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Class I Controversy Update

Updated: Dec 1, 2022

Geoff Vanden Heuvel

Director of Regulatory and Economic Affairs

When USDA last performed a major overhaul of the FMMO classified milk pricing formula in the year 2000, it created separate formulas for Class III (milk used for cheese and whey) and Class IV (milk used for butter and powder) based on the market values for those products. It established a Class II price based on a differential that is added to the Class IV value and it established a Class I price based on the “higher of” either the Class III value or the Class IV value. In its justification for why it picked the “higher of,” USDA said:

“Because handlers compete for the same milk for different uses, Class I prices should exceed Class III and Class IV prices to assure an adequate supply of milk for fluid use. Federal milk orders traditionally have viewed fluid use as having a higher value than manufacturing use. The replacement Class I price mover reflects this philosophy by using the higher of the Class III or Class IV price for computing the Class I price.”

Setting Class I prices using the “higher of” continued until 2019 when Congress instructed USDA to change the Class I mover to use an “average of” Class III and Class IV values, and add an additional $0.74 per cwt. to the price. This Congressionally mandated change was done at the request of the National Milk Producers Federation (NMPF) and the International Dairy Foods Association (IDFA). These are the two main national dairy industry groups representing producers and processors, respectively. IDFA had approached NMPF and asked for the change because it asserted that the “higher of” made risk management difficult for Class I handlers. NMPF agreed to the change in exchange for the $0.74 per cwt. bump in the Class I price. The $0.74 approximated what the “higher of” factor generated over what the price would have been if the “average of” had been in place since 2000. The idea was to make the change from “higher of” to “average of” revenue neutral to producers.

Then the pandemic hit. Class III prices soared and Class IV prices languished. Suddenly using the “average of” instead of the “higher of” began costing producers real money. It also increased the incentive for Class III handlers to de-pool their milk, thereby increasing negative Producer Price Differentials (PPDs) for those remaining in the Federal Order pool. While the spread between Class III and Class IV is narrowing, the “average of” is still yielding a lower Class I price than the “higher of” would have generated.

Producers want change, but IDFA is saying no. Some view this response by IDFA as bad faith. When processors had a problem with risk management, they asked the producers for help and producers did help with the understanding that they would be essentially held harmless by the change. The producers have now been harmed, not only by losing out on Class I revenue, but also because large negative PPDs undermine producer risk management tools and IDFA is not willing to cooperate in addressing the producers’ problem.

So where does this leave us? The NMPF board voted to petition USDA for a hearing to consider changing the Class I formula. Its proposal would continue with the "average of" either the Class III or Class IV price and increase the adjuster from the current addition of $0.74 per cwt. to whatever the average of the last two years would have been. Since the last two years includes 2020 the adjuster under this proposal would go up to about $1.60 for the next two years. NMPF proposes to floor the adjuster at $0.74 per cwt. and recalculate the number every two years.

Additionally, four Midwest dairy producer groups put out a press release proposing a slightly different approach. The groups want to change the Class I adjuster from the "average of" Class III and IV to be exclusively based off the Class III price. However, this proposal does not completely ignore the Class IV price. It calls for an annual adjustment based on the trailing three years of spreads between Class III and Class IV. So, when Class IV is higher than Class III, that information is captured in the adjuster for the next year. This proposal also does away with advanced Class I prices.

There is another group led by the American Dairy Coalition that is leaning toward supporting simply going back to the "higher of.” There is also talk of asking USDA to allocate some of the remaining pandemic relief funds directly through the Federal Milk Marketing Orders to more specifically compensate producers who stayed in the pool.

Meanwhile, Secretary Vilsack was quoted during a recent presentation to the North American Agricultural Journalists saying, “I know that within the dairy industry there are conversations, and I think those conversations need to mature a bit more before anybody makes a decision that there’s going to be a significant change.”

The current status of the issue: IDFA is opposed to a change and dairy producers are not in agreement.

In other news, Hilmar Cheese Company announced earlier this week that it will build a new cutting edge cheese and whey production facility in Dodge City, Kansas. Read more here.

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