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By Ryan Dennis

Milk Pricing: A Survey of 5 Economic Communities

The price the farmer receives for his milk is his most immediate concern, yet little seems to be known about the calculations and factors that go into determining farmgate prices.  Many of the present systems are being called into question, or are soon expected to be.  As new ideas are sought, one country has the potential to learn from the approaches and programmes of another.  The following is a brief survey of the milk pricing systems in the United States, Canada, the European Union, New Zealand and Australia.  Similarities seem to be a function of geography, as the US and Canada, and New Zealand and Australia most closely resemble each other, while the EU is in a process of transition.

United States

The federal pricing system in the United States is based on milk marketing orders that organise the states into eleven areas.  Milk is pooled in each section and values are calculated with a classified pricing system based on the end use of milk in wholesale products.  Class I represents fluid milk, Class II soft dairy products (butter, cottage cheese), Class III hard dairy products (most cheeses) and Class IV is  nonfat dry milk.  The final price a farmer receives inside a marketing order is a blend of the class prices, with Class III or Class IV generally having the most influence (see Appendix A below for formulas).  Milk marketing orders set a minimum Class I price, but because it is up to processors how they use the milk they collect, it has only marginal effect on the blend price received by farmers and cannot guarantee them a fixed price.  Marketing orders have the legal authority to audit handlers and ensure that they pay the appropriate minimum Class I price.  The actual wholesale dairy prices are determined weekly from trading on the Chicago Mercantile Exchange.  California is the only state that prices its own milk and is not under a marketing order.  Instead, it bases five class prices on butterfat and solids nonfat (SNF).  It also operates on a quota system, in which quotas can be bought, sold, or readjusted by the state.

The established milk support price was terminated in 1999.  The Commodity Credit Corporation (CCC) took over as the main form of market assistance.  The purpose of CCC is to buy and remove surplus dairy products from the market in an attempt to bolster poor prices.  Storage has been the chief obstacle, shifting a majority of the CCC’s purchases to nonfat dry milk.  When possible, the US tries to place a specific quantity of surplus to targeted overseas market, via the Dairy Export Incentive Program (DEIP).  The Milk Income Loss Contract Program (MILC) has also been implemented intermittently the last several years to provide farmers with direct payments when the price falls below a specific level.

In 1996 congress granted consent for the formation of the Northeast Dairy Compact, giving a handful of small states (several more joined later) more regulative authority in the pricing of their milk.  The Northeast Dairy Compact sets the minimum Class I price at $16.94 per hundred weight of pounds and requires handlers to pay the difference if not met.  The said monies is pooled by the compact and first reimburses the CCC for any purchases resulting from surpluses in area milk, and then to the farmers.  The result is that producers in the compact area may receive a slightly higher price for their milk than they would if only regulated by the milk marketing order.  Many other states have tried to create or join similar compacts, but have not found the legislative support.

Canada

The Canadian Dairy Commission (CDC) operates a supply management system that works to plan production in a year starting on August 1st and ending July31st.  Under the National Milk Marketing Plan, the Canadian Milk Supply Management Committee (CMSMC) establishes the market-sharing quotas (MSQ) for the country, which the CDC monitors and adjusts when necessary.  Target production is measured in terms of butterfat.  The CMSMC gives each province its share of the MSQ, and then the province allocates them to its individual producers as it sees fit.

Like the US, the milk produced in Canada is priced with a Harmonized Milk Classification System, breaking down the end use of wholesale products into five classes.  Class I consists of fluid milk, Class II of most soft products (except butter), Class III for cheeses, Class IV is butter, milk powder, and certain components like casein, and Class V includes ingredients used elsewhere in manufacturing.  Each class has multiple subsets that further organise the products.  The provincial boards set the butterfat price, while protein and other solids are determined by the CMSMC every August 1st and February 1st.  Revenues from milk components used in rennet casein are pooled among all the provinces, and CDC receives milk utilisation declarations from all provinces on a monthly basis for pooling purposes.

