February 8, 2000
Mr. Chairman and Members of the Committee, the Department of Agriculture appreciates your invitation to discuss the impact of dairy policy and programs on producers, consumers and Federal outlays. I will start with a brief overview of the economic situation in dairy markets. This description provides the context in which dairy policy will operate in the future. I will then review the performance of the major Federal programs operating today: the milk price support program, emergency market loss assistance programs, the Dairy Export Incentive Program (DEIP), the Federal milk marketing order program and dairy compacts.
The State of the Dairy Economy
Milk production. Over the past decade, milk production has increased by about 1.2 percent per year, as milk production per cow increased about 2.2 percent per year while milk cow numbers declined about 1 percent per year. Milk production is projected to increase 2.3 percent to 164.9 billion pounds during the current 1999/00 marketing year, which began on October 1. This would be the second largest percentage increase in milk production during the decade of the 1990's surpassed only by last year’s 3 percent increase. In contrast, milk production rose just 0.4 percent during 1997/98. During the past two years, ample feed supplies, low feed prices, favorable weather in most areas of the country and strong milk prices until recently have supported the expansion in milk production. In response to these economic incentives, producers have reduced milk cow culling rates and increased the number of dairy replacements causing cow numbers to remain steady.
Milk production continues to shift regionally. California surpassed Wisconsin as the nation’s top milk producing state in 1993. California now produces one-third more milk than Wisconsin. Milk production also is increasing rapidly in several other western States supported by an ample supply of good quality forage and a favorable weather. For example, Idaho currently ranks 6th in the nation in milk production behind California, Wisconsin, New York, Pennsylvania and Minnesota, compared with 12th just 10 years ago. Ten years ago, New Mexico was in the bottom one-half of all states in milk production and now it is in the top ten.
Milk Use. Commercial disappearance of dairy products increased 2 percent per year over the past 10 years led by a 3.5 percent per year increase in commercial disappearance of cheese. Commercial disappearance of butter registered gains of 4 percent per year from 1988-95, reversing the trend of the previous decade in which disappearance of butter stagnated amid consumer health concerns. From 1995-98, commercial disappearance of butter again stagnated, but still remains 25 percent above decade-earlier levels. Fluid milk consumption continues to grow slowly at less than 1 percent per year. Commercial disappearance of nonfat dry milk increased sharply in 1995 and 1996 but has since dropped 14 percent. In 1998, commercial disappearance of nonfat dry milk was up 18 percent, compared with 10 years ago.
In 1998/99, commercial disappearance of dairy products rose 2.6 percent, despite prices well above those for most of the 1990s, in large part due to continued strong U.S. economic growth. Continued favorable economic growth and steady-to-lower retail prices are expected to boost domestic dairy product sales by 3 percent this marketing year.
Prices. Farm-level milk prices were record-high in 1998/99 averaging $15.37 per cwt., up from the previous high of $14.60 per cwt. in 1997/98. Soaring milk production caused milk prices to collapse during the final months of 1999. In November and December, the Basic Formula Price (BFP) for manufacturing uses of milk fell to the lowest level in more than 21 years, as cheese prices fell to near the support price and nonfat dry milk prices were at support with the Commodity Credit Corporation (CCC) buying nonfat dry milk at a relatively high rate. For the 1999/00 marketing year, USDA predicts the all-milk price will average $12.45 per cwt., which would be the lowest all-milk price in 9 years. The decline in farm milk prices should start to trim growth in milk production by the second half of 2000 supporting a recovery in farm prices.
Retail dairy product prices rose 5.6 percent in 1999, reflecting strong farm-level milk prices. In 2000, weakening farm-level prices are forecast to lead to 1-2 percent decline in retail dairy product prices.
Financial condition of U.S. Dairy Farms. U.S. dairy farms improved their financial position in 1998 and 1999. Dairy concentrate expenses dropped 10 percent in 1998 and dropped further in 1999. The drop in feed costs combined with record-high milk prices caused returns over concentrate costs in 1998 and 1999 to be considerably above the average of the 1990's. Nationally, net cash returns, defined as gross revenue less cash expenses, increased from only $0.65 per cwt. of milk sold in 1997 to $3.42 per cwt. in 1998 and were likely near that level in 1999.
