Christopher A. Wolf Testimony (witness statement, September 15, 2021), agriculture.senate.gov
Summary
Cornell University professor Christopher A. Wolf gave this testimony on September 15, 2021 to the Senate Subcommittee on Livestock, Dairy, Poultry, Local Food Systems, and Food Safety & Security for its hearing "Milk Pricing: Areas for Improvement and Reform." Wolf says the US dairy industry produced more than 223 billion pounds of milk with farm cash receipts exceeding $40 billion in 2020, and that record low negative Producer Price Differentials that year were driven by many factors, chiefly depooling of milk and also the Class I pricing change of May 2019. Wolf describes the Class I skim milk mover, now the average of the Class III and IV prices plus a fixed $0.74/cwt, as lowering Class I prices when the two diverge by more than $1.48/cwt. It also covers pooling rules, make allowances, the Farmers to Families Food Box Program and the Federal Milk Marketing Order hearing process.
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Testimony of Christopher A. Wolf, Ph.D.
before the United States Senate Subcommittee on Livestock, Dairy, Poultry, Local Food
Systems, and Food Safety & Security
Hearing “Milk Pricing: Areas for Improvement and Reform”
September 15, 2021
Christopher A. Wolf
E.V. Baker Professor of Agricultural Economics
Charles H. Dyson School of Applied Economics and Management
Cornell University
435 Warren Hall
Ithaca, NY 14853
Chairwoman Gillibrand, Ranking Member Hyde-Smith, and Members of the Committee, thank
you for inviting me to be part of this hearing. I currently serve as the E.V. Baker Professor of
Agricultural Economics in the Charles H. Dyson School of Applied Economics and Management
at Cornell University where I have been a faculty member since 2019. Prior to 2019, I was on
faculty at Michigan State University for about 22 years. My research and extension program
focuses on dairy markets and policy as well as dairy farm business management where I provide
education and information for decision-making and analysis for dairy industry stakeholders and
policymakers.
The US dairy industry is a key agricultural sector producing more than 223 billion pounds of
milk generating farm cash receipts exceeding $40 billion in 2020. Major trends that have
influenced the US dairy market include changing consumption patterns, the rise of international
trade as a major outlet for US dairy products, and consolidation at all levels of the supply chain.
With respect to consumption, beverage milk per capita consumption has trended downward on a
per capita basis since the 1970’s with the rate of decline increasing since 2010. Interestingly, the
fluid milk consumption decline largely halted during the pandemic but recently has reverted to
long-run trend declines with more people eating away from home. In contrast to beverage
consumption, per capita cheese consumption has grown consistently for decades. Butter
consumption recently reversed long-term per capita declines to grow as well. Total US dairy
consumption per capita has largely increased consistently as dairy is considered a fundamental
part of a balanced and healthy diet. At the same time, milk production growth has outstripped
domestic dairy consumption in recent years. The rise of exports has coincided with the increase
in milk production and the declining influence of the former Dairy Price Support Program. Since
2005, dairy exports have grown from accounting for about five percent of milk production to
currently accounting for more than 16 percent. Export markets assist in balancing the production
of butterfat and milk proteins. Because export markets are the marginal value of many US dairy
products, there are farm milk price implications of the burgeoning dairy exports including the
influence of international supply and demand as well as the political impact of trade.
The issues that motivate this hearing relate to farm milk pricing under the Federal Milk
Marketing Orders. Federal Milk Marketing Orders (FMMOs) are one of the determinants of farm
milk price. FMMOs have their origins in the Great Depression Era and have been reformed or
updated periodically to reflect market and industry evolution. The primary functions of FMMOs
include providing an adequate supply of consumer milk and promote orderly milk marketing.
The most recent major FMMO reform was put in place in 2000. In recent years, there has been
an underlying dissatisfaction with the farm milk price and this, along with the length of time
since the last major revision of FMMOs, has focused attention on this set of policies. Part of the
dissatisfaction with FMMO performance has to do with the shrinking influence of fluid milk
revenues to be shared across the pool. The declining share of fluid milk is a consequence of both
increasing consumption of cheese, butter and other dairy products as well as declining per capita
consumption of fluid milk. When the FMMOs were created, the majority of milk in those Orders
was used in fluid products. Shrinking relative share of Class I (fluid consumption) milk means
that there is less money in the pool. This change, along with international markets, technology
and other economic factors argues for a re-examination of FMMOs and their role.
