This Working Paper analyzes the impacts on the net cash income of representative dairy farms for six Class I Federal Order milk pricing options relative to the baseline for the single year 1997. These options were developed and defined by USDA as a component of the dairy policy reform mandated by the 1996 Farm Bill.

The regions most adversely impacted by the options, in general, are the Northeast and the Southwest. In the Northwest, option 1A generates the same income as under the baseline. Four of the six options raise NCFIs for the representative Wisconsin dairies, but by less than 4 percent. The other two options leave Wisconsin NCFI unchanged. The 1A option affects the smallest changes in NCFI across all of the representative farms.

It needs to be emphasized that this analysis assumes no farm adjustments to the net cash income experience. The results suggest that under options other than 1A, regional adjustments would be substantial which could, in turn, impact national price levels for milk and, possibly, feed. Further analysis will be needed to determine these longer-run impacts.

The 1996 farm bill required that the current Federal Milk Marketing Orders be consolidated into 10 to 14 orders. In addition to this mandate the farm bill allowed the Secretary of Agriculture to study other issues in the pricing of fluid milk such as the Class I differentials and the Basic Formula Price (BFP). This briefing paper contains an analysis of the first year impacts on revenue assuming no other adjustments of six Class I differential alternatives identified by USDA on U.S. representative dairy farms. As a result of these first year impacts, one would expect longer-term regional and national supply, demand and price adjustments. These longer-run effects are not analyzed in this report.

In March of 1997 USDA identified 6 Class I pricing options in its Preliminary Report on Milk Pricing dated March 7, 1997. These options were summarized in the USDA Report to Congress on the Consolidation and Reform of Federal Milk Marketing Orders dated April 1, 1997 as follows:

1A --	Location-Specific Differential uses a $1.60 per cwt. fixed differential (multiple basing point) in the Upper Midwest, West, and Southwest surplus milk regions. Differentials in six other regions reflect regional fluid and manufacturing milk values.
1B --	Modified Location-Specific Differential sets a $1.00 per cwt. fixed differential plus a component to reflect bulk milk transportation costs to milk deficit areas.
2 --	Relative Use Differential. A fixed differential of $1.60 per cwt. plus a Class I utilization based component meaning that higher fluid utilization markets get a higher price for Class I milk.
3A --	Flat Differential of $1.60 per cwt. across the entire country with no transportation or utilization adjustment.
3B --	Flat Differential Modified by Class I utilization. The differential equals $2.00 per cwt. for areas with Class I utilization below 70 percent and is increased based on utilization greater than 70 percent.
4 --	Demand Based Differential uses $1.00 per cwt. fixed differential plus a transportation credit based on reserve milk supply location.

Each option is referred to by its number as identified in the USDA report -- 1A, 1B, 2, 3A, 3B, and 4 hereafter in this report.

Analysis Assumptions

• The 1997 FAPRI baseline was used as the baseline for comparison of the alternatives. This baseline of variables important to this study is contained in Appendix A.

• Milk blend prices for each alternative were developed by Mark Stephenson and Andrew Novakovic at Cornell University. These estimates (Table 1) represent the impact of each alternative during the first year of implementation only. They do not include any producer adjustments in terms of feeding or other management variables.

• Each alternative is assumed to be implemented in 1997.

• Changes in net cash farm (NCFI) income for each alternative are compared to the baseline for the year 1997.

The dairy farms used in the analysis represent 21 of the 76 representative crop and livestock farms chosen from major production areas across the United States and are shown in Figure 1. Characteristics for each of the feed grain farms in terms of location, size, crop mix, assets, acreage, and receipts are summarized in Appendix B. The location of these farms are primarily the result of discussions with staff for the House and Senate Agriculture Committees. Information necessary to simulate the economic activity of these representative farms are developed from panels of producers using a consensus building interview process. Normally two farms are developed in each region using separate panels of producers: one is representative of moderate size full-time farm operations while the second panel usually represents farms that are two to three times larger.

The data collected from the panel farms are analyzed in a whole farm simulation model (FLIPSIM) developed by AFPC. The producer panels are provided pro-forma financial statements for their representative farm and are asked the verify the accuracy of the model's ability to reasonably reflect economic activity on their representative farm prior to using the farm for policy analysis.

Results

• Wisconsin farms are the only two that increase net cash farm income (NCFI) under each option. The moderate farm's NCFI increases from the base range from 0 to 2.4 percent ($2,150). The large Wisconsin farm increases by 3.7 percent under the flat differential option with adjustments for over 70 percent fluid utilization (Alternative 3B).

