IB97011: Dairy Policy Issues

Ralph M. Chite

Resources, Science, and Industry Division

April 2, 2001

CONTENTS

• SUMMARY
• MOST RECENT DEVELOPMENTS
• BACKGROUND AND ANALYSIS
• Emergency Federal Assistance for Dairy Farmers: Recent History and Current Issues
• Market Loss Assistance in FY2001 Appropriations
• Low Market Prices for Milk Used in Cheese Production
• Use of Milk Protein Concentrates in Cheese Production
• Dairy Price Support Program
• Price Support Action and Proposals
• Federal Milk Marketing Order Issues
• Background
• Legislative and Regulatory Modifications to Milk Marketing Orders
• Background and Summary of Action
• Required Consolidation of Orders
• Legislative Action to Mandate Option 1A
• Replacing the Basic Formula Price (BFP)
• Class III Pricing Issues
• Forward Price Contract Pilot Program
• Mandatory Price Reporting Legislation (P.L. 106-532)
• Dairy Compacts
• Background
• Current Compact Issues
• Northeast Compact Sunset Date
• Northeast Compact Supply Management Program
• Proposed Southern Dairy Compact
• LEGISLATION
• 107^th Congress
• 106^th Congress
• Footnotes

SUMMARY

Three major dairy policy issues captured the attention of the 106^th Congress, and are expected to remain issues of concern to the 107^th Congress-- federal financial assistance for dairy farmers; implementation by USDA of changes to federal farm milk pricing regulations; and regional debates over the market effects of dairy compacts.

The FY2001 agriculture appropriations act (P.L. 106-387, H.R. 4461) contained provisions to help mitigate the effects of volatile farm milk prices on dairy farmers by authorizing USDA to make emergency direct payments to all dairy farmers. USDA began making an estimated $675 million in payments under this authority in December 2000. The 107^th Congress might be faced with considering further assistance in 2001, especially for producers of milk used in cheese production, for whom prices remain relatively low.

Authority for the dairy price support program, which supports farm milk prices through USDA purchases of surplus dairy products, was scheduled to expire at the end of 2000. However, P.L. 106-387 extended the legislative authority for the federal program for one year, through December 31, 2001. An additional one-year extension, through 2002, likely will be considered this year.

A separate milk pricing tool, federal milk marketing orders, requires processors to pay a minimum price for farm milk depending on how the milk is used. On January 1, 2000, as required by law, USDA began to implement its final rule to consolidate the number of marketing order regions from 31 to 11 and make major changes to the federal pricing system. In 1999, USDA released a preliminary proposal that included two options for pricing fluid farm milk under the consolidated orders. One option (1A), supported by Eastern and Southern farm groups, left prices little changed from past policy, while the other option (1B), which USDA and Midwest dairy farmers preferred, would have reduced minimum farm prices for fluid milk in many regions.

USDA originally opted for a modified version of Option 1B in its final decision. However, Congress passed a measure (H.R. 3428) as part of the FY2000 consolidated appropriations act (P.L. 106-113) which required USDA to adopt Option 1A as the new method for pricing fluid farm milk, effective January 1, 2000. USDA has made additional changes to its formula for pricing farm milk used in manufactured products, which it estimates will have minimal impact on farm milk prices. However, one pricing change that would have valued the butterfat in cheese differently than the butterfat in other products was challenged in the courts. On January 31, 2001, a judge granted an injunction to block USDA from making that change.

The New England states have temporary authority for a regional Northeast dairy compact, which allows the region to establish minimum fluid milk prices above the minimum federal level. A provision in P.L. 106-113 extended authority for the Northeast compact through Sept. 30, 2001. Processors and Upper Midwest producers oppose compacts, saying that they distort dairy markets. An extension of the Northeast compact and a proposed new Southeast compact likely will be debated by the 107^th Congress.

MOST RECENT DEVELOPMENTS

USDA is nearing the completion of disbursing an estimated $675 million in direct "market loss assistance" payments to dairy farmers to help mitigate the effects of recent low farm milk prices. This marks the third consecutive year that such payments have been made available to all dairy farmers. The current round of payments was authorized in emergency supplemental spending provisions contained within the FY2001 agriculture appropriations act (P.L. 106-387, H.R. 4461).

On December 1, 2000, USDA issued regulations that modify its new formulas for pricing farm milk under federal milk marketing orders. USDA was required by legislation to issue these regulations by December 1, 2000 and implement them by January 1, 2001. Some dairy farmer groups challenged in the courts a proposed change that would have valued the butterfat in milk used for cheese differently than the butterfat in other products. These groups contend that this pricing change would increase the manufacturing costs of cream cheese (which has a higher fat content than most other cheeses) and would also cause greater volatility in farm milk prices. On January 31, 2001, a judge issued a preliminary injunction that prohibits USDA from making that change.

