Recent news of negative producer price differentials (PPDs) has resulted in massive depooling of milk from Federal Milk Marketing Orders (FMMOs). This depooling, and not the negative PPDs that led to it, is the real threat to dairy farm income.
To see why, let’s begin with a broad look at how prices get set in a FMMO. First, market administrators use complex formulas to set prices for milk used in Class I, Class II, Class III and Class IV. These prices, along with the amount of milk used in each class, result in a blend price that balances milk sales and money paid to participating farmers.
The blend price is normally higher than what the pricing formulas say the Class III price should be. The difference between the blend price and the Class III price gets added to the Class III price to determine the announced price that all farmers must be paid regardless of where they sell their milk. That difference that gets added onto the Class III price is the producer price differential, or PPD.
Take a look at what happened during June 2019, for Federal Order 30. The blend price for that month was $16.52 and the calculated Class III price was $16.27. The difference between these two prices, the PPD, was 25 cents. That amount was added to the Class III price to get the announced minimum price of $16.52.
This is the way things work in normal times. Sales to cheese plants get a bump from the PPD. There is no incentive to leave a cheese plant and chase higher prices in a bottling plant. Farmers stay in the pool and are happy to do so.
As you well know, the summer of 2020 will never be called normal by dairy farmers. The Class III price has risen so far and so fast that the price formulas are out of sync with markets. Now the PPD is negative.
Here’s an example, again from Federal Order 30, but this time for June 2020. What a difference a year makes. The calculated Class III price was $21.04, but there was not enough in total sales to pay that much for all milk sold. To cover the shortfall, the FMMO declared a negative PPD of $3.81. Participating farmers were guaranteed $17.23 as a final minimum price.
Most of the milk sold in the U.S. goes to make cheese. What this means is that, most of the time, a farmer or whoever represents that farmer in the market, wants to participate in the FMMO. The positive PPD is a price add-on that is too good to pass up.
A negative PPD sends the opposite price signal to farmers and their marketing representatives. They now have an incentive to jump out of the FMMO and sell directly to cheese plants. In the example I used of June and Federal Order 30, why take $17.23 when the Class III price is $21.04? More than 80% of the Class III milk in Federal Order 30 was depooled in June.
When higher-priced milk is taken out of the pool, that milk cannot be used to calculate a higher price for all farmers in the pool. The announced minimum price goes down, and that is bad for all farmers. If all of the milk in Federal Order 30 had stayed in the pool, the situation would have been much different. The PPD would have remained negative, but at a significantly lower level: $1.14. The resulting minimum price for cheese plants would have been $19.90 instead of $17.23.
The FMMO system was originally set up to provide orderly marketing. Part of that mission was the pooling system that prevented farmers from getting into a race to the bottom by chasing Class III markets with ever-lower offers to sell. Now, we see the same thing, only it is favorable Class III prices that are ripe for destruction by dog-eat-dog competition. The FMMO formulas for calculating Class III prices will put more money in farmer’s pockets. The only thing that can stop that is farmers themselves by allowing their milk to be depooled.
The more milk that is pooled and stays pooled, the more the system works for farmers who want to protect and grow their share of the retail dairy food dollar. That’s why we need a single national FMMO that covers all of the milk all of the time.
