Stephenson explains COVID deductions on April milk checks
Friday, May 29, 2020
By Mark Stephenson, Director of Dairy Policy Analysis, University of Wisconsin, Madison
As you are all well aware, the dairy supply chain has been working its way through some very turbulent times. Our shelter at home orders caused an immediate shutdown of virtually all schools, sports, and restaurants overnight. This in turn was a dramatic decline in demand for dairy products as about half of dairy product consumption has historically been in out-of-home eating. On the other hand, as we all ran to the grocery stores to stock up on toilet paper, beans, flour and fluid milk, we saw stock outs on the store shelves and rationing to customers. The dairy industry seemed to agree that the net effect was something like 10 percent more milk than was needed at the time.
Dairy markets have seismic price movements on ±2 percent changes in supply or demand, so you can imagine that 10 percent was uncharted territory. Many handlers—cooperative and proprietary—either asked for voluntary reductions in milk shipped or invoked base-excess plans of anywhere from 5 to 20 percent depending on the plant’s customer needs. A few plants did not ask for reductions and some, like fluid, even requested greater volumes.
Farms did not reduce milk production overnight. We saw many news headlines of milk being dumped as there wasn’t any place to find processing. This is part of what you are seeing on the April milk check deduction. Another larger but more invisible culprit is what is called “distressed milk” sales.
Federal milk marketing orders set minimum prices monthly that must be paid by plants. Those prices differ depending on what the milk is used to make. Class I is milk used for fluid milk purposes and Class III is milk used to make hard cheeses. Class I prices are almost always the highest prices and as you can imagine, farms would fight against one another to sell their milk to a fluid plant rather than a cheese plant except that the federal order calculates a weighted average price (called the statistical uniform price) from the milk that is pooled across all uses. Then, Class I plants must pay their farmers the uniform price (also referred to as the blend price) and contribute the difference between the Class I price and the uniform price to the “producer settlement fund”. Cheese plants get to take a pool draw from the producer settlement fund to add that money to their Class III milk price and also pay their producers the same uniform price. That way, there is isn’t any reason for a farmer to fight for the Class I sale.
Cheese plants choose to participate in federal orders because there is usually money in the pool for them to access to partially pay their producers. However, they are not under any requirement to be a pooled plant. In the rare occasion where the Class III price may be bigger than the Class I price, that would mean that cheese plants would have to contribute to the pool and fluid plants would get to take a draw from it. This is when we would get a negative PPD. But, cheese plants can choose to not be regulated by the federal order and pay whatever price they need to get milk into their plant. Some cheese plants are also partially regulated and if they have a dedicated receiving bay and silo into which they can unload and store unregulated milk, they can also participate in other bays and silos with regulated milk.
When there is too much milk available, plants may choose to either deregulate or use their partially regulated status to purchase milk below the federal order minimum at distressed milk prices. These prices may be anywhere from $1 to $10 dollars below the regulated minimum prices depending on how severe the stress. Most of the milk from Michigan that was coming over into Wisconsin cheese plants was being sold here at distressed prices, and in April and May, there was quite a bit of Wisconsin milk that simply couldn’t find a home at federal order minimum prices.
There is always a small amount of dumped milk in a federal order if a truckload tests positive for antibiotic, comes in too warm, or overturns in a ditch. Usually a handler can cover those losses and blend them back to producers with a slightly smaller premiums paid on the milk check (remember, premiums are “over order” and paid above the federal order minimum prices). But this time, the distressed sales price of milk was too low and there was too much volume to hide in smaller premiums. So, handlers decided to show that in a line item that might be labeled as a “COVID deduction” on the check. This should also signify just how unusual it is and maybe only a one or two month occurrence and hopefully never seen again.
As upset as producers are at seeing these deductions for distressed milk sales on their checks, I would try to offer one other perspective. Many cheese plants lost significant customer sales. They would not want to purchase milk and make cheese for sales they didn’t have. However, at the discounted prices of distressed milk, many were willing to take a gamble and make product for future sales they hope to make. And, many processors were interested in helping farmers find a home for the milk even at a small loss to their own business. You can see the evidence of this in the attached graph of cold storage which shows an unprecedented jump in stored cheese from March to April. Distressed sales may be at a low price, but they are perfectly legal outside the federal order and the alternative was to dump milk at a zero dollar price.
I hope that this gives you some idea as to what the milk checks are showing. It is possible that the May checks, which farmers will receive in mid-June, could also have that deduction, but marketing channels and price opinions are improving rapidly and we shouldn’t see them after that.