2. BASIC FORMULA PRICE REPLACEMENT AND OTHER CLASS PRICE ISSUES.

This rule closely follows the pricing plan described in the

proposed rule by replacing the current basic formula price (BFP)

with a multiple component pricing system that derives component

values from surveyed prices of manufactured dairy products. The

adopted pricing system determines butterfat prices for milk used

in Class II, Class III and Class IV products from a butter price;

protein and other solids prices for milk used in Class III

products from cheese and whey prices; and nonfat solids prices for

milk used in Class II and Class IV products from nonfat dry milk

product prices.

The calculation of the Class I skim milk and butterfat prices

for each order, determined in the proposed rule by computing a six

month declining average of the higher of the Class III or Class IV

skim milk prices for the second preceding month and adding a fixed

Class I differential to the result, has been changed to reflect

more closely the value of milk used in manufacturing. The Class I

skim price for a month will be determined by adding the fixed

Class I differential for each order to the higher of a Class III

or IV skim value, calculated from product prices reported by NASS

for the most recent two-week period for which prices are available

on the 23rd day of the previous month. Similarly, the Class I

butterfat price will be calculated by adding the fixed Class I

differential divided by 100 to a butterfat value computed by using

product prices for the same two-week period.

The price of Class II skim milk for a month will be computed

by the sum of a Class IV skim price per hundredweight, calculated

from product prices reported by NASS for the most recent two-week

period for which prices are available on the 23rd day of the

previous month, and the 70-cent Class II differential. The Class

II butterfat price will be determined from the NASS-reported

butter price, as in Classes III and IV, plus .7 cents per pound to

incorporate the Class II differential. This price will be

announced on the 5th day of the month and apply to butterfat in

Class II during the previous month.

A table showing current and re-calculated prices for the

period 1994 through 1997 appears at the end of this discussion of

the BFP replacement. The basis for re-calculating the prices is

described later in this discussion.

Provisions for Federal milk orders regulating the handling of

milk in areas for which a multiple component pricing system has

not been adopted will maintain a hundredweight skim/butterfat

pricing system instead of the component pricing plan. The

hundredweight prices will be determined by using the component

price formulas contained in this decision to compute corresponding

hundredweight prices using standard component levels.

Background.
The proposed rule described in some detail the development in

the early 1960's of the Minnesota-Wisconsin manufacturing grade

milk price series (M-W) as a means of identifying a price

determined by supply and demand for milk used in manufactured

dairy products. Also described were the developments that have

made the M-W less representative of the value of milk used in

manufactured products. The two primary trends making the M-W less

representative over the last four decades are the declining volume

of Grade B (manufacturing grade) milk and the declining numbers of

plants from which payments could be reported to update the base

month price.

The problem of the declining number of plants from which

payments could be reported to update the base month M-W survey of

two months previous was addressed in 1995 by using an updating

formula that uses changes from the base month to the next month in

prices paid for butter, nonfat dry milk, and cheese. However, the

problem of using a declining volume of Grade B milk to accurately

represent the value of milk used for manufacturing was not solved

with the implementation of the current BFP. The decision based on

the basic formula price hearing recognized that "the adoption of

the base month M-W price, or any Grade B milk series, is only a

short term solution, since the amount of Grade B milk production

is expected to continue declining."

Process.

The Basic Formula Price Replacement Committee was one of

several committees formed to deal with specific issues involved in

restructuring the Federal milk order system pursuant to the 1996

Farm Bill. The Committee established goals and criteria for a new

BFP, hosted a July 1996 public forum on dairy price discovery

techniques in Madison, Wisconsin, and considered over 1,600

comments submitted by interested persons relative to the basic

formula price in response to the May 1996 invitation to comment on

Federal Order restructuring. The Committee conducted extensive

study and analysis, worked with a University Study Committee (USC)

commissioned to conduct objective analysis of the performance of

numerous alternatives to the current basic formula price, and

issued a preliminary report on BFP replacement in April 1997. The

Committee studied the comments responding to the preliminary

report, as well as those received earlier, in the development of

the BFP replacement portion of the proposed rule, which was

published in January 1998.

The goals and criteria to be met by a replacement for the

basic formula price were discussed in detail in the proposed rule. 

Briefly, the goals are: (a) meet the supply and demand criteria

set forth in the Agricultural Marketing Agreement Act of 1937 (the

Act), (b) not deviate greatly from the general level of the

current BFP, and (c) demonstrate the ability to change in reaction
to changes in supply and demand.

The criteria established to evaluate the various alternatives

were: (a) stability and predictability; (b) simplicity,

uniformity, and transparency; (c) sound economics--e.g.,

consistency with market conditions; and (d) reduced regulation.
Comments.

Of the more than 1,600 comments received relative to the

basic formula price in response to the May 1996 invitation to

comment on Federal Order restructuring, most favored one or more

of five categories of alternatives to the current BFP. These five

alternatives were: economic formulas, futures markets, cost of

production, competitive pay price, and product price and component

formulas. In addition, numerous comments were received relative

to the use of National Cheese Exchange prices in particular and

exchange prices in general in the determination of a basic formula

price.

After publication of the proposed rule in January 1998,

nearly 600 comments were received relating to some aspect of the

basic formula price replacement. Approximately 450 of these

comments were form letters or very general in nature. For the

most part, comments that related specifically to the proposal

supported the use of product price formulas and the use of

surveyed product prices to calculate component prices in

determining the value of milk. Many of the comments, however,

suggested modifications to the proposed rule. These comments are

addressed in the discussion of each of the individual topics

involved in these pricing issues.

The only alternative previously considered that retained

considerable support from producer organizations was a competitive

pay price. In addition, many individual producer comments

continued to advocate cost of production or a floor for the BFP

ranging from $14.50 to $18.00. Some producers also suggested

letting the market determine prices, and a few suggested supply

management to ensure that farmers receive fair milk prices. One

processor opposed product price formulas, suggesting that futures

are the preferred tool used by markets to manage risk. Several

producers supported basing producer prices on retail prices, while

a state senator from Wisconsin suggested paying producers on the

quality and quantity of their milk.

As noted in the proposed rule, the reason the USC dropped

cost of production from consideration was that cost of production

represents only the supply side of the market, ignoring factors

underlying demand or changes in demand for milk and milk products.

Competitive Pay Price.

Although some producer groups submitted comments on the

proposed rule that continued to support use of a competitive pay

price for determining the BFP replacement, a number of these

comments stated that the pricing proposal contained in the

proposed rule was one they could support. Other commenters

continued to express the view that a competitive pay price is the

best indicator of the national supply and demand for milk and that

continuing to use such a price would provide a simple,
economically defensible method of calculating the true value of

milk used in manufactured dairy products.

Several proponents suggested including a competitive pay

price for Grade A milk, with some adjustments, as a way to improve

the size and representativeness of the competitive pay price. 

As described in the proposed rule, a competitive pay price to

be used as a BFP must represent the result of open market

negotiation between dairy farmers (or their cooperatives) and milk

processors. Competition requires sufficient numbers of buyers and

sellers so that no one participant or group of participants can

unduly influence the price. In addition, the price cannot be a

Federal- or State-regulated price, such as the price for Grade A

milk currently priced under Federal milk orders. 

Identification of a competitive pay price in today's dairy

industry, where 70 percent of the milk is currently covered under

Federal milk marketing orders, appears to be an unsurmountable

challenge. After accounting for state regulations, only about two

percent of Grade A milk is unregulated, and it is unlikely that

even this small amount of milk is not affected by regulated

prices. Only about five percent of the total milk marketed in the

U.S. is Grade B or unregulated, and 42 percent of that milk is

located in Minnesota and Wisconsin. The remainder is scattered

among 23 states in amounts too small and delivered to too few

processing plants to generate a competitive pay price. In areas

where alternative markets exist, the price for unregulated milk

likely is not below the price paid for regulated milk, since

producers would prefer to sell their milk to regulated handlers to

receive the higher regulated price. Thus, unregulated handlers

are compelled to meet the regulated price in order to attract

sufficient supplies of milk. The circular result is that the

regulated price ultimately becomes the competitive price. This

process does not lead to a representative competitive pay price

for milk.

The concept of a competitive pay price has appeal from the

standpoint of sound economics. However, serious concerns must be

raised about the degree of competition reflected in a price based

on the declining volume of Grade B milk produced and purchased, or

the introduction of Grade A milk that, even if unregulated, is

significantly influenced by minimum order prices and therefore

suspect as a "competitive" price.

The proposed rule contained a description of a BFP

Replacement Committee attempt to determine a competitive pay price

series that included nine states’ pay prices for Grade A milk used

in manufacturing, with the prices adjusted for protein content,

performance premiums, over-order premiums, and hauling subsidies. 

The nine states accounted for approximately 75% of the Grade A

milk used for manufacturing in the U.S.
The reduced price level that resulted from the study was

explained in terms of currently effective pay prices in the states

included in the survey and the heavier weighting of milk used in

butter/powder production than in the current BFP. In addition to

the negative aspects of the reduced price level and the

uncertainty of being able to identify prices paid to producers

that are not influenced by regulated prices, the USC analysis

found that two competitive pay price series that passed the USC’s

level one criteria were questionable in their ability to reflect

the manufactured milk market. Neither performed well when tested

using the level two criteria and therefore were dropped from

further consideration. 

Product Price Formulas and Component Pricing.

Most comments filed in response to the proposed rule

supported adoption of the use of product price formulas to derive

multiple component prices for most markets as a viable marketoriented alternative to the current basic formula price. 

Favorable comments expressed the opinion that a price determined

from the national finished product markets more accurately

reflects the value of milk for manufacturing than other methods of

determining a milk price. The price handlers can afford to pay

for milk is determined by the price for which the finished product

can be sold. Therefore, a pricing system that translates finished

product prices to a price for raw milk results in a representative

raw milk price for both producers and handlers. Component

pricing, with prices determined for butterfat, protein, nonfat

solids, and “other solids” (solids other than protein), can best

be accomplished through product price formulas, to reflect the

value of each component in finished product prices. The product

price formulas adopted in this rule are relatively easy to use and

understand, and the value of milk may be computed on an on-going

basis by everyone in the dairy industry by following commodity

markets. 

Because milk used in manufactured products obtains its value

from the components of milk, it is the components that should be

priced; particularly butterfat and protein, and to a lesser extent

the other solids contained in the milk. 

Opposition to product price formulas was directed primarily

at the need for establishing product yields and make allowances in

determining a milk price or component prices. Opponents expressed

the view that yields and make allowances would not reflect actual

processing yields and costs in manufacturing plants, and therefore

would not yield an accurate price for milk. Opponents further

explained that when yields and make allowances are determined,

they would be difficult to adjust and would not react to changes

in manufacturing conditions. Opponents also argued that when an

incorrect make allowance is established, plants are guaranteed a
return, or profit, to the detriment of dairy farmers. Some

comments even described the make allowance as an unfair charge

paid by dairy farmers to processors to have their milk made into

products. Other opponents explained that an incorrect yield or

make allowance may force payment for milk at a level that would

not allow a return to the manufacturing plant.

The USC tested several product price formulas, including a

one-class multiple component pricing formula and a set of formulas

similar to the formulas recommended in this decision. Based on

the results of the USC analysis measured against several criteria,

the multiple component pricing formulas had the best overall

performance of any of the alternatives considered.

Commodity Prices.

As recommended in the proposed rule and contained in this

final decision, commodity prices determined by surveys conducted

by the USDA’s National Agricultural Statistics Service (NASS) will

be used in the formulas that replace the BFP. A considerable

number of comments were received concerning the use of commodity

prices in determining prices for milk used in manufactured dairy

products. Most of those commenting supported use of a price

survey, but many commenters urged that participation be mandatory

and reported prices audited, with the survey enlarged to include

plants representing the entire nation so that the prices are truly

representative.

Proponents of the NASS surveys explained that the NASS data

is unbiased and would yield accurate representative prices of the

products that are being marketed. Several comments contained

specific recommendations for product categories to be surveyed to

obtain the most accurate representative result. 

NASS data traditionally have been collected via a survey with

voluntary participation. The price information in the current

cheese price survey, like most NASS data, is not audited. NASS

applies various statistical techniques and cross-checking with

other sources to provide the most reliable information available.

