# Compact Over-Order Price Regulation > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A97-10831 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** April 28, 1997 - **Citation:** 62 FR 23032 ## Text NORTHEAST DAIRY COMPACT COMMISSION 7 CFR Chapter XIII Compact Over-Order Price Regulation AGENCY: Northeast Dairy Compact Commission. ACTION: Proposed rule. ----------------------------------------------------------------------- SUMMARY: This rule proposes a compact cover-order price regulation for the territorial region of the six New England states, in the amount of $16.94 (Zone 1), for six months duration. The Northeast Dairy Compact Commission (Compact Commission) establishes this price regulation based on its determination that it is necessary to assure the viability of dairy farming in New England and to assure the region's consumers of a continued adequate, local supply of fresh and wholesome milk, reasonably priced. DATES: Comments must be received by May 12, 1997. ADDRESS: Comments should be submitted to the Northeast Dairy Compact Commission, 43 State Street, P.O. Box 1058, Montpelier, VT 05601. The complete file for this proposed rule is available for public inspection during normal business hours at the offices of the Commission. FOR FURTHER INFORMATION CONTACT: Daniel Smith, Executive Director, Northeast Dairy Compact Commission at the above address or by telephone at (802) 229-1941 phone or by facsimile at (802) 229 -2028. SUPPLEMENTARY INFORMATION: Background The Compact Commission was established under authority of the Northeast Interstate Dairy Compact (Compact). The Compact was enacted into law by each of the six participating New England states as follows: Connecticut--Pub. L. 93-370; Maine--Pub. L. 89-437, as amended, Pub. L. 93-320; Massachusetts--Pub. L. 93-370; New Hampshire-- Pub. L. 93-184-A; Rhode Island--Pub. L. 93-336; Vermont--Pub. L. 89-95, as amended, 93-97. Consistent with Article I, Section 10 of the United States Constitution, Congress consented to the Compact in Pub. L. 104- 127 (FAIR ACT), Section 147, codified at 7 U.S.C. Sec. 7256. Subsequently the United States Secretary of Agriculture, pursuant to the FAIR ACT, authorized implementation of the Compact. Section 8 of the Compact empowers the Compact Commission to engage in a broad range of activities that are designed to ``promote regulatory uniformity, simplicity and interstate cooperation.'' For example, the Compact authorizes the Compact Commission to engage in a range of investigations of the existing milk programs of both the participating states and the federal milk marketing system, to make recommendations to participating states, and to improve industry relations as a whole. See Compact, Art. IV, Sec. 8. In addition to the powers conferred by Section 8, the Compact also authorizes the Compact Commission to consider adopting a compact over- order price regulation. See Compact, Art., IV, Sec. 9. A ``compact over-order price'' is defined as: A minimum price required to be paid to producers for Class I milk established by the Commission in regulations adopted pursuant to sections nine and ten of this compact, which is above the price established in federal marketing orders or by state farm price regulation in the regulated area. Such price may apply throughout the region or in any part or parts thereof as defined in the regulations of the commission. See Compact, Art. II, Sec. 2(8); see also Compact, Art. IV, Sec. 9 (``The Commission is hereby empowered to establish the minimum price for milk to be paid by pool plants, partially regulated plants and all other handlers receiving milk from producers located in a regulated area.'') Such price regulation establishes the minimum procurement price to be paid by fluid milk processors to farmers used for New England fluid milk consumption. The regulated price established by the Compact Commission is actually an incremental amount above, or ``over-order'' (Federal Order #1) the minimum price for the same milk established by Federal Milk Market Order. Section 11 of the Compact specifically delineates the procedures that the Commission must employ in the event it wishes to promulgate an over-order price regulation. Before promulgation of any regulations establishing a compact over-order price or commission marketing order, including any provision with respect to milk supply under subsection 9(f), or amendment thereof, as provided in Article IV, the commission shall conduct an informal rulemaking proceeding to provide interested persons with an opportunity to present data and views. Such rulemaking proceeding shall be governed by section four of the Federal Administrative Procedures Act, as amended (5 U.S.C. Sec. 553). In addition, the commission shall, to the extend practicable, publish notice of rulemaking proceedings in the official register of each participating state. Before the initial adoption of regulations establishing a compact over-order price or a commission marketing order and thereafter before any amendment with regard to prices or assessments, the commission shall hold a public meeting. The commission may commence a rulemaking proceeding on its own initiative or may in its sole discretion act upon the petition of any person including individual milk producers, any organization of milk producers or handlers, general farm organizations, consumer or public interest groups, and local, state or federal officials. Pursuant to Sec. 11 of the Compact, the Compact Commission issued a Notice of Hearing on December 13, 1996, and held public