost supplier of high-quality products.
Farm-level milk prices in Wisconsin and the Upper
Midwest are already relatively high, especially compared with the West.
This further limits the ability for unilaterally bargaining for higher
prices in Wisconsin alone without further eroding its market share for
manufactured products under current conditions.
Q: Are dairy cooperatives more interested in making a profit than they are in earning better prices for their dairy farmer members?
First of all, dairy farmers have a say in the cooperative by exercising their rights and responsibilities of being informed, attending the annual or district meetings, reading the cooperative's publication, asking questions, participating in the election of qualified directors to represent them and then holding the directors accountable but also respecting their decisions.
After all, directors should be in a better position to set policy and hold the manager or chief executive officer accountable than the members in general, simply because directors have spent more time and have more information available to them than other members. The directors are legally responsible to protect the equity of all members in the cooperative. That means members will be paid prices that are realistic under existing supply and demand conditions and operating costs of the cooperative.
Both dairy farmers and dairy cooperatives need to make a profit—not only to survive but also to grow. There are some real opportunities for dairy farmers to add value to their milk by processing, packaging and marketing it and other dairy products and thereby capturing more of the consumer dollar. But dairy processing, packaging and marketing requires substantial amounts of capital for equipment, modem technology and market penetration.
Some dairy cooperatives are doing a good job of this, but there are additional opportunities. Members have a responsibility to provide equity capital to their cooperatives, which can't operate entirely on debt capital. Hence, dairy cooperatives must make a net profit at the end of the year to maintain themselves and provide for future growth.
Cooperatives need to keep up with modern technology that will enable them to add value to members' milk, and to retire the equity of those members who have retired from dairying. Remaining profits are returned to members as cash patronage refunds. Noncooperative dairy firms do not pay cash patronage refunds.
Another critical issue facing dairy cooperatives is how to obtain the capital to modernize and grow in the increasingly competitive market place—essentially a problem similar to that faced on the farm . If members of dair y cooperatives are the source of that capital, in a sense the relatively high milk prices paid in the Upper Midwest come at the expe nse of ensuring proper capitalizati on for long-term market share and growth.
Upper Midwest dairy cooperatives already pay higher prices for milk going into cheese and other manufactured dairy products than any other region of the United States. Yet, they need to market these products competitively in a national market. Because these cooperatives are able to get some premiums for their products, plus additional value out of processing byproducts such as whey and other products, they still have some profits left at the end of the year.
But, there is always room for improvement. While
members should hold directors accountable, and directors hold management
accountable to strive for improvements and add value to members' milk,
they also need to recognize the realities of the marketplace and have realistic
expectations as to what may be accomplished.