The Canadian Dairy Commission annually determines support prices for butter and skim milk powder.  They work much like the United States CCC in purchasing butter and skim milk powder at this established price, creating a support floor on the market.   Once a year the CDC collaborates with the provinces in a national study on the farmer’s cost of production.  In addition to this, the CDC holds a forum with producers, processors, restaurant owners and consumers.  The results of the study, forum, and considerations of other economic indicators lead to a price support that becomes effective February 1st of each year.

Provinces in Canada function in similar ways as marketing orders in the US.  While the government has federal authority over the marketing of industrial milk and products (solid goods), provinces regulate the marketing and export trade of fluid milk.  Provinces generally license producers, distribute milk quotas to producers, determine the prices charged to processors, and some assume other specific responsibilities, such as negotiating shipping costs with transportation agencies.  There are two pooling agreements among provinces.  All Milk Pooling or P5 (because of the five signatory provinces) pools both industrial and fluid milk, transportation costs, and provides for multiple component pricing, a daily quota system and quota trade, and the pricing of components based on their end use in products.  The four western provinces created the Western Milk Pooling Agreement (WMP).  The WMP has been engaged in discussion on a pricing system that would provide WMP provincial boards to adopt fluid milk pricing that would allow for the consumer price index, cost of producing milk, and the farmer’s disposable income.

New Zealand

The pricing of New Zealand milk differs from that of Canada and the US in that is not market-variable and sees very little influence from the government.  Fonterra, a coop that distributes 95% of the nation’s milk, sets an annual price based on mechanisms such as negotiated sales and export revenue.  Although there is no competition, Fonterra operates like a traditional business in that producers are shareholders in the cooperative, receiving one share for each kilogram of milk solids they are contracted to provide.  This is allows farmers to receive returns from the cooperative’s value added activities, in addition to the milk check.  An independent party appointed by the Shareholders’ Council determines the value of the shares.  All of the Fonterra’s income is distributed to shareholders as a payout, both from milk payments and return from value added activities.

Without competition, there is no market to determine the milk price.  It is difficult to use milk prices in other countries due to variances in cost structures.   Instead, Duff and Phelps, the same independent group that determines the share value, also calculates the Commodity Milk Price (CMP). The CMP is a theoretical price that a competitor could pay for the milk of equal quality and quantity to that supplied to Fonterra after subtracting costs from commodity revenue.   From this a Historical Commodity Milk Price (HCMP) is assessed using actual milk volumes, base commodity prices, and exchange rates used by Fonterra during the season.  Finally, the cooperative uses its own product portfolio and operating costs to determine the Fonterra Commodity Milk Price (FCMP), which is the price paid to farmers.  The FCMP is compared to the HCMP to determine the Milk Gap, a performance indicator used to asses Fonterra’s efficiency.  The FCMP is determined annually and doesn’t change per month, regardless of the season.  In its simplest form, the price is based on the following formula: fat kilograms + protein kilograms – a small volume charge.  The New Zealand milk price is based nearly entirely on milk solids (only 4% was sold as fluid milk last year), with milk fat retaining 33% the value of protein.  Currently New Zealand dairy farmers receive $5.10 NZD per kilogram of milk solids.

EU

The 27 countries that make up the European Union are joined by a Common Agricultural Policy (CAP) that is based on a single market and common financing.  The policy is presently in transition.  The dairy industry was previously seen as part of a larger European position of agricultural being multifunctional, fulfilling a broad range of roles, from maintaining rural communities to protecting environmental welfare.  Farmers were paid both for their milk, and on the basis of commodity-focused supports in the form of subsidies that rewarded producers for these other inherent services they provided.  Supply was controlled and dictated by a quota system similar to Canada’s.  Nonetheless, these quotas are in the process of being phased out, with a complete termination targeted for 2015.  The present agricultural commission supported a paradigm shift that believed the market would be more efficient for price determination.  The previous subsidies schemes are being replaced by a decoupled payments that are not based on the amount of milk produced.