hearings on December 17 and 19, 1996. The Notice also invited the public to submit written comments through January 2, 1997. Following the close of this comment period, the Commission met on January 16, 1997 and established three working groups to consider the testimony and data submitted. The Commission issued a Notice of Additional Comment Period on March 14, 1997. This comment period closed on March 31, 1997; the reply comment period closed April 9, 1997. Statement of Required Findings of Fact Sec. 12(a) of the Compact directs the Commission to make four findings of fact as the basis for promulgating a compact over-order price regulation. (a) In addition to the concise general statement of basis and purpose required by section 4(b) of the Federal Administrative Procedure Act, as amended (5 U.S.C. Sec. 553(c)), the commission shall make findings of fact with respect to: (1) Whether the public interest will be served by the establishment of minimum milk prices to dairy farmers under Article IV. (2) What level of prices will assure that procedures receive a price sufficient to cover their costs of production and will elicit an adequate supply of milk for the inhabitants of the regulated area and for manufacturing purposes. (3) Whether the major provisions of the order, other than those fixing minimum milk prices, are in the public interest and are reasonably designed to achieve the purposes of the order. (4) Whether the terms of the proposed regional order or amendment are approved by producers as provided in section thirteen. Compact Art. V. Sec. 12. For purposes of clarity, the analysis of the testimony and comment first addresses the substance of findings (2) above, or the level of price needed by producers to cover their costs of production and which will elicit an adequate supply of milk for inhabitants. The conclusion of that analysis is that the current pay price is not sufficient to cover cost of production or to elicit an adequate supply of milk for inhabitants. Based on that determination the [[Page 23033]] resulting analysis addresses the substance of finding (1) above, or whether the establishment of minimum milk prices to dairy farmers would serve the public interest. Summary of Comment I. Finding What level of prices will assure that producers receive a price sufficient to cover their costs of production and will elicit an adequate supply of milk for the inhabitants of the regulated area and for manufacturing purposes.\1\ --------------------------------------------------------------------------- \1\ The Compact Commission has determined that the findings here required need not contain any determination with respect to the provision of milk supplies utilized for manufactured purposes. Under current circumstances, the Compact Commission is authorized to regulate only the price of milk used for fluid consumption. See 7 U.S.C. Sec. 7256(2) (``The Northeast Interstate Dairy Compact Commission shall not regulate Class II, Class III, or Class III-A milk used for manufacturing purposes or any other milk, other than Class I fluid milk, as defined by a Federal milk marketing order issued under 7 U.S.C. Sec. 608c of this title, reenacted with amendments by the Agricultural Marketing Agreement Act of 1937.'') The Commission has concluded that the finding provision with regard to milk used for manufactured purposes stems from the Compact's alternative authority to regulate that additional milk supply with a Commission marketing order. See Compact, Article IV, Sec. 9(c). Under the Compact, however, this authority could be utilized only in the event the federal Market Order System is eliminated. See Compact Article IV, Secs. 9(a) and (c). This is not presently the case. Morever, this residual authority was struck by the Congress when it approved the Compact. Pub. L. 104-127(2). Accordingly, because the Commission has authority only to regulate the price of milk used for fluid milk purposes, its findings only deal with fluid milk supply and consumption issues. --------------------------------------------------------------------------- This finding requires consideration of the core issues regarding the financial health of the region's dairy farmers and the Compact's associated purpose of assuring the region's adequate supply of milk. More specifically, this finding requires the Commission to make a determination of the price level necessary both to ensure the continuing financial viability of New England dairy farms and to elicit an adequate supply for the region's fluid, or milk beverage, consumption. Section 9(e) of the Compact provides guidance to the Commission with regard to the factors to be considered in analyzing the cost of production issue. That section directs the Commission. to consider the * * * costs of production including, but not limited to the price of feed, the cost of labor including the reasonable value of the producer's own labor and management, machinery expense, and interest expense. Section 9(e) also guides this inquiry by requiring the Commission to consider ``the price necessary to yield a reasonable return to the producer and distributor. Based upon this statutory guidance, the Commission sought testimony and comment on the following subjects and issues: (1) Farmer costs of production, including the components identified by Compact Section 9(e), and the pay price needed to yield a reasonable rate of return to producers; and (2) Prevailing pay prices received by dairy farmers in the New England region; and (3) The balance between production and consumption of fluid milk products.