MarketView...U.S. Dairy Outlook Brief October-December 2010

Dr. Cameron Thraen, Extension Specialist, The Ohio State University

In this installment of The MarketView, I will take a look at the variability for both dairy commodity prices (butter, cheese, nonfat dry milk, and whey) and the Federal Order 33 Blend Price.  This MarketView is a departure from the more traditional dairy cows and market prices review of past articles and tackles the question of variability and sources of variability in your milk price.

On Variability vs. Volatility

We hear a great deal today about the excess ‘volatility’ in milk prices.  As an illustration, consider the following quote from Charles Nicholson, agribusiness professor at California Polytechnic State University at San Luis Obispo, addressing the USDA Dairy Industry Advisory Committee meeting this past September.   Dr. Nicholson states “There is an issue.  There is a problem.  There has been an extreme level of volatility and the length and depth of the increases and decreases will grow greater and deeper” (italics added for emphasis).

Now, what is misleading about this statement is the fact that professor Nicholson is making the mistake of confusing volatility with variability.  The fact that the dairy industry has experienced an increased level of price variability over the last 11 years is obvious.  Increased volatility is not as obvious. Market price lows are at the safety net level; however, the high price levels are historic.   However, it is not clear that this translates into an increased level of volatility in milk prices.  Volatility has a very precise definition, and simply observing prices that vary, even vary a lot, over time, is not evidence that they are volatile.  I will not go into the definition of volatility in this article, but we will save that discussion for the next article.  Just keep in mind that the two concepts are not interchangeable.

Identifying the Variability in the Milk Price

Before getting directly at exploring the variability in the Federal Order Blend Price and the sources of that variability, it is necessary to explain the origin of the price series used to support this article.  The price series are butter, cheese, nonfat dry milk, and whey.  These prices are those reported for each week of a given year by the National Agricultural Statistical Service (NASS) and used to calculate federal order milk prices.  The Federal Order 33 blend price is constructed by me for each week by applying the federal order pricing rules (and a couple of other adjustments) to these NASS prices, just as they are done on a monthly basis.  Doing this for each week provides more pricing information than using the announced monthly prices.  Each price series is deflated (divided) by its standard deviation calculated over the data period, 2000 to 2010.  This standardization allows a more direct comparison among the price series and does not change the pattern of variability over time.

Chart 1 shows the pattern of variability for the standardized prices over the past time period 2000 to 2010, 563 weeks.  As you look over this chart, recall that in the years leading up to the Federal Order pricing reform, implemented beginning January 2000, the dairy industry, and in particular, dairy producers, wanted a milk valuation system that reflected the changing value of those primary dairy commodities into which milk was manufactured.

Chart 1
Chart 1. Pattern of variability of standardized prices for the Federal Order (FO) 33 blend price, butter,
cheese, nonfat dry milk (NDM) , and whey.

Federal Order 33 Weekly Blend Price:

Focus your attention on the solid line in the chart and its ups and downs over the almost 11 year period.  Notice that there are three and one-half periods of price variability where the blend price is high relative to its standard deviation and then declines.  For example, in the third period, beginning with week 341 and ending with week 482, and coinciding with the years 2007 and part of 2008, the blend price is almost eight times its standard deviation.  Now let’s look at the contributors to this variability.

NASS Nonfat Dry Milk Price:

This price series is depicted by the dashed line.  Notice that for the first two periods of blend price increases and declines, there is no real association between the nonfat dry milk price and the blend price.  The significant association occurs in the third period when the nonfat dry milk price rises to over seven times its standard deviation.  This occurs with the entry of the United States dairy industry, as an exporter, into the world skim milk powder market in 2007.  The fact that nonfat dry milk prices were pulled up to this level was the result of a number of factors, including economic, political, and weather driven, which may or may not repeat in the future.

NASS Butter Price:

The NASS butter is depicted as the larger dashed line in the chart.  The link between the variability of the butter price and the Federal Order blend price is most apparent.  In the first and second major blend  price upswing, the butter price plays an important role.  Note that as the butter price peaks and declines, so does the blend price, unless the blend price is held up by another dairy commodity price.  Even the latest surge in the butter price, occurring in the latter part of 2010, the influence on the blend price is apparent.  Note that in the third period of high federal order blend price, the butter price was not a contributor.

NASS Cheese Price:

The NASS cheese price series is the dotted series shown on Chart 1.  Note that it moves somewhat in tandem with the butter price, reinforcing both blend price highs and lows.  When the cheese price is not in tandem with the butter price, it often carries the blend price itself, as evident in the weeks between 180 and 220 (mid 2002 on into 2003).  This is especially evident for the period 2007 through mid-2008 (weeks 380 to 460).  The nonfat dry milk price had already declined and the blend price was falling until the cheese price highs produced resurgence in the blend price in late 2008.  By the time the cheese price collapsed in December of 2008, all of the other dairy commodity prices had retreated to lower levels, and the blend price came right along.

NASS Whey Price:

A look at the whey price series, shown as the light dotted line in Chart 1, indicates that the variability in this price series contributes to the overall variability in the federal order blend price.  This contribution is apparent, although it is less pronounced than the other commodities in its contribution.  Note that the whey price contribution to the record high blend price coincided initially with the general dairy commodity price run-up in early 2007 (data points 341 through 410), at which time it retreated, leaving the other commodities the task of keeping up the blend price.  The whey price, while improved in the later part of 2010, is currently not a factor in the strengthening of the federal order blend price.


Back in the mid to late 1990’s, the dairy farming sector was concerned that changing market prices for major dairy products were not being correctly or adequately reflected in the valuation of milk and milk components, as under the old Minnesota-Wisconsin or Basic Formula pricing rules.  As consumers demanded and consumed more cheese, for example, dairy producers wanted the increased value of that cheese, in the form of protein and butterfat, reflected directly back into the milk price.   Now that you have had the opportunity to review the role of the four major dairy commodity markets and their respective price variabilities into the level and variability of the all important federal order blend price, you can ask yourself the following question:  Did we get what we wished for?  Perhaps, more than we expected.  Clearly, the milk price reflects the variability in the dairy commodity markets.
In the next MarketView, I will discuss and explore the nature of price variability versus price volatility.  In doing this, I will address the question of whether or not dairy prices and the milk price have become more volatile over time, or are they simply more variable as we experience new market highs.  I will also consider the prospects for the observed variability in dairy commodity prices to continue into the future.
To keep up with the dairy futures market and other important market news, visit the OhioDairyWeb 2010 website: