Dairy Futures and Options Tutorial

An Overview of Classified Pricing under Order Reform

Below is a general review of the classified price system for milk after Federal Order Reform which took effect on January 1^st, 2000. Besides a general overview of the pricing system (see Example of Classified Pricing) , a more detailed explanation can be obtained by clicking on highlighted items throughout the following discussion.  An more detailed overview of classified pricing under the FMMO system can also be found by examining Jesse and Cropp(2001) publication.

Four Classes of Milk

• Class I:  Beverage Milk
• Class II:  Soft Manufactured Products (Yogurt, Cream, Cottage Cheese)
• Class III:  Hard Cheeses and Cream Cheese
• Class IV:  Dry Milk Products and Butter

Basics of the Pricing System after 2000

• Class prices based on component values
• There is no longer any base price at a given test. Instead, there are component values associated with each milk class
• Each producer will have a unique milk price based on the total value of their milk's components, plus the Producer Price Differential
• Each component value is based on its relationship to dairy product yield and value. The product used in this valuation depends on the class of milk
• General Component Value Formula:
  Milk Component Value = (Component Relationship to Product Yield) x (Product Price - Manufacturing Cost)

The Class I Milk Price

• The standard milk is assumed to be composed of 3.5% fat and 96.5% skim milk
• Class I Mover: The higher of the Advanced Class III and the advanced Class IV skim milk plus a differential that varies by market (each county has a differential) plus an (Advanced Butterfat Value/lb + a differential/100) x 3.5, the assumed butterfat lbs/cwt.
• Class I Mover announced on a Friday on or before the 23^rd of the month prior to production
• The 1-A Differentials under Order Reform are very similar to Class I differentials under the previous system. 1-A is higher than previous differentials in some parts of US, slightly lower in others.
• Detailed county-level Class I differentials can be obtain by clicking here.

The Class II Milk Price

• The Class II skim milk price equals the Advanced Class IV skim milk price factor, plus $0.70
• The Class II butterfat value is the announced Class IV/III butterfat price plus a differential of $0.007
• Most Class II Products can be manufactured from Class IV products butter and nonfat dry milk, so the relationship between the two prices is logical
• The new Class II Price is tied to Butter-Powder markets (Class IV), not cheese markets (Class III).
• Class II skim milk uses Advanced Pricing formulas and is determined by the 23^rd of the prior month.

The Class III Milk Price

• Class III milk is used primarily for cheese
• The total Class III and producer component prices are based on three dairy products:

  Component Value	Commodity
  Butterfat	Butter
  True Protein	Cheddar Cheese
  Other Solids	Dry Whey

Weekly averages of NASS price surveys are used as basis for these calculations

• The Class III price must be released by the 5th but will be released the Friday before this date unless this date is a Friday.
• Class III future contracts for a given month will cease trading the day before the release and are cash settled at announced Class III price.

Class IV Milk Price

• The Class IV component values are based on two dairy products:

  Component Value	Commodity
  Butterfat	Butter
  Solids Non-fat	Non-fat Dry Milk

Weekly averages of NASS price surveys are used as basis for these calculations.

• The Class IV price must be released by the 5th but will be released the Friday before this date unless this date is a Friday.
• Class IV future contracts for a given month will cease trading the day before the release and are cash settled at announced Class IV price.

How Producers are Paid

Producer Price Differential (PPD)

• Difference between the value of milk used in manufacturing versus actual use.
• PPD = [(Class I - Class III) x % of milk used for Class I] +[(Class II - Class III) x % of milk used for Class II] + [(Class IV - Class III) x % of milk used for Class IV]

Quality Adjustment

• 350,000 somatic cell count as base
• Premiums for each 1,000 less than 350,000 and discounts for each 1,000 above 350,000
• Quality adjustment based off of the price of cheese:

  Quality adjustment = (Cheese price x 0.0005) / (1000 somatic cell count difference from 350,000)

For a detailed presentation of the pricing of all classes of milk using current NASS survey prices, click here