At the present time there appears to be no need for the

suggested changes to the proposed surveys. The scope of the

surveys that have been undertaken by NASS, and their geographic

representation, appears to be comprehensive. Unless there is some

indication that the prices gathered by the survey process are not

representative, the very significant increase in regulation

required to audit those prices and the steps that would need to be

taken to make participation mandatory would be excessive and are

not anticipated to be undertaken at this time.

Several alternatives to a NASS price survey were considered.

There is a weekly cash butter contract trading on the Chicago

Mercantile Exchange (CME). This contract is currently used to

establish the butterfat differential and butterfat price in all
federal milk orders. This price series has been criticized due to

the "thinness" of trading. Dairy Market News (DMN) publishes

regional wholesale butter prices. However, since DMN price series

cover cash or short-term contract transactions, they may not be

representative of the predominant long-term contracts. Criticism

of cheese exchange trading, including inaccurate representation of

cheese prices and accusations of market manipulation, reached the

point that the National Cheese Exchange (NCE) discontinued

trading, and cash trading of cheese moved to the CME. The CME

also has received some criticism for thinness of trading.

There is very limited exchange trading of nonfat dry milk. 

Other alternatives to a NASS survey for nonfat dry milk and dry

whey are limited to prices published by Dairy Market News (DMN). 

The prices reported by DMN are generally considered to be

representative of the dry product markets. However, the prices

are reported as a range. A simple average of the prices is used

to compute a monthly price and may not reflect the weighted

average price at which the product moved. The DMN prices are not

intended to establish prices but are provided for market

information.

The NASS “Dairy Products Prices” reports wholesale cheese

prices which are used to compute the current BFP. The NASS survey

requests prices for cheddar cheese. The instructions for the

survey specify what should and should not be included in the

reported prices. The instructions state that a sale occurs when a

transaction is completed, cheese is “shipped out”, or title

transfer occurs. Prices for cheddar cheese only are to be

reported f.o.b. the processing plant/storage center. Prices

should be for “bare” or “naked” cheese with only the minimum

packaging required for 40-pound blocks. Processors are asked to

include all sales transactions of 40-pound blocks and barrel

cheese 4-30 days old, the total volume sold, the total dollars

received, or price per pound, and the moisture content of barrel

cheese when it is sold. Intra-company sales, forward pricing

sales, resales, transportation charges, clearing charges, and

block cheese that will be aged should not be included. 

At the time the proposed rule was published the NASS survey

included prices for cheddar cheese only. Since publication of the

proposed rule, NASS has begun surveys of Grade AA butter prices,

dry whey prices, and nonfat dry milk prices. These surveys

incorporate input from the dairy industry on appropriate types of

products, packaging, and package sizes to be included for the

purpose of obtaining unbiased representative prices. A sale is

considered to occur when a transaction is completed, the product

is shipped out or title transfer occurs. In addition, all prices

are f.o.b. the processing plant/storage center, with the processor

reporting total volume sold and total dollars received or price
per pound.

Butter prices are for USDA Grade AA butter with 80 percent

butterfat, salted, fresh or “storage,” in 25-kilogram and 68-pound

boxes. Processors are instructed not to include transportation

charges, unsalted butter, Grade A butter, intra-company sales,

forward pricing sales, and resales. 

Nonfat dry milk prices are for USDA Extra Grade or USPH

Grade A non-fortified dry milk in 25-kilogram bags, 50-pound bags,

or “totes,” and tanker sales. Several commenters suggested

excluding nonfat dry milk processed with high heat treatment since

such product is a higher-cost specialty product, making its price 

unrepresentative of the nonfat dry milk market. As a result of

the comments, it was determined that only low and medium heat

process nonfat dry milk should be included in the price survey. 

The instructions inform processors to exclude transportation

charges, sales of product more than 180 days old, instant nonfat

dry milk, dry buttermilk, intra-company sales, forward pricing

sales, and resales. 

Dry whey prices are for USDA Extra Grade edible

nonhygroscopic dry whey in 25-kilogram bags, 50-pound bags,

“totes,” and tanker sales. As is the case with the other

commodities, transportation charges, intra-company sales, forward

pricing sales, and resales are to be excluded as well as sales of

product more than 180 days old. 

Several comments expressed concern about the “circularity” of

survey pricing that could be caused by including sales whose price

is based on previous survey information. According to this view,

NASS-reported prices would cease to reflect market supply and

demand, with market prices reflecting NASS-reported prices

instead. These comments stated that the current pricing system

relies on the market (in the form of the base month M-W survey) to

correct survey results.

Under any method of discovering prices, whether those paid to

producers or those paid for manufactured dairy products, prices

currently known will be used as one of the determinants of prices

for the following period. Under the current pricing system, it is

inconceivable that handlers paying Grade B producers for their

milk used in manufactured products do not consider the most

recently announced prices as a starting point for determining what

prices to pay their producers. When butter and cheese prices are

determined at an exchange, both buyers and sellers use the

exchange prices in arriving at the prices at which products will

move. Ultimately, prices move in response to supply and demand

conditions in the marketplace.

Basic Formula Price Replacement.

Application of the BFP and USC Committees' criteria for BFP

replacement to the various BFP alternatives and consideration of
comments received in response to the proposed rule resulted in the

determination that the component pricing product price formulas

contained in this final rule best meet the stated goals and

criteria for the replacement of the BFP. 

A BFP based on commodity prices is subject to the same

problems of stability as the underlying commodity prices. For the

most part product price formulas do not reduce the volatility in

producer milk prices. 

Product price formulas are relatively simple to compute and

understand, and may be applied uniformly, or on a regional basis,

accommodating differences in yields or make allowances. Product

prices established in a relatively free and open interaction

between supply and demand directly translate the value of the

finished products to the value of milk and its components. 

Therefore, they have a sound economic underpinning.

Product price formulas can require increased data collection,

particularly if industry insists that data used in the formulas be

audited.

The predictability of prices computed from product price

formulas should be reasonably good, or at least no worse than

predictability of the underlying commodity prices. Short run

predictability may improve since all information needed to compute

prices is reported on an ongoing basis. This contrasts with the

present BFP computation in which the base month

Minnesota-Wisconsin price is not reported until the actual basic

formula price is announced. 

Product price formulas are transparent, since the information

to compute the price is available, and the effect of a change in

commodity prices or one of the other factors may be observed and

quantified. 

This final rule replaces the current BFP with a multiple

component pricing (MCP) system which will determine butterfat,

protein, and other solids prices for milk used in Class III

products and butterfat and nonfat solids prices for milk used in

Class IV products. 

Numerous comments were received, primarily before issuance of

the proposed rule, concerning whether the revised orders should

keep Class III-A (i.e. a four class market) or whether all hard

manufactured products should be priced in Class III. The

opposition to Class III-A centered around two issues: (1) the

integrity of the classified pricing system, and (2) the perception

that a butter/nonfat dry milk class would reduce producer pay

prices. The supply/demand for butter and nonfat dry milk is

sufficiently different from the supply/demand for cheese to

justify separate classification and pricing. In addition, the

decision to use the higher of the Class III or Class IV price for

determining the Class I price, and base the Class II price on the
Class IV price, should more accurately reflect the value of these

different categories of use.

Changes in the cheese market have a major impact on the dairy

industry. The cheese industry has evolved from cheese production

being a means of surplus milk storage and removal to a competitive

consumer demand-driven industry. More milk is used in cheese

production nationally than is used in Class I. The nonfat dry

milk industry is now one which balances surplus milk storage and

removals. This category is also evolving, with increasing

commercial uses for nonfat dry milk, and dry milk products

formulated for specific needs. Increasing quantities of nonfat

dry milk are being produced for use in other dairy products and

the food and pharmaceutical industries. 

The separation of manufacturing milk into two classes will

assure that shifts in demand for any one manufactured product will

not lower the prices for milk used in all other classifications,

including Class I prices. Recent milk price increases have been

attributed to increased cheese values. Many people expect that

per capita cheese consumption will continue to grow. However,

some warn of impending market saturation as more cheese plant

capacity materializes and consumer tastes and preferences change. 

Cheese consumption patterns are based on many factors outside the

dairy industry's control. Health concerns relating to changing

demographics, changes in pizza consumption and income growth, as

well as retail and wholesale inventory decisions, etc., will

impact consumption and prices. A recent report by the Food and

Agricultural Policy Research Institute noted that "anything that

results in demand weakness for cheese will likely result in a

markedly different outlook for the entire dairy sector." The

adopted pricing system will allow other manufactured products

(i.e. Class IV) to move Class I prices, helping to reduce the

volatility in milk prices.

Over the last six years cheese prices, and to a lesser extent

butter prices, have shown considerable fluctuation while the

nonfat dry milk price remained relatively stable. Price changes

for these finished products are indicative of varying

supply/demand situations over time. The stable nonfat dry milk

prices and the butter prices prior to the fall of 1995 were a

reflection of large stocks being carried in storage and flat

demand. Prices for nonfat dry milk and butter became more

volatile once government inventories were depleted and were no

longer a factor in stabilizing prices. Butter prices increased

during May and June of 1997 in response to demand for cream, while

both cheese and nonfat dry milk prices remained relatively flat. 

These differences in price movements indicate separate supply and

demand balances for different manufactured dairy products. 

Research cited in the proposed rule supports the conclusion
that the different supply and demand characteristics for the

cheese and butter/nonfat dry milk market segments warrant separate

classification and prices. This pricing plan will allow the

market-clearing price level of each of these manufactured products

to be achieved independent of the other products. As a result,

dairy farmers will be paid a price which is more representative of

the level at which the market values their milk in its different

uses.

The importance of using minimum prices that are marketclearing for milk used to make cheese and butter/nonfat dry milk

cannot be overstated. The prices for milk used in these products

must reflect supply and demand, and must not exceed a level that

would require handlers to pay more for milk than needed to clear

the market and make a profit.

The current BFP serves two functions: (1) a fixed

differential is added to the current BFP to establish the Class I

and Class II prices for the second succeeding month; and (2) the

current BFP serves as the Class III price. In some Federal milk

orders, a seasonal adjuster is added to the BFP to determine the

Class III price. The BFP replacement will function in a similar

fashion, using component prices. Class IV (butter and dry milk

products) will be priced on a butterfat and nonfat solids basis. 

Class III (hard cheese) will be priced on a butterfat, protein,

and other solids basis. The price of butterfat will be the same

in Class III and Class IV. Class II will use the same butterfat

price as Class III and Class IV with an adjustment to reflect the

addition of the Class II differential. Payments to producers

under MCP will be based on butterfat, protein, and other solids

contained in the producers’ milk, in addition to the producer

price differential. Most Federal milk orders with MCP will also

contain an adjustment to producer pay prices for the somatic cell

counts of producers' milk. 

The producer price differential reflects the collective value

of participation in the marketwide pool. Primarily, it represents

the producer’s pro rata share of the additional value of Class I

and Class II use in the market. The butterfat, protein, and other

solids prices are component prices based on the value of the use

of milk in manufacturing.

The Class I price will consist of a Class I butterfat price

and a Class I skim milk price. As modified from the proposed

rule, the Class I butterfat price will be determined by adding a

fixed Class I differential divided by 100 to an advanced butterfat

price computed using product prices for the most recent two-week

period for which prices are available on the 23rd day of the month

and will apply to the following month. The Class I skim milk

price will be determined by adding the fixed Class I differential

for each order to the higher of an advanced Class III or IV skim
milk price, calculated by using product prices for the same twoweek period. The calculation of Class I prices will be the same

for both MCP and non-MCP markets. 

Announcement of Class I butterfat and skim milk prices in

advance eliminates current problems caused by calculating the

butterfat differential after the month for which it is effective. 

Handlers will have true advance Class I pricing. There will be

three different butterfat prices each month (Class I, Class II,

and other classes) but no butterfat differential. The separate

Class I butterfat price should present no administrative or

verification problems since Class I butterfat testing and

reporting currently exists. 

The prices for butterfat, protein, and other solids used in

Class III will be computed as follows:

Butterfat price = ((NASS AA Butter survey price -

0.114)/0.82)

Protein price = ((NASS cheese survey price - 0.1702) x

1.405) + ((((NASS cheese survey price -

0.1702) x 1.582) – butterfat price) x 1.28)

Other solids price = ((NASS dry whey survey price -

.137)/0.968).

For milk used in Class IV products the butterfat price is the

same as the Class III butterfat price, while the nonfat solids

price will be computed as follows:

Nonfat solids price = ((NASS nonfat dry milk survey price -

0.137)/1.02).

This system of pricing best fits the three established goals and

criteria, discussed previously, for a replacement to the BFP.

