Geoff Vanden Heuvel
Director of Regulatory and Economic Affairs
The Bulk Butter Bulge
Bulk butter inventories surged when the pandemic hit in March. The reason was obvious. Restaurants and institutional food service shut down and the butter started backing up. Butter has been a bright spot for dairy over the past number of years. From 2014 to the beginning of the pandemic in March, the bulk butter price as established at the Chicago Mercantile ranged between $2 and $2.50 per pound despite world prices for butter often ranging 30-50 cents per pound lower.
After the initial drastic drop in all dairy product prices in the Spring, there was a modest recovery in prices. Then USDA’s Food Box program kicked in, and with it, a need to put consumer-sized packages of dairy products in the box. This was a phenomenal windfall for cheese prices, but for butter a practical problem revealed itself.
The pandemic greatly altered the way people accessed their food. You have basically two channels in the food distribution system – food service and grocery. The packaging and logistics requirements of each channel are vastly different. The blend between bulk butter demand and print butter demand had been a remarkably successful mix as demonstrated by how well the bulk butter price (which also sets the value for print butter) held up over the past number of years. But now the grocery stores were enforcing limits on how much print butter a customer could purchase at the same time bulk butter inventories were growing.
USDA’s latest cold storage numbers tell a story. A bulge in butter inventories emerged in the early days of the pandemic, which has hung over the industry since then. It appears that there is somewhere between 40 and 60 million pounds of extra butter in cold storage. We hear that print butter sales are great, and yet butter prices are still way below the $2 price of recent years.
We now hear about another round of the Food Box program. Certainly, there are hungry people in the country who need food assistance, but something significant needs to be done to deal with the effects of this bulk butter bulge on the price of butter. Huge differences in the value of milk used for cheese versus milk used for everything else creates significant relative position challenges in the dairy community. When those differences are the result of government actions, then government does have a responsibility to assist in addressing it. Hopefully, we will soon hear of actions that will cause all boats to rise with the tide.
Federal Order Class I Formula
Another big problem revealed by the gyrations of the pandemic dairy market is what a fiasco the change to the Class I pricing formula has turned out to be. Since about the year 2000, the Class I price in the Federal Order system used the higher of either the cheese/whey product values or the butter/NFDM values as the base price to which the Class I differentials were added in the various Federal Orders. Bottlers complained that because the system was based on the “higher of” which could change from month to month, they had a difficult time hedging their price risk. On behalf of producers, National Milk Producers Federation was open to a fix and agreed to change the base price to the average of Class III and IV instead of the higher of, in exchange for an added permanent increase of $0.74 per cwt. over the base price. The $0.74 per cwt. was determined to be the long-term average benefit from the “higher of” feature. Said another way, if the spread between Class III and Class IV is less than $1.48, then this change is positive for producers. Conversely, if the spread is greater than $1.48 the result is negative.
This change took effect in May of 2019 just before 2020 happened. As a result of the massive spreads between Class III and Class IV prices in 2020, hundreds of millions of dollars in less Class I revenue has been paid to producers than what would have occurred under the old pricing formula. The fundamental principle of the classified pricing system, which is that Class I is the highest value, is now being violated with impunity, causing very destabilizing results in the Federal Order system. The situation must be corrected. If it is not, then the whole premise of the Federal Order system begins to unravel with very unpredictable results.
Dairy Revenue Protection
On the good news side, The Dairy Revenue Protection (DRP) crop insurance program made an adjustment in the Expected Yield Per Cow factor for endorsements purchased by California producers. The DRP is a revenue insurance policy. Revenue for a dairy farmer is based on two factors, the price for milk and the volume of milk sold. When an endorsement is purchased for a future quarter there is an expected production per cow number that is attached to that endorsement. When the covered quarter is over, the actual milk production per cow for each state that is announced by USDA is compared to the expected production per cow that was listed on the endorsement at the time it was purchased. Each state has its own milk production per cow number. California’s expected yield per cow numbers listed on policies sold to California producers have consistently underestimated the actual production per cow announced by USDA since the program started at the beginning of 2019. Sometimes the amount has been small, but the amount was larger in Q3 of 2020. This discrepancy was brought to the attention of the operators of DRP as well as USDA and they developed a fix, which was adopted by USDA’s Risk Management Agency (RMA) board a week ago and immediately implemented for coverage purchased from this point forward. Many thanks to Dr. Marin Bozic and Dr. John Newton who operate the DRP program and to the RMA for being willing to acknowledge a problem, devise a fix and implement it in record time.
Dairy Margin Coverage
Reminder, signups for the 2021 Dairy Margin Coverage program (the program you sign up for at the Farm Service agency) ends next Friday, December 11. It is hard to understand, but only 7,846 producers had enrolled as of last week representing about 32% of the dairy operations that have established production history. Signing up for the $9.50 margin costs $0.15 per cwt. There is a $100 administration fee due right away, but the remaining cost is not due until September. The DMC estimator shows a very good likelihood that this program will make payments in 2021. But if you are not signed up, you will not receive them. Also, if you signed up in 2019 for the five year deal and took advantage of the 25% discount in the cost, you still need to contact your local FSA office and pay the $100 administration fee.