• The Washington representative farms are negatively impacted negligibly by only two of the options (1B and 3A). In both cases, NCFI falls by less than 0.5 percent.

• The Northeast farms (New York and Vermont) are negatively impacted by all but the 1A option. Declines in NCFI under the 3A option range from 13.6 percent ($16,520) for the moderate Central New York farm to 31.9 percent ($19,120) for the moderate central New York farm. The reduction in net cash income for the moderate Central New York farm could be sufficient to force restructuring.

• The Southwest farms (Texas and New Mexico) are adversely impacted under most options. The New Mexico dairy would see a slight increase in NCFI under option 4 but the Texas farm's NCFIs would decline under all the options although the reduction is less than 3 percent for option 1A. Changes in NCFI for the moderate Central Texas (TXCD400) dairy range from -$3,220 to -$51,520 (44.5 percent) under options 1A and 4, respectively.

• Results were mixed for the representative Missouri farms. NCFI income changes range from -9 to 9 percent and -11 to 11 percent for the moderate and large farms respectively. These farms fared relatively better with the utilization-based differentials.

• Representative farms in the Southeast fare very well or very poorly depending on the option. The moderate Georgia dairy (GAND175) is in poor financial shape under the baseline so large changes in blend prices indicate large percentage changes in NCFI. Option 2, the utilization based differential, results in a 112 percent increase in NCFI for the 175 cow Georgia dairy while option 3A reduces NCFI 215 percent.

The 1997 baseline projected all-milk price is $13.69 per cwt. Historically, this is an extremely good price for milk. The annual U.S. all-milk price averaged $12.83 per cwt. and ranged between $12.26 and $13.69 per cwt. over the 1985-1995 period.

Given history, how would the representative farms fare given the same estimated Class I option price impacts and a lower baseline price? To shed some light on this question the Wisconsin, New York Central, and Central Texas dairy farms were analyzed assuming a U.S. all- milk baseline price of $12.69 per cwt. That is $1.00 per cwt. below the projected 1997 price and is within the range of prices observed during the 1985-1995 period.

The results indicated that the moderate sized Texas and New York farms would have a difficult time cash flowing under the baseline or any of the Class I options. Net cash farm income declines for the moderate Texas farm ranged from 6.3 percent to 100.2 percent for options 1a and 4, respectively. The moderate New York farm's net cash farm income declined 53.6 percent under the 3a option. The Wisconsin farms gained modest amount, in percentage terms, under four of the options.

Summary

The regions most adversely impacted by the options, in general, are the Northeast and the Southwest. In the Northwest, option 1A generates the same income as under the baseline. Four of the six options raise NCFIs for the representative Wisconsin dairies, but by less than 4 percent. The other two options leave Wisconsin NCFI unchanged. The 1A option affects the smallest changes in NCFI across all of the representative farms.

It needs to be emphasized that this analysis assumes no farm adjustments to the net cash income experience. The results suggest that under options other than 1A, regional adjustments would be substantial which could, in turn, impact national price levels for milk and, possibly, feed.

Longer run, producers in the areas that benefit would likely see higher gains as producers in the negatively impacted areas begin to be forced out of business, thus increasing national milk prices. Moderate and smaller producers in negatively impacted continue to build up debt until forced out of business. The regional changes suggested in this one-year analysis would continue in the longer run as producers attempt to adapt to the changing market environment.

