CHOICES
A publication of AAEA
After a lengthy administrative process to evaluate the evidence about the need for pricing changes that began in March 2023, the Dairy Division of the USDA released a final decision in mid-November 2024 detailing changes to milk pricing under Federal Milk Marketing Orders (FMMO). In the subsequent producer referendum in December 2024 and January 2025, these changes were approved for all 11 current FMMOs, and new pricing formulas became effective in June 2025. These changes are the most substantive in more than 2 decades and include many modifications to formulas affecting minimum regulated milk prices. This article summarizes the changes and assesses their potential impacts on milk prices through 2028. A review of FMMO pricing sets the context for the upcoming modifications.
FMMOs set minimum regulated prices paid to producers (and cooperatives) and pool the revenues from those prices to generate a weighted-average producer price (a blend price). The changes implemented in June 2025 affect pricing, not pooling. Minimum regulated prices are based on product price formulas that determine an implied value for farm milk based on the products made from it. FMMOs survey wholesale dairy product prices for butter, cheddar cheese, dry whey, and nonfat dry milk and use formulas to calculate the value of four components in farm milk (butterfat, protein, nonfat solids, and other solids). The values of these components determine the minimum regulated prices paid for farm milk, based on the use of the milk, or its class. The formulas also account for the yield of product; for example, about 1.2 lb of butter can be made from a pound of butterfat because commercial butter contains only 82% butterfat plus water and salt. Product price formulas also account for the cost of transforming farm milk into the surveyed products, a dollar value per pound that is known as a make allowance. A typical calculation for a component value would thus be specified as Component price = (Wholesale product price – Make allowance) × Yield factor, where the component price is measured in $/lb of component (like butterfat), the wholesale product price and make allowance are measured in $/lb of product (like butter), and the yield factor is measured in pounds of product (butter) per pound of component (butterfat).
The current FMMO system sets minimum prices for four classes each month based on the product into which farm milk is made: Class I (beverage products), Class II (soft products like yogurt and ice cream), Class III (cheese and whey products), and Class IV (other products such as butter and milk powders). FMMOs focus on the policy goal of maintaining a sufficient supply of farm milk available for beverage use (that is, for use in Class I). Achieving this implies there is “orderly marketing” of farm milk for beverage use. (This term is contained in the original authorizing legislation for FMMOs but is not precisely defined.) As a result, Class I prices are set differently than prices for the other classes. First, Class I prices are set in advance of the month to which they apply; other class prices are calculated after the month is completed. Class I prices depend on the values of Class III and Class IV skim milk prices (currently based on their average plus $0.74/cwt). The Class I price also includes a location-specific “differential” that reflects the extra cost of servicing the fluid milk market and regional supply, demand, and transportation considerations. Thus, Class I milk often has the highest of the four class prices. Finally, payment of minimum prices for Class I milk by fluid milk processors is mandated in FMMOs, but the buyers of farm milk for other uses may opt out of minimum price regulation. Other classes of milk will typically agree to pay minimum regulated prices when they will share in the value of the “pool” of dollars that includes the higher value for milk used in Class I.
Minimum class prices are computed and reported by USDA based on component values assuming standardized milk composition values of 3.5% butterfat and 96.5% skim milk. However, the actual minimum regulated value for milk varies in the 11 different FMMO marketing areas. In Multiple-Component Orders, the minimum value is based on the value of protein and butterfat in farm milk at Class III values, with the remaining weighted average revenues distributed as a Producer Price Differential (PPD). In Skim-Fat Orders, producers are paid based on the value of fat and skim milk solids.
Changes will be made to many elements of these pricing formulas, including which wholesale product prices are surveyed, the make allowances, a change to one of the yield factors, the assumed standard milk component composition, how advanced Class I skim prices are determined, how extended shelf-life milk will be priced, and the Class I location differentials (Table 1).
As noted earlier, the desire to change (increase) make allowances was a major motivation for the hearing, and the final decision increased these between 5.2 and 7.1 cents (Table 2). In relative terms, the increases are
26%–42% higher than the existing make allowances. Proposals to increase the make allowances were supported by many major dairy organizations, including those representing both dairy farmers and dairy manufacturing companies. The specific values proposed and the implementation timelines differed for these organizations, and some proposals included methods for automatic adjustments in the future. (Make allowances were last adjusted in 2008, and this was an attempt to ensure they would be adjusted more regularly in the future.)