BACKGROUND AND ANALYSIS

Emergency Federal Assistance for Dairy Farmers: Recent History and Current Issues

Over the past two fiscal years (FY1999 and FY2000), Congress provided just over $21 billion in emergency spending for USDA programs, primarily to help farmers recover from low farm commodity prices and natural disasters. The majority of these funds were for supplemental direct farm payments made to producers of certain commodities, primarily grains and cotton, but also including soybeans, peanuts, tobacco and milk. Of this amount, dairy farmers received supplemental "market loss" payments of $200 million in FY1999 under the Omnibus Consolidated and Emergency Supplemental Appropriations Act, 1999 (P.L. 105-277), and $125 million under the FY2000 agriculture appropriations act (P.L. 106-78).

Market Loss Assistance in FY2001 Appropriations

The FY2001 agriculture appropriations act (P.L. 106-387, H.R. 4461), which was signed into law on October 28, 2000, contained authority for USDA to provide a third consecutive year of market loss payments to dairy farmers. The statute did not provide a specific appropriation to fund these payments, but instead authorized USDA to use the borrowing authority of its Commodity Credit Corporation to fully fund a payment formula contained in the law. USDA began making payments under the program in December 2000 and is expected to disburse approximately $675 million once payments are completed.

The formula in P.L. 106-387 required USDA to make these payments based on 35% of the difference between the level of farm milk prices in 2000 and the average milk price over the previous 5 years. USDA estimated that this formula would yield a payment rate of approximately 65 cents per hundredweight (cwt.) of milk production per farmer. The amount of annual production on which an individual farmer can receive a payment is limited to 3,900 cwt. (or 3.9 million pounds), which means that the maximum payment a farmer can receive is approximately $25,000.

For more information on supplemental farm assistance, see CRS Report RS20416, Emergency Farm Assistance in FY2000 Appropriations Acts, and CRS Report RL30501, Appropriations for FY2001: U.S. Department of Agriculture and Related Agencies.

Low Market Prices for Milk Used in Cheese Production

Reflecting market conditions within the cheese industry, the minimum price received by dairy farmers for milk used for cheese (Class III) fell in November 2000 to $8.57 per hundredweight (cwt.), a 23-year low. Although the Class III price has since risen to $10.27 per cwt. in February 2001, this is still a low level in recent history. Dairy farmers in the Upper Midwest (Wisconsin and Minnesota) are the most adversely affected by low cheese milk prices, since the vast majority of that region's milk production is used in the manufacturing of cheese. At the same time, the farm price of milk used for butter and nonfat dry milk (Class IV) rose to its highest level of the year at $13.00 per cwt. last November, before dropping back to $12.13 per cwt. in January 2001 and rising again to $12.70 per cwt. in February. Under new federal milk pricing policy, the farm price of milk used for fluid consumption is pegged to the higher of the Class III and Class IV price for the month, meaning that farmers in high fluid consumption regions (mainly in the East) are somewhat insulated from the low cheese milk prices. (See "Federal Milk Marketing Order Issues" below for background information on the mechanics of federal milk pricing policy.)

Consequently, milk producer groups in the Upper Midwest are calling for legislation to provide temporary income assistance for farmers affected by low Class III prices. The National Milk Producers Federation (NMPF) has proposed legislation to make federal payments available to producers who sell milk for cheese use, whenever the Class III milk price falls below $11.08 per cwt. Under the proposal, if a monthly Class III price falls below the $11.08 target price, a federal payment to producers selling milk used for cheese would compensate for the difference between the market price and the target price. NMPF plans to work with members of the 107^th Congress to develop legislation based on the proposal.

A Senate bill (S. 294) introduced on February 8, 2001, would make direct payments to all dairy farmers when Class III prices fall below $12.50 per cwt. Producer payments would be made on the first 26,000 cwt. of production at a rate of 18 to 50 cents per cwt. depending on how much below $12.50 the annual average Class III price falls. Additional payments of 14 to 30 cents per cwt. would be disbursed to farmers who keep their current fiscal year milk production below the previous fiscal year. The payment program would run through FY2008.

Use of Milk Protein Concentrates in Cheese Production

Conferees deleted from the FY2001 agriculture appropriations bill, a Senate provision that would have prohibited the Food and Drug Administration from issuing any regulations that would allow milk protein concentrates (MPC) as an ingredient in the production of cheese. Milk protein concentrate is a product, in which certain milk proteins necessary for cheese production are selectively included and all or most of the water is removed from the milk, thus making it efficient to ship long distances. Dairy farmer groups, which support a prohibition on the use of dry MPC, are concerned that imports of MPC will displace domestic milk used for cheesemaking and depress farm milk prices. Currently, neither wet nor dry MPC is allowed as an ingredient in any U.S. cheese which has a standard of identity defined by the Food and Drug Administration, which includes most cheese. Cheese processors had petitioned FDA for a change in standards to allow MPC in cheese production. A bill (S. 117) proposed in the 107^th Congress would prohibit FDA from allowing milk protein concentrates as an ingredient in any cheese with a standard of identity.

On March 5, 2001, the General Accounting Office released a study on the production, imports, and regulation of milk protein concentrates. The study found that MPC imports grew rapidly from 1990 to 1999 - from 805 to 44,878 metric tons, including a near doubling in 1999 over 1998 alone. According to the study, six countries (New Zealand, Ireland, Germany, Australia, the Netherlands and Canada) accounted for 95% of the 1999 imports. For the full text of the GAO study, see http://www.gao.gov/new.items/d01326.pdf.

