by Tamara Scully

As many dairy farmers realize, understanding your milk check and the mathematics behind the mystery of just how much you’re going to get paid almost requires an advanced degree in economics. That’s why Cornell Cooperative Extension Central New York Dairy, Livestock and Field Crops Team welcomed Dr. Chris Wolf, dairy economist from Cornell’s Charles H. Dyson School of Applied Economics and Management, in a recent webinar titled “Milk Check Mysteries.”

The presentation covered an array of topics, all of which influence the price dairy farmers are paid for their milk, including milk pricing, depooling, producer price differentials (PPDs), milk check-off dollars and current trends in dairy markets.

Federal Milk Marketing Orders (FMMOs) – there are currently 11 – cover most regions in the U.S. There are a few states or regions (such as Maine and Western New York) that run their own milk markets. About 75% of the milk in the nation is marketed via FMMO.

Each FMMO is not the same. In some regions, milk primarily goes into cheese. In others, milk is prioritized for fluid use. Still others have a good amount of soft foods, such as yogurt, ice cream or packaged cream. This is important because each class of milk – fluid is Class I, soft products such as yogurt or ice cream that can be eaten with a spoon are Class II, cheese and dry whey comprise Class III and Class IV is non-fat dry milk and butter – commands a different price.

The price of all milk classes is variable. As the prices change, they affect the entire mathematical calculation which eventually ends up determining each FMMO’s uniform price. But that uniform price is not what farmer see. Other factors – the regional market and the farm’s own specifics – also factor into the final calculations before the milk check is generated.

So how did this begin? Is it necessary? What does it mean on the practical level for dairy farmers?

The Role of FMMOs

FMMOs were designed to set a minimum price by class for milk. Established in 1937, at a time when Grade A fluid milk was sometimes scarce and supplies were variable across the nation, FMMOs provided orderly marketing of fluid milk and enhanced the bargaining power of dairy farmers.

“They [FMMOs] are not considering cost of production at the farm level at all. It’s all about serving the beverage markets,” Wolf said. From that perspective, FMMOs have been successful. “Almost never and almost nowhere do we wonder is there’s going to be milk on the shelf.”

FMMOs do not restrict the milk supply, regulate producers, set prices on the wholesale or retail level or set maximum prices for haulers, Wolf emphasized. The FMMOs set the rules of the milk market, establishing a minimum level of classified pricing at the farm level. They also enforce payment throughout the milk supply chain, verify tests and audit records and provide market information.

The FMMOs define the minimum price by class, and then calculate a blend price, weighted by use, to determine the PPD.

The minimum prices for each class of milk originate from the wholesale price of products. The minimum price for Class III and Class IV milk is the same across all FMMOs. However, the blend price can be different, as each FMMO utilizes its milk differently.

“The FMMOs define minimum prices based on how the milk is used, and then they calculate a weighted average of how the milk is used in each one of those geographic orders, and say that everybody in that order has to get the minimum, or uniform, price,” Wolf said.

Different orders serve different population areas; the need for fluid milk is not the same everywhere. “One thing that the Northeast has going for it is that it captures Boston, NYC, Philadelphia, Washington, D.C., Baltimore – which is why the Northeast has a high amount of Class I, which is fluid milk,” Wolf said.

A farm may not physically be in a FMMO territory, but it can still participate in that FMMO. For example, a farm in the Western NY that ships milk to a processor in the eastern region of the state would be covered by the Northeast FMMO even though Western NY is not in the FMMO itself.

“It’s about where the milk is moved, not where it is produced,” Wolf explained.

Getting to the PPD

The PPD is the price the FMMO is going to pay all producers. This is not the final value of the milk check; it is a first step.

“The producer price differential is actually an accounting procedure that says ‘We’re going to calculate the weighed average price, which is the uniform price, and then we are going to subtract out the Class III price,’” Wolf said. “The residual that is left over is called the PPD, which is the pooled value in excess of the class price.”

Cheese is the biggest driver of milk pricing, so paying the cheese cost first (the Class III price) makes sense from an accounting perspective.

The actual accounting process involves breaking pricing down to the component level and then adding it all up again to get to the hundredweight (cwt.) price. Each week, the wholesale value of components – butterfat, protein and other solids – are determined. These values are then used to finalize the Class III and Class IV pricing.

All of this matters because Class III and Class IV pricing is directly calculated from the previous month’s weekly averages of actual product pricing. Class I and Class II pricing are derived from the same factors but include some differential and premiums based on FMMO location.

Class I and Class II prices are further complicated as they are based on an advanced price for two weeks, as well as the previous month’s average from the last two weeks, rather than the average pricing of the previous four weeks.

“This timing issue right here has been the driver of the negative producer price differential that we used to see,” Wolf said. “If we saw a big change in those last two weeks, we could conceivably have a really big positive PPD, or we could even have a negative one. Historically, a negative PPD is no fun… but what that means is your next check is going to be bigger. That also meant that if there was a big decline in the last two weeks of the month that you wouldn’t see that whole decline in that check. You kind of had this lag effect, which smoothed out milk pricing a little bit.”

Component pricing is important at the PPD level, and it becomes more important at the farm level, as producers also receive premiums from their cooperatives for high component values.

The three factors which determine the final milk check are the FMMO price, the regional market aspects and the farm specific components, hauling costs and quality of milk.