Origin: Federal milk marketing orders(FMMO) are authorized by the Agricultural Marketing Agreement Act of 1937(AMAA). Under this law the Secretary of Agriculture may establish FMMOs that regulate the first buyers of milk. Order are initiated and approved by dairy farmers (usually through their cooperatives) in a market area. A market order is a Federal regulation issued to regulate the minimum price paid to dairy farmers by processors or handlers of Grade A milk in a specific market.

Purpose: FMMOs assist farmers in developing steady, dependable markets and help correct conditions that result in price instability and disorderly marketing. This also helps guarantees consumers a stable supply of fresh fluid milk. Under the orders, dairy farmers are assured a minimum price for their milk that takes into consideration the economic conditions throughout the year. This high degree of assurance should make dairy farmers willing to make the heavy investments in cows and equipment that are needed to produce the high-quality milk that consumers demand. The basic characteristics of milk make its market inherently unstable. Milk is highly perishable and must be moved promptly to the market. Because milk is produced every day of the year, farmers must continue shipping it to market, even when market prices are not satisfactory. Also, milk production varies widely with the seasons. Because of the biological process, cows produce more milk in the spring, much less during the hot and humid summer and fall. Therefore, when there is enough milk in the fall to meet demand, there is too much in the spring. The demand for fluid milk also varies from season to season but deviates even more from day to day. Because of its perishable nature, milk cannot be stored to balance the peaks and troughs of supply. The industry, therefore, must continually produce an oversupply or reserve to insure there will be enough fluid milk at all times for the day-to-day needs of consumers. Reserve milk that is not needed for fluid use is manufactured into other dairy products. But milk used in these products returns a lower price to producers than milk used for fluid purposes. Producers, therefore, endeavor to get as much of their milk as possible into the higher-valued fluid uses, and, in the absence of regulation, may make uneconomic price concessions to achieve that end. (As part of order reorganization, the Secretary is recommending a more market oriented approach to pricing.)

Current Operations: Currently, there are 31 Federal Milk Orders covering most of the major population centers in the U.S. except California(the largest dairy state), which has its own State order(FAIR Act requires this number to be reduced to 10-14). About 70% of U.S. milk production is regulation by FMMO. The AMAA spells out the provisions to be included in a Federal Milk Order. For example, each order includes provision for classified pricing and pooling, determining the minimum blend prices handlers or processors are required to pay producers, verifying weights and tests of milk shipped by producers, and auditing handler reports to verify milk usage and to insure payments to producers. FMMOs do not set wholesale or retail milk prices, establish limits on production, prevent farmers from selling milk to any handler, or regulate from whom or where a handler can buy milk.

Pricing: Under classified pricing, the minimum prices that handlers are required to pay are established according to the use of the milk. Milk used in perishable fluid products is designated Class I and commands the highest price. Milk used in soft products such as ice cream and cottage cream is Class II and has a lower price. Milk that is used to manufacture storable products such as hard cheeses, butter and whole milk powder is Class III and is priced lower than Class II. A sub-category of Class III is Class III-A for milk used to make nonfat milk powder. Class I, II, and III prices are based on the Basic Formula Price (BFP) - the average price paid for Grade B milk in Minnesota and Wisconsin for the previous month updated using a butter/powder/ cheese product price formula. The Class III price is equal to the BFP in all Federal Orders. This is because Class III products compete directly with products made with Grade B milk. The Class II price is determined by adding $.30 to the BFP. The Class I price is determined by adding a Class I differential to the BFP. This differential reflects the added price needed to attract milk away from manufacturing outlets, as well as the additional costs of producing and marketing milk for fluid use(Class I differentials are a major reorganization issue). The BFP is the price mover in all orders for Class I, II, III milk. The result is that the supply and demand for cheese in the Midwest determines milk prices in all orders. The Class III-A price is based on the market value of nonfat dry milk and is usually the lowest priced class of milk. Most cooperatives charge more than the order minimum price for Class I milk. This over order price is used to offset the cost of services provided by the co-op and at times it is a true premium. Over order premiums typically range from 20 cents to several dollars and vary drastically over time and between orders. For example, during 1997 the order Class I price was on 92 percent of the announced co-op price in the Southeast order. In 1995 it was 99 percent and in 1996 it was 94 percent.

Marketwide Pooling: All orders operate marketwide pools for determining producer prices. Under marketwide pooling, the entire value of the milk used in all classes is divided by the total milk deliveries to determine the blend or weighted average price for the market. The blend price is the minimum price that must be paid to each producer under the order. This price is adjusted to reflect variations in butterfat and, in some orders, other components. The location at which the milk was received by the handler also effects the price. Thus, each producer shares proportionately in the returns produced by all milk uses in the market. Co-ops may combine the proceeds of its members from different markets and pay a reblended price to members. This price may be different than the price received by individual producers.

Formulation: Federal Milk Orders are established or amended through a public hearing or formal rulemaking process (the current reorganization allows for informal rulemaking) at which all interested can present their views. A decision on the proposals being considered is based solely on the hearing record. After USDA issues a final decision, at least two-thirds of the producers voting in a referendum must approve a new or amended order. Co-ops can block vote for their members. For amendments to orders, the vote is on the entire order as proposed to be amended rather than on separate amendments. The act provides procedures for terminating an order if producers desire to do so. (Producers will vote on the reorganization even though it was not required in the FAIR Act.)

1996 FAIR Act: Congress required USDA to reorganize FMMOs. The Secretary is required to: Consolidate current 31 FMMOs to 10-14 orders (11 proposed); use "informal rulemaking"; cannot base new class I differentials on current ones (2 schedules proposed); implement final changes by 4/1/99; allow California to be a FMMO if requested. Secretary was authorized to: Use utilization rates and multiple base points in developing fluid milk pricing; use uniform multiple component pricing when developing one or more basic formula prices (included in proposal). USDA has issued proposals which include 11 consolidated orders, four classes of milk, a revised BFP, two Class I differentials proposals, and an updating of other order provisions.

Compacts: Dairy compacts allow states to work collectively together to resolve regional marketing and price issues for milk. Compacts are allowed under the Compact Clause of the U.S. Constitution and must be approved by Congress. Congress has approved the Northeast Dairy Compact which currently includes six states(several more states have passed legislation to join). Eleven states have passed legislation to form a Southern Dairy Compact (AL, AR, KY, LA, MS, NC, OK, SC, TN, VA, WV,) with two (MO, TX, & GA) seeking legislation in 1999.

The Compacts work with the existing Federal order program. However, orders do not fully account for regional differences in the costs associated with milk production and marketing. In recent times, the federally established minimum prices have been well under market prices and have imposed financial stress on milk producers. (Compacts can work without Federal orders, but they operate more efficiently along with orders.)

A Compact creates an interstate commission with consumer, producer and processor (individual state option) members. It has the authority to impose regional over-order prices for Class I milk above the Federal order minimum price. The commission will set a minimum price for milk ultimately sold for fluid consumption in the Compact area. Any Compact regulation would be only a marginal, over-order addition to the federal floor price, and have no effect on the operation of the federal order program.

There would be no restriction placed on the ability of non-Compact farmers or processors, from any state, to market fluid milk in the Compact area. The flow of milk into and out of the region would be according to existing competitive patterns. The regulated market would also function the same as under today's federal regulation, except for any increase in the regulated floor price imposed under the Compact.

1. William A. Thomas, Professor and Agricultural Economist, The University of Georgia, May 1998.

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