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Guest Columns

Perspective:
Dairy Pricing

The next step in dairy price discovery

Mike McCully

Mike McCully is owner of The McCully Group LLC, New Buffalo, Michigan, and contributes this column for Cheese Market News®.

Using spot prices from a thinly traded market without full industry participation results in a marginal load of product setting the price for millions of dollars of milk and dairy products. This inherently leads to volatility in pricing, an unwanted side effect of the current dairy pricing system.

The CME spot market has long been the central price discovery point in the United States for cheese and butter, and more recently, nonfat dry milk (NDM). While the dairy industry has relied on centralized spot markets for price discovery, they are not without issues. A very small amount of product trades on the CME spot markets relative to production. In 2018, 2,073 loads of block and barrel cheese traded on the CME. This represented only 0.7% of total cheese production and 2.3% of cheddar cheese production. For butter, 3.2% of production traded on the CME while NDM was only 1.4%. Despite the small amount of product traded, CME prices are used to price not only cheese, butter and NDM, but also indirectly influence the price for all classes of milk in the United States.

The industry’s reliance on CME spot markets and commodity products is deeply intertwined with the use of multiple component pricing in federal milk marketing order milk pricing formulas. However, multiple component pricing is needlessly complicated and has resulted in an unintended consequence of encouraging commodity production resulting in commodity milk prices. Why not let plants compete for milk in a market-oriented system? It’s time to rethink how milk is priced in the United States to better position the industry for innovation and growth. To achieve that, a new price discovery system is needed to provide timely information to the market.

The dairy industry can look to its livestock cousins for inspiration. An example of how a new dairy pricing system could be structured is Livestock Mandatory Price Reporting. This was implemented in 2001 and, according to USDA, “Livestock Mandatory Reporting was developed to facilitate open, transparent price discovery and provide all market participants, both large and small, with comparable levels of market information for slaughter cattle, swine, sheep, boxed beef, lamb meat, and wholesale pork.” Beef and pork processors above a certain size are required to report on a daily basis the prices they paid for cattle and hogs along with the prices they received for various cuts of meat. USDA’s Livestock, Poultry, and Grain Market News has a number of daily and weekly reports on prices as well as number of cattle and hogs harvested.

There is no centralized spot market for these products. Instead, the USDA report is used as the price benchmark for transactions in the meat industry. The National Daily Direct Afternoon Hog Report and the National Daily Boxed Beef Cutout and Boxed Beef Cuts reports are good examples of the information provided by USDA.

A daily USDA dairy price report could contain the volume of milk processed, prices paid for milk, butterfat, and nonfat solids as well as prices for a variety of products — cheeses, butter, whey products and milk powders. Instead of waiting for the Milk Production report, information on milk supplies would be available in real time. There also would be improved transparency for prices of more products than are available today and those prices could replace CME spot prices for buying and selling products. The prices also would represent the average for larger volumes of products versus today’s marginal load of product at the CME. Think of it as a super-charged combination of the National Dairy Products Sales Report and Dairy Market News. If the beef and pork industries can do it, why can’t dairy?

A daily report on milk volumes and prices for milk and key products can serve as the foundation for a new milk pricing system. It’s time to consider a change to milk pricing and move away from multiple component pricing and regulated minimum prices for non-fluid milk products. A daily price report from USDA would give buyers and sellers the information they need to transact business in a transparent way in a market-oriented system.

Plants would know what their milk costs are when they use it and farmers would know what their milk is worth when it leaves their farm. This is how it works in the beef and pork sectors and it can work for dairy. This would make supply and demand more responsive to current market conditions and help reduce the volatile swings in prices.

For some, this idea is revolutionary. Companies and people that are invested in the current system will be concerned about an uncertain future and will prefer to stay with the status quo, but the status quo isn’t working. The U.S. dairy industry faces a multitude of challenges, and it needs a more market-based system of pricing milk and products than what we have today. The industry needs timely and accurate market information, which includes government reports on current market prices and production volumes. The more we do to improve the quality and availability of market information, the industry will benefit from better price transparency throughout the dairy supply chain.

Dairy and milk prices are inherently volatile, but the price discovery mechanisms shouldn’t add to the volatility. It’s time for the dairy industry to consider daily price reporting used by other livestock sectors.

CMN

The views expressed by CMN’s guest columnists are their own opinions and do not necessarily reflect those of Cheese Market News®.

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