Make allowances that are lower than the actual costs of transforming milk into products for a large number of manufacturers would make it difficult for those manufacturers to pay the minimum regulated class prices for milk (or any price premiums above them). Thus, they also provide an incentive to de-pool (opt out of the regulated pricing system) to avoid having to pay the minimum prices. Make allowances lower than actual costs could also discourage investment in new processing facilities unless the new facilities could achieve costs lower than the current make allowance values. Based on the generic pricing formula indicated above, an increase in the make allowance will result, for a given product price, in a reduction in the milk component values because a larger value is subtracted. This would lead to lower minimum regulated milk prices, at least in the short term.
Milk composition factors represent the protein, other solids and resulting nonfat solids in skim milk. These composition factors affect the prices of Class III and Class IV skim milk, which in turn affect the reported Class III and Class IV prices and the Class I price. USDA specified increases the protein composition, the other solids composition (used in pricing Class III skim milk), and the nonfat solids composition (used in pricing Class IV milk) (Table 3).
This increase is in response to proposals to have base prices reflect current milk composition. All milk component levels in farm milk—butterfat, protein and other solids—have increased since the last update in 2000. Component levels are increasing because of economic incentives provided by component-based prices, facilitated by improved genetics and nutrition. Increases in the composition factors will increase Class III and Class IV skim milk prices and, therefore, have a positive impact on the Class I skim milk price. Proponents of changes to composition factors indicated that these changes would increase the Class I skim milk price by $0.60/cwt to $0.70/cwt, which would promote “orderly marketing” by encouraging movement to Class I uses.
Class III prices are for milk used in cheese with dry wheyas a co-product. To determine cheese prices, wholesalecheddar prices are surveyed using a weighted average of 40-lb blocks and 500-lb barrels (with an adjustment for the moisture content). The final decision removes 500-lb barrel cheddar cheese from the surveyed dairy products.
Testimony in favor of dropping barrels asserted that the spread between barrels and block prices has become volatile—rarely near the assumed $0.03/lb value in the current formulas. Dropping barrel cheese from the price calculations could create more orderly marketing conditions by reducing uncertainty for dairy farmers and manufacturers. It was also noted in favor of this change that the spot market CME block cheddar cheese price is used to price 90% of the natural cheese produced in the United States.
The Class I skim milk price (part of the Class I price) is currently calculated as the average of the Class III and Class IV advanced skim milk price plus $0.74/cwt. This method was introduced in May 2019. Prior to that change, the Class I skim milk price was calculated as the higher of the Class III and Class IV advanced skim milk price. June 2025 will see a return to return to the higher of Class III or Class IV skim milk price for determining the Class I price. Testimony in favor of returning to the higher of the two prices noted that this method tends to maintain Class I as the highest-priced class and reduce milk price variation. However, concerns were raised in other testimony that the primary motivation to change from the higher of the two prices to the average was to provide certainty for milk processors about their raw milk costs and to facilitate risk management. In addition to the return to the higher of Class III and Class IV skim milk for pricing Class I, the USDA also specified alternative pricing for Extended Shelf Life (ESL) milk, which is “longer lasting” and does not spoil as quickly as fresh milk. The longer shelf life means it can be marketed and transported differently than shorter shelf life, non-ESL milk. Changes for ESL milk included an adjustment to the Class I price equal to the difference between the higher of and average of plus a 24-month rolling adjuster with a 12-month lag. This change largely affects the timing of the payments to Class I, not the overall value of Class I milk.
Class I differentials are specified for each US county where farm milk is first received for processing. The values of Class I differentials will be increased by up to $2.40/cwt in areas of the Southeast, with an average nationwide increase of $1.24/cwt, but maintain the current minimum value of $1.60/cwt. Organizations representing dairy farmers proposed increasing Class I differentials to address increases in milk hauling costs, changes in milk supply and demand locations, changes in supply patterns resulting in longer hauls, and insufficient price premiums to cover the cost of servicing Class I markets. Class I differentials outside of the Southeast had not been updated since 2000. Testimony based on a large-scale spatial economic model provided information about how milk values in Class I had changed over time due to changes in milk supply, product demand, transportation costs, and the location and capacity of fluid milk processing plants.