The first goal, that a replacement for the basic formula

price meet the supply/demand criteria set forth in the Act, may be

the most difficult to evaluate definitively since the Act

specifically mentions minimum prices to producers. The BFP, as

part of a classified pricing system, does contribute to minimum

prices to producers. However, the basic formula price does not

need to be set at a level to "assure an adequate supply of

wholesome milk" since the BFP makes up only a portion of the

minimum price paid to farmers. The minimum price to farmers is a

weighted average of the value of all of the milk in the market

place, of which the BFP is a part. The BFP replacement meets the

supply and demand criteria for milk used in butter/nonfat dry milk

and cheese even though the component prices are established from

finished product commodity prices. The commodity prices are based

on a competitive marketplace and reflect the supply and demand for

those products (Class III and Class IV) that utilize approximately

50% of the Grade A milk supply. 

The supply and demand for Grade A milk is not limited to one

category of products. The same milk may be used for fluid or soft
manufactured products as well as the Class III and Class IV

products used to determine the BFP. As a result, the minimum

prices established for Class III and Class IV reflect supply and

demand for the milk used in all products. 

In several comments received in response to the proposed

rule, commenters expressed the view that the proposed product

price formulas did not meet the requirements of the Act, and that

an updated competitive pay price resembling the current BFP would

be the appropriate replacement for the current BFP. For a price

to be competitively established there must be a large number of

willing buyers and sellers. The current base month price is

established from a survey of pay prices for Grade B or

manufacturing grade milk in Minnesota and Wisconsin. Whether

prices paid for Grade B milk are representative of the value of

Grade A milk is debatable. In addition, the volume of Grade B

milk involved represents a declining production base from which to

gather pay prices, and the number of plants buying manufacturing

grade milk is continuing to decline, with many plants refusing to

buy manufacturing grade milk even when they need milk and Grade A

milk is more expensive. In other situations the manufacturing

grade milk is procured because the seller of the milk is a member

of the cooperative purchasing the milk and the cooperative will

not deny market access to its member. Such a situation clearly is

not competitive.

The Act stipulates that the price of feeds and the

availability of feeds be taken into account in the determination

of milk prices. This requirement currently is fulfilled by the

BFP. If the price of feed increases the quantity of milk produced

would be reduced due to lower profit margins. As the milk supply

declines, plants buying manufacturing milk would pay a higher

price to maintain an adequate supply of milk to meet their needs. 

As the resulting farm profit margins increase, so should the

supply of milk. Likewise, the reverse would occur if the price of

feed declines. The price of feed is not directly included in the

determination of the price for milk, but rather causes a situation

in which the price of milk may increase or decrease. A change in

feed prices may not necessarily result in a change in milk prices. 

For instance, if the price of feed increases but the demand for

cheese declines, the milk price may not increase since milk plants

would need less milk and therefore would not bid the price up in

response to lower milk supplies. 

The pricing system contained in this decision will function

in the same manner as the current pricing system by accounting for

changes in feed costs and feed supplies indirectly. The product

price formulas adopted in this rule should reflect accurately the

market values of the products made from producer milk used in

manufacturing. As feed costs increase with a resulting decline in
production, commodity prices would increase as a result of

manufacturers attempting to secure enough milk to meet their

needs. Such increases in commodity prices would mean higher

prices for milk. The opposite would be true if feed costs were

declining. Additionally, since Federal order prices are minimum

prices, handlers may increase their pay prices in response to

changing supply/demand conditions even when Federal order prices

do not increase.

The second goal for a BFP replacement is that it should not

deviate greatly from the price level of the current BFP. In

effect, prices established by the current BFP formula in the past

were used as a benchmark to compare how well the product price

formulas adopted in this decision tracked the supply and demand

conditions exhibited by the BFP. Several comparisons of the basic

formula price replacement were made to the current BFP to

determine whether the price computation formulas result in a price

level for milk used in manufactured products that is reasonably

close to the current BFP. It must be recognized that after the

initial implementation of the revised prices, supply and demand

factors will interact to adjust the actual price level to reflect

the market for milk used in manufactured dairy products. 

Protein, butterfat, and other solids values were combined to

compute a Class III hundredweight price using standard factors of

3.1 for protein and 5.9 for other solids contained in skim milk,

and 3.5 for butterfat. The resulting price averaged $0.47 or 3.7

percent below the current BFP for the 60-month period of January

1994 through December 1998. The Class IV hundredweight price,

computed from the butterfat price times 3.5 and the nonfat solids

price using a standard factor of 9 for nonfat solids contained in

skim milk, averaged $0.50 or 3.9 percent below the current BFP

during the same period. The replacement Class III and Class IV

prices were both highly correlated with the current basic formula

price. The Class III price had a .981 correlation coefficient

while the Class IV price had a .744 correlation coefficient.

The above comparisons are based on applying the component

pricing formulas to commodity prices that were in effect during

the period examined. Therefore, price level comparisons can only

provide an indication of how the BFP replacement prices may have

behaved. The current BFP has been responding to changing market

conditions, while the replacement formulas are applied to historic

data which has exhibited changes over time in response to existing

price levels, rather than marketing conditions that would have

occurred under the BFP replacement. Additionally, the current BFP

may have a greater tendency to reflect supply and demand

conditions in Minnesota and Wisconsin rather than national

supply/demand conditions. The formulas in this decision use

national commodity price series, thereby reflecting the national
supply and demand for dairy products and the national demand for

milk.

The basic formula price replacement also meets the third

primary goal. The formulas have the ability to respond to

supply/demand changes. The Class III and Class IV prices should

respond appropriately since the formulas use NASS-surveyed

commodity prices that reflect national supply and demand for these

commodities.

Overall, the BFP replacement formulas (for Class III and

Class IV) meet the established criteria necessary for a BFP

replacement. The formulas are relatively simple to use and can be

applied uniformly. The formulas are transparent and the Class III

and Class IV formulas meet the sound economics criterion. 

In the near term, the use of NASS survey prices may reduce

the ability to predict Federal order class prices since there is a

limited history of using NASS survey prices. Predictability

should improve over time as the relationship between the survey

prices and easily-tracked exchange prices becomes apparent to

industry observers.

The formulas used in the basic formula price replacement

likely will result in prices that are less stable than the current

BFP. Unlike the current BFP, in which commodity updates are used

to adjust the producer pay price survey, changes in product prices

will be the sole determinants of changes in component prices. 

Past observation of competitive pay prices and commodity prices

indicates that generally competitive pay prices do not move as

quickly as commodity prices. Since the current BFP is based

primarily on the base month survey price, the commodity-driven

price series adopted in this rule will react more quickly to

changes in the commodity markets than the current BFP reacts.

Make Allowances.

Use of an economic engineering approach to determine

appropriate make allowances was investigated. Neither the time

nor the resources are available to construct models for

determining appropriate make allowances at this time. As an

alternative, various sources were used to determine appropriate

make allowances for the basic formula price replacement. Research

by Stephenson and Novakovic of Cornell University indicates that

results obtained by using an economic engineering approach can be

comparable to a survey of plants. Resources may need to be

devoted to developing an economic engineering model, a survey, or

a combination of the two. 

The make allowances contained in the proposed rule were

developed primarily from make allowance studies conducted at and

published by Cornell University and an analysis of manufacturing

plant size in relationship to the data contained in the Cornell

studies. Audited cost of production data published by the
California Department of Food and Agriculture was also used in

determining a reasonable level of make allowances.

The proposed rule make allowances used in computing the

component prices for Class III and Class IV resulted in per

hundredweight prices which did not deviate greatly on average from

the current BFP over the period analyzed, one of the criteria for

a basic formula price replacement. During the September 1991

through May 1997 period on which the analysis in the proposed rule

was based, the proposed Class III price level would have averaged

$0.26 per hundredweight above the current BFP, with Class IV

prices averaging $0.22 per hundredweight below.

Nearly all comments received relating to make allowances

asserted that the proposed rule allowances were understated. Both

handler and producer interests argued that failure to cover

processors’ costs of converting milk to finished products results

in a disincentive to produce finished dairy products. They

expressed concern that the disincentive would discourage

investment in the manufacturing sector, leading to reduced

manufacturing capacity and reduced outlets for producers’ milk. A

few commenters stated that make allowances should cover the costs

of only the most efficient processors, and others objected to the

inclusion of any make allowances, which they characterized as a

charge against producers to pay processors for processing milk.

Producers objected to the inclusion of manufacturing

allowances for milk processors while no allowance is made for

producers to recognize any fixed recovery of the cost of producing

milk. The current pricing system, using the BFP, also does not

assure producers a fixed rate of return. However, because the BFP

is based on a competitive pay price of what manufacturers pay

dairy farmers for milk, the manufacturers’ make allowance has, in

effect, been deducted from prices received from the sale of

manufactured products before the pay prices are reported. 

Therefore the differences between the current pricing system using

the BFP and the pricing system contained in this decision with

respect to make allowances deals with the level and stability of

make allowances rather than their existence. 

National Milk Producers Federation (NMPF) supported use of a

survey of dairy product manufacturing costs that has been

conducted by the Rural Cooperative Business Service (RCBS), with

some modifications, to establish Federal order make allowances. 

Many other comments supported the NMPF position. NMPF suggested

adding a marketing cost allowance of $0.015 per pound of product

to the manufacturing costs. NMPF explained that the addition of

the marketing allowance was necessary since the NASS price data

that will be used in the formulas includes the marketing costs

covered by the $0.015.

The RCBS survey contains data for six cheese plants, six
nonfat dry milk plants and five butter plants. In addition, the

survey results include manufacturing data from three dry whey

plants. The plants included in the survey represent a wide

geographic representation of the United States. Given the limited

number of plants involved in the study, however, regional

information is unavailable. The survey results also represent a

range of packaging types which can affect the final make

allowance. 

International Dairy Foods Association (IDFA) suggested that

make allowances be determined by computing weighted averages of

the results of the RCBS survey and the California audited make

allowances. IDFA also included a $0.015 marketing cost adjustment

as well as adjusting the RCBS make allowance to incorporate the

same return on investment that is included in the California make

allowance. IDFA and numerous other commenters explained that a

return on investment is necessary for manufacturers to continue to

invest in plants and equipment.

A number of comments were filed urging that make allowances

be determined by auditing manufacturing plants in the same manner

practiced by the State of California. Proponents explained that

California has had long and successful experience with auditing

make allowances and that a similar procedure could and should be

implemented in Federal orders. 

At this time the use of the RCBS study and the California

data are deemed to be adequate for determining the initial make

allowances contained in this decision. Several problems exist

with auditing make allowances. First, the Federal milk order

system currently is not equipped to handle the type of audits

necessary for determining appropriate make allowances. An

increase in market administrator administrative fees would be

required to acquire and train auditors to conduct the make

allowance audits, since these audits would have to be done in

addition to the current audit program. Since most Class III and

Class IV manufacturing is done in plants that currently are 

unregulated, authority to audit these plants to obtain make

allowance data would need to be obtained. In addition, the

industry may request a hearing on an expedited basis and present

relevant data to justify changing make allowances. Therefore,

there is no current plan to begin auditing manufacturing plants

for the purpose of obtaining make allowance data. 

The level of the make allowances included in this decision is

based on input by all sectors of the dairy industry. If the make

allowances are established at too low a level, manufacturers will

fail to invest in plants and equipment, and reduced production

capacity will result. If the make allowances are established at

too high a level there will be unwarranted incentive to increase

capacity above the needs of the industry, leading to overcapacity
and resulting losses to manufacturers. Either scenario would not

be in the best interest of the dairy industry. Manufacturing

plant operators who find the level of make allowances inadequate

compared to their actual costs also have the alternative to not

participate in a Federal order marketwide pool.

Most commenters agreed with NMPF and IDFA that the make

allowances proposed to be used for the butterfat and nonfat solids

prices were too low, and the resulting prices too high.

NMPF suggested that a make allowance of $.1327 per pound of butter

(plus the $.0015 marketing cost, or $.1342) would be appropriate

for use in the butterfat price calculation, and IDFA favored a

make allowance of $.114, compared to the proposed make allowance

of $.079. Several commenters suggested use of California make

allowances.

The formula for determining the butterfat price for butterfat

used in Class III and Class IV products will be computed using the

following formula:

Butterfat price = ((NASS AA Butter survey price - 0.114)/82).

