Under the current federal milk pricing system, Class I milk price (i.e., fluid sales) is treated as a product of Class III and Class IV prices. Whereas Class III and Class IV milk are traded on the CME, Class I is not. However, Class I milk price can have a significant impact on your milk check. There are three factors that determine the impact on your milk check: 1) advance prices for Class III and IV; 2) change in prices from the advance announcement to the release of the Class and Component prices, and 3) utilization of Class I in your region.
In October, Federal Milk Marketing Order (FMMO) reported a Class I milk utilization from a high of 84% in Order 6 (Florida) to a low of 23-24% in Orders 30 (Upper Midwest), Order 51 (California), and Order 124 (Pacific Northwest). This demonstrates that Class I milk price is an important part of each producer’s final milk check.
To determine Class I pricing, USDA surveys butter, cheese, non fat dry milk (NFDM) and whey for a two week period to calculate the Class I skim price and the Class I butterfat price. Most recently, USDA conducted the survey for the weeks ending 11/7 and 11/14 to determine the December Class I skim price of $14.88/cwt and the butterfat price of $1.57/pound. The Class I skim price was determined by averaging the Class III and Class IV skim prices and adding $0.74. Butterfat price is based on the price a butter price of $1.4726/lb. In this case, Class III skim for these two weeks was calculated to be $20.07/cwt and Class IV was $8.21/cwt resulting in $0.74+($20.07 + $8.21)/2 or $14.88. When 3.5% butterfat is added, the Base Class I price is $19.87. So, the first point to make about the Class I price is that it is equally influenced by Class III and Class IV prices. Figure 1 shows the Class I base price for the past year. December Class I base price increased $1.83 from November and is at its highest level this year.
Figure 1. Class I skim price for the last year
The next point to make is that even though there is a national base Class I price (e.g., $19.87/cwt), each FMMO adds a differential to develop a regional Class I price. For example, Order 1 (Boston) has a Class 1 differential of $3.25/cwt resulting in a December Class I price of $23.12/cwt. Florida (Order 6) has a $5.4 differential giving them a $25.28/cwt while Order 32 (Central) and 33 (Mideast) have a $2.00 differential resulting in $21.88/cwt. The impact of the national Class I milk price changes regionally according to the FMMO on which your check is based.
The reasoning for pricing Class I milk with advanced formulas is that most fluid milk is sold and consumed before the typical class and component values are released at the end of the month. This creates a 6-week lag which has the unintended consequence of dampening overall milk prices. For example, the December Class I values were just released (11/18/20) whereas the actual December class and component values will not be released until December 30th.
Given the recent collapse of the cheese spot market, the Class III skim values for calculating December Class I ($20.07/cwt) will be much higher than that reported for December Class III (~$10/cwt). In times of rapidly declining prices, Class I prices tend to hold up the on-farm price for a while. Likewise, in rapidly rising prices, Class I prices will tend to hold down the on-farm price for a while.
Figure 2 shows the Class I base price that is announced in blue.
Using the same calculations at the time the Class and Components are released six weeks later gives us the green symbols. The line between the two symbols shows the difference which is also shown at the bottom of the graph. For example, the June Class I skim was released on May 20th and was $7.08 based on $6.88 Class III, $5.99 Class IV, and $1.2538/lb butter price. By the time the actual Class and Component values were released (July 1st) the Class III skim increased to $15.06/cwt, Class IV skim increased to $6.62, and butter increased to $1.7067/lb.
Consequently, the Class I milk price dampened the overall June milk price, depending on utilization, by a factor of -$6.26/cwt. With 84% utilization, this effect would have been -$5.26 and regions with 23% utilization, the effect would have been -$1.44/cwt. You might remember in June, that despite high Class III prices, on-farm prices were much less impressive due to negative Producer Price Differentials which were influenced by this Class I lag. For example, in June Order 51 (California) had a -$7.91/cwt PPD resulting in a uniform price of $13.13/cwt, in spite of a Class III price of $21.04/cwt. Over time, the effect of Class I lag has been close to zero. However, in particular months, it has had a significant impact on milk checks.
Figure 2. Class I base versus that calculated from actual Class III and IV prices
There are two main conclusions that can be drawn for this scenario. First, during volatile markets, the impact of Class I milk price on a particular milk check can be substantial. Second, using hedging strategies such, as the DRP, will not protect your farm from these impacts. To illustrate this final point, consider a farm that purchased DRP protection for Class III and Class IV for a future month. However, after the Advanced prices are released, there is a significant rise in prices (e.g., government intervention). The DRP protection becomes worthless (loss of premium) but the Class I impact is a large negative impact. The resulting milk check will be lower even though there was DRP protection. Realizing the impacts of Class I pricing on your milk check is import for planning and any hedging strategies for your final milk check.
Editor’s Note: Lawrence R. Jones, PhD, is Vice President, FARME Institute, Inc. in Homer, N.Y. He can be contacted at ph. 607-591-9727 or firstname.lastname@example.org