The National Milk Producers Federation is urging the government to examine several trade policy options for addressing the milk protein concentrate import issue. These include provisions in the Trade Act of 1974 that allow the President (following an International Trade Commission investigation) to provide relief to a U.S. industry adversely affected by imports; a 1974 Trade Act provision that allows the U.S. Trade Representative to retaliate against certain foreign trade policies; and the use of antidumping laws and countervailing measures.

Dairy Price Support Program

The Agricultural Act of 1949 established the dairy price support program by permanently requiring the U.S. Department of Agriculture (USDA) to support the farm price of milk. Since 1949, Congress has regularly amended the program, usually in the context of multi-year omnibus farm acts and budget reconciliation acts. Current authority for the dairy price support program is provided by the Federal Agriculture Improvement and Reform Act

of 1996 (P.L. 104-127, the 1996 farm bill).

Historically, the supported market price for milk is intended to protect farmers from price declines that might force them out of business and to protect consumers from seasonal imbalances of supply and demand. USDA's Commodity Credit Corporation (CCC) supports milk prices by its standing offer to purchase surplus nonfat dry milk, cheese, and butter from dairy processors. Government purchases of these storable dairy products indirectly support the market price of milk for all dairy farmers. Prices paid to the processors are set administratively by USDA at a level that should permit them to pay dairy farmers at least the federal support price for their milk.

Table 1. Commodity Credit Corporation Milk Price Support Operations 1979/80-1999/2000

Source: U.S. Department of Agriculture, Farm Service Agency, selected publications.

a. The marketing year is October 1-September 30.

b. The milk equivalent is the pounds of fluid milk used to manufacture cheese and butter, on a milkfat basis.

c. Includes $200 million emergency "Market Loss" payments authorized by P.L. 105-277.

d. USDA estimate, includes $125 million in net outlays for market loss payments authorized by P.L. 106-78.

During the 1980s, the dairy sector experienced a chronic surplus, much of which was acquired by the CCC. At their peak in fiscal year 1983, government surplus acquisitions represented about 12% of all U.S. milk output, at a net outlay cost of $2.6 billion. A series

of legislative actions since then reduced the dairy support price from its peak of $13.10 per cwt. in 1983, to $10.10 per cwt. from 1990 through 1995, which helped reduce CCC acquisitions to under 5% of production in more recent years. Consequently, program outlays dropped as well -- to an annual average of $130 million between FY1992 through FY1998. The annual average rose to $580 million in FY1999 through FY2000, because total outlays of the program include the ad hoc direct emergency payments (market loss assistance) to dairy farmers authorized by annual appropriations acts. (See table 1).

Price Support Action and Proposals

The 1996 farm bill (P.L. 104-127) retained the level of support at the then-current price of $10.35 per cwt. for the remainder of 1996, but then required it to fall to $10.20 on January 1, 1997, to $10.05 on January 1, 1998, and to $9.90 on January 1, 1999. In order to achieve this support price, USDA has set its product purchase prices at $0.6549 per lb. for butter, $1.0032 for nonfat dry milk, $1.1314 per lb. for block cheddar, and $1.1014 per lb. for barrel cheese. P.L. 104-127 originally required the dairy price support program to terminate at the end of 1999. However, a provision in the FY2000 agriculture appropriations act (P.L. 106-78), signed into law on October 22, 1999, extended program authority through 2000. The FY2001 agriculture appropriations act (P.L. 106-387), which was signed into law on October 28, 2000, contained a provision to extend authority for the dairy price support program an

additional year, through calendar year 2001. Another one-year extension of the program, through 2002, likely will be considered by the 107^th Congress. If the 2002 extension occurs, the dairy program would be slated to expire at the same time as all other farm commodity support programs authorized by the omnibus 1996 farm law. The future direction of federal support for all farm commodities is being debated in the 107^th Congress in the context of a multi-year farm bill.

Federal Milk Marketing Order Issues

Background

The farm price of approximately three-fourths of the nation's fluid milk is regulated under federal milk marketing orders. Federal orders, which are administered by the U.S. Department of Agriculture (USDA), were instituted in the 1930s to promote orderly marketing conditions by, among other things, applying a uniform system of classified pricing throughout the market. Unlike the dairy price support program, (see "Dairy Price Support Program" above) federal milk marketing orders are permanently authorized and therefore do not require periodic reauthorization. Some states, California for example, have their own state milk marketing regulations instead of federal rules. Producers in federal marketing order regions are affected by two fundamental marketing order provisions: the classified pricing of milk according to its end use, and the pooling of receipts to pay all farmers a blend price.

