The Two Professors Come to California

By Geoff Vanden Heuvel MPC Board Member and Economics Consultant

By Geoffrey Vanden Heuvel

The author, a dairyman in Chino, Calif., is a board member and economics consultant for the Milk Producers Council.  This piece appears in the MPC newsletter dated Apr. 20 and is used here with permission

Dr. Andy Novakovic from Cornell University in New York and Dr. Mark Stephenson from the University of Wisconsin, two of America’s leading academic dairy economists, made presentations at three events this week sponsored by Western United Dairymen on the proposed California Federal Milk Marketing Order (FMMO).

Dr. Novakovic started the meeting with an interesting history of the development of what ended up becoming the federal milk marketing order program with the depression era passage of the Agriculture Marketing Agreement Act of 1937. The FMMO that USDA has now proposed for California finds it legal justification in this 80-year old federal law.

Dr. Novakovic made the point that the FMMO’s are very supportive of dairy farmer cooperatives. They use the power of the government to support the efforts of cooperatives to effectively market dairy farmers’ milk. That doesn’t mean they don’t pay any attention to the public interest – they do – but protecting processors is not a FMMO priority. He pointed out that this reality had implications.
He said that the National Milk Producers Federation, to which two of our three major California cooperatives belong, is very influential in national dairy policy development. He pointed out that some changes to FMMO rules can be made by the local market administrators, but the big decisions to make
modifications would be national in scope and those decisions would be made in Washington DC and be influenced by the views of cooperatives and producers from the whole country and not just California.

Actually, I find this to be one of the most attractive selling points of the FMMO. What I seek as a California dairy farmer is a level playing field with our fellow producers in the rest of the country.
For many years California state officials have established milk pricing polices deliberately designed to make milk cheaper in California than everywhere else. For a while, our cost of production advantages made this cheap milk policy effective in allowing us to grow as an industry, but when those advantages
began to evaporate, the State was unwilling to change their ways. Having an opportunity to get into a system where milk pricing rules in California will be the same as the milk pricing rules effective for most of our out of state competition seems like a good thing.

 Another interesting point Dr. Novakovic made was that USDA is very picky about making sure that there is accurate milk testing and accounting for the utilization of the milk that they regulate. He said that if we become a FMMO we will likely see changes in our component testing as a result of the strict enforcement that the FMMO’s do. He also emphasized the same point that the USDA officials
emphasized last week in their meetings – that FMMO’s main purpose is to regulate milk for the class I market and milk that has no connection to the class I market is not regulated by them.

Dr. Stephenson then went through his presentation on the economics that function in the American dairy industry. A major point that Dr. Stephenson emphasized is that milk has a location value. Where milk is produced is not usually where that milk or the dairy products made from that milk will be consumed. This reality has a big impact on the actual economic value of milk. These differences in value are explicitly reflected in the class I regulated prices in effect in the FMMO system.

For example, the class I differential in Miami, Florida is $6 per cwt. Because there is high demand for class 1 milk in Miami and the milk supply that is needed to meet that demand has to travel a long way to get there, the FMMO sets a very high class I differential as an incentive for milk to be marketed in that area. By contrast, the class I differentials in areas where milk production is concentrated can be as low as $1.60 per cwt. which is the class I differential that would apply in the lower Central Valley of California.

 Dr. Stephenson also presented maps generated by his model that showed the direction and distances manufactured dairy products needed to travel to reach customers for those products. For the most part, the surplus milk supply is in the Western U.S., and the population and therefore demand for those dairy products is in the Eastern part of the U.S. Dr. Stephenson pointed out that the FMMO regulated milk prices for manufactured dairy products like cheese and butter and nonfat dry milk are uniform throughout the country and do not explicitly recognize these different location values. One of Dr. Stephenson’s maps showed that his model would indicate that there is about a $0.70 difference (lower) location value between the value of milk used for cheese in the West and the value of that milk used for cheese in the Midwest. He indicated that with recent declines in California milk production and increases in Midwest production, that difference might now be closer to $0.30 per cwt. What is interesting to me is that USDA deliberately does not use their regulating power to reflect those location values in the prices they establish. They set up uniform rules and prices and let the market decide what the values of manufacturing milk are. It is also important to note that the Class III price for cheese milk reflects the prices cheddar cheese manufacturers of block and barrel cheddar are receiving for their product on a weekly basis. There is an enormous amount of the national supply of cheddar block and barrel cheese that is produced and sold from California and other Western cheese plants and is part of that National price survey. If Dr. Stephenson’s model is correct, then that volume of cheese from the West would be discounted in price because of its location from the market and those discounted prices would be reflected in the cheese price that drives the class III milk price formula. The bottom line is that while location does play a role in the difference in the value of milk between regions, some or maybe most of that difference may be baked into the class III prices that USDA establishes.

Dr. Stephenson also did some work to estimate what the potential differences in producer prices might be in California under a FMMO rather than our current State order. He did warn that since California prices would no longer be calculated if California went into the FMMO system, we would never really know what those differences were. However, using 2017 pricing data he did calculate what regulated price might be both assuming all milk was pooled and then he ran scenarios where quite a bit of milk was not pooled. For 2017 under a scenario where all of the milk is pooled his estimate was that the uniform blend price at standard test for California would be $16.11. The California overbase price for 2017 was $15.05 which would mean that the California blend price at standard test was probably about $15.43 since about 22% of California’s milk is covered with quota.

Dr. Stephenson then made an informed guess, based on class price relationships to the blend price, how much milk would not have pooled in a California FMMO in 2017. He assumed that none of the class II would pool and most of the class III cheese milk would not pool and then he recalculated the blend price. Interestingly, the blend price only dropped to $16.07 a four cent per cwt. drop. Dr. Stephenson also made the point that these are estimates that will not be exactly correct. And of course, we know that whey prices in 2017 were significantly lower than they had been in previous years and it is the whey portion of the FMMO class III price formula that has generated much of the difference over the past number of years between the California state prices and the FMMO prices.

Dr. Stephenson also spent some time talking about the function of the Producer Price Difference (PPD) and location differentials which both play an important role in what producers actually get paid. I will not attempt in this article to try to explain these complicated, but important details, but watching the YouTube video of Dr. Stephenson’s presentation could be helpful in getting more clarity on this subject.

We thank the two good professors for coming out and sharing their knowledge with us. Thanks too, to Western United Dairymen for sponsoring these events and opening them up to everyone. I know that during this coming week the cooperatives are continuing with their member meetings and I understand the boards of directors for the three major cooperatives who have decided to block vote will be held late in the week. So, the time for decision is nearing.

Featured Image: The author is shown center with the two professors… Dr. Mark Stephenson, left, Director of Dairy Policy Analysis at UW Madison and Dr. Andy Novakovic, right, professor of ag economics at Cornell University.