Confused about negative PPDs? Expert explains what that number means

Grace Connatser
Wisconsin State Farmer
Combined, the value of negative PPDs, i.e., the shortfall in FMMO revenue sharing pools, from June to November is estimated at -$2.7 billion.

Despite negative producer price differentials plaguing the dairy industry in 2020, many people are still confused on what a PPD is and how it affects their milk check.

Marin Bozic, assistant professor of dairy food marketing and economics at the University of Minnesota, was a guest on Dairy Business Association's Dairy Stream podcast and took a stab at explaining the meaning of federal milk marketing orders and PPDs and what to expect of them this year.

FMMOs, which are region-specific, are a collective bargaining tool that ensures a minimum price paid to dairy farmers for their milk. If there were no FMMO, Bozic said, large corporate players like Walmart could artificially lower the value of milk by lowering the buying price of fluid milk.

On the other hand, Bozic said that PPDs are a promise to producers from processors that they will pay for the value of butterfats and solids found in each producer's milk. So when the pool of money for those payments is fully allocated to each producer with money left over, that equals a positive PPD. However, promising those payments to producers where that money doesn't exist leads to negative PPDs, Bozic said.

"We use the skim solids in powders and we use the skim solids in cheese. We pay the producers based on the value of skim solids from cheese, but those skim solids may not deliver as much value when they're used in powders," Bozic said. "So we have a deficit and that's manifested as a PPD."

The pool total is exceeded when the spread between Class III and Class IV prices is large, usually when cheese is high in demand and value, but milk powders are low in demand and value. But, Bozic said, since these prices are tethered to each other, it leads to overvaluing the milk powders in order to pay the value of cheese. In 2019, he explained that the pricing formula changed to average the class prices together, despite their values being vastly different.

Bozic said that due to the large spread between class prices, processors began depooling their milk so that they were not obligated to the FMMO of their region. That led to processors being able to pay any amount to their producers because depooling also meant deregulation. Bozic also emphasized that processors that depooled were able to pay the full value, but those who did not fully depool their milk were unable to pay it.

Marin Bozic

"We've seen, in 2020, some record levels of depooling that we have not seen in the previous 20 years," Bozic said. "It is sort of like a cascading failure – you first have record negative PPDs, then cheese processors realize that if they stay in the pool, they will have to share a substantial part of their revenue from cheese sales with ... powder makers or fluid bottlers, and then they decide en masse to just leave the pool for the time being so that they can keep all that revenue."

The amount of depooled milk in 2020 far exceeded the amount of any other year recorded since 2000, when this data tracking began, Bozic said. While the money in the pool never actually existed, it's still shown as a deduction on milk checks, which Bozic said has led to a lot of confusion among dairy farmers.

Bozic said some of the fallout from the pandemic was prevented by the US Department of Agriculture starting the Farm to Families Food Box Program, which bought dairy products in bulk for struggling families. However, this move also in part drove negative PPDs because the boxes raised demand for cheese, while they didn't do the same for milk powders, leading to further friction between the class prices.

Bozic said he believes some processors who depooled during the pandemic were "double-dipping" and finding loopholes in their contracts to avoid paying farmers the full value of their milk while also making more profit. He said dairy farmers should review their contracts with processors thoroughly and find room to negotiate for a better base price in case of further depooling.

"When the contract between dairy farmer and the processor says that the processor commits to paying at least the federal order minimum price ... that works well when PPD is positive, but when PPD is negative, that processor depools and they have no payments to depool," Bozic said. "They keep all the money from high cheese prices, and then they turn around and they pay the producers just as if they were pooled."

For 2021, Bozic said FMMO economists expect to see more negative PPDs throughout the rest of the year because the spread between Class III and Class IV prices has doubled to $2/cwt, when the typical spread pre-pandemic was about 92 cents per hundredweight. And with the food service industry slowly coming back to life as well as cheese manufacturing plants completing expansions, it's difficult to predict any lasting positive changes.

The dairy industry should also come together as a unit to reform the milk pricing formula, Bozic said, rather than competing to install the best solution. He said that's because if the dairy industry comes to a majority consensus on how to move forward, USDA will likely accept their proposal, but if multiple groups present solutions, it's less likely to affect the status quo.

"USDA doesn't like to be seen as picking winners and losers, so if that were to happen – if we have a hearing where we have multiple groups with quite different ideas put into the record – then it's entirely possible that the status quo would prevail," Bozic said.

Bozic also called for a "social contract" between dairy farmers and processors that relies on core principles to guide business contracts. He said he has four principles in mind: 1) ensuring the milk price reflects the milk value; 2) allowing producers to engage in meaningful risk management; 3) forcing processors to shoulder all risk if they're making multiple dairy products; and 4) encouraging producers to join forces for more control.

The role of government should also serve to facilitate competition in the industry as well as incorporate those principles into pricing design, Bozic said. He also cautioned against throwing out the entire system and instead advocated for building upon the current system.

"As frustrated as we are with the current system, we should never just say throw out everything and let's start from scratch. You cannot do that," Bozic said. "You have to start from where you are today, not from some imaginary standpoint. For all its shortcomings, we should still feel satisfied that we have a system that allows people to manage risk."