Using survey information, the Economic Research Service (ERS) estimates the net cash income of dairy farms with annual gross sales of $50,000 or more averaged $95,000 in 1998 and 1999, compared with the 1994-98 average of $64,800. In 2000, the net cash income of dairy farms is projected to fall by 21 percent to $74,900. Due to the strength of dairy farm balance sheets, the drop in income in 2000 is expected to lead to a small increase in the share of vulnerable dairy farms. The share of dairy farms considered financially vulnerable--negative farm income with debt-asset ratio exceeding 0.4--fell to 2.6 percent at the end of 1998, the lowest level in the 1990s. In comparison, nearly 5 percent of all farm businesses were considered to be financially vulnerable at the end of 1998. Eleven percent of dairy farms had debt repayment problems (debt equal to 120 percent or more of debt that can be repaid with current income) at the end of 1998, compared with 22 percent of all farm businesses. Declining milk prices are expected to increase the proportion of dairy farms with debt service problems to about 17 percent at the end of this year.
Despite the improvement in returns in 1998 and 1999, the number of dairy farms continued to decline as smaller dairy farms give way to fewer, larger operations. In 1999, the number of operations with milk cows as reported by the National Agricultural Statistics Service dropped 5 percent from 117,180 to 111,220. While the total number of dairy farms is declining, the number of large operations is increasing. In 1999, the number of dairy operations with fewer than 50 cows, over one-half of all dairy farms, dropped by over 8 percent. In contrast, the number of dairy operations with 500 or more cows, about 2 percent of all dairy farms, increased by more than 6 percent. There are no indications that the structural adjustment taking place in dairy farming will slow down anytime soon and appears largely unaffected by current dairy programs.
Long term outlook. Looking beyond the current marketing year, we expect trend growth in commercial use of dairy products to keep pace with increases in milk supplies. Milk cow numbers are expected to decline slowly, continuing a long-term trend. Nevertheless, milk production is projected to grow about 1-2 percent per year as productivity gains and structural changes continue to increase efficiency.
The traditional centers of milk production appear to be in the early stages of the most dramatic structural changes in milk production since the adoption of bulk tanks. A new type of dairy farm appears to be emerging that is much larger, lowering capital costs per cow. This new dairy farm will use more purchased inputs, including labor, and have other characteristics similar to typical western dairy operations.
Farm milk prices are projected to remain under some pressure over the next couple of years, with the all-milk price averaging between $12.50-$13.00 per cwt. These subdued prices and higher feed costs are likely to lead to declining cow numbers, slowing the growth in milk production. Continued expansion in demand for dairy products should then lead to higher milk prices and improved returns. However, milk prices and returns will likely continue to remain quite volatile both from year-to-year and season-to-season.
The often-stated objectives of Federal dairy policy are not unlike those for agriculture in general and include assuring an adequate, safe supply of milk at reasonable cost to consumers; maintaining prosperity of producers; protecting the environment; ensuring program spending is cost-effective; promoting market orientation and competitiveness; and honoring international trade agreements. To address these objectives, the Federal government operates a number of interrelated programs. This section describes the major programs, including the milk price support program, the Dairy Export Incentive Program (DEIP), emergency market loss assistance programs and milk marketing orders. CCC outlays for the milk price support program, DEIP, and emergency assistance to dairy producers amounted to $480 million in FY 1999 and are expected to surpass $500 million in FY 2000.
Milk Price Support Program. The CCC administers the price support program by announcing purchase prices for butter, cheese and nonfat dry milk. These purchase prices are set by formula and established so that firms of average processing efficiency can pay producers the support price for milk. The formula takes into account the amount of each product produced from 100 pounds of milk and provides an allowance for the cost of converting milk into manufactured dairy products. Since butter and nonfat dry milk are joint products, increasing the purchase price of either product can be offset by an equivalent decrease in the other, leaving the milk price support level provided to producers unaffected. Tariff-rate quotas prevent imports from undermining the milk price support program.
Prior to late October 1981, the Agricultural Act of 1949, as amended (1949 Act), required that the support price for manufacturing milk be set at 75-90 percent of parity. Under this legislation, the support price for manufacturing milk rose steadily to $13.49 per cwt. in October 1981, leading to excessive surpluses of dairy products and record outlays under the price support program.