The make allowance of $0.114 per pound of butter is determined by

adding to the RCBS survey make allowance a marketing cost of

$0.015 and a return on investment of $.0068, which is the same

return on investment included with the California butter

processing cost. The RCBS make allowance included packaging costs

for print butter; therefore, $0.0175 was deducted from the make

allowance to adjust for the difference between print and bulk

butter packaging. The California butter processing cost was also

adjusted by the $0.015 marketing cost. A weighted average make

allowance was then computed using the adjusted RCBS make allowance

and pounds of butter contained in the RCBS survey and the adjusted

California butter processing cost and the pounds of butter

represented by the California butter plant audit. The resulting

make allowance of $0.114 is $0.035 greater than the $0.079 make

allowance contained in the proposed rule. An increase in the

butter price formula make allowance will allow plants to recover a

larger percentage of the costs of producing butter than under the

proposed rule.

Comments on the computation of a nonfat solids price included

suggestions by NMPF that the nonfat dry milk make allowance level

should be $.1245 plus the $.0015 marketing cost, or $.126, and by

IDFA that $.137 would be an appropriate level, compared to the

$.125 used in the proposed rule. Several other commenters favored

the California make allowance, suggesting something in the $.135-

$.14 per pound range for nonfat dry milk.

The formula for computing the nonfat solids prices for milk

used in Class IV will be as follows:

Nonfat solids price = ((NASS nonfat dry milk survey price -

0.137) / 1.02).
As in the case of computing the butterfat make allowance, the

nonfat solids make allowance is a weighted average of the RCBS

survey and the California processing costs. A marketing cost of

$0.015 and a return on investment of $0.0159 was added to the RCBS

survey while the $0.015 marketing cost was added to the California

price. The resulting make allowance of $0.137 per pound of nonfat

dry milk is $0.012 more than the proposed rule make allowance of

$0.125. The resulting increase in the make allowance will allow

plants to recover a larger percentage of the cost of producing

nonfat dry milk than they would have using the make allowance

included in the proposed rule. 

In addition to revising the make allowance for computing the

nonfat solids price, the yield factor is also adjusted. In the

proposed rule a yield factor of .96 was used in the nonfat solids

formula. The .96 was intended to represent the 96 pounds of

solids in 100 pounds of nonfat dry milk. Most parties, including

IDFA and NMPF, commented that the .96 was inappropriate and that a

factor of 1.02 was more appropriate. Since buttermilk powder is

also a product of manufacturing butter and nonfat dry milk, its

value needs to be addressed. Because the proposed rule did not

account for the yield of buttermilk, the .96 factor was

appropriate. However, failing to account for buttermilk powder

resulted in overstating the nonfat solids price since the pounds

of nonfat solids were understated. Use of the 1.02 factor allows

the nonfat solids contained in nonfat dry milk and buttermilk

powder to be accounted for, and the value of all nonfat solids to

be accurately reflected in the nonfat solids price.

The results of the revisions made to the butterfat and nonfat

solids formulas yield a Class IV hundredweight price that would

have averaged four cents below the current Class III-A price and

fourteen cents above the California 4a price over the period of

January 1994 through December 1998. These results address the

major concern of many of the comments that the Class IV prices in

the proposed rule were too far out of alignment with California 4a

prices for Federal order plants to be competitive. The more

important criteria of reflecting supply and demand is also met by

the revised formulas. Research by Knutson, Anderson, Awokuse, and

Siebert showed that the formulas contained in the proposed rule

outperformed the current basic formula price in reflecting supply

and demand. Under the revised formulas the level of prices will

be changed, but not their relationship to supply and demand. 

Nearly all comments on the cheese make allowance proposed for

use in computation of the protein price described the proposed $

.127 make allowance as too low, resulting in a too-high protein

price. NMPF supported use of the RCBS survey results ($ .1421),

which were somewhat higher than the proposal. IDFA supported

using an average of the RCBS survey and California make
allowances, which generally are higher still ($ .152). A number

of other commenters argued that the proposed cheese make allowance

would cover the cost of making none of the cheese made in

California. The Dairy Institute of California advocated make

allowances of at least $.17 for blocks and $.14 for barrels.

Many commenters insisted that barrel cheddar cheese prices

should be included in a weighted average with block cheddar prices

since much more barrel cheese is produced than block cheese. NMPF

urged that the barrel price not be included because barrels don’t

have uniform composition, and because the use of such prices would

have the effect of unnecessarily reducing prices to producers. 

Other commenters suggested that if barrel prices are included,

they should be increased by 3 cents per pound to make up for the

difference in packaging costs. Still other commenters argued that

all varieties of cheese should be included in the NASS price

survey to assure that all cheese value is captured.

The formula for computing the protein price for milk used in

Class III is as follows: 

Protein price = ((NASS cheese survey price - 0.1702) x

1.405) + ((((NASS cheese survey price -

0.1702) x 1.582) – butterfat price) x 1.28);

The NASS cheese survey price will be determined by adding

three cents to the moisture-adjusted barrel price and then

computing a weighted average price using the block cheese price

and the adjusted barrel price times the pounds of each cheese type

in the NASS survey and dividing by the total pounds of block and

barrel cheese in the NASS survey. Including both block and barrel

cheese in the price computation increases the sample size by about

150 percent, giving a better representation of the cheese market. 

Since the make allowance of $0.1702 is for block cheese, the

barrel cheese price must be adjusted to account for the difference

in cost for making block versus barrel cheese. The three cents

that is added to the barrel cheese price is generally considered

to be the industry standard cost difference between processing

barrel cheese and processing block cheese. 

The make allowance used in computing the protein price,

$0.1702, was established by computing a weighted average make

allowance using the RCBS survey and the California processing

costs. The RCBS survey was adjusted by adding a marketing cost of

$0.015 and a return on investment of $0.0104 for a total of

$0.1540 while the California processing costs were increased by a

marketing cost of $0.015 for a total of $0.1855. The weighted

average was then computed by multiplying the pounds of cheese

represented in each study by the respective prices. The resulting

total was divided by the total pounds of cheese represented by the

studies. 

The factors used in the formulas for computing component
prices are determined by the quantity of the component in the

commodity, except for protein, for which the Van Slyke yield

formula is used. In the protein formula, the 1.405 and 1.582 are

yield factors derived from the Van Slyke cheese yield formula. 

Both the 1.405 and 1.582 factors are determined by calculating the

change in cheese yield if an additional tenth of a pound of

protein or butterfat is contained in the milk, holding everything

else constant.

The proposed rule used a 1.32 factor times the cheese price

for use in computing the protein price. The change to a factor of

1.405 reflects the use of true protein as the basis for payments

for protein rather than using a measurement of “total nitrogen”

for the protein content of milk. The resulting protein price will

be for a pound of “true protein.”

Total nitrogen protein content and true protein content both

result from chemical (Kjeldahl) testing methods approved for

determining the protein content of dairy products by the

Association of Official Analytical Chemists. When expressing

protein based on total nitrogen, the protein percentage is overstated by the amount of non-protein nitrogen (which has little or

no effect on dairy product yields) present in the milk. 

Therefore, when milk is priced on the basis of its true protein

content rather than its content of protein measured by total

nitrogen, the price per pound of protein should be higher.

Currently, nearly all testing of milk for payment purposes is

performed using infrared electronic testing equipment. At the

wave-length filter at which protein is measured, only true protein

is detectable. To calibrate for total nitrogen a bias factor has

to be used to compensate for the non-protein nitrogen. It is also

likely that the level of non-protein nitrogen will vary in every

set of calibration samples, creating more problems in accurately

calibrating electronic infrared instruments. Calibration for the

true protein content of milk is more accurate than the calibration

for total nitrogen protein. Because the accuracy of testing for

true protein is higher than for total nitrogen protein, which has

relatively little value, Federal milk orders should price milk on

the basis of its true protein content rather than its total

nitrogen protein content.

Comments on the proposed rule included discussion of the

proposal to incorporate the difference in butterfat value between

cheese and butter within the protein price. NMPF suggested that

the .90 factor that results in a 1.582 multiplier should, instead,

be .91 and result in a 1.60 multiplier because that factor more

closely reflects the current retention of butterfat in cheddar

cheese manufacturing. The IDFA comment argued that using the 1.60

multiplier would increase an already-high protein price. Another

comment urged that the Grade A butter price be used instead of the
AA price, because the value of butterfat in cheese shouldn't be

increased over its value in butter. Further, the comment argued

that the additional value of butterfat in cheese is added by the

cheesemakers, and shouldn't be used to increase prices to

producers.

Since Class III includes other types of cheese, such as

mozzarella that has a lower fat retention than cheddar cheese,

increasing the value attributed to that retention is not

appropriate. Increasing the protein price for all milk used in

Class III based on only a portion of the products included in

Class III would put the other Class III products at a competitive

disadvantage. Calculation of a minimum price will enable handlers

to adjust prices paid to producers to account for additional value

above the minimum Federal order prices. Therefore, the 1.582

factor will be used in the protein price formula contained in this

decision. 

Since Class III and Class IV use the same butterfat price,

accounting for the difference in value of butterfat in cheese

versus the value of butterfat in butter is necessary. This

difference in value is included with the protein price calculation

as a means of quantifying the amount by which the value of

butterfat in cheese varies from the value of butterfat in butter. 

Attributing the additional value to protein is possible because it

is the casein in protein that forms the molecular matrix that

retains the butterfat in cheese. Without enough protein in milk

to retain the butterfat in cheese, the butterfat would have a

lower value in whey butter in most months. The ratio of butterfat

to protein, 1:1.28, is calculated from the protein and butterfat

yield factors of 1.405 and 1.582.

An alternative to incorporating the butterfat value in cheese

with the protein price is to compute a separate butterfat price

for Class III. This would be a relatively simple formula to

compute. However, having multiple butterfat prices would require

full plant accountability of components in all manufacturing

plants. The resulting increased accounting, reporting, and

administrative costs were determined to not be warranted when

viewed against the small gain from having an additional butterfat

price. 

Use of the protein price formula adopted in this decision

will increase the protein price by approximately 15 cents per

pound when compared with calculating the protein price on the

basis of total nitrogen protein. However, the increase is almost

entirely negated by the lower content of true protein than of

total nitrogen protein in milk. On a hundredweight basis, the

change to true protein results in an increase to the Class III

price of an average of 2 cents when compared to the formula using

total nitrogen protein.
Use of true protein instead of total nitrogen protein for

determining payments to producers should have a minimal impact on

producer revenues. Producers with relatively high levels of nonprotein nitrogen in their milk could see a slight drop in their

revenue derived from the protein content of their milk.

In addition to changing the coefficients in the protein price

formula to adjust for the use of true protein, the fixed protein

and other solids values used in computing a per hundredweight

Class III price must be adjusted. Accordingly, the Class III

price will be computed by multiplying the butterfat price by 3.5

and adding the result of multiplying .965 times the sum of 3.1

times the protein price and 5.9 times the other solids price.

In comments filed in response to the proposed rule, NMPF

suggested a $.1575 whey make allowance plus the $.0015 marketing

cost, for $.1590, rather than the $.10 proposed. IDFA argued that

a $.171 make allowance would be more appropriate. Wisconsin

Cheesemakers indicated that the Class III price should not include

a value for whey, as it frequently represents a cost to

manufacturers. The Dairy Institute of California agreed that a

whey factor should not be included, but that if it is, the yield

factor (divisor) should be .98 (instead of .968).

The formula used for computing the other solids price is: 

Other solids price = ((NASS dry whey survey price - .137)/

0.968).

The determination of the $0.137 make allowances was based on

several factors. Whereas the other make allowances were based on

a weighted average of the RCBS study and California make

allowances, the other solids make allowance is based primarily on

the Cornell study of dry whey and whey protein concentrate make

allowances. The Cornell study was used since California does not

audit dry whey manufacturing costs and the RCBS survey has very

limited data on dry whey manufacturing costs. The data on dry

whey in the RCBS study expresses the costs on a per pound of

cheese basis rather than on a per pound of dry whey basis. The

$0.137 figure is slightly above the average cost of the model

plants in the Cornell study and the same as was used for nonfat

solids.