It is often said that transparency is key for farm milk pricing. I would argue that FMMOs are, in
fact, transparent in that they operate in a very deliberate and clearly defined manner. However,
they are complicated and incomprehensible for many and, as such, are often misunderstood and
the subject of blame. The process of moving from wholesale product prices to the FMMO pool
price for a given Order and month farm prices involves many steps. The resulting farm price
includes market and cooperative factors as well as farm specific aspects including quality and
hauling. Understanding the drivers of farm milk price must consider all of these aspects. 2020
was a challenging year for many in the dairy industry. In particular, dairy farm financial
outcomes were a function of (1) where and how farm milk was marketed including regional and
cooperative issues; (2) farm risk management program participation—particularly what a given
farm operation had in place entering 2020; and (3) government payments and programs for
which the farm qualified and signed up including CFAP and PPP.
The dairy farm financial stress of 2020 was the result of farm milk price volatility and
uncertainty. FMMO’s in multiple component orders pay farms based on component value plus a
value termed the Producer Price Differential (PPD) that reflects the pool revenue in excess of
components valued using wholesale prices. In 2020, record low negative PPDs caused
consternation and frustration among dairy farmers. These PPDs were not just abnormal in
magnitude, they were unpredictable and greatly contributed to farm milk price volatility. Recent
research shows that the large declines in PPDs were driven by a whole host of factors including:
trends in utilization driven by consumption changes, trends in milk component production, the
change in the Class I skim milk pricing mover from the higher of Class III and IV to the average,
and depooling of milk by Class III processors. The impact of each of these factors varied both
across Federal Milk Marketing Order and over time. The regional FMMO impacts depended on
utilization, processing capacity, and other market factors. On average across FMMOs, the largest
impact in contributing to negative PPDs in 2020 was due to depooling of milk while another
significant impact was the Class I pricing change that went into effect in May 2019 (Bozic and
Wolf, 2021). Both of these factors were exacerbated by the historically wide divergence in Class
III and IV prices in 2020 due to the change in consumption from split between food at and away
from home as well as government purchases of dairy products.
With this background in mind, I briefly address each of the issues raised by the Committee.
1. Class I milk pricing methods were changed in the 2018 Farm Bill and implemented in
2019 to make the Class I skim milk mover be the average of the Class III and IV
advanced skim milk price plus a fixed $0.74/cwt rather than the higher of those
advanced prices. The $0.74/cwt add on was chosen to be “revenue neutral” to farm
milk price in the sense that it was set equal to the long-term difference between the
average and higher of Class III and IV prices. One implication of this rule change is
that when the difference between the Class III and IV advanced skim milk prices
exceeds $1.48/cwt the resulting Class I price built from this new formula is less than it
would have been using the higher of the two prices. The pandemic in 2020 resulted in a
wide and prolonged divergence in Class III and IV prices due to many factors including
the increased production of butter to balance milk supplies that were formerly
consumed in restaurants as well as government purchases of cheese for donation (Wolf,
Novakovic and Stephenson, 2021). This large divergence in butter and cheese prices,
and resulting Class III and IV milk prices, meant that Class I milk prices were lower
than they would have been under the former pricing rule. Many solutions have been
discussed by the dairy industry including reverting to the old, higher of rule, as well as
snubbing the difference to avoid effects of large price divergences. This is one potential
pricing change that would almost universally help farm milk prices.