Amendments to the 1949 Act by the Agriculture and Food Act of 1981 were the first to relate the minimum support price for milk to the size of CCC purchases, severing adjustments in the support price to parity. Between October 1981 and October 1990, the support price for milk fell by over 25 percent to $10.10 per cwt. The support price remained at that level through December 31, 1995, before increasing to $10.35 per cwt. on January 1, 1996.
Also during the 1980's, Congress authorized two short-term voluntary supply management programs to help balance supply and demand for dairy products. The first of these programs, the Milk Diversion Program, paid producers $10 per cwt. for reducing their marketings by 5 to 30 percent. The second of these programs, the Dairy Termination Program, paid producers to liquidate their herds and remain out of milk production for 5 years. Both programs were opposed by livestock and consumer interests. In the short-term, these programs helped to reduce milk production, purchases under the price support program and government stockpiles of dairy products and boost prices to producers. In the long-term, producers responded to higher prices by expanding milk production. In order to help pay for these programs and to reduce the cost of the milk price support program, Congress also authorized producer assessments on milk marketings. These assessments peaked at $1.00 per cwt. in the early 1980s of which $0.50 was refundable to producers who had not expanded production.
The Federal Agriculture Improvement and Reform Act of 1996 amended the milk price support provisions of the 1949 Act by setting the support price for milk at $10.35 per cwt. during 1996, with $0.15 per cwt. reductions annually through 1999 at which time authority for the price support program was to expire. In addition, no authority was provided for producer marketing assessments, which producer interests had strongly opposed. Last year, Congress extended the price support program through December 31, 2000, with the support level set at $9.90 per cwt. Under current legislation, the milk price support program is to be replaced by a processor recourse loan program for dairy products at the equivalent of $9.90 per cwt. on January 1, 2001. The President’s Budget request for FY 2001 proposes extension of the milk price support program through 2002, at which time the current farm bill expires.
During the early 1980s, the cost of milk price support escalated rapidly reaching a record $2.5 billion in FY 1983. Reductions in the level of support, producer marketing assessments and other program changes reduced the cost of the price support program over the next several years. By FY 1995, the price support program had a net budget inflow of $164 million, as producer marketing assessments exceeded government dairy product purchase costs. Over the past three years, increasing milk production, the elimination of producer marketing assessments and weak demand for nonfat solids have caused the cost of purchases under the milk price support program to rise steadily, reaching $183 million in FY 1999.
The CCC purchased 172 million pounds of nonfat dry milk in FY 1999, up from 121 million pounds the previous year. From October 1, 1999 through February 4, 2000, the CCC has purchased 100 million pounds of nonfat dry milk, compared with about 2 million pounds over the same period last year. Increased purchases of nonfat dry milk could push the cost of the price support program to over $350 million in FY 2000, the highest level in nearly a decade. USDA has not purchased any butter or cheese under the price support program in several years, but cheese prices are currently near support.
The milk price support program has performed with fewer problems during the 1990s than during the 1980s. The burdensome dairy stockpiles that were once headlines are gone. With the exception of nonfat dry milk, purchases have not been excessive. While program costs are on the rise, they are well below the peak set in the mid-1980s and not out of balance with respect to other commodities. In FY 1999, the milk price support program accounted for less than 1 percent of total CCC outlays, compared with over 13 percent in FY 1983.
As the support price for milk has declined, manufacturing milk prices increasingly have been above support and farm milk prices have become more volatile both from year-to-year and from season-to-season. During 1980-88, the price of manufacturing milk followed the support price, but by the late 1980s the price of manufacturing milk had moved considerably above support. During the 1990s, the manufacturing milk price averaged more than $2 per cwt. above the support price, and this marketing year USDA projects the manufacturing milk price will average about $0.55 above support. This suggests that the price support level is not providing a large incentive for producers to expand milk production. Alternatively, because the price support program is not providing much downside price support, it could be argued that the program is not very effective in reducing the extremely volatile milk prices in recent years faced by farmers, processors and consumers, and therefore is not very effective as a farm safety net program. Nevertheless, given the current and rising surplus of nonfat dry milk, terminating the price support program at the end of this year could prove disruptive to dairy producers and processors.
