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Retooling Needed if Federal Orders are to Work

August 2004

Issues in Class III and IV pricing for manufacturers in portions of the western U.S. have broader implications for the future of the Federal Order system, Doug Marshall said at the 46th Annual Meeting of National All-Jersey Inc., as he in turn predicted that hearings are in the offing.

“That is why I am talking about these issues today,” the senior vice-president of Seattle-based Northwest Dairy Association (NDA) said during the afternoon meeting on July 3. “A lot of them affect cheese plants, and cheese plants are probably the biggest markets for Jersey milk.

“It is only profitable plants and co-ops that can give premiums. So let’s start with that common basis of self-interest.”

NDA is the nation’s fourth largest dairy marketing cooperative, handling 7.2 billion pounds for producers in Washington, Oregon, Idaho and California. Through WestFarm Foods, it posted $1.3 billion in sales in the most recent fiscal year.

Life Without Federal Orders

The “view from Seattle” on milk pricing, Marshall explained, has been particularly dynamic, most recently including “the experience of living without a Federal Order in Utah and Idaho for three months.”

For now, he noted, record high Class III prices and cheese prices have not provided an incentive for a price war in what used to be the Western order, eliminated on April 1.

“It’s too early to tell,” Marshall said, how deregulation of milk prices will affect marketing in the area. However, “the key as to whether competition breaks out is at the bottler level, the retailers who look for an advantage, just like everybody else, against the guy who’s selling milk across the street. Producers may leave each other alone, or they may elect to compete and that would be an interesting thing. The test will be low prices coming in and destabilizing the market.”

That situation, plus other unique features of the West milk marketing picture, lead to a bottom line, Marshall said: “Milk pricing is not uniform in the west.

“If pricing isn’t uniform, can regulated pricing survive? One of the principles of regulated pricing is to make sure that people are all on the same playing field and don’t have reasons to go around that regulatory structure.

“So, I suggest that the Federal Order system is not likely to survive unless all the patchworks (in the map, Fig. 1) and regulatory systems are in alignment.”

Toward A Fix

How might Federal Orders be maintained, “a goal that benefits dairy farmers all over the country?”

Begin by fixing the “flat pricing surface” in the system, Marshall said. “It’s unrealistic” not to adjust the value of producer milk to reflect distance from the intended markets. “Two-thirds of the people live in the Eastern and Central time zones, but the growing areas of milk supply are in the West.” That difference in geography “translates to about four cents per pound of cheese to move it to the Midwest and eight cents to move it to the East coast.”

By comparison, Marshall noted, “California adjusts the value of producer milk to reflect distance from the eastern markets.” That move—”very pro-producer in its intent”—has given California a competitive marketing advantage.

The difference to cheesemakers between the Federal Order Class III price and California Class 4b price “highly fluctuates,” from over $2.00 per hundredweight on the plus side to about $1.00 on the down side.

“Some policy questions that I pose to you,” Marshall continued. “Does it help producers in the Federal Order system across the country to have a higher Class III or IV price than California? Not if that is one reason for loss of market. On the other hand, does it help producers in California? If they are focused on higher prices, it does not.”

Other Considerations

The basis for pricing products also puts “market distortion” into the Federal Order system. “California uses the CME’s prices whereas the Federal Order prices are based on the NASS price survey,” based on the previous week’s numbers compiled from plants across the country. “What happens is, a combination of the one-week survey lag and the day of make pricing can result in a two- to four-week lag between two prices,” Marshall said. “Over time, the CME and NASS cheese pricing do average out to be about the same. Yet in a given month, that lag is very disruptive to the marketplace.

“We can hopefully look forward to a Federal hearing someday on going to CME pricing.”

Calling it “the biggest difference in California and Federal Order pricing,” Marshall noted that California invests considerable effort in making sure that plant cost data and pricing formulas are kept up to date. “The Federal order system just doesn’t do that. Dramatic increases in labor and energy costs since 1998 are not captured in the current manufacturing allowances. We are working today—2004—with a system that reflects plant problems and deficiencies from 1998 to 1999.

“So we expect a Federal Order hearing to have some of these cost factors updated.”

A Plea For Industry Support

“Federal Orders should remain in effect,” Marshall concluded. “They have to be workable and fair. The Federal Order system, in my judgment, has to become more activist to make them more responsive. That requires support from the industry. Let’s make Federal Orders more responsive and relevant to the changing times, changing market conditions. ”