From The MPC Newsletter
A Look at California "Pooling"
Much of the recent discussion regarding the California milk pricing system has focused on the various monthly minimum prices that are announced by the California Department of Food and Agriculture (CDFA). The issue of how our Class 4b price is calculated vs. how the Federal Order Class III price is calculated has been a regular feature in this newsletter and other publications. But it’s important to recognize that those minimum prices are only part of the story. Dairy farmers in California are paid based on a blend – or “Overbase” – price, which is a weighted-average calculation that includes prices paid for milk in all five classes.
The five minimum prices that are announced each month determine what processors must pay for the milk they need. However, milk pooling is designed to allow every dairy in the pool to share equally in the pooled revenues from the sale of California milk. That means that a dairy farmer shipping milk to a fluid plant (Class 1) receives payment based on the same Overbase price as a dairy farmer shipping milk to a cheese plant (Class 4b).
Where the minimum price formulas and pooling collide is the relationship between the various class prices and the overall blended Overbase price. When a plant’s monthly minimum price is below the calculated Overbase price, that plant is entitled to a “pool draw” to make up the difference. On the other hand, when a plant’s monthly minimum price is above the calculated Overbase price, that plant must make a “pool contribution” for the difference. To demonstrate this, let’s take a look at the most recent data available for January 2013:
As you can see from the chart, when CDFA finalized the pool information for January 2013, the blended Overbase price that dictates what an individual dairy farmer receives was $16.60 per hundredweight. However, each of the five classes had a different relationship to that Overbase price. For classes 1, 2, 3 and 4a, the price that plants had to pay for milk (the announced minimum price) was above the price their producers had to receive for their milk (the Overbase price). For Class 4b, the price that plants had to pay for milk was below the price their producers had to receive for their milk.
So how is this difference made up? That’s where the “pool draws” and “pool contributions” come into play. Looking at the two main manufacturing classes (4a and 4b, which account for about 75 percent of the milk produced and sold in California), a Class 4a manufacturing plant had to pay their producers the Overbase price of $16.60 per hundredweight. But they were ultimately responsible for paying the full minimum price of $17.08 per hundredweight. So in that case, the plant would pay $16.60 per hundredweight to their producers, and the difference of $0.48 per hundredweight into the pool as a “pool contribution.” Looking at the other side of the equation, a Class 4b manufacturing plant also had to pay their producers the Overbase price of $16.60 per hundredweight, but were only required to have $15.84 per hundredweight (the Class 4b minimum price) come out of their pockets. The difference of $0.76 per hundredweight was made up by a payment from the pool, which is a “pool draw.”
(It’s important to note that these figures are used for simplicity purposes. The actual pool draw/contribution calculations for each plant are based on the amount of fat, solids-not-fat and fluid carrier (for Class 1) that is purchased by the plant. However, the end result can be fairly demonstrated by the broader “per-hundredweight” figures above.)
So even from this simple example, it’s easy to see that while every dairy farmer participating in the California pool is entitled to the same Overbase price, the manufacturing plants from the various classes are exposed to different price dynamics within that system.
So why is this important? Over the past three years, producer groups have argued that our Class 4b price has been artificially discounted by CDFA compared to the Federal Order Class III price used as a benchmark price for milk sold to cheese plants around the country. We’ve pointed out that since January 2010, the California Class 4b price has averaged $1.73 per hundredweight below the Federal Order Class III price, resulting in our State’s cheese manufacturers putting significantly less money into the “California pool” than what they would if our Class 4b price more closely tracked with the Federal Order Class III price. We’ve calculated that the difference in real dollars is more than $745,000,000 since January 2010 that our plants didn’t have to put into the pool.
While that story has been told by dairy organizations and news outlets around the state (and even around the country), very little has been said about what impact that has had on the operation of the California pool. The impact has been significant, as demonstrated below:
Looking at the two main manufacturing classes (4a and 4b, which as stated earlier, make up about 75 percent of the milk produced and sold in California), you can see that over the past three years, our Class 4a plants have had to pay an average of $16.44 per hundredweight for their milk, with $15.72 per hundredweight going to their producers and the other $0.72 per hundredweight paid as a pool contribution. During that same time period, the Class 4b plants had to pay their producers the same Overbase price of $15.72 per hundredweight, but only $15.05 per hundredweight came out of their pockets, with the remaining $0.67 per hundredweight received as a pool draw.
In real dollars, Class 4a plants have made pool contributions in the amount of more than $289,000,000 since January 2010. Those contributions are above the amounts those plants had to pay to their producers for the milk they bought. At the same time, the Class 4b plants received more than $371,000,000 in the form of pool draws.
Pooling, which was introduced in California through the Gonsalves Milk Pooling Act in 1967, brought benefits for both producers and processors. For producers, it allowed an equitable distribution of pool revenues to every producer, regardless of where their milk was being sold. For processors, it allowed all plants to compete equally for a milk supply, since the pool would allow each plant to pay the same Overbase price, regardless of the minimum price a plant is responsible to pay out of their pocket. However, what we have seen in the past three years is a situation where one of those classes (4b) is significantly discounted compared to the national prices paid for comparable milk, the impact on how the different classes are affected by the pool has been significant.
Processors and their organizations like the Dairy Institute of California have repeatedly opposed dairy producer efforts to raise the Class 4b price to bring it closer to Federal Order Class III price levels, arguing that a lower Class 4b price is appropriate and that over-order premiums should be used to move mailbox milk prices higher. Sounds logical, right? Maybe even sounds like a “free market” argument? What is left out of those arguments is the fact that our cheese manufacturers have been on the receiving end of a $371,000,000 subsidy from the California pool for the past three years!
Here’s a “free market” question: How much milk would the Class 4b plants have been able to buy over the past three years at $15.05 per hundredweight, while the Class 1, 2, 3 and 4a plants were paying significantly higher prices? We know the answer: Only whatever milk was left when the plants for the other four classes had what they needed. Instead, our State’s pooling system has allowed those cheese manufacturers to collect more than $371,000,000 from the pool, allowing them to pay their producers the same Overbase price as those plants that are paying significantly more for the milk they buy. At the same time, the Class 4a plants – which are virtually all operated by dairy farmer owned cooperatives, had to not only pay their producers the Overbase price, but also kick in an additional $289,000,000 into the California pool, which was directly handed over to the Class 4b manufacturers.
It’s pretty gutsy for the State’s cheese manufacturers and their representatives to make a “free market” argument when those same plants are collecting such a massive subsidy from the California pool. This inequity needs to be fixed, which is why MPC and other producer organizations/cooperatives are working together in the California Legislature to approve AB 31, a bill that would require our Class 4b price to more closely track the Federal Order Class III price. A hearing on the bill is expected to be held in the next 1-2 months, so stay tuned for more developments on this issue.
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