By Jayne Sebright, Executive Director at the Center for Dairy Excellence
“We are living in unprecedented times” is a phrase I have heard all too often over the past few months. With the COVID-19 pandemic causing havoc on all aspects of our society, including the dairy industry, it has left many of us trying to grapple with the uncertainty and uneasiness that both seem to be commonplace right now.
One area that has been filled with uncertainty over the past few months is the milk markets. On March 4, just before the pandemic hit, the 12-month average for Class III milk futures on the CME averaged $16.65 per hundredweight. By April 30, that 12-month average Class III milk futures price had fallen to $14.73 per hundredweight. Today, on June 30, the 12-month average Class III milk futures price has more than rebounded to $17.14 per hundredweight, with the Class III price for June and July forecasted to be above $20.
While it is great to see milk futures prices rebounding above where they were pre-COVID, it is generating two different questions within the farm community. The first is, “How long will these prices last?” And, the second is, “How long will it take for these prices to show up in my milk check?” Although milk pricing is extremely complicated and difficult to explain, I am going to attempt to shed some light on both these questions in this month’s column.
How long will these prices last?
The truth is that nobody, even the best market analyst, knows for sure what is going to happen over the next six months. A couple of different factors are driving up the milk price right now.
The first is that demand is up over expectations. Restaurants and food service institutions are coming back online, with more milk being utilized through these outlets. At the same time, the CARES Act approved $100 million per month in USDA purchases of dairy products to be distributed through the charitable food system. Both the increasing food service sales and charitable food purchases are generating an increase in demand.
The second factor driving up the milk price is a decreasing milk supply. With many handlers instituting mandated reductions in milk production because of the pandemic, total US milk production fell 1.1 percent year-over-year in May, the steepest decline since October 2009. Cow numbers fell 15,000 head in just two months to 9.37 million head, still 37,000 head above year ago levels, while milk production per cow was down 1.5 percent from a year ago to 2,011 pounds for the month. All the top eight major dairy states except Texas posted declines in milk production.
Going forward, tremendous uncertainty in the demand side of the equation still exists. With schools still unsure of their reopening plans, school milk sales may not be there this fall to replace the ice cream sales that are higher through the summer months. A bigger concern, though, is whether a second wave of the pandemic may shut down restaurants and institutions again this fall. A second wave may also mean a decrease in export opportunities, with other borders closing to US products.
The supply side is heavily dependent on what milk handlers decide to do going into the fall. If mandated milk production reductions are lifted, many farms may begin to feed their dairy herd more aggressively again, increasing their milk production per cow. Also, with milk prices higher than expected, some herds may decide to expand cow numbers. Both scenarios would increase supply.
Any slight change in milk supply or demand could weigh heavily on milk prices, which is why now may be an optimal time to consider your risk management options. Dairy Revenue Protection (DRP) is one of those options. DRP can be used to set a milk price floor to protect against drops while not giving up the top side of the market if prices move higher. DRP is a Federal Crop Insurance program overseen by the USDA’s Risk Management Agency (RMA) that guarantees a quarterly revenue based on the quarterly milk price and production insured. Policies are available up to five future quarters.
When will these prices show up in my milk check?
With commodity prices for both cheese and butter increasing dramatically over the past few weeks, Class III and Class IV milk futures prices have also been trending higher. However, USDA will not announce the June Class III and IV prices until July 1. Once those prices are announced, the Class III price will be used to calculate the price you receive for your components – butterfat, protein, and other solids — on your June milk check.
However, since the June Class I base price was calculated from the May Class III and Class IV prices, the Class I price will be much lower than the Class III and Class IV milk price for this month. The June 2020 Class I price was announced at $11.42 per hundredweight, which is well below the Class III price currently on the board at $20.94 per cwt. and under the Class IV price of $13.02 per cwt. The lower Class I milk price will pull down the “blend price” announced in each Federal Order, which is the price calculated based on that order’s utilization of milk in Class I, II, III and IV.
When the value of Class III milk for that month is higher than the value of Class I, II, and IV milk, it is reflected as a negative “Producer Price Differential” listed on your milk check. Simply put, PPD is the relationship of Class III value relative to the value of the other three milk classes. When you get your June milk settlement check around July 20, you can expect to see a significantly negative PPD because Class III price increased more quickly relative to Class IV and the announced Class I base price. This will weigh on the final mailbox price you receive. In contrast, when Class III prices were falling this spring, dairy farmers saw positive PPDs of $1 or more per hundredweight. While negative PPDs do not look good on your milk check, you are still benefitting from the increased Class III price.
Once Class I and Class IV prices catch up with Class III prices, the PPD will come back up to be more in line with historical expectations. The most recent forecast I saw had the June blend price for Federal Milk Marketing Order 1 at $15.70 per cwt. The blend price forecast for the third and fourth quarter averaged between $17.75 and $18 based on current futures prices. Like I said earlier, anything can happen between now and the end of the year. That is why looking at your risk management options now is so critical to protect the future of your business.
To learn more about the Dairy Revenue Protection Program and other risk management options, you can email Zach Myers, our risk education program manager, or call the Center at 717-346-0849.