WAD185	A 185-cow Northern Washington (Whatcom County) moderate size dairy farm that produces 25,500 pounds of milk per cow. The farm plants 112 acres of silage and generates 98 percent of its receipts from milk. The farm has been updated for 1996.
WAD850	A 850-cow Northern Washington (Whatcom County) large dairy farm that produces 23,500 pounds of milk per cow. The farm plants 500 acres of silage and generates 97 percent of its receipts from milk. The farm has been updated for 1996.
TXCD400	A 400-cow Central Texas (Erath County) moderate size dairy farm that produces 16,100 pounds of milk per cow. The farm plants 118 acres of hay and 172 acres of silage. Milk is 95 percent of the farms gross income. The farm has been updated for 1996.
TXCD825	A 825-cow Central Texas (Erath County) large dairy farm that produces 19,200 pounds of milk per cow. The farm plants 215 acres for silage and milk accounts for 96 percent of receipts. The farm has been updated for 1996.
TXED210	A 210-cow East Texas (Hopkins County) moderate size dairy farm that produces 16,000 pounds of milk per cow. The farm plants 195 acres of hay and generates 90 percent of its receipts from milk. The farm has been updated for 1996.
TXED650	A 650-cow East Texas (Lamar County) large dairy farm that produces 17,000 pounds of milk per cow. The farm plants 140 acres of hay and 425 acres of silage. The farm generates 93 percent of its receipts from milk. The farm has been updated for 1996.
WID70	A 70-cow Eastern Wisconsin (Winnebago County) moderate size dairy farm that produces 20,500 pounds of milk per cow. The farm plants 37 acres of hay, 40 acres of corn, 23 acres of silage, and 102 acres of haylage. Milk makes up 92 percent of this farm's receipts. The farm has been updated for 1996.
WID600	A 600-cow Eastern Wisconsin (Winnebago County) large dairy farm that produces 19,800 pounds of milk per cow. The farm plants 350 acres of corn, 200 acres of silage, and 450 acres of haylage. Milk accounts for 93 percent of the farm's receipts. The farm has been updated for 1996.
MOD85	A 85-cow Southwestern Missouri (Christian County) moderate size dairy farm that averages 15,600 pounds of milk per cow. The farm plants 211 acres of hay. About 91 percent of the farm's receipts come from milk. The farm has been updated for 1996.
MOD300	A 300-cow Southwestern Missouri (Christian County) large dairy farm that averages 17,300 pounds of milk per cow. The farm plants 573 acres of hay and 107 acres of silage. Milk accounts for 95 percent of this farm's receipts. The farm has been updated for 1996.
NYWD700	A 700-cow Western New York (Wyoming County) moderate size dairy farm that produces 22,700 pounds of milk per cow. The farm plants 510 acres of silage and 425 acres of haylage. About 94 percent of the farm's receipts come from milk. The farm has been updated for 1996.
NYWD1200	A 1200-cow Western New York (Wyoming County) large dairy farm that produces 21,700 pounds of milk per cow. The farm plants 825 acres of silage and 700 acres of haylage. Milk accounts for 96 percent of the farm's receipts. The farm has been updated for 1996.
NYCD110	A 110-cow Central New York (Cayuga County) moderate size dairy farm that produces 22,000 pounds of milk per cow. The farm plants 50 acres of hay, 75 acres of corn, 76 acres of silage, and 94 acres of haylage. Milk accounts for 95 percent of the farms receipts. The farm has been updated for 1996.
NYCD300	A 300-cow Central New York (Cayuga County) large dairy farm that produces 21,500 pounds of milk per cow. The farm plants 155 acres of hay, 145 acres of corn, 170 acres of silage, and 286 acres of haylage. The farm generates 95 percent of its receipts from milk. The farm has been updated for 1996.
VTD85	A 85-cow Vermont (Washington County) moderate size dairy farm that averages 22,400 pounds of milk per cow. The farm plants 73 acres of hay, 57 acres of silage, and 70 acres of haylage. Milk accounts for 91 percent of the receipts. The farm has been updated for 1996.
VTD350	A 350-cow Vermont (Washington County) large dairy farm that averages 22,000 pounds of milk per cow. The farm plants 332 acres of hay, 200 acres of silage, and 168 acres of haylage. Milk accounts for 96 percent of the farm's receipts. The farm has been updated for 1996.
GAND175	A 175-cow Central Georgia (Putnam County) moderate size dairy farm that produces 18,000 pounds of milk per cow. Rather than plant any crops, this farm opts to purchase all of its feed requirements in the form of a premixed ration. Milk accounts for 96 percent of the farm's gross income. The farm has been updated for 1996.
GASD650	A 650-cow Southern Georgia (Houston County) large dairy farm that produces 19,000 pounds of milk per cow. The farm plants 150 acres of hay and 200 acres of silage. Milk makes up 96 percent of the farm's receipts. The farm has been updated for 1996.
FLND380	A 380-cow North Florida (Lafayette County) moderate size dairy farm that averages 17,000 pounds of milk per cow. The farm grows 200 acres of hay. All feed requirements, in addition to hay, are met through a purchased pre-mixed ration. Milk sales account for 95 percent of the farm's receipts. Excess hay sales provide one percent of cash receipts and are expected to provide supplemental sales from year to year. The farm has been updated for 1996.
FLSD2000	A 2000-cow South Central Florida (Okeechobee County) large dairy farm that produces 16,500 pounds of milk per cow. The farm grows 1210 acres of hay. In addition to grass hay, grass silage, and pasture, cows receive a purchased premixed ration. Milk sales generate 94 percent of its receipts. The farm has been updated for 1996.
NMD2000	A 2000-cow Southern New Mexico (Dona Anna and Chaves County) large dairy farm that averages 22,400 pounds per cow. Rather than plant any crops, this farm purchased all commodities necessary for blending its own total mixed ration. Milk sales account for 95 percent of cash receipts. The farm has been updated for 1996.