STATEMENT OF KENNETH C. CLAYTON

ASSOCIATE ADMINISTRATOR

AGRICULTURAL MARKETING SERVICE

U.S. DEPARTMENT OF AGRICULTURE

BEFORE

THE SENATE COMMITTEE ON AGRICULTURE,

NUTRITION, AND FORESTRY

February 9, 2000

Good morning, and thank you, Mr. Chairman, for the invitation to appear before the Committee to provide testimony on our progress in implementing changes to the Federal Milk Marketing Order Program. Accompanying me today is Richard McKee, Deputy Administrator, Dairy Programs, Agricultural Marketing Service.

Yesterday, Dr. Keith Collins, USDA's Chief Economist, offered testimony describing the overall situation and outlook for the U.S. dairy sector and our dairy farmers. Dr. Collins briefly touched on the role of the Federal order program within the larger constellation of dairy policy as well as actions taken to support dairy farmers' incomes. I will address the Federal milk marketing order program in a bit more detail. My remarks will briefly describe Federal milk marketing orders, the steps we have taken to meet the 1996 farm bill mandate, and the anticipated effects of milk order program changes on producers and consumers of dairy products.

Background

The Federal Milk Marketing Order program is intended to promote the orderly marketing of a highly perishable commodity, namely, milk. The Federal order program does so by helping to prevent marketplace behavior that might otherwise erode the price of milk at the farm gate and, ultimately, drive producers out of business. The significance of this protection, of course, depends on the relative bargaining positions of dairy farmers and those who purchase their milk. The number and size of processors bidding for producers' milk, the market strength of cooperatives selling milk on behalf of their producer members, and other factors come into play when assessing the respective bargaining positions of dairy farmers and processors.

Under Federal orders the proceeds from the sales of farmers' milk are pooled within a market area with an average value being returned to producers. The prices at which processors must account to a pool are based on the end value uses of milk. To allow pooling to work, a set of classified prices is established under Federal orders. These are minimum prices that processors must pay for milk corresponding to its value in several end product categories.

Class I or fluid milk generally earns the highest minimum price, because of supply and demand characteristics that tend to make fluid milk more valuable.

Class II products have lower minimum prices. Products covered include ice cream, yogurt, and the like -- the so-called "soft" dairy products.

Class III and Class IV manufactured dairy products -- including butter, dry milk products, and cheese -- have the lowest minimum prices. These products are traded in a national market and, because they are more easily stored than fluid milk or soft dairy products, they serve as the residual claimant for milk not needed for Class I or Class II products. It is these manufactured dairy product prices that provide the foundation to which differentials are added to determine the prices for Class I and II products.

As already noted, producers selling milk under a Federal order receive a uniform or weighted-average price, called the blend price, that reflects all of the uses of milk in a market area. Thus, all producers benefit from the higher price on milk that is marketed for fluid consumption. Likewise, all producers share in the lower prices for milk diverted to manufactured products. Equity is preserved with producers not needing to engage in behavior that may be contrary to their interests, such as bidding the price of their milk down to its manufacturing value, even though it may be used for fluid consumption. In this same vein, under Federal order pricing, handlers are unable to play producers against each other. As previously noted, the extent to which such behavior might actually occur would depend on the relative bargaining positions of dairy farmers and those to whom they sell their milk.

These market relationships are preserved with the revisions that have been made to the Federal order program. Minimum prices are still established according to a hierarchy of end product values. In complying with the mandate to make changes in the Federal milk order program, considerable care was taken to ensure the continued orderly marketing of milk in a manner that balances the various interests of producers, handlers, and consumers in the Nation's dairy market.

The Revision Process

Let me turn now to the process we undertook to achieve the Congressional mandate. First, Congress directed the Department to reduce the number of milk marketing order areas -- in essence, to redraw the geographic boundaries to reflect the larger marketing areas in which milk is now sold, distributed, and consumed. Second, Congress directed the Department to consider changes to the pricing structure utilized under the Federal order program. The system of classified prices was examined, as were the relative levels of Class I prices within and between milk marketing order areas.

From April 1996, until issuing a final decision on March 12, 1999, the Department worked closely with interested parties to revise the current program in a manner that would be beneficial to both dairy farmers and consumers. Throughout the process, the Department conducted extensive outreach efforts to educate interested parties regarding changes under consideration and continually solicited public input on all aspects of the program. As a result, more than 8,500 comments were received.

The final decision issued in March 1999 detailed the changes to the Federal milk order program. Basically, the program provided for 11 consolidated milk order areas, established a nationally coordinated Class I price structure that provided greater efficiencies in milk assembly and distribution, established new methods for pricing milk used for manufacturing purposes, made minor changes to the classification of milk provisions, and standardized various provisions, definitions, and terms across the orders.

The Department conducted extensive outreach efforts to ensure that dairy farmers were educated about the contents of the final decision. In August 1999, referenda were conducted to determine producer approval of the revised Federal milk marketing orders. Dairy farmers approved the 11 orders and a final rule implementing the consolidated program was issued on August 23, 1999. The revised orders were to become effective on October 1, 1999, in compliance with legislated mandates.

Several producer cooperatives contested in Federal Courts the implementation of the Class I price structure contained in the final decision. On September 28, 1999, a temporary restraining order was issued enjoining the Secretary from implementing the final rule revising Federal milk marketing orders.