A value for other solids is included in Class III to assure

that the Class III price reflects most of the value of milk used

in Class III products. In the Federal milk orders currently

pricing three components, the other solids price is determined by

subtracting the value of butterfat and protein from the BFP. In

this final rule the other solids price is established

independently of the butterfat and protein price. Even though

there is not a market for other solids as such, the dry whey price

was determined to be the best indicator of value for other solids

and provides a method of accounting for and distributing the value
in Class III milk that is not accounted for in the protein and

butterfat components. Other potential price series that could be

used to determine the value of other solids were whey protein

concentrate and lactose. Under present market conditions, dry

whey offers more market activity with less specialization than

either whey protein concentrate or lactose, and therefore

constitutes a better price series for determining a minimum

Federal order price. Comments filed by several parties supported

the use of dry whey for the determination of the other solids

price. The 0.968 factor in the formula represents the pounds of

solids contained in a pound of dry whey. 

Since the make allowances are applied on a component basis

rather than on a hundredweight of milk basis comparisons to

traditional make allowances may be difficult. Also, a make

allowance that may seem reasonable when applied to a component may

be seen as inappropriate when combined with the other components

in the finished product. To evaluate the make allowances on a per

hundredweight basis the Class III and Class IV milk prices were

compared to the value of cheese and butter/powder using the CCC

yield factors. These results were compared to the same

calculation using the current BFP and the CCC yield factors. A

comparison over time between the current level of class prices

paid for producer milk and the value of the manufactured products

made from that price class of milk shows a reasonably stable

difference between the two levels. This difference is the implied

make allowance.

The implied make allowance for butter/powder using the

current BFP for the period January 1994 through July 1998 was

$0.83 per hundredweight, while the implied make allowance for

butter/powder versus the Class III-A price was $1.37 per

hundredweight. The implied make allowance calculated for the

Class IV price, based on historical prices, would have been $1.41

per hundredweight. With the implied make allowance for the

Class IV price being only $0.04 from the actual implied

Class III-A make allowance, the butter make allowance and the

nonfat dry milk make allowance, in combination, appear to

approximate the current implied make allowance. 

Determination of the make allowance for Class III is more

difficult than for Class IV, in which butterfat and skim solids

make two unique finished products. In cheese manufacture, most of

the butterfat remains in the cheese with most of the protein, and

a portion of the protein, butterfat and remaining nonfat solids

are contained in the whey, which can be made into various

products. The combination of the butterfat, protein, and other

solids make allowances resulted in an implied make allowance of

$2.72 for Class III (cheese) compared to the implied make

allowance of $2.21 for the current BFP. Even though the implied
make allowance using the Class III formulas in this decision is

greater than the current implied make allowance it is appropriate

since the CCC formula is basically a cheddar cheese yield formula

whereas Class III contains multiple varieties of cheese and

certain other products. A slightly larger make allowance in Class

III will not place makers of products that have significantly

different cost structures than cheddar cheese at a competitive

disadvantage when participating in Federal orders relative to

handlers who do not participate in the Federal orders.

Changes in make allowances will affect component prices and

per hundredweight milk values. A one-cent per pound change in the

butter make allowance will affect the butterfat price in the

opposite direction by $0.0122 per pound. This would be $0.0427

per hundredweight for milk at 3.5 percent butterfat. The

butterfat price also is used in the computation of the protein

price. The protein price will change inversely to the butter make

allowance by $0.0146 per pound or $0.046 per hundredweight for

milk with 3.15 percent protein. A positive make allowance change

for nonfat dry milk will result in a decline in the nonfat solids

price. A one-cent change in the nonfat dry milk make allowance

will result in a $0.0098 per pound or $0.0882 per hundredweight

opposite change in the nonfat solids price. A one-cent change in

the protein make allowance will cause an opposite change in the

protein price by $0.0322 per pound or $0.1014 per hundredweight

for milk with 3.15 percent protein. Finally, a one-cent change in

the other solids (dry whey) make allowance will change the other

solids price by $0.0103 per pound or $0.0567 per hundredweight in

the opposite direction.

This pricing system eliminates the need for regional yields

based on regional differences in milk composition. The value of

milk will be adjusted automatically based on the level of

components contained in the milk in each order even though the

component prices are the same nationally. This automatic

adjustment means that handlers will pay the same price per pound

of component but may have differing per hundredweight values based

on the milk component levels, creating equity in the minimum cost

of milk used for manufacturing purposes.

Several comments were received suggesting that regional BFP

replacement prices be used rather than a national BFP replacement. 

The commenters explained that cheese, butter, and nonfat dry milk

have different values in different regions of the country, and

that the Cornell study described a price surface for milk used in

manufactured products across the United States. Therefore, they

concluded, the replacement BFP also should be determined

regionally. 

This decision replaces the current BFP with a national

Class III price and a national Class IV price. Although there may
be some justification for regional pricing, there are two

principal reasons for using national pricing. First, pricing milk

on the basis of the pounds of components contained in the milk

eliminates some of the regional differences in milk prices. 

Second, regional commodity price data, and for that matter

regional competitive pay price data, are unavailable. Resulting

attempts to estimate regional differences, with the ensuing

regional differences of opinion, would yield minimal benefits.

An analysis of the basic formula price replacement requires

several assumptions. Historical commodity price surveys are not

available for all of the commodities. Prices used as substitutes

for historical price survey data in this analysis include a cheese

price computed by comparing the current NASS cheese price series

to the comparable NCE/CME price series for the purpose of

determining a historical protein price. The NCE/CME series was

then adjusted by means of a regression analysis to reflect the

differences between the NASS prices and the exchanges. The

resulting price series simulates the use of the NASS series for

the time period studied. For the butter price, the data from the

“BFP Committee Commodity Price Study” was compared to the CME

Grade AA cash butter price series. The CME Grade AA price series

was then adjusted accordingly to make it more comparable with the

Committee Price Study. Available survey prices used were nonfat

dry milk prices and dry whey prices, both of which are published

monthly by NASS in "Dairy Products". While a nonfat dry milk

price and dry whey price are published in “Dairy Products” at the

beginning of each month for the second previous month, the new

weekly NASS survey discussed earlier is necessary to determine

prices on a more current basis. 

One of the initial requirements of a basic formula price

replacement, based on the assumption that the national supply and

demand for manufacturing milk as reflected in the current BFP is

in relatively good balance, is that the price level not deviate

greatly from the current basic formula price. The examples

contained in the proposed rule resulted in the Class III portion

of the BFP replacement averaging $0.45 per hundredweight above the

current Class III price, and the Class IV portion of the BFP

replacement averaging $0.13 per hundredweight above the current

Class III price, both for the 48-month period January 1994 through

December 1997.

In addition to comparing the Class III and Class IV price

series to the current BFP, the Class III price was also compared

to the California 4b price, while the Class IV price was compared

to the Class III-A price and to the California 4a price. 

Comparisons to the California prices are included because many

commenters expressed the view that the proposed rule resulted in

prices that put plants regulated by Federal orders at a
competitive disadvantage to California plants and that alignment

with California pricing was essential. Most commenters did not

express the view that Federal order prices should equal California

prices, but that Federal order prices should be in alignment, i.e.

“reasonably close”. For comparison purposes all prices are

expressed on a per hundredweight basis with 3.5 percent butterfat. 

The Class III price was determined by using 3.1 pounds of protein

and 5.9 pounds of other solids in 100 pounds of skim milk. To

compute a 3.5 percent hundredweight price the skim milk value was

multiplied by .965 and added to the butterfat price that was

multiplied by 3.5. The same procedure was used for the Class IV

price, with 9 pounds of nonfat solids in a hundred pounds of skim

milk. 

For the period January 1994 through December 1998, the

Class III price averaged $0.47 below the current BFP and $0.20

above the California 4b price, while the Class IV price averaged

$0.50 cents below the current BFP, $.04 cents below the current

Class III-A price, and $0.15 above the California 4a price.

In addition to comparing the value differences between the

Class III and Class IV prices and the current BFP, it is important

to compare the relationship in price movements between the

Class III and Class IV prices and the current basic formula price. 

Correlation coefficients were computed to statistically test the

relationships between the Class III and Class IV prices, the

current basic formula price, and the California prices. The

correlation coefficient between the Class III price and the

current basic formula price is above .98 while the correlation

coefficient between the Class IV price and the current basic

formula price is approximately .74. The correlation between the

Class IV price and the current Class III-A price is .99. The

correlations between the Class III and Class IV prices and

California prices are also quite high, with the Class III price

and the California 4b price having a correlation coefficient of

.97 while the Class IV price and the California 4a price show a

correlation coefficient of .99. These relationships are expected

since the current basic formula price is weighted more heavily on

milk used for the manufacture of cheese than on the value of milk

used in the manufacture of butter and nonfat dry milk. 

The Class III and Class IV formulas are computed from product

prices representing the use of milk in each class. That is, the

Class III price is derived from the value of cheese while the

Class IV price is derived from the value of butter and nonfat dry

milk. Therefore the Class III and Class IV prices can be expected

to vary significantly from the current BFP in individual months,

reflecting the economic (supply and demand) conditions for cheese,

butter, and nonfat dry milk. This situation is particularly true

of the Class IV price. For example, during 1993 and 1994 the
price of butter and nonfat dry milk was relatively low and stable

compared to the price of cheese. The degree of variability of

individual months' prices from the average for the year is

expressed by a standard deviation. A lower standard deviation

indicates that individual observations (in this case, monthly

product prices) vary less from the mean than would be indicated by

higher standard deviations. These statistical descriptions

indicate the difference in variability of prices between

butter/powder and cheese in 1993 and 1994.

During 1994 the Class IV price would have averaged $10.26

with a standard deviation of $0.11, compared to the 1994 BFP

average of $12.00 with a standard deviation of $0.57, and the

average Class III price of $11.47 with a standard deviation of

$0.69. For 1998, when the economic conditions for butter and

nonfat dry milk had changed and prices became more volatile, the

Class IV price would have averaged $14.79 with a standard

deviation of $2.13 versus the 1998 BFP average of $14.20 with a

standard deviation of $1.97, and the Class III average price

calculation of $13.84 with a standard deviation of $2.14.

The Class III and Class IV prices clearly reflect the value

of the milk used in the respective manufactured products, whereas

the current basic formula price reflects primarily the value of

milk used to manufacture cheese in a particular region of the

U.S.(Minnesota and Wisconsin).

Class I.

As in the proposed rule and currently, the basic formula

price replacement will act as a mover for the Class I price in

addition to establishing prices for milk used in Class III and

Class IV. Also as proposed, the Class I value will be separated

into two parts: skim milk and butterfat. However, instead of the

proposed six-month declining average of the higher of each month’s

Class III and Class IV skim and butterfat prices, the Class I

price mover will be determined by the most recent manufacturing

product prices available. The advanced price aspect of the Class

I price mover will also be shortened from the current and proposed

timing of the Class I price announcement. Both the Class I skim

and butterfat components will be announced on the 23rd day of the

preceding month using advance pricing factors based on product

prices for the most recent two weeks. The Class II skim milk

price will be announced similarly. This change from the proposed

rule is being made to respond to numerous handler comments on the

proposed rule and to address class price inversion that occurred

during the second half of 1998.

Comments relating to replacement of the BFP as a Class I

price mover that were filed before issuance of the proposed rule

ranged from favoring continuation of the current system to

establishment of the Class I price independently of the basic
formula price(s) for milk used in manufactured products. One

comment suggested eliminating the basic formula price and pooling

only the Class I and Class II differentials. These comments were

fully considered in the proposed rule.

Numerous comments received in response to the proposed rule

favored advance pricing of Class I skim and butterfat separately. 

However, a number of commenters expressed concern that use of the

higher of the Class III or Class IV prices in the calculation of

the Class I price mover would result in undue enhancement of Class

I prices. The most controversial aspect of the Class I price

mover proposal was the use of a 6-month declining average. Many

of the comments received concerning the Class I mover expressed

the view that the Class I price must be closely and directly

linked to the manufacturing price in the same manner that occurs

currently. Commenters expressed the view that the current system,

two-month advance pricing, closely links the manufacturing value

of milk to Class I and therefore gives appropriate price signals

to producers. They opposed the six-month declining average on the

basis that the delay in linkage with the Class I price would be

too long and that Class I pricing would be counter cyclical. Some

who opposed the time lag built into the 6-month declining average

suggested that a 3-month average would do as well at attaining

some stability without as much "de-linking." 

Several commenters opposed building less volatility into

Class I prices than into manufacturing class prices. Among the

reasons given were that added stability for Class I would mean

greater volatility in prices for manufactured products, and that

added stability would favor producers in high Class I markets.