Proponents of federal orders argue that orders are necessary because dairy farmers have a competitive disadvantage vis-a-vis dairy handlers (processors) when it comes to determining prices that farmers receive for their raw milk. Federal orders regulate handlers who sell milk or milk products within an order region by requiring them to pay not less than an established minimum price for the Grade A milk they purchase from dairy producers, depending on how the milk is used. This classified pricing system requires handlers to pay a higher price for milk used for fluid consumption (Class I) than for milk used in manufactured dairy products such as yogurt, ice cream, and sour cream (Class II products), cheese (Class III), and butter and nonfat dry milk (Class IV products).

Blend pricing allows all dairy farmers in the order region to pool their milk receipts and then be paid a single price for all milk based on order-wide usage (a weighted average of the four usage classes). Paying all farmers a single blend price is seen as an equitable way of sharing revenues for identical milk directed to both the higher-valued fluid market and the lower-valued manufacturing market.

Manufactured class (Class II, III and IV) prices generally are the same in all orders nationwide and are calculated monthly by USDA based on current market conditions. The Class I price for milk used for fluid consumption varies from area to area and in recent years has been a source of regional controversy. Class I prices are determined by adding to a monthly base price, a "Class I differential" that generally rises with the geographical distance from the Upper Midwest, traditionally a milk surplus region.

Class I differential pricing is a mechanism designed to ensure that local farmers receive a guaranteed minimum price for their fluid milk that generally is high enough to encourage adequate production. Local dairy farmers are protected by the minimum price rule against lower-priced milk that might otherwise be hauled into their region. Although a primary goal of federal milk marketing orders is to facilitate the flow of milk from surplus production regions to deficit regions, some dairy producer groups contend that federal order pricing policy actually discourages such movement of milk.

In recent years, producers in the Upper Midwest (Wisconsin and Minnesota) have maintained that federal orders are in need of reform, while many dairy processors contend that orders are market-distorting and should be gradually eliminated. These critics contend that the Class I differentials in some regions are too high and encourage milk production in higher cost of production regions (particularly the Northeast and Southeast) at the expense of traditional dairy states such as Minnesota and Wisconsin. As a result, they say, these regions are becoming less dependent on the Upper Midwest for supplemental supplies in the short production months. Since processors must pay as much for milk shipped in from surplus regions as they would for local production, the critics maintain that there is no economic incentive to bring in milk from other regions, even if that region has a lower cost of production.

Milk producer groups in the Northeast and Southeast generally support the current order system and want Class I differentials to remain no lower than their current levels. Eastern producers contend that any reduction in Class I differentials would reduce their incomes and force smaller farmers out of business. In fact, many Northeast and Southeast producers argue that Class I differentials are not high enough, which led to the formation of the Northeast Dairy Compact and a proposal for a Southern compact, to mandate fluid milk prices that are higher than the minimum federally mandated level. (See "Dairy Compacts" below for more information on the Northeast and Southern dairy compacts.)

Legislative and Regulatory Modifications to Milk Marketing Orders

Background and Summary of Action. Although Upper Midwest farm groups sought legislative changes to the federal order pricing system in the first half of the 1990s, the lack of consensus among regions precluded any mandated changes to federal orders in the omnibus 1996 farm bill. However the 1996 farm law (P.L. 104-127) did require USDA to reduce the number of milk marketing orders -- to at least 10 but no more than 14 from the current 31 orders -- and originally gave USDA until April 4, 1999 to administratively achieve this goal. (The deadline date was extended until October 1, 1999 by the FY1999 omnibus appropriations act (P.L. 105-277). When USDA released its final decision on March 31, 1999, it not only proposed a consolidation of orders from 31 to 11, but also proposed comprehensive changes to milk pricing policy by revising how Class I (fluid) milk should be priced and devising a substitute for the basic formula price for farm milk. The text of the final decision can be found in the Federal Register of April 2, 1999, or on the USDA website at http://www.ams.usda.gov/fmor/.

The final decision had to be approved by two-thirds of voting farmers in each of the consolidated regions before it could become effective, which farmers did in all of the consolidated regions in early August 1999. If farmers had rejected the final decision, it would have meant the end of federal milk marketing order regulation in that region. Once the final decision was approved by farmers, it was published in the Federal Register and became a final order or rule, which USDA planned to implement on the statutory implementation date of October 1, 1999. However, a legal challenge posed by Northeast dairy farmers and affirmed by a Vermont federal district court temporarily postponed the implementation of a final decision.

Following the legal challenge, Congress agreed to legislation (H.R. 3428) as part of the FY2000 consolidated appropriations bill (P.L. 106-113, H.R. 3194) which was signed into law on November 30, 1999. It required USDA to implement an alternative option (1A) that maintains minimum prices for fluid-use farm milk close to their current levels. (See "Legislative Action to Mandate Option 1A" below for more information.)

Required Consolidation of Orders. USDA's final decision reduced the number of marketing orders from 31 to 11 orders, effective January 1, 2000 (see map). In considering what regions should be combined, USDA said it looked for overlapping areas of milk supply and considered whether the proposed merged regions have other common features, such as the types of manufactured products produced.