On November 29, 1999, the Consolidated Appropriations Act, 2000, was signed which required that the revised orders become effective on January 1, 2000, utilizing the so-called option 1A Class I differentials contained in the proposed rule published on January 30, 1998, as corrected and modified through April 2, 1999. The Act further directed the Secretary to establish a forward contracting temporary pilot program and to hold a hearing on Class III and Class IV milk pricing formulas. The Department expects to issue a notice regarding the pilot program soon and we issued a notice on January 31, 2000, inviting proposals to be considered at a hearing on Class III and Class IV prices to be held later this year.

Finally, on January 1, 2000, the final rule consolidating and revising the Federal milk marketing order program became effective.

Expected Impacts on Dairy Farmers and Consumers.

I would now like to review the expected impacts of the revised Federal milk marketing order program on producers and consumers.

The Final Regulatory Impact Analysis that accompanied the Department's final decision assessed the economic effects of that decision as well as the so-called option 1A Class I differentials on dairy farmers, fluid milk processors, dairy product manufacturers, consumers, and USDA's food assistance programs.

Impacts under both sets of Class I prices were measured against the Department's national annual projection of supply, demand, and prices for milk and dairy products as adapted for the regulatory analysis. This baseline assumed: (1) the price support program would end on December 31, 1999; (2) the Dairy Export Incentive Program would continue; and (3) the Federal Milk Marketing Order Program would continue unchanged. National assumptions for the cost of milk production, especially feed, and the commercial utilization of milk and dairy products were adjusted to a regional basis.

Indicators chosen to gauge the economic effects of the revised Federal orders on dairy farmers and consumers included: 1) the all milk price (defined as the weighted-average minimum use value including Class I over order premiums); 2) farm cash receipts from milk marketings; 3) retail fluid milk prices; and 4) consumer expenditures on fluid milk and manufactured dairy products.

For purposes of the analysis, impacts were measured at 36 major pricing points. These included the 32 previously existing Federal order market areas (including the terminated Tennessee Valley order) and 4 non-Federally regulated areas (California, unregulated areas in the Western states, certain unregulated areas in New York and New England, and other unregulated areas in the Eastern states).

A summary table that compares the impacts of current (option 1A) differentials and the Department's final decision is attached as Table 1. It provides comparisons for both areas regulated under Federal orders and the overall United States.

Impact on Dairy Farmers

The all milk price across all Federal orders is expected to average less than $0.06 per hundredweight -- or about 0.4-percent -- higher under the current (option 1A) Class I differentials compared to those in USDA's final decision over the 2000-2005 period.

The all milk price at 16 of the previously existing Federal order pricing points is estimated to increase from $0.02 to $0.79 per hundredweight under the current Class I differentials. For the 16 other Federal order pricing points, the all milk price is estimated to decrease from less than $0.04 to $0.42 per hundredweight.

The six pricing points with the greatest average increase in the all milk price include: Denver at $0.79 per hundredweight; Oklahoma City at $0.44; Dallas at $0.42; and Knoxville, Charlotte and Philadelphia at $0.34. The five pricing points with the greatest reduction in the all milk price include: Miami at -$0.42 per hundredweight; Grand Junction (CO) at -$0.40; Peoria at -$0.39; and Des Moines and Omaha at -$0.35.

Under the current (option 1A) Class I differentials, the estimated annual gross cash receipts for all Federal order markets combined are expected to average $107.7 million - or about 0.6-percent - higher compared to what they would have been under the Department's final decision for the 2000-2005 period.

Gross cash receipts are expected to be higher at 16 of the previously existing Federal order pricing points compared to the Department's final decision. Average annual receipts for producers measured at the Dallas pricing point are estimated to increase $34.0 million; followed by New York at $29.7 million; Philadelphia at $29.2 million; Denver at $19.2 million, and Oklahoma City at $16.8 million.

Gross cash receipts from milk marketings measured at the other 16 pricing points are estimated to be lower during 2000-2005. The largest declines in cash receipts include: Chicago at -$28.8 million; Des Moines at -$11.6 million; Alton (IL) at -$7.2 million; Omaha at -$7.1 million; and Miami at -$7.0 million.

Impacts on Consumers

In general, changes in farm milk and wholesale product prices are passed through to consumers. However, the speed at which price changes are passed on to consumers continues to be a point of debate. It was assumed in the Final Regulatory Impact Analysis that all changes in fluid processor milk costs and wholesale manufactured dairy product costs would be passed through immediately to the retail level without any changes in processor-retail or wholesale-retail margins.

Accordingly, current (option 1A) Class I differentials are estimated to increase the average retail price of fluid milk across all Federal market order areas by $0.02 per gallon over the 2000-2005 period compared to the Department's final decision. Markets with the greatest average increase in retail price per gallon include: Denver at $0.08; Dallas at $0.07; Phoenix and Philadelphia at $0.06; and Oklahoma City and New York City at $0.05. Markets with a lower retail price per gallon include: Miami at -$0.04; and Grand Junction, Tampa, Peoria, Des Moines, Omaha, and Chicago at -$0.02.

Consumer expenditures on fluid milk products in all Federal market order areas combined are estimated to average $116.8 million per year higher under the current Class I differentials than under the Department's final decision. This is an increase of about 1.5 percent, given average annual consumer expenditures of $7.6 billion on fluid milk products in Federal market order areas.

Average annual consumer expenditures on manufactured dairy products across all Federal market order areas are estimated to decrease by $9.1 million per year compared to the Department's final decision. With average annual expenditures on manufactured dairy products totaling $9.3 billion, this amounts to a savings of about 0.1 percent.

Closing

Mr. Chairman, this concludes my statement. I will be happy to answer any

questions the Committee may have. Thank you.