Milk Price Inversion in Ohio Federal Milk Marketing Orders

Cameron Thraen 
Dairy Economist, OSUE 
Agricultural, Environmental & Development Economics

Consider the following set of events. You open up the envelope from your favorite milk buyer expecting to find a price per hundredweight of $14.77 plus some additional money. BIG SUPRISE, instead you find that your milk price is short of $14.77! What is going on here? You know that the announced July BFP is $14.77 and that this price represents the Class 3 price for milk in Ohio. You also know from experience that Class 1 and Class 2 prices are always higher than the Class 3 price. You know that your milk is being pooled under one of the Ohio Federal Milk Marketing Orders, either FMMO 33 or 36. As an informed milk producer you also know that the utilization for Class 1 typically runs about 50% (53% #36) and Class 2 about 25%(13% #36) in July of the year. That leaves Class 3 at 25%(34% #36) With these typical utilization rates and Class 1 and Class 2 price higher than the Class 3 price, then how could your milk check be for a price LESS than the Class 3 or BFP price? This raises a number of questions. The primary one of course is why is there a deduction in my milk price for July? And, second, what happened to the money that was deducted?

In this short article I will attempt to provide an answer to each of these questions. In case you are in a hurry and inclined not to read the entire explanation, I will provide a short answer to each of these questions before a more detailed explanation is offered.

First, why is there a deduction in my milk price? The answer is that in July of 1998 sets of events occurred that are not typical of Ohio milk markets. Class 1 and Class 2 milk prices are LESS than the Class 3 price. Because of this "class price inversion" the typical addition to the Class 3 price becomes a subtraction from the Class 3 price.

Second, why are Class 1 and Class 2 prices less than Class 3 price? The BFP has increased very strongly after reaching its low price in May of $10.88. Your Class 1 and Class 2 milk prices are based on the May price of $10.88, NOT the July Class 3 price, $14.77 and the relative amounts of milk being pooled in each class.

Third, what happened to the money represented by the deduction? Who received this money? The answer here is simple.From the perspective of the market pool the deduction is an accounting adjustment only. It keeps the current total value of the milk in the Federal Order Pool in line with the Uniform Milk Price based on all uses of milk in the pool; Class 1 and 2 as well as Class 3.

Fourth, when will I see the benefit of these high Class 3 prices? Your milk check for milk delivered in August, September and October will reflect the high Class 3 prices recorded in June ($13.10), July ($14.77) and August ($14.99). If you are in Order 33 these prices (not accounting for farm specific factors) for August, September and October will be $15.14 and $16.81 and $17.03. If you are pooled in Order 36 the August Class I price will be $15.10, the September $16.77 and October $16.99.

Now, having read the short answer version of my explanation if you are interested in the details about how your milk price is determined get a cup of coffee, have a chair and read on! Here is my explanation (as brief as I can be and still get across the key points) for why the Uniform Milk Price announced for July of 1998 is $ 12.47 in the Ohio Valley Federal Milk Order-33 and $13.33 in the Eastern-Ohio Western Pennsylvania Order-36, while the announced July BFP is $14.77.

The key to understanding why there can be an announced BFP price that is greater than the announced Uniform Price is (1) the timing of the pricing calculation for the Class 1 and Class 2 prices, (2) a rapid rise in the BFP from May 1998 to July 1998, and (3) the effect of less Class 3 milk being pooled in an Order and therefore an increase in the Class 1 and 2 utilization rates. I will explain each of these items in turn but first we need to review the calculation of the Uniform Price for both Orders 33 and 36.