On November 12, USDA released its final decision on the Federal Milk Market Order (FMMO) reform process that started back in 2023. There were only minor changes between the recommended decision released on July 1, 2024, and the final decision.
Next, ballots will be mailed out to farmers who were pooled on a federal order during January 2024 to vote on the proposed changes. The ballots must be post-marked by January 15, 2025, and returned to USDA to be counted. Two-thirds of the farmers or two-thirds of the pooled milk in each order needs to vote to accept the changed FMMO language; otherwise, that specific order will be dissolved. The expectation is that all orders will vote to accept the new FMMO language, but there have been rumblings that the Upper Midwest might be a close vote. We should know the results somewhere between late January and mid-February.
USDA will also release the implementation timeline at that point. From a risk management perspective, the implementation timeline is now the biggest unknown. The changes could start as soon as March pricing, or they could possibly be delayed a few months longer. One thing we do know is that the implementation of changes to assumed component content will be delayed six months from the other changes.
I’ve tried to breakdown the impact of the various changes on prices in the following tables.
Make allowances: USDA is raising the assumed cost of converting milk into bulk dairy products. That means a greater proportion of the revenue from selling bulk dairy products will stay with the processor and less of the revenue will be passed back to farmers, which lowers the price of milk across the board.
Butterfat retention: USDA is (correctly) assuming cheese plants have become more efficient over time and a larger percentage of the fat in milk is getting converted into cheese, which helps raise Class III and, consequently, the Class I price a little.
Solids: USDA is raising the assumed protein and other solids content of milk. Assumed protein content is changing from 3.1% to 3.3%, and other solids is moving from 5.9% to 6%. With higher solids in the milk, the yield of bulk commodities is higher and there is more revenue that should be passed back to the dairy farmer, raising the announced Class I, II, III, and IV milk prices. However, there is some nuance with this change. Seven out of the 11 FMMOs are “multiple component orders” and farmers are paid based on the actual pounds of solids that are delivered and used in Class II, III, and IV, so they do not rely on assumed component content of the milk for paying the farmers. Therefore, the change in the assumed component content won’t have an impact on the actual pay prices except for Class I in those orders. (It’s complicated, but Class I is calculated on the value of skim milk using assumed solids content, not on the actual amount of protein and other solids used.) This change will raise the Class II, III, and IV milk prices in the butter/skim orders (Arizona, Florida, Southeast, and Appalachian), and it does raise the announced Class III and IV milk prices that the futures settle to. In the proposed decision, USDA was initially going to delay the implementation of the change in solids content for 12 months after the other changes for “risk management considerations,” but in the final decision they have shortened that to a six-month delay. Because of that delay, I’ve calculated both the total impact when all changes are implemented as well as all of the changes except the increase in solids content to reflect the impact that the changes will have for the first six months of implementation before the solids are adjusted.
Remove barrels: Currently, the cheese price used to calculate the value of protein and set the Class III milk price is the volume weighted average of 40-pound blocks of cheese and 500-pound barrels. Under the new calculation, the barrels will be dropped and the cheese price will just be based on block cheese. If the block-barrel spread is around 3 cents per pound (like it was 2012 to 2016), removing barrels has very little impact on anything. But barrels averaged significantly less than blocks for most of 2017 to 2023, so removing barrels during those years would have raised the price of cheese and the price of protein, which boosts the Class III and I milk prices. With barrels averaging higher than blocks this year, removing them would actually reduce the Class III price for 2024.
Class I mover: The FMMOs were designed so that the Class I milk price would normally be the highest price to encourage sellers to supply Class I (bottling) plants first before directing milk into other dairy products. From 2000 through late 2018, the pricing formulas used the higher of the Class III or Class IV skim milk price to set the base Class I price. However, that makes it difficult to hedge since you don’t know whether your price will be based off of Class III or IV in the future. So, in late 2018, the calculation was changed to using the average of the Class III and IV skim milk prices. But when there is a large and sustained spread between Class III and Class IV, using the average of the two depressed the Class I price relative to using the higher of method, so the FMMOs are switching back to using the higher of for most Class I milk. However, if a plant is producing extended shelf life (ESL) milk, their pricing will be based on the average of Class III and IV with a rolling adjustment factor to make up for the difference between the average of and higher of pricing over time. This will make it easier to manage the price risk on ESL. My tables only reflect the higher of calculation.
Class I differentials: This wasn’t included in any of the tables. Think of the Class I differential as local basis; it is set county by county and is being raised by 5 cents to $2.60 per hundredweight (cwt.) depending on the location. The smaller increases were generally in the Western U.S., while the Southeast and Appalachian regions are seeing the largest increases.
If the new formula had been in place over the past 12 years, it would have been roughly neutral on Class III, reducing the price by about 16 cents per cwt. on average. The new formulas would have resulted in a higher Class III milk price in 2020 and 2021 when barrel cheese was at a big discount to blocks, but if you assume a spread around 3 cents, the changes would reduce the Class III milk price slightly compared to the old formula. With the six-month delay in implementing the increase in assumed solids content, the new formula does shift Class III lower by something around 62 cents per cwt. for six months.
If the new formulas had been in place for the past 12 years, they would have lowered the Class IV (and Class II) milk price by an average of 47 cents per cwt. Since the “butterfat retention” and “remove barrels” changes only apply to cheese, they don’t impact the Class IV/II milk prices. With the change in assumed components delayed six months, the initial impact from the formula changes should be closer to 77 cents per cwt. for Class IV/II.
So, what does it all mean? After all the changes are implemented, the Class II and IV prices will be lower than they would have been with the old pricing formulas while Class III will be roughly neutral (depending on block-barrel spread) and the Class I price will be higher (after accounting for increased differentials). The net impact to the farmers’ milk price depends on the product mix inside their order. The USDA’s analysis suggests that over the past five years, the Upper-Midwest, California, Pacific Northwest and Arizona pooled revenue would have been smaller with the new formulas while the other orders would have seen higher revenue. It is important to remember that the Class I, II, III, and IV milk prices are minimum prices and premiums are often paid on top of the minimum. With the make allowances shifting higher, processors may be willing (or forced, depending on how tight regional milk supplies are) to now pay a higher premium on top of the minimum price which could offset some or all of the pool losses for UMW/CA/PNW/AZ.
From a longer term perspective, it is the changes to Class I that offset (or more than offset) the negative to neutral impacts to Class II/III/IV, but Class I consumption is trending lower. So somewhere down the road (five years? 10 years?) the net impact of these changes will probably be negative on pool revenue as Class I makes up a smaller and smaller proportion of milk utilization.
