U.S. dairy producers and processors are paying close attention to preliminary discussions about the 2023 Farm Bill in anticipation of critical reforms to Federal Milk Marketing Orders (FMMOs). Prevailing consensus within the industry is that the FMMOs currently in place do not reflect today’s market environment, which could increasingly have detrimental consequences for dairy processors and farmers alike.
Key among the industry’s concerns are so-called “make allowances,” an important part of FMMOs that have not been updated since 2008, and were based on data from as far back as 2006. Make allowances are an estimate of dairy processors’ cost of converting milk into dairy products. Many of those production costs, including labor and energy, have skyrocketed since make allowances were last updated 15 years ago.
According to a new research brief from CoBank’s Knowledge Exchange, the discrepancy between the make allowances currently in place and actual manufacturing costs sends inaccurate price signals to the marketplace, potentially leading to a misallocation of capital and resources.
“Inadequate make allowances may lead to underinvestment in dairy processing facilities or result in over investment in low-cost plants,” said Tanner Ehmke, lead dairy economist for CoBank. “Ultimately, that could result in limited market access for U.S. dairy products and allow international export competitors to meet the rising global demand for high-value dairy products.”
Aside from milk and other milk components, which are the highest input cost for dairy product manufacturers, plants also spend money on labor, energy, packaging, transportation and other inputs to create finished products. The combined costs of labor and utilities like energy account for at least one-third, and up to one-half, of total production costs for dairy manufacturers.
While current make allowances in FMMOs have remained static since implemented in 2008, prices for industrial electric power rose 64% from 2006 to 2022, according to U.S. Bureau of Labor Statistics. Industrial natural gas prices fell 11% but were highly volatile. Labor costs in dairy product manufacturing climbed 48% per unit of production from 2006 to 2021.
“Cost structures among dairy processors or handlers will continue to change, requiring more frequent adjustments to make allowances over time,” said Ehmke. “And while updating make allowances does not guarantee more investment in new processing assets with every handler, failing to update them may result in lost market access and diminished growth opportunities for the U.S. dairy industry long term.”
Make allowances are also used to set the monthly minimum prices that regulated processors must pay for farm milk. While the first effect of increasing make allowances would be to lower prices paid to farmers, reducing the industry’s vulnerability to international competitors and export market access offers important long-term benefits.
CoBank is a cooperative bank serving vital industries across rural America. The bank provides loans, leases, export financing and other financial services to agribusinesses and rural power, water and communications providers in all 50 states. The bank also provides wholesale loans and other financial services to affiliated Farm Credit associations serving more than 76,000 farmers, ranchers and other rural borrowers in 23 states around the country. CoBank is a member of the Farm Credit System, a nationwide network of banks and retail lending associations chartered to support the borrowing needs of U.S. agriculture, rural infrastructure and rural communities. Headquartered outside Denver, Colorado, CoBank serves customers from regional banking centers across the U.S. and also maintains an international representative office in Singapore.