Other comments on the proposed rule supported variations of a

12-month rolling average Class I price mover, some with seasonal

adjustments. A number of comments favored the stability of the

longer-term basis for Class I prices. One graph submitted shows a

very close relationship between the 6-month declining average

mover and the current BFP.

There are several conflicting issues that must be balanced

when establishing the Class I price mover. First, the retail

demand for Class I milk is independent of the demand for

manufactured dairy products. Second, the raw material used in

both Class I products and manufactured dairy products is the same

and therefore the separate uses must compete for the given supply

of milk. Third, the elasticity of demand for the various dairy

products is significantly different, creating different consumer

responses to the changing prices for various dairy products. The

Federal milk orders have attempted to address these issues through

classified pricing. This system allows a higher price to be

applied to milk used for Class I uses due to inelastic demand for

Class I products. This higher price also allows Class I uses of
milk to compete for the raw milk supply against manufactured dairy

products. At the same time, marketers of Class I products support

some degree of forward pricing, requiring processors of Class I

products to know the Class I price in advance.

Most of those commenting on the proposed rule and the

Department perceive the need to reflect changes in the prices for

milk used in manufactured products in the price of milk used in

fluid products. Since Class I handlers must compete with

manufacturing plants for a supply of milk, the Class I price must

be related to the price of milk used for manufacturing.

It is apparent from the price patterns of a large part of

1998 that the current two-month lag between manufacturing and

fluid pricing does not establish as close a relationship between

the two price levels as is desirable. Indeed, from an analysis of

the differences between prices generated by a six-month declining

average and the current pricing system, it is clear that the

current two-month lag does not accomplish any closer relationship

between manufacturing and fluid prices than would the six-month

declining average.

When manufactured dairy product prices are relatively stable

the advance pricing of Class I milk works quite well. However,

since 1988 the volatility in the manufactured dairy product market

has caused problems with the advance pricing of Class I milk. The

first problem is readily evident in class price relationships

during the latter part of 1998. The frequent occurrence of price

inversions during that period indicates that some alteration to

both the proposed and current methods of computing and announcing

Class I prices may be necessary. Class price inversion occurs

when a markets’s regulated price for milk used in manufacturing

exceeds the Class I (fluid) milk price in a given month, and

causes serious competitive inequities among dairy farmers and

regulated handlers. Advanced pricing of Class I milk actually

causes this situation when manufactured product prices are

increasing rapidly.

Since the Class I price is announced in advance, in a rapidly

changing market the Class I price may not reflect the value needed

to compete for the necessary raw milk supply or the Class I price

may be overvalued relative to the raw milk price. Undervaluing

Class I milk is a particular problem since it reduces producers’

pay prices at a time when the producers should be receiving a

positive price signal. As an example, in July 1998 the Class I

price in every Federal order market except one was below the

Class III price. Although July is not a period of very high

Class I demand, it is a time when Class I demand is starting to

increase in some regions relative to total milk production. At

this same time producers in these regions received lower pay

prices. Many Federal milk orders also experienced a Class I price
below the Class III price in August as a result of two-month

advance pricing of Class I. Demand for Class I milk increases

substantially in August. While producer prices rose in August,

the increase would have been larger had Class I prices been based

on more current Class III prices. Under these pricing

relationships, the Class I handler may have a more difficult time

acquiring milk as the minimum Federal order Class I price puts the

handler at a disadvantage to handlers demanding milk for

manufacturing purposes. Since Class I handlers must compete with

manufacturing plants for a supply of milk, the Class I price must

be related to the price of milk for manufacturing.

Another problem inherent in the current method of announcing

Class I prices in advance is that the price for milk established

in advance is for milk containing 3.5 percent butterfat. The

current system does not determine the price of butterfat in

advance, therefore the Class I handler does not know the value of

milk at butterfat contents other than 3.5, until the butterfat

differential is announced in the month following sale of the

processed product. Under this final decision, Class I handlers

will have advanced price information for both the skim and

butterfat portions of the Class I price.

The purpose of the minimum Class I differential is to

generate enough revenue to assure that the fluid market is

adequately supplied. As a result of advance pricing, the

effective Class I differential -- that is, the actual difference

between the Class I and manufacturing use prices in a month -- is

not the same as the Class I differential stated in an order. 

While the effective Class I differential varies monthly, it

generally has remained positive. Recent increased volatility in

the manufactured product markets has resulted in more instances in

which the effective Class I differential has been negative,

especially in markets with low minimum Class I differentials.

In the past when price inversions have occurred, the industry

has contended with them by taking a loss on the milk that had to

be pooled because of commitments to the Class I market, and by

choosing not to pool large volumes of milk that normally would

have been associated with Federal milk order pools. When the

effective Class I differential is negative, it places fluid milk

processors and dairy farmers or cooperatives who service the Class

I market at a competitive disadvantage relative to those who

service the manufacturing milk market.

Milk used in Class I in Federal order markets must be pooled,

but milk for manufacturing is pooled voluntarily and will not be

pooled if the returns from manufacturing exceed the blend price of

the marketwide pool. Thus, an inequitable situation has developed

where milk for manufacturing is pooled only when associating it

with a marketwide pool increases returns.
Illustrative of the worsening class price inversion problem

are the growing volumes of milk that, while normally associated

with Federal milk orders, are not being pooled due to price

inversion problems. When the Class II, III, and/or III-A prices

are higher than a handler’s blend price adjusted for location, it

becomes disadvantageous for handlers processing soft and hard

manufactured products to pool milk. That is, instead of drawing

money out of the pool, they have to pay money into the pool. In

1995, the volume of milk not pooled due to class price inversion

was 5.3 billion pounds. In 1997, nearly 7.8 billion pounds were

not pooled for this reason. In 1998, 14.1 billion pounds were not

pooled due to class price inversions. During each of five of the

seven months of June through December 1998, the volume of milk not

pooled exceeded 2 billion pounds. In July 1998, class price

inversion occurred in all Federal order markets except

Southeastern Florida, and in 19 markets some milk was not pooled

due to class price inversion.

Since volatility in the manufactured product markets is

expected to continue, the Class I price mover developed as part of

this Federal milk order reform process should address this

disorderly marketing situation.

The advanced pricing procedure provided in this final

decision results in a Class I price that is based on a more recent

manufacturing use price, thus reducing (but not eliminating) the

time lag that contributes to class price inversion. For example,

the January 1999 Class I price for each market would be announced

on December 23, 1998 and would be based on product prices reported

on December 10 and 17. (The prices reported on these dates are

for the weeks ending December 4 and 11). Under the current

procedure, the January Class I price was announced on December 3,

1998 and was based on product prices reported for weeks ending

November 6, 13, 20, and 27.

While the advance pricing procedure in this decision reduces

the time period of advance notice by about 18 days, the reduction

in advance notice of Class I and II prices should not add

significant risk or burden to handlers. The pricing formulas are

based solely on product prices which are announced weekly;

therefore, handlers can update formulas on a weekly basis to

estimate what the Class I price will be before the price is

announced. Also, as more NASS product price survey observations

become available, basis differences from earlier traded/issued

product price surveys such as those from the Chicago Mercantile

Exchange or Dairy Market News will be more predictable and,

therefore, should provide for more accurate predictions of future

price levels. In addition, futures markets have been established

for the four dairy products in the NASS price surveys. While

trading to date in these contracts has not been large, interest in
these markets may increase as the industry learns to use them as

effective hedges to the component values determined under this

final decision. These markets also will assist handlers in

estimating the Class I price. 

Using the current two-month advance pricing system, but

substituting for the current BFP the higher of the Class III or IV

prices as defined under this rule, markets with a Class I

differential of $1.60 per hundredweight or less would have faced a

price inversion in four of the last seven months of 1998. The

range of the price inversion would have been $.21 to $1.49. In a

fifth month, price inversion would have occurred at a Class I

differential of $1.49 or lower. In September 1998, price

inversion would have occurred in all Federal order markets except

Florida. However, using the shortened advance period adopted in

this decision, for markets with a Class I differential of $1.60

per cwt., price inversion would have occurred in only two of the

last seven months of 1998. The range of the price inversion would

have been $.02 to $.86. The shortened period of advance pricing

reduces both the occurrences and level of price inversion.

To further illustrate that the advance pricing procedure in

this final decision provides a Class I price level that is less

likely to be below the manufacturing use price, the following

analysis was done. Averages of the 1998 NASS product prices for

the current month, the second preceding month, and the two-week

period available on the 23rd of the preceding month were computed

and compared. For all four products, the preceding month two-week

average provided a better estimate of the current month average

than did the average for the second preceding month. Looking at

the Cheddar cheese price series, the two-week preceding month

price was $.03 closer to the current month on a simple average

basis, and $.04 closer on an absolute average basis. This means

that using preceding month two-week average Cheddar cheese price

would result in a Class III skim milk price that would be about

$.40 per cwt. closer to the following month’s Class III skim milk

price than if the second preceding month’s price is used.

As stated earlier, advance pricing affects the function of

the minimum Class I differential. The advance pricing procedure

in this decision reduces the difference between the manufacturing

use price used to establish the Class I price and the

manufacturing use price in the current month. This procedure will

result in an effective Class I differential that would be closer

to the Class I differential stated in each order. Thus, reducing

the time lag of the Class I pricing advance improves the

functionality of the minimum Class I differential.

Comments filed by some southern interests indicated that

stability in pricing in the southeast U.S. should incorporate

seasonal price incentive programs as a necessary part of
adequately supplying the fluid markets of the southeast. 

According to the commenters, such a program would encourage

balancing production with fluid milk demand. The comments state

that because such a pricing plan would be revenue neutral, it

would allow for more price stability and more reliable price

signals than is currently available for producers in high Class I

utilization areas.

Addition of seasonal adjustments for marketing areas would

disrupt the uniformity in pricing between marketing areas that is

a goal of this pricing plan. The seasonal patterns of milk

production and consumption are not the same between regions, and

it would be difficult, if not impossible, to attempt to work out

seasonal pricing as a part of the BFP replacement.

As discussed previously, the price link between Class I use

and Grade A milk used to manufacture Class III and Class IV

products should be maintained since Grade A milk can be used for

fluid uses as well as for manufacturing uses. Because handlers

compete for the same milk for different uses, Class I prices

should exceed Class III and Class IV prices to assure an adequate

supply of milk for fluid use. Federal milk orders traditionally

have viewed fluid use as having a higher value than manufacturing

use. The replacement Class I price mover reflects this philosophy

by using the higher of the Class III or Class IV price for

computing the Class I price.

In some markets the use of a simple or even weighted average

of the various manufacturing values may inhibit the ability of

Class I handlers to procure milk supplies in competition with

those plants that make the higher-valued of the manufactured

products. Use of the higher of the Class III or Class IV price

will make it more difficult to draw milk away from Class I uses

for manufacturing. For example, if the Class IV price were used

as the Class I price mover there would be months in which the

Class III price would be more than two dollars above the Class IV

price. As a result, the Class I differential would have to be

well over two dollars for the Class I price to remain above the

Class III price. If the Class III price is used as the Class I

price mover, the reverse situation of having the Class IV price

well above the Class III price would result in the same problem. 

The potential of having a Class III or IV price in excess of the

Class I price is not entirely eliminated by using the higher of

the Class III or Class IV price because of the advance Class I

pricing feature. However, reducing the time period for which

Class I pricing is advanced should reduce the potential

considerably, allowing Class I handlers to compete more

effectively with manufacturing plants for fluid milk.

Class II.

Under this final decision, the value of Class II skim milk
will be computed by multiplying the hundredweight of producer skim

milk allocated to Class II by the sum of an advanced Class IV skim

price, calculated from nonfat dry milk product prices reported by

NASS for the most recent two-week period for which prices are

available on the 23rd day of the preceding month, and the 70-cent

Class II differential. The price used for valuing Class II

butterfat will be the current month’s butterfat price determined

from the NASS-reported butter price, as in Classes III and IV,

plus .7 cents per pound to incorporate the Class II differential.

Generally, the source of inputs alternative to producer milk

for the manufacture of Class II products is dry milk products and

butterfat that otherwise would be used in butter. Basing the

price of milk used to make Class II products on these alternative

ingredients should help considerably to remedy a situation in

which it is perceived that a separate product class for dry milk

(Class III-A) has resulted in a competitive advantage over

producer milk used to produce Class II products. The 70-cent

differential between the Class IV and Class II skim milk prices is

an estimate of the cost of drying condensed milk and re-wetting

the solids to be used in Class II products. One commenter

suggested that there should be a $1.00 difference between Class IV

and Class II.