The consolidated region into which a current order was merged was important to producers in that order because of the way farm milk is priced. In general, under federal order blend pricing, the more milk that is used for fluid consumption (Class I use) in an order, the higher that order region's average farm (blend) price will be. Therefore, if Order A, for example, is consolidated with other orders that have a lower Class I utilization rate than Order A, then Order A's blend price will fall when it is consolidated. Likewise, if Order A is consolidated with regions with a higher Class I use than Order A, then farmers in Order A will have a higher blend price when consolidated.

Currently, California, the largest dairy producing state, has a state milk marketing order that is separate from federal orders. The 1996 farm bill allowed California to have its own federal order if California dairy producers petitioned for and approved such an order. As amended by the FY1999 Omnibus Appropriations Act, current law gave California until October 1, 1999 to become a federal order if the state wanted to also retain its quota system. Under California's quota system, each farmer is assigned a quota for production and receives one price for production within quota and a lower price for production above quota. California continues to maintain its own state marketing order and remains separate from the federal order system.

Legislative Action to Mandate Option 1A. The most controversial portion of order reform was in establishing the level of Class I differentials within each of the consolidated orders. Class I differentials are what is added to the base price of milk in a region to determine the minimum price processors must pay for milk used for fluid consumption. USDA's differential pricing structure is based on the "location value" of milk -- that is, calculating how far a milk consumption region is from a milk production region, and establishing a minimum price that will attract sufficient milk to the market. This system has been in operation for many years and, prior to the recent reforms, was based on the premise that the Upper Midwest is the only surplus production region in the country. Upper Midwest producer groups have long sought a revision of differentials saying that the level of differentials encourage local production in many regions of the country at the expense of milk produced in the Upper Midwest.

When USDA issued its proposed rule in 1998, it offered two options. Option 1B, USDA's preferred option, would have reduced Class I differentials in many regions, which the Department said would make farm milk pricing more market-oriented. USDA also offered an Option 1A which would keep the Class I differentials at close to current levels. Option 1A was identified by USDA as being the most like the current pricing structure, except for some adjustments to reflect that there is more than one surplus market. Option 1B would result in lower Class I differentials for many regions, because this option recognizes that there are closer markets than in Option 1A from which milk can be drawn when supplies are low.

On November 29, 1999, the President signed into law the FY2000 consolidated appropriations act (P.L. 106-113, H.R. 3194) that among many provisions required USDA to implement Option 1A as part of its final decision. ⁽¹⁾ This provision was widely supported by dairy farmer groups in most regions outside of the Upper Midwest. Upper Midwest dairy farm groups, dairy processors, and consumer groups generally supported USDA's final decision (modified Option 1B) and strongly opposed a legislative mandate for Option 1A. An attempt by Upper Midwest Senators to filibuster the measure failed on a cloture motion that was approved 87-9 on November 19, 1999. Although the Administration opposed a legislative mandate for Option 1A, the President signed the measure, since the dairy provisions were one component of a wide-ranging budget agreement between congressional leaders and the Administration on FY2000 spending and other matters. As a result, USDA was required to adopt Option 1A as part of its final decision and to implement the revised final rule, without a comment period or another farmer referendum, on January 1, 2000. (See Table 2.)

Replacing the Basic Formula Price (BFP). USDA's final decision also included a replacement for the basic formula price (BFP), which had served for many years as the base price for all milk prices under the federal order system. The BFP was based on market prices paid by processors for unregulated Grade B milk in the Upper Midwest (U-M), updated by monthly changes in prices for manufactured dairy products, particularly cheese. The BFP had served as the Class III price, or the minimum price for all farm milk used for storable manufactured dairy products (butter, cheese, and nonfat dry milk), and the base price for milk used in Class II (other manufactured) products and Class I (fluid) milk. Since the amount of Grade B production has dwindled significantly over the years, USDA sought an alternative pricing measure that reflects changes in market supply and demand.

USDA's adopted final rule contained a four-class pricing plan that establishes a Class III price for cheese and a separate Class IV price for milk used for butter and powdered milk. Each of these two class prices are now computed based on the value of the components going into the production of these products. For example, the Class III cheese price is based on the value of protein, butterfat and lactose, the principal components of cheese. This method recognizes that the butter/powder market and the cheese market are two distinct markets and therefore should be priced separately.

Table 2. Comparison of Pre-Reform Class I Differentials to USDA's Preferred Modified Option 1B, and Option 1A As Mandated by Legislation, Grouped by Pre-Consolidated Order Regions
Dollars per hundredweight ($ per cwt.)

Source: U.S. Department of Agriculture. Federal Milk Marketing Order Reform. Regulatory Impact Analysis, March 1999.

Under the order system prior to implementation of the final rule, the minimum price paid by processors for milk used for fluid consumption (Class I) each month was equal to the basic formula price plus the regional Class I differential. The final decision continues the method of adding the Class I differential to a base price. However, the base price under the new system is now based on the higher of the Class III (milk used for cheese) or Class IV (milk used for butter/powder) price in each month. Under the old pricing system, the direction of farm milk prices was heavily dependent on the direction of prices in the cheese market. The newly implemented method of using the higher of the Class III or Class IV price means that if butter/powder prices are strong while cheese prices are weak, as they have been in recent months, the farm price of fluid milk (Class I) will not be as adversely affected as it was under the old system.