The effects of termination of the milk price support program at the end of this year depend on the amount of nonfat dry, and possibly other dairy products CCC would end up buying, if the price support program is continued beyond the end of this year. Assuming the growth in milk production moderates and nonfat dry milk purchases decline to near this past year’s level in 2001, elimination of the price support program could lower the average price of nonfat dry milk by $0.10-$0.15 per pound and the national average all-milk price by $0.35-$0.55 per cwt., or 3 to 5 percent in 2001. Under these assumptions, dairy producers’ incomes would fall by about $750 million. Likewise, consumer expenditures on dairy products would decline by about $750 million, while taxpayer costs would fall by about $200 million, excluding the cost of storage and disposition. If the disposition of CCC purchases displaces commercial sales, discontinuation of the price support program would result in a smaller drop in producer incomes and consumer expenditures. The drop in milk prices could be more severe in areas of the country where nonfat dry milk production is most heavily concentrated, such as the west and northeast.
Emergency Marketing Loss Assistance. In 1998, Congress appropriated $200 million for direct payments to dairy producers and authorized an additional $125 million in direct payments in 1999. To provide meaningful assistance to small and medium-sized dairy producers, USDA limited payments to each operation’s first 26,000 hundredweight of milk production. This limit on eligible production caps payments on farms having approximately 150 or more cows, about 13 percent of all farms in 1999. All dairy farmers who produced milk during the last quarter of calendar year 1998 were eligible to sign up to receive payments, and each operation could elect to receive payments on either 1997 or 1998 milk production.
The sign-up period for the initial $200 million in payments ran from April 12 to May 12, 1999, and these payments were disbursed to producers in June 1999. The payment rate was $0.225 per cwt. and the maximum payment was about $5,845. Sign-up for the $125 million in payments began on January 24 and continues through February 28, and the payments are expected to be paid out in late March and early April. These additional payments are being distributed using the same production criteria as the initial payments--payments on the first 26,000 cwt. of production and on either 1997 or 1998 production. Farmers who received payments last June do not need to reapply for assistance. Only those eligible producers who did not participate in the previous program need to sign up. Based on the results from the previous sign-up, the payment rate on the $125 million in payments should turn out to be about $0.14 per cwt. with a maximum payment of about $3,650. These emergency payments provide modest short-term relief to dairy producers and for the most part are a direct transfer from taxpayers to producers, with negligible effects on consumers of dairy products.
Dairy Export Incentive Program. The DEIP is an export subsidy program similar to the Export Enhancement Program for other U.S. agricultural commodities. The program is used to assist U.S. dairy products to meet competition from subsidizing countries, especially the European Union, in targeted markets. Products exported under DEIP include milk powders, butterfat and several cheese varieties.
The DEIP provides cash bonuses to approved exporters based on bids submitted for specific products and markets. The DEIP bonuses are based on the difference between U.S. and world prices. For example, in FY 1999, the average bonus was $1,043 per metric ton for nonfat dry milk, $940 per ton for butter/butteroil, and $1,548 for cheddar cheese. In past years, bonuses have been as low as $528 for nonfat dry milk, $475 for butter, and $788 for cheddar cheese, reflecting higher world prices. Practically all U.S. butter and nonfat dry milk exports are made under the DEIP, whereas the DEIP is much less significant for cheese exports. Total DEIP spending was about $127 million in FY 1999.
Use of the DEIP is governed by the World Trade Organization (WTO) rules on export subsidies. WTO members agreed to reduce exports subsidies 21 percent by volume and 36 percent in value over a 6-year implementation period, which ends next year. In the first 2 years of the implementation period, the use of DEIP for nonfat dry milk was well below the WTO limits, but DEIP subsidies in the past 3 years, including expected use for this year, have exceeded the annual WTO limits. The United States has used the flexibility provisions in the WTO to exceed the annual limits, but in order to be in compliance at the end of the implementation period, allowable DEIP subsidies for 2000/01 (July - June) will be available for only 68,000 metric tons of nonfat dry milk. That volume represents a 33-percent drop from 1999/00's forecast level of DEIP-assisted exports of about 100,000 tons.
