Milk in a glass and pitcher.
October 12, 2020

​​​​​​​Rebooting Dairy Policy

 |  By: Dairy Talk

2020 will go down as one of the craziest years in the annals of dairy history. It appears to be ending on a positive note, with farm balance sheets returning to black due to rebounding prices and government assistance.

Still, as I write this in mid-October, the price shocks and volatility point to a needed rebooting of U.S. dairy policy. Some argue that this year’s extreme price volatility is likely a one-off event, driven by the COVID-19 pandemic that essentially shut down half the dairy market. Maybe so.

But the damage left by this price shock was devastating—and potentially catastrophic. The numbers from negative Producer Price Differentials (PPDs) showed a shortfall in Federal Order revenue pools of $527 million in June, $667 million in July and $286 million in August, according to estimates by the American Farm Bureau Federation (AFBF). Combined, that’s a shortfall approaching $1.5 billion.

Economists says these negative PPDs were not dollars totally lost from farmers’ pockets. They say processors paid out some portion of the negative PPDs through other premiums, and evidence bears that out. Plant payments in the Upper Midwest were $1.50 negative in June when the PPD there was -$3.81 and $2.50 negative in July when the PPD  was -$4.86, says Mark Linzmeier, with MARGINSMART Dairy Analyzer.

The new Class I price mover—which takes the average of Class III and IV prices and adds 74₵/cwt—was partly to blame for the negative PPDs. It was enacted with the 2018 Farm Bill to allow farmers and fluid milk handlers to better manage risk. Early on, the old and new mover were closely aligned, with the average difference of 9₵/cwt in dairy farmers’ favor—until COVID hit, says John Newton, AFBF chief economist.

To jump start the dairy economy, the Trump Administration instituted its Farmers to Families Food Box Program, which ordered million of pounds of cheese in short order. Cheese prices soared, creating $6 to nearly $11 spreads between Class III and IV prices. The new price mover didn’t full capture this rally in Class III prices. In combination with depooling brought on by negative PPDs, the pooled value of Class I milk was $400 million lower July through October than it would have been under the old “higher-of” formula, estimates Newton.

Under the old formula, milk prices in South Florida would have approached $30/cwt in August where Class I utilization exceeds 80%. Under the new formula, Class I prices in Tampa peaked at $25.38 in August.

On the flip side, this is much less of an issue in low Class I utilization Federal Orders. In the Upper Midwest, for example, where Class I utilization is often less than 10%, Federal Orders are often contributing less than 5% to producer milk checks, says Mark Stephenson, a University of Wisconsin dairy economist.

“[Federal Orders] do provide services and order that are important,” he says. “But you almost have the wrong tool for the job.”

Yes, the COVID pandemic was a once-in-a-century price shock. But remember 2009?  Both events show the dairy industry, given its inelastic supply/demand characteristics, is vulnerable to extreme price volatility.

Remember, too, that the U.S. industry is continually driving to expand its export markets. That’s a good thing. But it also subjects the industry to greater and greater market risk.

The industry, collectively, needs to rethink its approach to dairy price regulation. The sooner, the better.