Editor's note: The following article was issued by John Newton, Department of Agricultural and Consumer Economics at the University of Illinois at Urbana-Champaign; Cameron Thraen, Department of Agricultural, Environmental and Development Economics at The Ohio State University; and Andrew Novakovic, The Charles H. Dyson School of Applied Economics and Management at Cornell University.
click image to zoom The 2014 Farm Bill permits California producers to keep some form of their unique quota system if a Federal Milk Marketing Order is adopted. The value of the California quota state-wide is estimated to exceed $1 billion dollars and entitles California producers to as much as $1.70 per hundredweight in additional milk price revenue.
Any gains in farm level milk prices due to the adoption of Federal Order classified prices in California would be dependent on the market-wide utilization of milk and may be offset if high value milk is consistently de-pooled.
Current California state order pricing rules contribute to California's competitive position in the national cheese market. If Federal Milk Marketing Order provisions are adopted in California higher milk prices paid by California cheese makers may make them less competitive along the supply chain and could provide long-run incentives to shift processing capacity away from cheese into other dairy ingredient sectors.
Across the U.S, with California as a major exception, the USDA Federal Milk Marketing Order program (FMMO) ensures that participating dairy farmers receive a uniform price for their milk based on market prices for specific dairy products. This is accomplished through the use of end-product price formulas that convert wholesale dairy product prices into a farm-gate milk price, and formal discriminatory pricing (classified pricing) based on milk utilization. FMMOs also provide for revenue pooling, and other pricing functions such as plant auditing and milk testing (for details on FMMO functions see here and here). This classified pricing and revenue pooling system regulates prices paid by dairy processors and as a price discrimination scheme is designed to increase dairy farmer producer surplus.
California has regulated its dairy industry under their own milk pricing plans and revenue pooling arrangements and has remained autonomous from the rest of the U.S. and the FMMO program. Over time the FMMO classified milk prices and the California state order milk prices have been rather highly correlated, with the general feature that the California prices averaged a bit lower. This lower price gave California manufacturers a cost advantage and was justified as a way to encourage increased investment in manufacturing capacity for a State whose farmers found even these slightly lower prices to be a sufficient incentive to their own ongoing growth. However, since 2009 certain California and FMMO classified milk prices have shown a much wider divergence that at times has resulted in the Federal Order class III (milk used for cheese) exceeding the corresponding California class 4b prices by as much as $3 per hundredweight of milk. Inasmuch as the amount of milk used to make cheese in California has grown to be the single largest class use, the lower class 4b price has resulted in significantly lower average farm prices. In addition dairy producers in California have seen the cost of purchased feeds on the dairy increase dramatically. Lower milk prices and higher purchased feed costs have combined to squeeze the income-over-feed-cost margins in California and has contributed to the closure of more than 400 dairies over the last five years. As a result, the system of regulations setting minimum milk prices coupled with the rising expense of purchased feeds have been matters of great concern in California.