Fourth Quarter 2000
Volume 3, Number 3

The 2001 Agricultural Appropriation Act, signed October 28, provides money to the National Agricultural Statistics Service (NASS) "to develop and implement a biweekly cream/milkfat survey to benefit all segments of the dairy industry." NASS is now developing its plan for the survey, and is in contact with ABI staff.

ABI members are strongly encouraged to contact Dan Kerestes or Bob Milton at (202)720-3570 or rmilton@nass.usda.gov in order to provide input on such issues as: pricing points (f.ob. at the supplying plant or other), whether to survey buyers or sellers or both, who those buyers and sellers should include, and other practical matters connected with the survey. Another issue of interest may be whether to put the survey on a biweekly or semi-monthly schedule, since the latter would more easily align with Federal order price announcements to allow better comparisons.

With support from both dairy producer and processor groups, both houses of Congress unanimously approved mandatory reporting of dairy product sales and storage, and it was signed into law on November 22. The Dairy Market Enhancement Act of 2000 says that manufacturers of the dairy products used in calculating Federal order prices must report on the price and quantity of product sold. Based on current and forthcoming regulations, this includes butter, nonfat dry milk, cheddar cheese in both 40-lb. blocks and 500-lb. barrels, and whey. Barrel cheese makers also must report moisture content. In addition, storage reporting is mandatory for any dairy products the department chooses.

Violators face fines of up to $10,000 per offense, and records must be kept available for audit for up to 2 years. The Secretary may exempt manufacturers of less than a million pounds per year. All proprietary information is to be kept confidential.

On December 1, 2000, the last day allowed by Congress, USDA announced new Federal order price formulas. These were the result of hearings held in May and will take effect on January 1, 2001. The clear good news for butter makers is that the make allowance in the Class IV butterfat formula is slightly higher, up to 11.5¢ per pound of butter from 11.4¢. At any given butter price, this would reduce the butterfat price by about 0.12¢ per pound, and the price of 40% cream goes down by just under 5¢ per hundredweight.

However, the most significant change for butter makers may actually be the change in the Class III butterfat calculation. Rather than define the relative market values of protein and butterfat (as the current formulas do), the new formulas allocate the cheese value of Class III milk in fixed proportions between protein and butterfat.

At the May hearings, Dr. David Barbano, a dairy scientist from Cornell University, testified that it was unfair to price the butterfat in cheese the same as other butterfat, and proposed instead that Class III butterfat and protein values be jointly calculated from cheese prices using their marginal yields. USDA adopted this recommendation. Based on a cheese yield formula, Class III butterfat will always be worth 12.6% more than Class III protein, and will have no direct relationship to market prices for butter or cream. This should have a series of secondary effects on dairy markets, and butterfat markets particularly.

Although the direct effect on milk prices overall and on Class IV butterfat prices will be minimal, the incentives to use and produce butterfat will be changed. The minimum class prices at typical producer tests will be up about 10¢ at any given set of product prices; but the indirect effects of new make allowances and, especially, changes to Class III component prices, are likely to be greater.

Old and New Class III and IV price Formulas, Based on 2000 Prices to Date
	NASS Butter Price	NASS Cheese Price*	Bf Old	Class IV Prices			Class III Prices
				Bf	Milk at 3.5%		Bf	Protein		Milk at 3.5%
				New	Old	New	New	Old	New	Old	New
Jan	0.88	1.15	0.94	0.94	10.73	10.84	1.58	2.17	1.40	10.05	10.00
Feb	0.90	1.11	0.96	0.96	10.80	10.92	1.51	1.98	1.34	9.54	9.52
Mar	0.95	1.11	1.02	1.02	11.00	11.11	1.51	1.92	1.34	9.54	9.54
Apr	1.04	1.10	1.14	1.13	11.38	11.51	1.50	1.74	1.33	9.41	9.45
May	1.17	1.10	1.29	1.28	11.91	12.02	1.50	1.55	1.33	9.37	9.45
Jun	1.27	1.11	1.41	1.41	12.38	12.50	1.52	1.43	1.35	9.46	9.58
Jul	1.15	1.22	1.27	1.27	11.87	11.99	1.69	1.97	1.50	10.66	10.69
Aug	1.15	1.17	1.27	1.26	11.87	11.99	1.60	1.80	1.42	10.13	10.19
Sep	1.16	1.23	1.27	1.27	11.94	12.06	1.71	2.01	1.52	10.76	10.78
Oct	1.13	1.16	1.24	1.24	11.81	11.93	1.59	1.80	1.42	10.02	10.07
Nov	1.41	1.02	1.57	1.57	13.00	13.11	1.38	0.91	1.22	8.57	8.79
Avg.	1.11	1.14	1.22	1.21	11.70	11.82	1.55	1.75	1.38	9.77	9.82
*The new calculations are based on a higher cheese price using a lower moisture standard for barrel cheese.

Using product prices for the first ten months of 2000, the Class III butterfat price under the new rule would have been 34¢ higher on average than the Class IV butterfat price. (See the table on page 1.) Butterfat will typically be more expensive for use in cheese than in butter, based on what we generally consider "normal" cheese and butter prices.

Farmers will see the new Class III butterfat price as part of a new "uniform butterfat price". If this price is higher than the butter-based butterfat price, it could encourage producers to feed (and breed) for higher tests, possibly easing the current short butterfat situation. However, the new blended butterfat price will also dilute the response of dairy farmers to changes in butter prices, since about 40% of producer butterfat won't be priced according to butter prices.

On the processor side, higher Class III butterfat prices could lead to the reduced use of butterfat in the cheese vat, which would reduce overall demand for butterfat. Another effect could be butter, plastic cream, anhydrous milkfat, and butteroil (all now in Class IV) going into the making of nonstandard cheeses, boosting the demand for butter without increasing the final use of butterfat.

Finally, splitting out Class III and Class IV butterfat prices may exacerbate the general problem of the Class III/IV price spread. The lack of a market incentive for milk to move to higher valued uses has allowed this spread; producers and cooperatives receive the blend regardless of where their milk goes, and processors pay a price that allows only a minimum margin. Now butterfat also will lack this incentive for efficient movement. The question is whether this will further widen the spread between Class III and Class IV prices, or whether capacity constraints have already defined the limits of this gap. The secondary effects of the new pricing may be as much of a surprise in 2001 as they were in 2000.

The Federal order formulas that take effect on January 1, 2001, make the Class III butterfat price a function of the cheese price. They also change make allowances and the powder yield factor in the Class IV formulas. This requires new calculations for forward pricing both Class IV and Class III butterfat. As a follow-up to the calculations presented in the previous ABI Outlook, these are presented below:

Beginning with January 2001, the calculation of the Class IV butterfat price from the Class IV milk and the nonfat dry milk prices is as follows:

Using the above formulas, a 200,000 pound Class IV milk contract forward prices 7,000 pounds of Class IV butterfat. A Class III butterfat value can be calculated from the new Class III price and the whey price. (Like nonfat dry milk, whey has a futures contract on the Chicago Mercantile Exchange that has had no volume to date.)

Using this formula, a 200,000 pound Class III milk contract forward prices 12,314 pounds of Class III butterfat. (It is relatively easy to assume a whey price, since its impact on the formula is small: doubling the current whey price would reduce the implied Class III butterfat price by only 3¢.)

U.S. butter production through October of 2000 was 1,082,603 pounds, 2.9% above the first 10 months of 1999. This compares to a 3.8% increase in estimated U.S. milk production through October. High butter prices have not drawn butterfat to the churn. NASS reported October 31 butter stocks at 58 million pounds, drawn down 32 percent from the end of September to meet coming holiday demand, but also down 10 percent from October 1999. Estimated commercial use of butter during the third quarter was 336.5 million pounds, 5.7% more than during 1999's third quarter. The Federal order butterfat price for November was $1.5745, reflecting rising butter prices; on December 1 the butter price on the CME reached $1.8525. The average retail butter price in U.S. cities was $2.63 per pound in October, about 3¢ below last October's average.

Milk production is still growing, and butterfat is still short, as evidenced by butter's jump to $1.80 in early November and its continuing in the $1.80's in early December. Demand is expected to top out as the holidays approach, leading to lower prices; but any forecast beyond the end of the year is dicey, since the new Federal pricing will again rearrange the milk markets in yet-unknown ways. The futures markets call for butter to dip below $1.10 in the spring and spend the summer near $1.20 before rising to $1.30 in the fall.

Briefly:ABI is on the Web at http://www/butterinstitute.org.