Milk basis - what does that really mean?

By Mark Linzmeier, CEO of MARGINSMART, certified public accountant, owner of Linzmeier Business Solutions, LLC

Chances are that you have heard a lot about milk basis in recent years, but why is it important and what does it really mean? 

Milk basis is crucially important because it determines the final pay price that a dairy farm receives for its milk each month and differentiates how dairy plants pay the farms supplying them with milk. Technically, basis means the difference between a quoted or benchmark price and the price that an individual market participant receives for the same commodity. As it relates to milk, the industry generally thinks of the Class III price as the benchmark, although Class IV or other prices could also be considered. For purposes of this discussion I will focus on the Class III price.

While the technical definition calls for the commodity to be “the same,” we know milk produced by dairy farms will vary in component levels, somatic cell count and other quality characteristics. So, again, for this discussion I will use a definition that is inclusive of these differences. In addition, hauling and some checkoffs are charged differently by plants, so to truly compare farm-to-farm these should be included.

The other major contributor to differences in milk basis relates to differences in prices. It is general knowledge that dairy procurement plants have different pricing structures for premium programs and trucking costs. However, it is not as widely known that dairy plants have the ability to pay different prices than what is quoted by the Federal Order – so long as private plants meet the overall minimum required pricing.

Each month, this newsletter reports the producer prices for Federal Milk Marketing Order (FMMO) No. 30 and No. 33, including component prices, the SCC adjustment and the Producer Price Differential (PPD). These all have a bearing on the overall price paid to a particular dairy farm for their milk. 

A whole article (or more) could be focused on the PPD itself, which is calculated by the FMMO and is an adjustment to the Class III price to create the Statistical Uniform Price. So, the PPD is also part of the milk basis computation. But, it is not that easy. Using FMMO No. 30 as an example, the PPD changes based on the distance the processing plant is from Cook County, Ill.  There are four other zones throughout the FMMO, each resulting in an additional $.05/cwt reduction in PPD the farther from Cook County that the processing plant is located.

Using FMMO No. 33 as an example, the PPD changes based on the distance the processing plant is from Cuyahoga County, Ohio.

Milk basis will vary throughout the calendar year primarily due to fluctuations in component percentages and to some degree PPD, SCC and other quality factors. If you use basis to help project future net milk prices for a specific month, it is recommended that you use a basis for the corresponding month. Milk basis is also highly correlated to supply and demand levels.

In recent years, basis in FMMO No. 30 and No. 33 has deteriorated despite higher component levels. The primary reasons for this vary by dairy plant but may include one or more of the following:

1) Not paying the full FMMO price per pound for component values

2) Not paying the full PPD level

3) Reducing payment rates for various plant premium programs

4) Increasing hauling charges

5) Lower component prices per pound in general and

6) Market and other “adjustments” (prevalent with co-ops)

MARGINSMART’S SMART MILK BASIS peer group in FMMO No. 30 has seen their net milk basis drop $.80/cwt from 2014 to 2017 as shown in the chart below (Figure 1).

I anticipate the net milk basis will continue to contract in 2018 until milk supply and demand equilibrate in FMMO No. 30 and No. 33 and the U.S. Therefore, the following are key items to consider.

• Review your milk settlement statement monthly. If your plant does not specifically show both the FMMO and plant prices being paid for PPD per cwt and prices per pound of each component, calculate them yourself to see how your plant compares.
• Create a historical summary of each portion of your basis, including all premiums and hauling and checkoffs.
• Consider the impact of items that the farm can control related to milk basis (component percentage, SCC, other quality premiums) and items purely managed by the milk plant.
• Use the information (including historical averages for similar months) to make management changes to improve basis where possible, project future milk prices or to evaluate your dairy plant.