Comments filed in response to the proposed rule generally

supported basing the Class II price on the Class IV price. 

However, many commenters, including operators of plants

manufacturing food products, argued that the proposed $0.70

differential is too high. In many cases they stated that the cost

for rehydration is substantially lower than $0.70, if the nonfat

dry milk is rehydrated at all.

Only a small portion of the $0.70 differential is intended to

represent the cost of rehydration. The majority of the $0.70,

$0.57, represents the cost of drying condensed milk. Comments

filed by Kraft, Inc., stated that the cost of using nonfat dry

milk (NFDM) in Class II is 0-3 cents per pound. At a rate of

9 pounds of NFDM per hundredweight of skim milk, this cost could

represent as much as 27 cents per hundredweight. When added to

the 57-cent cost of drying condensed milk, the 70-cent

differential appears to be justified. It should be noted that the

cost to purchase or manufacture NFDM for use in Class II products

would include not only the cost of milk at the Class IV price, but

the cost of making NFDM (in excess of $1.20 per hundredweight of

skim milk when the make allowance for a pound of NFDM is

multiplied by the yield).

Many of the commenters suggested that a rate of $0.30 is

appropriate since that is what is used currently in the Federal

orders. The current Class II differential, $0.30, was established

by a national hearing conducted in 1991. At that hearing
proponents of a $0.30 Class II differential explained that the

average difference between Class II prices and Class III prices

over a recent time period had averaged $0.30. The $0.30

difference was not based on the actual cost differences between

existing classes of milk.

The Class II price level determined under this final rule

should not, on average, be higher than its predecessor. The

concern of commenters that the level of the proposed Class II

price would be excessive should be mitigated somewhat by the

reduction in the level of the Class IV formula adopted in this

rule. For the period January 1994 through December 1998, the

Class II price as determined in this final rule averaged $0.01

higher than the current Class II price. There is a very large

variation from year to year in the differences between the current

and adopted Class II prices. In 1994, the current Class II price

averaged $1.50 more than the Class II price calculated according

to this decision. For 1998, however, with butter prices at record

levels, the Class II price computed from butter and powder prices

averaged $1.58 higher than the current Class II price. These

price differences illustrate the result of pricing Class II milk

on the basis of manufactured ingredients instead of on the basis

of cheese.

Many of the comments received concerning the Class II price

opposed the proposal to price Class II on a current basis rather

than on an advance basis as is currently the case. The commenters

argued that since Class II products are sold on an advance basis

similar to Class I products the continuation of advance pricing of

Class II is essential. Other commenters expressed the view that

the skim portion of Class II could be forward priced but butterfat

should be priced on a current basis since competing uses for

butterfat such as cheese and butter would be priced on a current

basis. Class II products high in butterfat, such as ice cream,

could be placed at a competitive disadvantage in procuring

butterfat if the current month’s butterfat prices are

substantially different than the advanced priced butterfat price. 

The Class II price adopted under this rule will result in

forward pricing the skim milk portion of Class II while pricing

butterfat on a current basis. Butterfat used in Class II products

competes on a current-month basis with butterfat for used in

cheese and butter, and its price should be determined on the basis

of the same month’s values. Forward pricing of skim milk will, of

course, eliminate some of the desired direct linkage between the

nonfat solids price in Class II and the nonfat solids price in

Class IV. However, especially with the shortened period of

advanced pricing, in most cases the linkage should remain close

enough so that the Class II differential does not encourage the

drying of milk for Class II uses just to receive a price
advantage. This alignment also should reduce perceived problems

in the use of nonfat dry milk to make Class II products. Tying

the Class II price to the Class IV price by this fixed

differential, even with advanced pricing for Class II skim, should

reduce the incentive to produce nonfat dry milk for use in

Class II products.

Quality Adjustments. 

This final decision provides for the adjustment of producer

payments for the somatic cell count of producers' milk under most

orders using multiple component pricing. Payments made by

handlers for milk used in Class II, Class III, and Class IV also

will be adjusted on the basis of the somatic cell count of the

milk. 

A somatic cell count (SCC) adjustment is appropriate for

several reasons. First, SCCs are not only an indicator of general

milk quality, but also are an indicator of the potential yield of

milk in cheese and other products that require casein for their

structure and body. Research has shown a direct link between

increased SCCs and decreased cheese yields.

Second, many producers currently are subject to some type of

multiple component pricing plan or quality premium program that

adjusts their pay prices for somatic cell levels even if the order

in which their milk is pooled does not incorporate such

adjustments. Although many producers' returns are affected by the

SCC of the milk, there is little, if any, oversight of the testing

for somatic cells if the order does not include pricing

adjustments. Fair and accurate testing can be assured by

incorporating multiple component pricing and somatic cell

adjustments into Federal orders.

The somatic cell adjustment will apply on a hundredweight

basis and be computed by subtracting the SCC (in thousands) from

350 and multiplying the result by the product of .0005 times the

monthly average cheese price used to compute the protein price. 

This level of adjustment has worked well in orders currently

containing somatic cell adjustments, and is supported by data and

research contained in Federal milk order hearing records.

There was not a great deal of agreement on how to determine

which orders should provide for SCC adjustments. Some commenters

favored their inclusion in all markets and some favored a SCC

adjustment on all milk priced under multiple component pricing. 

NMPF favored SCC adjustments for regions that want them. A

Northeast producer group argued that the limited effect of SCCs on

Class II and Class IV uses makes them unsuitable for use as an

adjustment factor for milk in the Northeast. One fluid milk

handler opposed their application to Class I use, while several

others opposed excluding Class I milk from using somatic cell

count as a cost component because such an adjustment could result
in fluid handlers receiving lower-quality milk.

The application of somatic cell adjustments will be limited

to orders providing for multiple component pricing, since the

detrimental economic effect of somatic cells has been shown to

occur principally with respect to the protein component of milk. 

SCCs unquestionably do have detrimental effects on the flavor and

keeping quality of fluid milk products, and undoubtedly on other

dairy products as well, but the economic quantification of those

effects is not part of the information available for this

decision. There are three order areas in which producer sentiment

is opposed to the inclusion of SCC adjustments, and these

adjustments are not adopted for the three orders. In the case of

the Pacific Northwest and Western consolidated orders, most

producers already are covered under very effective SCC payment

programs, and the average SCC in these markets is less than

250,000 (below the neutral level for SCC value adjustments). 

There would seem to be little reason to require additional SCC

programs for these orders. In addition, the Northeast order does

not contain a SCC adjustment. Comments filed by Northeast

interested persons argued that the predominant use of milk for 

manufacturing in that area is nonfat dry milk and butter, and that

yields of these products are not affected by SCCs. A somatic cell

value adjustment is not, therefore, included in the Northeast

order. 

As in the proposed rule, for the orders containing a somatic

cell adjustment provision the adjustment will be applied to milk

used in Classes II, III and IV for handler billings, and to all

producer milk for payment to producers. This application of a SCC

adjustment has worked well in the orders currently providing for

it, and should result in no additional marketing, testing or

accounting requirements in those orders. At least some portions

of most of the consolidated orders for which the SCC adjustment is

provided already contain such provisions.

Several comments suggested including a maximum count of

25,000 psychrotrophic bacteria as a criterion for payment of

positive SCC adjustments. Even though there may be a valid reason

for including psychrotrophic bacteria for payment purposes,

bacteria counts will not be included with this decision. Somatic

cell counts are the only quality adjustments in this final

decision. The issue of whether to include psychrotropic bacteria

as a payment criteria is better left to a Federal order hearing

that specifically addresses the issue. In contrast to a somatic

cell adjustment, which already is contained in many of the orders

with multiple component pricing, none of the orders currently

provide for adjustments for bacteria counts.

Application of the Replacement Basic Formula Price(s).

Under this final rule, producers in most Federal order
markets will be paid on a multiple component basis since the basic

formula price replacement is based on individual milk component

prices. Producers will be paid for the pounds of butterfat,

pounds of protein, pounds of other solids, a per hundredweight

price known as the producer price differential, and a per

hundredweight somatic cell adjustment. The producer price

differential returns to producers their pro rata share of the

proceeds of the classified pricing system. The butterfat,

protein, and other solids prices paid to producers will be the

same as the prices for those components announced for Class III

use regardless of the utilization of the milk. Handler

obligations and producer payments under the Federal orders that do

not provide for component pricing will be based on hundredweight

prices computed from these component prices.

Although several comments supported the proposal that

multiple component pricing (MCP) be applied only to milk used in

Classes II, III and IV, several comments from the Southwest area

argued that it should be applied to all milk or not adopted at

all. National Farmers Organization (NFO) also favored the

adoption of component pricing for all classes of milk, and other

comments favored the adoption of MCP for all Federal milk orders.

Several New York comments stated that MCP would not benefit

producers, would serve only to impose higher costs on handlers,

and shouldn’t be adopted for the Northeast. Michigan Milk

Producers expressed concern that the adjustment of protein value

to reflect the effect of additional butterfat in cheese would

increase costs in the Mideast because of the high percentage of

milk used in (lowfat) Italian and Swiss cheese in that market, and

requested that the Mideast market provide for the same kind of MCP

pricing currently used in the Southern Michigan market.

All Federal orders outside of the three southeast orders with

relatively high Class I use (Appalachian, Florida and Southeast)

and Arizona-Las Vegas should contain the same component pricing

plan. The affected orders have a large portion of their milk used

in manufactured products, and the components in that milk that

determine the yield of product available for handlers to sell are

the most appropriate basis for determining its value. At the same

time, there is no indication that MCP should apply to Class I

milk, and it is difficult to justify pricing fluid milk on an MCP

basis in terms of the economic value of components in those

products.

Although the proposed rule included provisions for the

Mideast order that would continue elements of the current Southern

Michigan MCP plan, further study supports the conclusion that

there is no benefit to establishing a component pricing plan under

one order that differs significantly from the rest of the

consolidated orders. This issue is discussed more thoroughly in
the Mideast section of this decision.

All of the Federal milk orders will require changes to

accommodate replacement of the current BFP with the multiple

component pricing plan or with its hundredweight price equivalent. 

There will no longer be a butterfat differential under any order,

but butterfat prices. The same butterfat price will be used for

butterfat in Class II (with an addition of .7 cents per pound to

reflect the Class II differential), Class III, and Class IV, while

a separate butterfat price, announced in advance, will apply to

butterfat used in Class I.

For purposes of allocation of producer receipts the

assumption will be made that the total nonfat solids, protein and

other (nonfat) solids cannot be separated easily from skim milk. 

These nonfat solids will therefore be allocated proportionately

with the skim milk based on the percentage of protein and other

solids in the skim milk received from producers. 

For the Market Administrator to compute the producer price

differential, handlers will need to supply additional information

on their monthly reports of receipts and utilization. Handlers

that are filing reports in orders that currently have multiple

component pricing and a somatic cell adjustment will see little or

no change in their reporting requirements. Under orders that are

adopting component pricing for the first time, the pounds of

protein, the pounds of other solids, and somatic cell information

will be needed in addition to the product pounds and the butterfat

currently reported. This data will be required from each handler

for all producer receipts, including milk diverted by the handler,

receipts from cooperatives as 9(c) handlers and, in some cases,

receipts of bulk milk received by transfer or diversion.

Payments by handlers to cooperative associations for Class I

milk will be calculated on the basis of the hundredweight of

Class I skim milk times the Class I skim price plus the pounds of

Class I butterfat times the Class I butterfat price. Payment for

Class II milk will be determined on the basis of the Class II

pounds of nonfat solids times the Class II nonfat solids price

(or, in non-MCP orders, the Class II skim milk price times the

hundredweight of Class II skim milk), and the pounds of butterfat

in Class II times the Class II butterfat price. The Class II

nonfat solids price is computed by dividing the Class II skim milk

price by 9. Class III milk will be paid for based on the pounds

of protein in Class III times the protein price, the pounds of

other solids in Class III times the other solids price, and the

pounds of butterfat in Class III times the butterfat price. The

pounds of nonfat solids in Class IV times the nonfat solids price,

and the pounds of butterfat in Class IV times the butterfat price

will be used to calculate obligations for Class IV milk. Milk

used in Classes III and IV in orders that do not include MCP will
be paid for on the basis of the butterfat price per pound and the

applicable skim milk price per hundredweight. The appropriate

somatic cell adjustment will apply to milk in Class II, Class III,

and Class IV. 