DEIP exports increase producer milk prices, consumer expenditures and taxpayer costs. If we assume 68,000 metric tons of nonfat dry milk exported under DEIP at a subsidy level of $1,050 per ton and elimination of the milk price support program, no DEIP exports would lower the price of nonfat dry milk by about $0.10 per pound and the all-milk price by about $0.35 per cwt. Under these assumptions, dairy producers’ incomes would fall by about $575 million. Likewise, consumer expenditures on dairy products would decline by about $575 million, while taxpayer costs would fall by $71 million. As with elimination of the price support program, the drop in milk prices could be more severe in areas of the country where nonfat dry milk production is most heavily concentrated, such as the west and northeast.
Federal Milk Marketing Orders. Federal milk marketing orders are authorized by the Agricultural Marketing Agreement Act of 1937. Producers located in an area of the country decide by a two-thirds vote whether their milk marketings should be regulated by a Federal order. Federal orders regulate about 70 percent of the milk marketed in the United States. Milk marketings in California, which accounts for nearly one-fifth of milk marketings nationally, are regulated by a State order. The 1996 Farm Bill required the Secretary to reduce the number of Federal milk orders to 10 to 14. On January 1, 2000, the number of Federal milk marketing orders was reduced from 31 to 11 and other significant changes were instituted at that time.
Each Federal order specifies the minimum price that handlers must pay for milk. These minimum prices vary depending on how the milk is used. Class I milk is milk used in fluid milk products. Class II milk is used in fluid cream products, other food products and in perishable manufactured products such as ice cream, cottage cheese and yogurt. Class III milk is used in the production of hard cheeses, and Class IV milk is milk used in the production of butter and dry milk products. Class I milk receives the highest price and the minimum price for Class I milk varies by location. The minimum prices for Class II, III and IV milk are uniform across all orders. The prices of all classes of milk vary from month-to-month depending on supply and demand conditions for milk and dairy products. Revenues from all milk sales in each order are “pooled” together and each producer receives a minimum average or “blend” price adjusted for location.
Under the reforms implemented on January 1, 2000, the minimum Class I price equals the Class I price location differential plus the higher of an advanced Class III or Class IV value (new Class I mover). The minimum Class II price equals the Class IV price plus $0.70 per cwt. The Class III price is based on a product price formula that includes the prices of butter, cheese and dry whey. The Class IV price is based on a product price formula that includes the prices of butter and nonfat dry milk. The product prices used to calculate the Class III and IV prices are reported by National Agricultural Statistics Service (NASS) in its weekly Dairy Products Prices report. Prior to implementation of the Federal order reform, the minimum Class I price equaled the Class I price location differential plus the Class III price lagged two months (old Class I mover), the minimum Class II price equaled the Class III price lagged two months plus $0.30 per cwt. The Class III price equaled the BFP, which was determined by a survey of prices paid for milk by Grade B manufacturing plants in the Upper Midwest updated to the current month using a product price formula. The new Class IV price replaced the previous Class III-A price, which was also determined by a product price formula.
Some have been concerned that the new classified pricing structure will lead to lower prices to some producers, and Congress passed legislation last year requiring the Department to conduct hearings on the new Class III and Class IV pricing formulas. Beginning in September 1998 when the Department began publishing all of the data required to calculate the new Class prices, the BFP and the new Class III price formula both have averaged $13.41 per cwt. The new Class IV price averaged $13.32 per cwt., $0.07 per cwt. higher than the previous Class III-A price over the 16-month period, and the new Class I price mover averaged $0.60 per cwt. higher than the old Class I price mover from October 1998 through February 2000. The new minimum Class II price averaged $0.49 lower than the old minimum Class II price from October 1998 through January 1998. Across all Federal orders, had the new pricing structure been in effect since September 1998 the average producer blend price would have been about $0.20 per cwt. higher than under the pricing structure that was in place prior to January 1, 2000.
Several economic studies have shown that Federal order Class I differentials in some areas have been higher than necessary to attract fluid milk from supply areas, thereby enhancing producer incomes by raising the price producers would otherwise receive, and the price consumers would otherwise pay for milk used in Class I products (see Siebert, Stephenson and Anderson, Choices Magazine, 1997). These higher than necessary prices for milk used in Class I products lead to higher milk production and reduced consumption of fluid milk products. This results in increased supplies of milk available for the production of manufactured dairy products, lowering the price producers receive for milk used in the production of manufactured dairy products and the price consumers pay for butter, cheese and other manufactured dairy products. The extent to which a producer’s average blend price is increased varies depending on the amount of milk used in Class I products, the size of the Class I differential and other supply and demand factors.