Class III Pricing Issues

Another source of controversy in USDA's final decision concerned the new method by which USDA computes the Class III price, that is, the minimum price of farm milk used for cheese. In determining the Class III price, the final rule requires USDA to use a monthly survey of the wholesale price of cheese and determine the value of the components (protein, butterfat, and other solids) that went into the manufacturing of the cheese. Before determining the farm value, the formula subtracts from the wholesale price of cheese an administratively established "make allowance," which represents the cost to processors for converting the milk into cheese. There is an inverse relationship between the cheese make allowance and the Class III price; that is, the higher the make allowance is set, the lower the minimum Class III price paid to farmers will be. Many farm groups contended that USDA's final decision set the make allowance for cheese too high, thus meaning lower minimum prices paid to farmers for milk used for cheese. Since the higher of the Class III or Class IV price is also used as the base price for Class I milk, it might also mean lower prices for Class I milk as well, farm groups contend.

A provision in H.R. 3428, enacted as part of the FY2000 consolidated appropriations act (P.L. 106-113, H.R. 3194) required USDA to re-evaluate its make allowance for both cheese (Class III) and for butter and nonfat dry milk (Class IV), and use formal rulemaking to develop its pricing policy. P.L. 106-113 required USDA to publish a final decision on the Class III and Class IV milk pricing formulas on December 1, 2000, and implement the decision on January 1, 2001.

On December 1, 2000, USDA announced a slightly lower make allowance of 16.5 cents for cheese, down 0.52 cents from the 17.02 cent make allowance in USDA's final decision. USDA also decided to raise the make allowance for nonfat dry milk to 14 cents/lb. (from 13.7 cents), and for butter to 11.5 cents from 11.4 cents. According to USDA, these proposed changes would have minimal impact on farm milk prices over the next 5 years.

At the same time that the make allowance changes were proposed, USDA announced several other changes to its pricing formulas, some of which proved to be even more controversial than the issue of make allowance proposals. USDA proposed that the value of butterfat used in cheese should be valued differently than the butterfat used to make butter and other butterfat products, in order to properly value the milkfat used in cheese production. (Current regulations use the same formula for valuing butterfat in cheese and butter.) Many dairy industry groups denounced this decision stating that the new formula would overvalue fat and undervalue protein in cheese, which they said would have financial consequences for manufacturers of cream cheese and other processors that rely heavily on added fresh cream for their products. A contingent of milk producers legally challenged the USDA decision. On January 31, 2001, a U.S. District Court judge in Washington, DC issued an injunction that blocks USDA from implementing its proposed butterfat price for cheese products. The court did allow USDA to go forward with its proposed changes to make allowances.

Forward Price Contract Pilot Program

A provision in P.L. 106-113 authorized a temporary pilot program to allow individual dairy farmers or their cooperatives to enter into forward price contracts with processors for certain uses of milk. A forward price contract allows buyers and sellers of a commodity to negotiate a price for the commodity on a future delivery date and insulates both parties from price volatility. Under current law, a processor must pay a producer no less than the blend price (a weighted-average market price) each month for any milk the processor purchases. Some say that this discourages the use of forward price contracts for milk that is covered by federal orders. The adopted pilot program allows producers and cooperatives to enter into forward price contracts for all milk used for manufactured products. The contracted price will be the relevant price that the processor must pay, regardless of what the blend price is at the time of delivery. Some farm groups are concerned that forward pricing might harm the effectiveness of the federal order system, if large quantities of milk are priced outside of the mandated minimum pricing requirements of orders. Other farm groups view forward pricing as a desirable risk management tool. By law, the forward pricing program must terminate on December 31, 2004.

USDA issued final regulations for the forward price contract pilot program on July 18, 2000, which makes the program operational from August 1, 2000, through December 31, 2004. The final rule removed a controversial provision from the preliminary rule that would have given dairy farmers up to 3 days after signing a forward contract to decide whether to void the contract. Dairy processors sought for the deletion of this provision, contending that the three-day waiting period was excessive and that it would have required processors to absorb any price risk during that period. Some dairy farmer groups countered that the three-day period was a reasonable period of time. Another controversial provision that was removed in the final rule was a proposed 6-month limit to the term of any forward contract. The National Milk Producers Federation, the largest trade group representing dairy farmer cooperatives, supported the 6-month provision, but some producer and processor groups contended that the contract term should be longer.

Mandatory Price Reporting Legislation (P.L. 106-532)

On November 22, 2000, the President signed into law a bill (S. 2773, P.L. 106-532) that will require most dairy manufacturers to regularly report to USDA's National Agricultural Statistics Service (NASS) the price that they receive for cheese, butter, and powdered milk, as well as the level of product inventories. (NASS currently collects price data on a weekly basis, but manufacturer compliance has not been required.) The legislation was supported by both dairy farmer and processor groups. Under federal milk marketing orders, the minimum price that farmers receive for their milk is closely tied to the wholesale price of manufactured dairy products. Consequently, both producers and processors contend that a mandatory price reporting system is necessary to accurately reflect the supply and demand for dairy products. P.L. 106-532 requires USDA to penalize dairy manufacturers up to $10,000 for each incidence of noncompliance with the price reporting requirement. The measure exempts small dairy manufacturers (those processing less than one million pounds of dairy products per year) from the price and inventory reporting requirements.