\2\ --------------------------------------------------------------------------- \2\ 61 CFR 65604. --------------------------------------------------------------------------- A. Issue: Farmer Cost of Production and the Pay Price Needed To Yield a Reasonable Rate of Return to Producers The comment received makes clear that, despite the approach of Section 9(e), there is very little agreement on what ``costs'' should be included in the cost of production, and even how they should be calculated. Beyond actual cash costs, there is considerable disagreement over whether to include or exclude, and how best to consider, depreciation, family living costs, return or equity, a reasonable value for the farmer's own labor, and debt service. There was no common definition throughout the testimony among farmers or economists. Farmers, themselves, quite frequently, excluded the value of their own labor and or depreciation in calculating their own costs of production. The diversity of comment makes clear the difficulties of cost of production analysis. Cost of production can and do vary widely from farm to farm and year to year.\3\ Even one commenter who opposed the adoption of a price regulation agreed that there is a lack of consensus on the amounts that should be considered in calculating costs of production.\4\ University of Vermont dairy economist Rick Wackernagel suggests the difficulty of isolating the cost of producing a hundredweight of milk from what is typically a diversified farming operation, and that any such attempt is at best ``an approximation.\5\ --------------------------------------------------------------------------- \3\ See December 19, 1996 hearing transcript (12/19/96 HT): Putnam at 141, 148-49; Stevens at 158-60; Carlson, at 232-34; Buelow, at 248; Beach at 288-90; Platt, at 292. \4\ Vetne, 12/19/96 HT at 264-66. \5\ Wackernagel, Compilation of January 2, 1997 Written Comment (1/2/97 WC) at 482-83. --------------------------------------------------------------------------- As will be discussed, despite the diversity of their analytical approach, the comments do reflect near unanimous agreement on at least three important aspects of the cost of production equation: (1) For an extended period of time prices have not covered the full costs of production, however defined, (2) price instability has caused financial stress and made it impossible for farmers to plan financially; and (3) over time, net, ``mail box'' price levels received by farmers have not kept up with inflation. In addition, the Compact Commission will review the comments relating to the structure and health of the New England dairy industry. The Compact Commission's review of comment under this section includes a comprehensive survey of the testimony and comment received from dairy farmers, and a response to opposing comments received. The Commission notes that very few conflicting comments were submitted for consideration. (1) Price Insufficiency Commenters indicated again and again that, in general, farmers in New England had done a good job of holding down costs of production in response to flat milk prices by increasing productivity and efficiency.\6\ According to one survey of New England farmers, however, this efficiency and productivity has not equated to profitability. According to the survey conducted by the Farm Credit Services, forty- two percent of the farms had a negative cash margin in 1995.\7\ --------------------------------------------------------------------------- \6\ See DeGues, 1/2/97 WC at 74; Sciabarrasi, 1/2/97 WC at 309; and Smith, 12/17/96 HT at 36. \7\ See Smith, 12/17/96 HT at 36. --------------------------------------------------------------------------- This survey included seventy-three New England farmers who participate in Agrifax, a financial accounting service provided to farmers by local Farm Credit Associations. Despite the relatively small size of the survey sample, the results are useful to the Commission because, according to the authors, survey participants are generally larger and perhaps better managed than the average dairy farm in New England. The survey indicates that the average adjusted cost of producing milk by New England farms in this survey in 1995 was $15.37 per hundredweight, when including a 4% rate of return on equity. Before the 4% rate of return on equity the net cost of production was 14.25.\8\ --------------------------------------------------------------------------- \8\ See Smith, 12/17/96 HT at 36. --------------------------------------------------------------------------- Smith concluded When you consider the average price received by farmers in our survey for New England was $13.70 per hundredweight in 1995, it is not surprising that many dairy farms are having financial difficulty.\9\ \9\ Smith, 12/17/96 HT at 36. --------------------------------------------------------------------------- There was also abundant evidence in the record that costs of production for 1996 will likely be as high or even higher than in 1995 and again not be covered by the price received. Jim Putnam, a Senior Vice President with First Pioneer Farm Credit Bank, for [[Page 23034]] example, testified that he ``would estimate probably a dime or more higher in 96'' primarily as a result of a 29% increase in purchased feed prices which can account for up to 50% of the cost of production in New England.