Guest Columns

Perspective:
Dairy Markets

A market without barrels: Dairy industry adapts to FMMO change

Kevin Peterson

Kevin Peterson is a senior market advisor, commercial, at Ever.Ag*, a brokerage firm that specializes in dairy product price risk management. He contributes this column exclusively for Cheese Market News®.

Earlier this year, on Jan. 16, USDA released its final decision on updates to the federal milk marketing order (FMMO) pricing system for dairy. The ruling included changes to five key areas:

• Adjustments to milk component pricing
• Removal of the barrel from pricing formulas
• Updates to manufacturing allowances
• Revisions to the base Class I skim milk price
• Changes to Class I and II differentials

In this article, we’ll focus on the second point — the removal of the 500-pound Cheddar barrel from the National Dairy Products Sales Report (NDPSR) — and the ripple effects this is having across the industry.

• The CME spot market impact

It’s been roughly two months since barrels were officially removed from NDPSR pricing, and the market is still adjusting. Interestingly, barrels continue to be listed and traded on the CME spot market, even though they are no longer part of the Class III milk price formula.

Since the change, barrel trading volumes have declined significantly. Between February and May, weekly trading averaged 12 to 13 loads. Since June, that average has dropped to around five loads per week.

This reduction may reflect a new reality for physical traders: It could become harder to participate in a market where futures no longer offer effective hedging tools for barrels. Previously, cheese futures could hedge up to 50% of the risk on a barrel position — but that’s no longer the case.

• Is greater volatility ahead?

One key concern is the potential for increased volatility in cheese futures. For years, barrels and blocks would often move in opposite directions on a given day, offsetting each other and helping stabilize futures pricing.

Now, with blocks as the sole input into pricing, a single move could have outsized effects.

For example, a 7.5-cent move in CME block pricing (we moved 7.5 cents on Aug. 4) could trigger a limit move in cheese futures, something far more likely without the “buffer” effect of barrels. Historical data supports this.

Over the past three years, daily price variance increased by 14% when only block prices are considered.
The removal of barrels has also triggered shifts in contracting practices. Previously, many barrel contracts were priced using the prior week’s or month’s CME barrel average. Now, most processors and end users appear to have transitioned to pricing off block values.

This change mitigates the risk for manufacturers who may be purchasing block input but previously sold products priced off the barrel. This is a misalignment that could erode margins when barrel prices lag behind blocks.

A positive outcome of this shift is that barrels are now easier to hedge with minimal basis risk, thanks to their alignment if priced off the block — something that wasn’t possible before. This could improve market liquidity and benefit all participants in the long run.

• A smooth transition so far

When the USDA’s decision was first announced, it stirred concern across the industry. How would the market react? What would happen to volatility, pricing and risk?

Two months in, and the answer is not much has happened — at least not yet. The transition has been smoother than expected. One reason may be the relative size of the barrel market itself. Barrels only make up about 5% to 10% of total Cheddar production, which may have limited the overall impact.

While early signs suggest the market has absorbed this change with minimal disruption, the long-term implications are still unfolding. We’ll continue monitoring market behavior — particularly cheese futures and physical contracting — as the industry settles into this new era of a market without barrels.

CMN

The views expressed by CMN’s guest columnists are their own opinions and do not necessarily reflect those of Cheese Market News®.

*The risk of loss trading commodity futures and options can be substantial. Investors should carefully consider the inherent risks in light of their financial condition. The information contained herein has been obtained from sources to be reliable, however, no independent verification has been made. The information contained herein is strictly the opinion of its author and not necessarily of Ever.Ag and is intended to be a solicitation. Past performance is not indicative of future results.

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