Although the USDA’s primary responsibility is to ensure “orderly marketing” of milk for use in Class I, an outcome of broad interest to US dairy farmers is the impact of these changes on classified milk prices, the weighted-average (blend) price in different parts of the United States, and actual prices received. The USDA’s regulatory economic impact assessment (USDA, 2024) of the changes reported the impact on weighted-average prices at standard composition and actual composition (“at test”) for each of 11 milk marketing orders based on amounts of milk in the four classes using data from 2019 to 2023. Those analyses indicated that the overall effects of the changes on these prices would be positive, although negative for the Upper Midwest, California, and Arizona orders.
To illustrate the types of changes in classified milk prices implied by the modifications to pricing formulas, it is useful to consider an example for 1 month. If the changes in make allowances and yield factors were implemented with the product prices observed in December 2024, they would have resulted in a Class III price −$0.53/cwt lower than with current formulas (Table 4) and a Class IV price about −$0.52/cwt lower. Class I values for this month would have been $0.52/cwt higher, with the new pricing formulas due to increases in the Class I differentials, although offset to some extent by the lower Class III and Class IV skim milk values used in the calculation (due to make allowance changes). However, many dairy producers are paid based on the quantity of components; at the average component content of farm milk in the Upper Midwest order, the value of components used in Class III would be lower by $1.05/cwt.
However, impacts on component values and reported class prices may not always reflect the likely impact on farm milk prices. Farms pooling milk and receiving the full regulated minimum Class III price would see reductions in component values ranging from about $0.07/lb for butterfat to $0.10/lb for protein (Table 4). However, not all milk is pooled, and some pooled milk may receive less than the minimum regulated price due to deductions by cooperatives. For those farms, any price decreases will likely be smaller than those based on reported prices or component values—and pay prices for some producers could actually be higher. Similarly, impacts on Class I prices will vary by order. For example, increases in Class I differential values are similar in the Upper Midwest, Mideast, and Florida orders, but the impact on farm milk prices will be larger in Florida due to a higher proportion of Class I milk.
Our example of price impacts above is one common approach to evaluating the impacts of changes: Use historical data on product prices and modify make allowances and yield factors to calculate a new series of class prices. The USDA’s approach used observed historical quantities of milk and components pooled by order and then adjusted the monetary value of those quantities to reflect changes to the value of components based on modified pricing formulas. Although frequently used, these approaches are limited in that they do not account for how changes in the farm milk price due to changes in the formulas will affect milk production, its allocation to different uses, and product prices. In essence, both are static historical approaches that assume total milk production, allocation, and product prices will remain unchanged even as farm milk prices are changed. Thus, although helpful as a first approximation, historical static analyses can be complemented by a forward-looking, dynamic analysis that accounts for the potential effects of farm milk prices on milk production and allocation and thus also product prices that are used in the pricing formulas.
The changes to the formulas imply lower values for components and minimum regulated prices for milk used in manufacturing for given values of wholesale product prices (for butter, cheese, dry whey, and nonfat dry milk). However, these product prices are likely to be affected in the future by changes to the production of, and demand for, farm milk given the changes to the pricing formulas. We would expect that any reduction in component values and farm milk prices will result in different production decisions by dairy farms (less milk and components produced) and purchase decisions by dairy plants (more milk and components purchased). Thus, the farm milk prices beginning in June will affect future production and the demand for farm milk. Dynamic economic modeling (Nicholson and Stephenson, 2024) of these potential impacts indicates that any initial price decreases will result in somewhat lower milk production in the next couple of years, which in the future will affect the supply-demand balance for farm milk and mitigate some impacts of the changes that began in June (Figure 1). We project that over the next five years, the impact on the average All Milk price in the US will be about $0.07/cwt lower than it would have been without the changes (including estimated changes to over-order premium payments).
The USDA’s final decision, which was approved for all 11 FMMOs through a producer referendum early in 2025, represents the most substantive changes to milk pricing regulation under FMMOs in nearly 20 years, with important implications for dairy producers, processors and consumers. These changes will affect farm and dairy manufacturer profitability and consumer demand for years to come.
Nicholson, C.F., and M.W. Stephenson. 2024. Proposed Changes to Class I Differentials in the Recommended Decision and Potential Farm Milk Price Impacts. Dairy Markets and Policy Information Letter 24-04, July. Available online: https://dairymarkets.org/PubPod/Pubs/IL24-04.pdf
USDA Dairy Division. 2024. Regulatory Economic Impact Analysis of the Recommended Decision to Amend Federal Milk Marketing Order Pricing Formulas, July. Available online: https://www.ams.usda.gov/sites/default/files/media/DairyFMMO_ImpactAnalysisPricingRecDec.pdf [Accessed September 23, 2024]