The Class I value of milk to handlers will be calculated by

multiplying the hundredweight of producer skim milk in Class I

times the Class I skim price plus the pounds of Class I butterfat

times the Class I butterfat price. Class II milk value will be

computed on the basis of the Class II nonfat solids price times

the pounds of total nonfat solids in skim milk allocated to Class

II and the pounds of butterfat in Class II times the Class II

butterfat price. Class III milk value will be computed based on

the pounds of protein in Class III times the protein price, the

pounds of other solids in Class III times the other solids price,

and the pounds of butterfat in Class III times the butterfat

price. The pounds of nonfat solids in Class IV times the nonfat

solids price, and the pounds of butterfat in Class IV times the

butterfat price will comprise the value of Class IV producer milk. 

Milk used in Classes III and IV in orders that do not include MCP

will be paid for on the basis of the butterfat price per pound and

the applicable skim milk price per hundredweight. Also included

will be the appropriate somatic cell adjustment applied to milk in

Class II, Class III, and Class IV, the value of overage, the value

of inventory reclassification, the value of other source receipts

and receipts from unregulated supply plants allocated to Class I,

and the value of handler location adjustments. 

For each marketwide pool using MCP, a producer price

differential price per hundredweight will be computed that will

represent producers’ shares of the value of the pool. The total

value of milk to handlers in excess of the value of producer

protein, other nonfat solids and butterfat at the applicable

component prices will be determined by dividing that value by the

hundredweight of milk in the pool. For orders without MCP, the

value of milk to handlers will be divided by the hundredweight of

producer milk to compute a uniform price per hundredweight to

producers.

The handler's obligation to the producer settlement fund

under MCP orders will be determined by subtracting from the

handler's value of milk the following values: a) the total pounds

of producer milk times the producer price differential adjusted

for location, b) the total pounds of butterfat times the butterfat

price, c) the total pounds of protein times the protein price, d)

the total pounds of other solids times the other solids price, e)

the total value of the somatic cell adjustments to producers’

milk, and f) the value of other source milk in Class I at the

producer price differential with any applicable location

adjustment at the plant from which the milk was shipped deducted
from the handler's value of milk. In orders without MCP, handler

obligations will be computed by subtracting the value of producer

milk at the uniform price per hundredweight from the value of milk

to the handler.

Payments to producers traditionally have been made in two

payments, a partial payment based, in most cases, on the prior

month's Class III price and a final payment at the uniform price

to producers. This traditional payment system will continue, with

any exceptions for local marketing practices noted in the regional

discussions. The partial payment will be paid on a per

hundredweight basis with the price equaling the combined value of

the skim and butterfat prices for the lowest-priced class in the

previous month. By computing the partial payment on a

hundredweight basis, confusion about the use of partial month

component test averages will be eliminated and handler's partial

payroll processing costs should not be affected. Final payments

to producers and for 9(c) milk will be based on: a) the

hundredweight of milk times the producer price differential

adjusted for location, b) the pounds of protein times the protein

price, c) the pounds of other solids times the other solids price,

d) the pounds of butterfat times the butterfat price, and e) the

somatic cell adjustment rate times the hundredweight of milk. 

Since producers will be receiving payments based on the

component levels of their milk, the payroll reports that handlers

supply to producers and to the Market Administrator must reflect

the basis for such payment. Therefore the handler will be

required to supply the producer not only with the information

currently supplied, but also: a) the pounds of butterfat,

protein, and other solids in the producer's milk, as well as the

average somatic cell count of the producer's milk, and b) the

minimum rates that are required for payment for each pricing

factor and, if a different rate is paid, the effective rate also. 

The requirement that payment factors be reported to producers when

producers are paid currently exists in all of the orders. 

Addition of the component information is purely a conforming

change. Administration of these provisions should not be changed

from current practices. 

With advance pricing of Class I and the inherent instability

of the commodity markets there may be occasions when the

computation of the producer price differential results in a value

of zero or below. The orders should contain no provision to

prevent the producer price differential from being a negative

value. 

The following tables contain the prices computed based on the

formulas and data series described in this final decision for the

period of January 1994 through December 1998. The prices are

shown for information purposes only. These prices result from the
strict application of the formulas to prior marketing situations. 

These prices should not be interpreted as prices that would have

actually occurred throughout the data period because industry

participants likely would have reacted differently to the price

levels that would have resulted from the revised pricing plan than

they reacted to the actual price levels.
Actual Class Prices and Final Decision Class Prices and Class I Price Mover*, by Month,

January 1994 through December 1998

Year and

Month

Basic

Formula

Price

Final Class

I Price

Mover*

Final Class

III Price

Class III-A

Price

Final Class

IV Price

Class II

Price

Final Class

II Price

1994 Dollars per cwt.

January $12.41 $11.72 $11.49 $10.22 $10.22 $13.25 $11.05

February $12.41 $11.73 $11.64 $10.23 $10.19 $12.26 $10.90

March $12.77 $12.02 $12.33 $10.32 $10.33 $12.61 $11.01

April $12.99 $12.90 $12.89 $10.34 $10.41 $13.19 $11.10

May $11.51 $12.15 $11.05 $10.24 $10.17 $13.88 $11.06

June $11.25 $10.56 $10.37 $10.09 $10.10 $12.18 $10.72

July $11.41 $11.10 $10.90 $10.13 $10.18 $10.35 $10.80

August $11.73 $11.63 $11.06 $10.38 $10.42 $11.84 $11.03

September $12.04 $11.84 $11.76 $10.35 $10.32 $12.95 $10.93

October $12.29 $11.92 $11.74 $10.36 $10.31 $12.15 $10.90

November $11.86 $11.80 $11.49 $10.40 $10.36 $12.53 $11.01

December $11.38 $10.91 $10.88 $10.17 $10.16 $12.24 $10.87

Average $12.00 $11.69 $11.47 $10.27 $10.26 $12.45 $10.95

*Developed for informational purposes only. Advanced skim milk and butterfat prices will

be used to calculate Class I price for succeeding month.
Actual Class Prices and Final Decision Class Prices and Class I Price Mover*, by Month,

January 1994 through December 1998

Year and

Month

Basic

Formula

Price

Final Class

I Price

Mover*

Final Class

III Price

Class III-A

Price

Final Class

IV Price

Class II

Price

Final Class

II Price

1995 Dollars per cwt.

January $11.35 $10.64 $10.66 $10.06 $10.07 $11.02 $10.71

February $11.79 $11.19 $11.33 $10.12 $10.23 $11.35 $10.85

March $11.89 $11.59 $11.49 $10.22 $10.25 $12.20 $10.85

April $11.16 $11.07 $11.08 $10.27 $10.28 $12.09 $10.89

May $11.12 $10.74 $10.55 $10.21 $10.29 $12.19 $10.89

June $11.42 $10.78 $10.56 $10.37 $10.36 $11.46 $11.04

July $11.23 $11.10 $10.64 $10.61 $10.60 $11.42 $11.23

August $11.55 $11.00 $10.88 $10.82 $10.94 $11.72 $11.52

September $12.08 $12.51 $12.37 $10.90 $10.89 $11.53 $11.52

October $12.61 $12.93 $12.69 $11.66 $11.46 $11.85 $12.09

November $12.87 $13.19 $12.96 $12.40 $11.95 $12.38 $12.52

December $12.91 $13.34 $12.84 $11.24 $11.13 $12.91 $11.61

Average $11.83 $11.67 $11.50 $10.74 $10.70 $11.84 $11.31

*Developed for informational purposes only. Advanced skim milk and butterfat prices will

be used to calculate Class I price for succeeding month.
Actual Class Prices and Final Decision Class Prices and Class I Price Mover*, by Month,

January 1994 through December 1998

Year and

Month

Basic

Formula

Price

Final Class

I Price

Mover*

Final Class

III Price

Class III-A

Price

Final Class

IV Price

Class II

Price

Final Class

II Price

1996 Dollars per cwt.

January $12.73 $12.82 $12.32 $11.16 $11.15 $13.17 $11.84

February $12.59 $12.62 $12.37 $10.39 $10.70 $13.21 $11.63

March $12.70 $12.66 $12.52 $10.32 $10.49 $13.03 $11.17

April $13.09 $12.84 $13.15 $10.52 $10.65 $12.89 $11.29

May $13.77 $13.68 $13.12 $11.90 $11.74 $13.00 $12.12

June $13.92 $14.28 $13.31 $15.12 $14.25 $13.39 $14.07

July $14.49 $15.41 $13.41 $16.01 $15.32 $14.07 $15.95

August $14.94 $15.32 $14.02 $15.82 $15.44 $14.22 $16.35

September $15.37 $15.74 $15.17 $15.85 $16.09 $14.79 $15.89

October $14.13 $15.28 $13.54 $14.94 $14.82 $15.24 $15.62

November $11.61 $12.33 $11.33 $12.18 $12.10 $15.67 $13.03

December $11.34 $11.06 $10.68 $11.75 $11.76 $14.43 $12.67

Average $13.39 $13.67 $12.91 $13.00 $12.88 $13.93 $13.47

*Developed for informational purposes only. Advanced skim milk and butterfat prices will

be used to calculate Class I price for succeeding month.
Actual Class Prices and Final Decision Class Prices and Class I Price Mover*, by Month,

January 1994 through December 1998

Year and

Month

Basic

Formula

Price

Final Class

I Price

Mover*

Final Class

III Price

Class III-A

Price

Final Class

IV Price

Class II

Price

Final Class

II Price

1997 Dollars per cwt.

January $11.94 $11.62 $11.05 $11.50 $11.68 $11.91 $12.52

February $12.46 $11.95 $11.56 $12.36 $12.34 $11.64 $13.02

March $12.49 $12.74 $11.55 $12.78 $12.80 $12.24 $13.33

April $11.44 $12.65 $11.23 $12.10 $12.13 $12.76 $12.87

May $10.70 $11.20 $10.23 $11.56 $11.58 $12.79 $12.53

June $10.74 $11.95 $9.96 $12.22 $12.06 $11.74 $12.77

July $10.86 $11.98 $10.13 $12.06 $11.93 $11.00 $12.54

August $12.07 $11.97 $11.50 $11.88 $11.91 $11.04 $12.63

September $12.79 $12.42 $12.32 $11.87 $11.83 $11.16 $12.55

October $12.83 $12.76 $12.54 $13.50 $13.29 $12.37 $13.98

November $12.96 $13.80 $12.59 $14.01 $13.86 $13.09 $14.56

December $13.29 $13.81 $12.55 $12.46 $12.72 $13.13 $13.43

Average $12.05 $12.40 $11.43 $12.36 $12.34 $12.07 $13.06

*Developed for informational purposes only. Advanced skim milk and butterfat prices will

be used to calculate Class I price for succeeding month.
Actual Class Prices and Final Decision Class Prices and Class I Price Mover*, by Month,

January 1994 through December 1998

Year and

Month

Basic

Formula

Price

Final Class

I Price

Mover*

Final Class

III Price

Class III-A

Price

Final Class

IV Price

Class II

Price

Final Class

II Price

1998 Dollars per cwt.

January $13.25 $12.76 $12.51 $12.04 $12.29 $13.26 $13.02

February $13.32 $13.03 $12.87 $12.89 $13.07 $13.59 $13.78

March $12.81 $12.75 $12.50 $12.67 $12.79 $13.55 $13.49

April $12.01 $12.69 $11.50 $12.88 $12.90 $13.62 $13.59

May $10.88 $13.27 $10.65 $13.96 $13.54 $13.11 $14.24

June $13.10 $14.20 $12.65 $15.38 $14.89 $12.31 $15.54

July $14.77 $15.35 $14.12 $15.59 $15.62 $11.18 $16.15

August $14.99 $16.25 $14.21 $16.52 $16.38 $13.40 $16.96

September $15.10 $18.32 $14.66 $19.81 $18.71 $15.07 $19.28

October $16.04 $18.06 $16.05 $18.13 $18.19 $15.29 $18.67

November $16.84 $16.82 $16.90 $14.87 $15.71 $15.40 $16.39

December $17.34 $17.44 $17.51 $13.48 $13.39 $16.34 $13.98

Average $14.20 $15.08 $13.84 $14.85 $14.79 $13.84 $15.42

60-Month Avg $12.70 $12.90 $12.23 $12.24 $12.20 $12.83 $12.84

*Developed for informational purposes only. Advanced skim milk and butterfat prices will

be used to calculate Class I price for succeeding month.