Economic studies suggest that national farm-level milk prices would decline by 1-3 percent in the absence of Federal orders, with farm income declining by $200-$500 million and consumer expenditures on dairy products falling by a similar amount. However, producers in markets with above average Class I utilization would see larger declines in their milk prices, while some producers in markets with below average Class I utilization could see their milk prices increase in the absence of Federal orders. Studies indicate that milk prices would fall more than the national average in the southeast, southwest and northeast, while increasing in the upper midwest.
Under the Secretary’s Final Decision, which was overturned by Congress, the Secretary chose to lower Class I location differentials in some areas where supplies of milk for fluid use can be attracted at lower cost. Class I location differentials were increased in the upper midwest to better reflect the costs of attracting milk from manufacturing plants and of hauling milk from where it is produced to where it is needed at processing plants for fluid use. The average Class I location differential would have been reduced by about $0.29 per cwt., from the pre-reform average of $2.57 per cwt. As noted above, had this decision been in effect over the past 17 months, this $0.29 average decline in the location differential would have been more than offset by the new and higher Class I price mover.
Congress passed legislation last year that extended congressional consent for the Northeast Interstate Dairy Compact (the Northeast Compact), which was due to expire with implementation of Federal order reform, through September 30, 2001. The Northeast Compact currently includes Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont. Maryland, New Jersey, New York, Delaware, Pennsylvania and Ohio can also join the Northeast Compact if the joining State is contiguous to one or more Northeast Compact States and upon approval of Congress.
Legislation was also introduced in Congress last year to provide congressional consent for a southern dairy compact consisting of up to sixteen states--Alabama, Arkansas, Florida, Georgia, Kansas, Kentucky, Louisiana, Mississippi, Missouri, North Carolina, Oklahoma, South Carolina, Tennessee, Texas, Virginia and West Virginia.
The economic effects of the current Northeast Compact and extending it to other States have been examined in several studies. The Agriculture Appropriations Act for FY 1998 directed the Office of Management and Budget (OMB) to conduct a study of the Northeast Compact. The OMB examined its effects over the period from July 1 to December 31, 1997. In January 1999, two University of Missouri researchers published a study that examines the economic implications of expanding the number of States covered by dairy compacts. In November 1999, several University of Vermont and University of Massachusetts researchers published a study of the effects of the Northeast Compact from July 1997-June 1998. These studies indicate that compacts have a range of economic effects.
For producers serving the regulated area, compact regulation raises the effective farm milk price and producer incomes by increasing the price handlers must pay for milk used in fluid products. The Missouri study indicates that a $2 per cwt. over-order compact price would raise the all-milk price by nearly $1 per cwt. in the Southeast. Dairy farmers react to higher prices by expanding their dairy herds and increasing feeding rates, both of which lead to higher milk production.
The studies indicate higher prices for fluid milk are fully passed on to consumers. The University of Missouri study indicates that a $2 per cwt. compact over-order price would increase the retail price of fluid milk by about $0.15-$0.31 per gallon depending on assumptions for the farm-to-retail price markup. Consumers react to the higher retail price for fluid milk by reducing fluid milk consumption.
Higher milk prices due to compact regulation raise milk production and lower fluid milk consumption in compact States, which results in more milk available for processing into manufactured dairy products, such as cheese, butter and nonfat dry milk, reducing prices for these products and farm milk prices to producers in non-compact States. The OMB study estimated that the average all-milk price outside the Northeast Compact was reduced by $0.02 per cwt. during July-December 1997. The Missouri study suggests that a combined northeast, southeast, and mid-Atlantic compact would reduce the all-milk price to producers in other areas of the country by $0.17-$0.23 per cwt.
Mr. Chairman, that completes my review of the current market situation for milk and the performance of the principal Federal dairy programs. I note that the programs reviewed here are supplemented by many other Federal programs that affect milk producers and the dairy market, including risk management programs, food assistance programs, trade programs other than DEIP, promotion programs and research and extension programs. I would be pleased to respond to questions.