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NCI Urges USDA To Move Quickly on Make Allowances

Jan 30, 2006

NCI Urges USDA To Move Quickly on Make Allowances

In testimony during a Federal Milk Marketing Order hearing last Friday, the National Cheese Institute (NCI), urged the U.S. Department of Agriculture (USDA) to move swiftly to update the make allowances used in all federal order minimum class price formulas.

"The current make allowances are outdated and causing substantial harm to the dairy industry," said Bob Yonkers, IDFA chief economist and director of policy analysis. "The tremendous gap between the current make allowances and actual manufacturing costs cries out for prompt resolution."

The hearing was called to consider whether any changes should be made to the Class III and Class IV make allowances currently contained in all federal orders.

During the hearing, the National Milk Producers Federation (NMPF) offered a proposal to de-couple any change in the Class III and IV make allowances from Class I and II pricing formulas, an action that would increase the Class I and II differentials by a significant amount. IDFA objected strenuously to this attempt to expand the scope of the hearing, and the administrative law judge sustained that objection. The hearing was allowed to proceed with testimony from interested parties on the need for updating the Class III and IV make allowances only.

In its testimony, NCI expressed full support for a proposal given by Agri-Mark, which suggests setting make allowances using the most recently available industry cost data from both the California Department of Food and Agriculture and USDA's Rural Business Cooperative Service. Eleven IDFA member companies also testified in support of the NCI and Agri-Mark proposal.

In addition, added Yonkers, "since the most recent data from these two sources covers industry cost data from 2004, these costs should be updated for the dramatic increases in energy costs between 2004 and 2005 using indices from the U.S. Bureau of Labor Statistics (BLS) for industrial electricity and industrial natural gas."

NCI also made these specific recommendations: 1) the make allowance for cheese should be set no lower than 18.1 cents per pound; 2) the make allowance for dry whey should be set no lower than 22.2 cents per pound; 3) the make allowance for butter should be set no lower than 15.4 cents per pound; and 4) the make allowance for nonfat dry milk should be set no lower than 19.7 cents per pound.

In terms of immediate procedural action, NCI urged USDA to omit a "recommended decision" and issue and implement a "final decision" and rule as quickly as is reasonably possible.

Yonkers outlined in his testimony the critical importance of make allowances in a pricing system based on product price formulas. Prior to 2000, the minimum class prices for federally regulated milk were based on competitive market prices paid for unregulated (Grade B) milk in the upper Midwest. Thus, the pricing system could adjust automatically to changes in manufacturing costs, without any need to amend the terms of the federal orders themselves.

But since 2000, the federal order system has adopted a product price formula approach which uses the price of finished products to determine the minimum prices.

"In general terms, a make allowance is the difference between the wholesale sales value of a manufactured dairy product and the cost to purchase the raw milk necessary for that product's production," said Yonkers. "It is critical that the make allowance covers the total costs of turning raw milk into a finished dairy product. Without an adequate level of make allowance, a manufacturing plant could not continue to operate, as it would have insufficient funds available to pay the vital costs necessary for operating the plant."

Yonkers explained that if a manufacturing plant is not getting enough money to cover its costs, it can't simply raise the price for its finished products, or lower the amount it is paying for its milk.

"Under the federal order system, the handler cannot reduce what it is paying its farmers below the minimum regulated price.... [And] the handler cannot escape from its conundrum by raising its finished product prices, either...because the pricing formula works as a ratchet. All of the finished product price increase gets passed on to the farmer in the form of a higher minimum milk price."

As a result, the federal orders must be amended when their make allowances no longer reflect the real costs of making manufactured dairy products.

"Neither Congress nor USDA intended to threaten the economic viability of the U.S. dairy industry by forcing manufacturers to lose money on every pound of cheese or other product produced," Yonkers said. "However...without any mechanism to adjust the make allowances in response to changes in industry costs, manufacturers are trapped into either losing money on every pound of product produced or stopping production entirely.

"There is, therefore, an overwhelming and imperative need for immediate relief from the highly injurious fixed relationship between output prices and minimum regulated milk prices that do not reflect current industry costs," Yonkers concluded.

To read NCI's complete testimony, click here.

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Posted January 30, 2006

Dairy Delivers