2. Pooling/depooling rules are unique to each FMMO depending on the utilization and
qualification factors in that region. Class I fluid processors, with a few exceptions for
very small processors, must participate in the Federal Milk Marketing Order while
other processors can participate if they qualify. A primary motivation for FMMOs is to
ensure availability of fluid milk for consumers. Thus, fluid processors do not have the
choice of whether to participate. This also means that Class II, III and IV processors
might choose not to participate (pool milk). One reason for non-fluid processors to
participate in Federal Orders is to share in the revenues from Class I sales that allows a
higher payment to farms from which they purchase milk. When Class III is the highest
price, cheese processors would be paying into the FMMO revenue pool rather than
drawing from it for that month. Cheese processors can choose to withdraw any or all
milk from the pool for that month and pay farmers with that money instead of sending
it to the FMMO. There is the potential that, after withdrawing, the cheese processor can
pay their farmers more than they would have received from the FMMO while still
paying less than the Class III price. In this case, the farmers selling milk to the cheese
processor that depooled may receive a higher price, but farmers selling to other
processors who are participating in the pool that month receive a lower price. One
reason that processors may hesitate to withdraw from the pool is that in order to pool
milk in future months, they must requalify that milk. The length of time it takes to
requalify milk varies by FMMO. For example, the Northeast FMMO has rules that
include many months to requalify while some other FMMOs are less stringent. The
precise qualification and pooling rules have evolved across FMMOs based on
utilization and specific market aspects.
3. Make allowances are the amount of the wholesale dairy product price that accounts for
the manufacturing cost when calculating the component farm value of milk. All else
equal, increasing the make allowance for a product means that the amount of the
wholesale dairy product price that is passed on to farmers is less. Make allowances
have been updated one time since the FMMO Reform in 2000 and that was more than a
dozen years ago. It is not difficult to see that many costs have changed since that reform
including energy and labor. The entire supply chain—from farmers to processors—
must be healthy for a prosperous dairy industry. If make allowances are inadequate,
then processors with higher costs will either be driven out or make up the difference
elsewhere. One option might be to depool allowing more flexibility in pay price.
Another potential impact of the make allowance is the incentive to invest in new
manufacturing capacity. If make allowances are not sufficient to provide a return to
invested capital, then they may act as an impediment to investment. It is time to
reconsider the costs of manufacturing dairy products used in FMMOs.
4. The Farmers to Families Food Box Program was implemented in 2020 to both assist
needy families through product donation and backstop dairy product demand. The
government intervened through the “Farmers to Families Food Box Program” which
particularly increased domestic disappearance of American-style cheese and fluid milk
and resulted in record high cheese prices as supply chain struggled to adjust to a shift in
demand between cheese types. The onset of the Farmers to Families Food Box program
coincided with record negative PPDs. In terms of the impact of the Farmers to Families
Food Box Program the lesson is that the industry and markets function better without
surprises which drive market volatility.
5. The FMMO Hearing Process. The Federal Milk Marketing Order Hearing Process is
one area that is subject to “formal rulemaking.” Formal agency Rulemaking is time
consuming but collects input from all interested parties and must weigh the interests of
all involved parties (consumers as well as producers, cooperatives and processors).
While it is clear that many in the dairy industry are unhappy with the length of time it
takes to go through the formal rulemaking process, it is not clear that there are areas
which can be sped up or what would be the potential consequences. Further, there are
examples of changes made to FMMOs outside of this formal process that resulted in
unintended consequences that required attention later. The strength of the current
process is that it balances all interests and is less likely to result in adverse
consequences.
Given the age of the FMMO system, length of time since the last major reform, and changes in
the market from both the production and consumption side, it is likely time to re-examine many
aspects of FMMOs including many issues that motivate this hearing. If we were to start over
with US dairy policy, it seems unlikely we would arrive at the current system. However, there
are legitimate reasons for making each of the previous policy revisions and choices. The current
set of markets and institutions has evolved around the FMMO system as it is currently
constituted and the ripple effects of reforms should be carefully considered. There may be
lessons that could be found in the systems found in other countries. Any reform should balance
the interests of all involved parties including equity as well as economic efficiency.
References
Bozic, M. and C. Wolf. “Negative Producer Price Differentials in Federal Milk Marketing
Orders: Explanations, Implications and Policy Options.” Journal of Dairy Science.
Accepted. September 2021.
Wolf, C., A. Novakovic and M. Stephenson. “COVID-19 and the US Dairy Supply Chain.”
Choices. 36(May 2021).
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