Dairy Compacts

Background

The 1996 farm bill gave the Secretary of Agriculture the power to grant the New England states the authority to enter into a regional dairy compact. Under the authorizing statute, this authority ends at the same time as the adoption of the required consolidation of federal milk marketing orders, which was set in current law as October 1, 1999. The legislatures of the six New England states agreed to enter into a dairy compact that would create an interstate commission with the power to set a minimum price paid by dairy processors to dairy farmers in the six New England states at a level above the federal minimum price. However, any proposed interstate compact had to be approved by Congress, as required by the interstate commerce clause of the U.S. Constitution.

New England farm groups support the compact because they believe that the current minimum milk prices dictated by federal milk marketing orders are not sufficient to cover the cost of producing milk on family-sized farms, thus forcing many dairy farmers out of business. The strongest opponent of the Northeast compact has been Upper Midwest dairy producer groups which maintain that the compact artificially encourages the production of milk within the compact region at the expense of other parts of the country that have lower production costs and can sell at lower prices. In addition, opponents maintain that the compact could set a precedent for other regions and industries to protect themselves from competition, an action which critics maintain is anti-consumer and market-distorting.

In late May 1997, New England dairy farmers gave nearly unanimous approval to a compact commission-proposed minimum price of $16.94 per cwt. for Class I milk in the compact region. (This compares with an average minimum fluid milk price of $14.82 for the first 8 months of 1997 in the New England milk marketing order; a 1996 average of $16.88; and a 1995 average of $14.87.) The $16.94 floor price became effective on July 1, 1997 and currently serves as the floor price for farm milk used for fluid consumption in the Northeast compact region.

Following the creation of the Northeast compact, many other states expressed interest in either joining the Northeast compact or forming a new, separate compact in the South. Current law allows New York, Pennsylvania, New Jersey, Delaware, and Maryland to join the Northeast compact as long as their membership is approved by their respective state legislatures and by the Congress. All five state legislatures have approved membership; congressional approval is pending. Fourteen other states, mainly in the South, have approved membership of their states in a new Southern dairy compact, which is also awaiting congressional approval.

Current Compact Issues

Northeast Compact Sunset Date. The 1996 farm bill (P.L. 104-127) required the Northeast dairy compact to terminate upon implementation of federal milk marketing order reforms. P.L. 104-127 mandated an April 4, 1999 deadline date for these reforms. However, a provision in the Omnibus Consolidated and Emergency Appropriations Act, 1999 (P.L. 105-277) extended the deadline date for reform to October 1, 1999, which in effect extended the life of the dairy compact until that date. On September 28, 1999, a federal judge granted a temporary restraining order requested by Northeast dairy farm groups to prohibit USDA from implementing its final rule for federal milk marketing order pricing reform on October 1. Since the termination of the dairy compact is directly tied to the implementation date of order reform, the compact did not terminate on October 1.

A provision in the dairy legislation (H.R. 3428) that was enacted as part of the FY2000 consolidated appropriations act (P.L. 106-113, H.R. 3194) extends authority for the Northeast dairy compact for 2 years until September 30, 2001. The measure does not address the extension of membership in the compact to the five states (NY, NJ, PA, DE and MD), which have approved membership in the compact at the state legislature level. Congressional approval is required before these states can join the Northeast compact. Hence, dairy compact legislation is expected to be debated in the 107^th Congress.

Northeast Compact Supply Management Program. The Northeast Dairy Compact Commission has issued proposed regulations for a supply management program that the Commission says will help prevent potential overproduction of milk in the Northeast region. Critics of the dairy compact contend that the higher mandated farm milk prices under the compact encourage farmers in the region to overproduce milk, which they say depresses milk prices for dairy farmers in other regions. The proposed rule would provide for an assessment of 5 cents per hundredweight (cwt.) on all farm milk sold within the compact region. At the end of the year, the annual funds collected would be refunded to any compact eligible producer who increased his annual milk production by less than 1%. One-half of the total amount refunded would be divided equally among all eligible compact producers; the other half would be distributed based on the total volume of milk produced during the year. A hearing on the proposed rule was held on April 5, 2000. In May, farmer members of the compact voted to approve the rule. The rule was finalized and printed in the Federal Register on July 7, 2000. Supporters of the assessment say that it will control potential excess production of milk in the Northeast and help limit the purchase of surplus dairy products by USDA. Opponents contend that the supply management program will be ineffective, and that it is designed more to fend off criticism of the compact as its sunset date approaches in September 2001.

