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Producer Price Differential: What to Expect in the Coming Months

In 2000, Federal Milk Marketing Order (FMMO) Reform occurred and set up a class pricing system by which dairy producers would be paid based on class utilization of milk within the FMMO. The system also set minimum prices for each classification based on historic actual values. The class pricing system was developed assuming that the value of Class I (fluid milk), Class II (icecream and yogurt), Class III (cheese and whey) and Class IV (butter and powder) dairy products would decrease in value by class—with Class I having the highest value and Class IV the lowest. As we have seen numerous times over the past 20 years, the decreasing price assumption is not always true. As a result of thispricing mechanism, unorthodox market conditions sometimes result in a negative Producer Price Differential (PPD) due to how class milk is priced and the timing of announced advanced prices.

Over the next few months, current market conditions are expected to generate negative PPDs for much of the country because of the spread between current Class III and IV prices as well as high Class III price relative to the announced Class I Mover.

The PPD is basically the difference between Class III dairy product value and the value of dairy products from Class I, II and IV. In “normal” market conditions, the value of Class I, II and IV will be greater than Class III value and will add money to the “pool” that can be returned to the farmer and shows as a positive PPD in your milk check. A few conditions can exist that cause the value of Class III to be greater than I, II and IV, resulting in less money in the“pool”. When this occurs, it shows as a negative PPD in your milk check. Two main factors right now are expected to cause the highest negative PPDs since the class pricing system began in 2000.

Prices change daily. This market information is an example for educational purposes. The market data below are compiled weekly by Farmshine, via CME & USDA reports

price and adding 74 cents per cwt. Under the “higher of” Class I calculation, the value of Class I would always be greater than Class III and would not contribute to a negative PPD. Under the current Class I pricing mechanism, when the spread between Class III and IV is larger than $1.48 per cwt, Class I price will drop below Class III and contribute to a negative PPD. The larger the spread, the more negative the PPD. The spread between June Class IIIand IV prices is $8.40. The other main factor contributing to negative PPDs is due to how the Class I Mover is calculated and the timing of when it is announced. The June Class I Mover was announced towards the beginning of May and was calculated using actual Class III and IV prices surveyed at theend of April and beginning of May prior to when the June Class III rally occurred. This resulted in a much lower value for Class I relative to June Class III.Another way to explain this scenario would be that it cost the processor more to manufacture and sell Class III product than what premium they received for bottling and selling fluid milk. PPDs will moderate eventually, but it will take time. The July Class I Mover is $16.56, up from $11.42 in June, and reflects the rally in Class III during June. However, based on July 7 futures prices, the spread in Class III and IV will not drop below the $1.48 threshold until December 2020. I know it will be difficult seeing a large negative PPD on your June milk check. Try to keep in mind that you are receiving some benefit of the Class III rally inyour blend price. Historically, in Pennsylvania, about half your milk check is determined relative to the Class III milk price.

Source: Center For Dairy Cattle Excellence


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