Like New Zealand, farmgate prices are determined by the cooperatives.  Unlike New Zealand, however, there is competition between the coops and the price the producer receives is specific to each organisation.  The determining formulas and factors involved in these calculations are private and seldom released.  The government has little involvement in the market, except for price support arrangements in association with the Intervention Milk Price Equivalent (IMPE).  The EU buys an allotted amount of units of unsalted butter and skim milk powder when the prices for these products fall to a determined level, functioning much like the CCC in the United States.  Another benchmark indicator used in Europe is the Milk for Cheese Value Equivalent (MCVE).  This figure determines a factorygate price by calculating the returns on mild cheddar, whey butter, and whey protein.  The MCVE has no direct bearing on the price received by farmers and is not used in any other calculations.  Instead, the level of its changes is used to indicate the adjustment in the value of the milk farmers supply to their cooperatives, and in turn can hope to receive back.

Australia

In 1999 Australia began the transition of moving into a completely deregulated dairy industry.  The Dairy Structural Adjustment Program (DSAP) eased the shift with an 11 cent per litre levy paid by consumers and allocated to farmers.  The DSAP has concluded, and the country has no legislative controls over the price of milk.  Instead, the farmgate price is largely dependent on international markets, as Australia historically exports 50% of its milk production, mostly to Asia.  Australia tends to receive slightly less for its milk than most countries, but the cost of production is also generally lower.

The lack of government involvement makes the Australian dairy industry similar to New Zealand, but instead of a cooperative organising payments, farmers receive their price from the processors directly.  Although each manufacturer will have its own way of determining farmgate prices, it is generally based on butterfat and protein content.  Payments to farmers will vary marginally, being affected by such factors as product mix, marketing strategies, and plant efficiency.  Each firm will also have its own forms of incentives and penalties to encourage milk quality and volume.

Due to the reliance on international markets, Australian farmers created Dairy Australia, an industry service company that works to maximize the conditions for export.  Dairy Australia is funded by levies paid by farmers on the fat and protein content of their milk.  The company researches new markets while monitoring established ones, and works on maximising effectiveness of overseas marketing.  Dairy Australia is also politically involved in assessing trade agreements in other countries and promoting the removal of trade barriers.  They have been very active in the World Trade Organisation discussions, as their industry may have the most at stake.

The Milk House sincerely thanks Teagasc, DairyNZ, Fonterra.

Appendix A: Federal Milk Marketing Order Price Formulas

Note: Milk prices are per 100 pounds or cwt, rounded to the nearest cent. Component prices are per pound, rounded to the nearest one-hundredth cent. Cheese, dry whey, butter, and nonfat dry milk prices are weighted averages of weekly NASS survey prices.

Class I

Class I price = (Class I skim milk price x 0.965) + (Class I butterfat price x 3.5).

Class I skim milk price = Higher of advanced Class III or IV skim milk pricing factors + applicable Class I differential.

Class I butterfat price = Advanced butterfat price + (applicable Class I differential divided by 100).

Note: Advanced pricing factors are computed using applicable price formulas listed below, except that product price averages are for 2 weeks.

Class II

Class II price = (Class II skim milk price x 0.965) + (Class II butterfat price x 3.5).

Class II skim milk price = Advanced Class IV skim milk pricing factor + $0.70.

Class II butterfat price = Butterfat price + $0.007.

Class II nonfat solids price = Class II skim milk price divided by 9.

Class III

Class III price = (Class III skim milk price x 0.965) + (butterfat price x 3.5).

Class III skim milk price = (protein price x 3.1) + (other solids price x 5.9).

Protein price (true protein) = ((cheese price – 0.165) x1.405) + ((((cheese price-0.165) x 1.582) – butterfat price) x 1.28).

Other solids price = (dry whey price – 0.140) divided by 0.968, snubbed at zero.

Butterfat price = (butter price – 0.115) divided by 0.82.

Class IV

Class IV price = (Class IV skim milk price x 0.965) + (butterfat price x 3.5).

Class IV skim milk price = nonfat solids price x 9.

Nonfat solids price = (nonfat dry milk price – 0.140).

Butterfat price = See Class III.

Producer Prices:

Butterfat price = See Class III.

Protein price = See Class III.

Other solids price = See Class III.

Somatic cell adjustment rate = cheese price x 0.0005, rounded to fifth decimal place. Rate is per 1,000 somatic cell count difference from 350,000.

This formula is provided by the This formula is provided by the USDA.

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