\10\ The average 1996 mailbox price in New England was measured as $14.25, leaving a shortfall of over $1.00, against this commenter's estimated cost of production. --------------------------------------------------------------------------- \10\ Putnam, 12/19/96 HT at 148-149; see also Smith, 12/17/96 HT at 38; Andrew, 1/2/97 WC at 5. --------------------------------------------------------------------------- Farmers consistently referred to the fact that low farm prices made it difficult for them to reach their ``break-even'' point, let alone generate any meaningful return.\11\ As one witness testified: \11\ See Mason, 12/17/96 HT at 87; d'Boer, 12/17/96 at 192; Putnam, 12/19/96 HT at 144-45, 146. I have two young children and she'll say gee, Dad, we've had a break-even for less price this year for a lower milk price and let's go out and eat and I've got to explain to her that when you break even, you don't eat, that's just paying the operating expenses and says nothing about investing in your business and making it a long range commitment.\12\ --------------------------------------------------------------------------- \12\ Holmes, 12/17/96 at 93. Other farmer-witness testified that they, themselves, were living below the poverty line and were eligible to participate in the WIC program.\13\ --------------------------------------------------------------------------- \13\ See Mason, 12/17/96 HT at 85-86. --------------------------------------------------------------------------- The result of these depressed prices and the inability to make ends meet will, according to one commenter, cause farmers to ``tighten their belt'' or ``hunker down'' and ``wait out the point in time when they'll go back to breakdown.'' \14\ Farmers, thus, are struggling to make ends meet. --------------------------------------------------------------------------- \14\ Putnam, 12/19/96 at 147-48. --------------------------------------------------------------------------- The testimony and comments also made clear that this failure of milk prices to cover, or even meet, the costs of production is not a short-lived phenomenon, but rather, is part of a long-term trend that extends back into the mid-1980s. Numerous studies, which were corroborated by substantial anecdotal evidence from farmers, documented the chronic price insufficiency over the last decade. The USDA Economic Research Service estimates that during the 1985 to 1990 period, cash receipts of Northeastern dairy farmers rose from $13.96 to $16.00 per hundredweight while the cost of production jumped from $12.06 to $16.46. In 1990, dairy farmers in the Northeast average a net loss of .46 cents per hundredweight of milk sold.\15\ --------------------------------------------------------------------------- \15\ Pelsue, 1/2/97 W/C at 274. --------------------------------------------------------------------------- Several other studies reached similar conclusions. For example, in a study commissioned by the Maine Milk Commission submitted by Mike Wiers, the Commission's Chair, economists Robert Milligan and Wayne Knoblauch analyzed total costs of production (cash costs, depreciation, a 5% return on equity, and a return on the farmer's labor) in Maine and the five Southern New England states of Vermont, New Hampshire, Massachusetts, Connecticut and Rhode Island--the six Compact states. They found that for Maine the total costs of production per hundredweight to be $17.24 in 1982 and $17.17 in 1987. For the Southern New England States, the costs were $16.65 and $16.62 respectively.\16\ For these years, the Market Administrator's Report indicates that the blend prices for Order 1, Zone 21 were $13.61 and $12.56, reflecting pay prices below the costs of production. --------------------------------------------------------------------------- \16\ In reply comment, Bill Gillmeister indicated that the higher cost of production in southern New England was a significant issue that must be addressed. See Gillmeister, Reply Comment, (RC) April 9, 1997. The Commission agrees that the loss of milk supply nearest to the population centers is an issue of utmost concern, and the reasons for this particular decline should be most carefully scrutinized. As described at footnote 3, the Commission has concluded that it should initiate a regional cost of production study by the close of the regulation adopted under this rule. The comparative costs of production within the region will be a key part of this analysis. --------------------------------------------------------------------------- University of Vermont Extension economist Rick Wackernagel submitted a study which relief upon an analysis of farm income and expense data from Agrifax and ELFAC farms to estimate costs of production for 1988 through 1990. The costs considered included cash operating expenses, capital costs (other than land) and the labor provided by the farm family; they did not provide for any return on the owner's equity in land. According to this study, net costs of production on these Vermont farms in 1988 were about $13 per hundredweight. In 1990, they had risen to $15 per hundredweight.\17\ By comparison, the Market Administrator's Report indicates blend prices for 1988 and 1990, Order 1, Zone 21 were $12.22 and $13.95, respectively. This study again confirms the fact that prices were inadequate to enable farmers to meet the break-even point. --------------------------------------------------------------------------- \17\ Wackernagel, 1/2/97 W/C at 515. --------------------------------------------------------------------------- Economist Neil Pelsue submitted another study of the costs of production in Vermont, conducted by the Community Development and Applied Economics Department at the University of Vermont.