Proposed Southern Dairy Compact. H.R. 1604 and S.J. Res. 22, as introduced in late April 1999, would grant congressional approval for a new Southern dairy compact. The following states already have enacted legislation approving membership in a Southern dairy compact: Alabama, Arkansas, Georgia, Kansas, Kentucky, Louisiana, Mississippi, Missouri, North Carolina, Oklahoma, South Carolina, Tennessee, Virginia, and West Virginia. Other states likely to consider membership are Texas and Florida. Congressional approval for the Southern compact was considered during conference deliberations on the FY2000 agriculture appropriations bill. A threatened filibuster by Upper Midwest legislators forestalled this action. Authority for a Southern compact also was not included in the subsequent dairy legislation (H.R. 3428) adopted by Congress that extended the authority of the Northeast compact for 2 years.

For more background on the Northeast dairy compact, see CRS Report 96-814, The Northeast Interstate Dairy Compact.

LEGISLATION

107^th Congress

S. 117 (Feingold)
Quality Cheese Act of 2001. Prohibits the Food and Drug Administration from making regulatory changes that would allow milk protein concentrates or casein as an ingredient in certain cheeses. Referred to the Senate Agriculture Committee on January 22, 2001.

S. 294 (Santorum/Kohl)
National Dairy Farmers Fairness Act of 2001. Authorizes through FY2008 a direct payment program for all dairy farmers. Payments would be made when the fiscal year average Class III farm milk price falls below $12.50 per cwt. Per unit payments would range from 18 to 50 cents per cwt. with the payment rate rising as the price falls. Additional payments of 14 to 34 cents per cwt. would be made to any producer who does not increase annual milk production during the applicable fiscal year. Referred to the Senate Agriculture Committee on February 8, 2001.

106^th Congress

P.L. 106-78/H.R. 1906 (Skeen)
The FY2000 Appropriations Act for the U.S. Department of Agriculture and Related Agencies. Among emergency provisions in the measure: 1) Section 805 authorizes the Secretary to provide $125 million to compensate dairy producers for economic losses incurred during 1999, and, 2) Section 807 extends authority for the dairy price support program for one additional year, through December 31, 2000. Conference agreement approved by the House on October 1, 1999 and the Senate on October 13, 1999. Signed into law October 22, 1999.

P.L. 106-113, H.R. 3194 (Istook)/H.R. 3428 (Blunt)
Requires the Secretary to adopt Option 1A as the pricing structure for fluid-use milk under federal milk marketing orders and provides temporary authority for forward price contracting between dairy producers and processors. The bill also provides a two-year extension of authority for the Northeast dairy compact until September 30, 2001 and requires USDA to reconsider its method for determining the cheese and butter/powder make allowance, but maintains the make allowances at the proposed levels in the interim. H.R. 3428 was introduced November 17, 1999; referred to the Committee on Agriculture, and subsequently included in a consolidated budget package (H.R. 3194) approved by Congress.

Section 1000(a)(8) of H.R. 3194 (a comprehensive FY2000 appropriations bill) provides for the enactment of H.R. 3428 upon enactment of H.R. 3194. The conference agreement to H.R. 3194 was approved by the House on November 18, 1999 and the Senate on November 19, 1999. Signed into law November 29, 1999.

P.L. 106-387, H.R. 4461 (Skeen)
The appropriations bill for agriculture, rural development and related agencies for FY2001. The conference agreement contains authority for USDA to make emergency supplemental direct payments to dairy farmers based on 35% of the shortfall in farm milk prices between 2000 and the previous 5-year average. A separate provision extends authority for the dairy price support program for one year, through December 31, 2001. H.R. 4461 reported to the House (H.Rept. 106-619) on May 16, 2000. Original measure passed the House by a vote of 339-82 on July 11, 2000. S. 2536 reported in the Senate (S.Rept. 106-288) on May 10, 2000. Text of S. 2536, as amended, substituted for the text of H.R. 4461, and passed by the Senate on July 20, 2000 by a vote of 79-13. Conference report (H.Rept. 106-948) was approved by the House (340-75) on October 11, 2000 and by the Senate (86-8) on October 18, 2000. Signed into law October 28, 2000.

P.L. 106-532, S. 2773 (Feingold) / H.R. 5495 (Simpson)
The Dairy Market Enhancement Act of 2000 requires USDA's National Agricultural Statistics Service to regularly collect data on the prices for which cheese, butter, and milk powder are sold by dairy manufacturers. Penalties of up to $10,000 are to be assessed to any qualified dairy processor that does not comply with the mandatory price reporting requirement. S. 2773 was introduced on June 22, 2000, and referred to the Senate Agriculture Committee. Substitute amendment (S.Amdt. 4340) passed the Senate by unanimous consent on October 25, 2000. S. 2773, as amended, was passed without objection on the House floor on October 25. Signed into law November 22, 2000.

Footnotes

1. ^(back)H.R. 3194 (P.L. 106-113) was a consolidation of the five appropriations bills for FY2000 that were not yet enacted as of early November 1999, and several other authorizing measures. Section 1000(a)(8) of H.R. 3194 provides that upon enactment of H.R. 3194, all language in H.R. 3428 is to be considered enacted as well. H.R. 3428 contains provisions which mandated Option 1A and extended authority for the Northeast dairy compact, among other dairy provisions.

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