A Negative PPD Explained

By Isa Siewert and Dave Lane


So this month, you may have notice that your milk check had a negative PPD (Producer Price Differential) line. This may seem like you are not getting the full value of your milk, but in reality, it is just the “adjustment or differential” needed to pay out the amount of money in the revenue pool. The good news is that it is a sign of a strengthening market!

What is milk pricing?
In the US, the minimum price of milk is set by the USDA through Federal Milk Marketing Orders (FMMO). Milk is priced by four classes, or categories, and the price of milk is actually determined by what the milk will be used for. Class I milk is fluid milk, Class II is for soft products like ice cream, Class III is for cheese, and Class IV is for butter and dry products. Each of these, when purchased from a farm by a processor, has a different price attached to it.

These prices are decided in a few different ways. Class I and II prices are announced as a set value prior to the month using price data from the last two weeks in what is called the advance pricing. Then, at the end of that month, class III and IV prices are announced using the aggregate pricing data from the whole month. Let’s take a look at a recent example:

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All of the money spent on the purchase of milk does not go straight to the farmers, rather it is gathered in a revenue sharing pool. This pool then is assigned one aggregate price per pound by combining the minimum price of each class. This conglomerate price is called the blend.

So what is the PPD?
So advance prices for class I and II are calculated using metrics called component prices. Components are the parts of the milk that will be used in each class such as protein, butterfat and other solids. Each of these are assigned a value using a full month’s data and is announced alongside the class III and IV prices. Advance prices are set using the component value data from the last two weeks.

At the end of the month, however, the new value of the components is released, which then dictates the true value of the milk that month.

PPD is the Producer Price Differential, and it is simply a measure of the difference between the blend price and the pooled price of the components. When class III prices are announced, within that announcement are the values of protein, butterfat, and other solids, the value of all three together is the pool price. Then the combined value of all four classes is the blend price.

So, we can say that the blend price is equal to class III plus the PPD.

Why is the PPD negative?
This month, the PPD is negative, which is a result of the pool price from class III being higher than the blend price! Historically, class III has been lower than class I and II, so when the prices come out, the blend price is higher than the component values, resulting in a positive PPD. But, this month, the class III price has skyrocketed and raised the component prices to a point where the value of milk is actually higher than what the blend can pay out.

Is a negative PPD bad?
No! The PPD is a representational measure and the blend of all four classes is still being paid out to farmers. The PPD isn’t actually subtracting anything from the amount received but is rather showing the difference observed between the class and component value. Even with a positive PPD, there is no extra money being added to your check.

A negative PPD can actually be an indicator of good things to come. Remember that advance prices are based on the component prices of the previous month. So the next advance price may be higher because it is based on this current month’s high component prices. Class III sets the stage for changing milk prices but there is a short time lag between component pricing and advance pricing.

In the upcoming months, milk prices will continue to rise and the PPD will slowly shift back away from the negative range as the market catches up. In the end, PPD is potentially a positive forecasting measure that can predict great movements in the milk market and it is not necessarily cause for concern.
 
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