For nearly 20 years, Federal Milk Marketing Order (FMMO) Class I prices have been set each month based on the “higher of” either the value of milk manufactured into cheese or the value of milk manufactured into butter and nonfat dry milk powder. Because the relationship of these values shifts around in an unpredictable fashion, Class I processors have had a very difficult time managing their price risk because the hedging tools that exist in the dairy industry for processors do not match up well with a “higher of” butter/powder – cheese scenario. As a result, a couple of years ago the processors approached the producer community with a proposal to use the “average” of these two values instead of the “higher of” so that hedges could be obtained that would provide them the opportunity to do price risk management.
Producers were sympathetic to the processors concerns but made the obvious point that using the “average” instead of the “higher of” was going to cost them money. A study was done and it was determined that over a long period of time, the “higher of” component of the Class I pricing formula added $0.74 per cwt to the Class I value. The processors agreed that in exchange for changing the underlying Class I base price from the “higher of” to the “average,” they would support raising the Class I differential in all Federal Milk Marketing Orders by $0.74 per cwt. Congress took this agreement between the processor and producer communities and ordered this change with the passage of the Farm Bill. The change will be effective on May 1, 2019.
I think this change could be quite positive for producer income. The $0.74 increase in the Class I price was based on a long period of history. When you do the math, you realize that if the difference between the value of milk for cheese and the value of milk for butter/powder is less than $1.48, then using the average of the two values plus $0.74 will result in a higher Class I price. The FMMO Class I price is announced in advance of each month and uses the most recent two weeks of sales price data for cheese and butter/powder in the formula. Right now, it looks like these values are pretty close in price and so at least in May this change should result in a higher Class I price.