\18\ This study analyzed cost of production by considering all cash expenses, capital replacement costs, and unpaid farm labor, using a hired wage rate. For 1990, the study found the average cost of production to be $14.33 per hundredweight, or about $0.67 less than the Wackernagel study determination. When the economic or ``full ownership'' costs of production was analyzed, however, which included a residual return to management and risk, the measurement of cost of production ballooned to an average of $16.41 per hundredweight. This determination is substantially higher than the Wackernagel analysis and well above the reported blend price of $13.95 for the year. --------------------------------------------------------------------------- \18\ Pelsue 1/2/97 W/C at 282. --------------------------------------------------------------------------- The Pelsue study also determined that nearly two-thirds of the surveyed farms had negative residual returns. The study concluded, that ``[m]ore than half of the survey farms had economic costs of production that exceeded their receipts. This implies that if current market conditions do not improve, those farms may find it hard to continue operating in the long run.'' \19\ --------------------------------------------------------------------------- \19\ Pelsue, 1/2/97 W/C at 282. --------------------------------------------------------------------------- Vermont Department of Agriculture economist Reenie De Geus provided testimony indicating that: In 1995, the most recent year, costs of production averaged $14.06 for the group. (Vermont Dairy farmers) This is $0.83 lower [sic] than the actual milk prices received of $13.23. In fact, in each of the last 5 years, milk price received was lower than the cost of production by an average of $1.08.\20\ --------------------------------------------------------------------------- \20\ De Geus, 1/2/97 WC at 74. --------------------------------------------------------------------------- Finally, as mentioned above, there was near unanimous testimony from farmers that price levels were inadequate to enable them to cover their costs of production. As one commenter summarized, the result of these chronically depressed prices will be ``attrition.'' \21\ --------------------------------------------------------------------------- \21\ Putnam, 12/19/96 HT at 148. --------------------------------------------------------------------------- The evidence submitted to the Commission regarding the inadequacy of prices paid to farmers currently and over an extended period of time is persuasive. Although the degree of the price inadequacy varies from commenter to commenter, the evidence supports the conclusion that costs of production exceed prices paid to farmers. \22\ --------------------------------------------------------------------------- \22\ The Commission again notes the disparities in study methodologies. While repeating its belief in the broad breadth and strength of these studies for the conclusion that current prices are not covering costs of production, the Commission also has identified the need for a uniform, regional, cost of production study, to be initiated before the close of the regulation imposed by this rule. --------------------------------------------------------------------------- (2) Price Instability Abundant testimony in the record indicates that price instability, and wide fluctuations in the price of milk, were significant sources of financial stress for the dairy industry. These wide [[Page 23035]] variations in price made it difficult for farmers to make good business decisions and to plan financially. Robert Wellington, Vice President of Agri-Mark, testified that: * * * data from the New England Market Administrator's office show*- *-*the price volatility exhibited in the past 12 months is triple that experienced in 1981 and much larger than most of the 1980's and nearly all of the 1990's. This combination of lower prices with unpredictable volatility has made business planning nearly impossible and has put severe financial strain on most farms. \23\ \23\ Wellington, 3/31/97 AC. --------------------------------------------------------------------------- Robert Smith of the Farm Credit System testified with respect to price instability that: The volatility in milk prices makes it very difficult for farmers to effectively plan and make the type of investment necessary to position themselves for the future. The Commission can play a major role in helping to reduce this volatility through establishing a higher minimum Class I price. This will help keep farmers and land in business and maintain a stronger agriculture industry in New England for future generations. It will enable dairy farmers to make necessary investments to enhance efficiencies and will benefit communities with enhanced economic activity. \24\ \24\ Smith, 12/17/96 at 39. --------------------------------------------------------------------------- Comments from farmers expressing frustration over the wide swings in milk prices were abundant and adamant. Tom Magnant, a dairy farmer from Franklin Vermont testified: ``We find it very difficult to make ends meet with the milk prices that fluctuate between $11.00 and $15.00 a hundredweight.'' \25\ --------------------------------------------------------------------------- \25\ Magnant, 12/17/96 at 227. --------------------------------------------------------------------------- Jeffrey Holmes, a farmer from Langdon, New Hampshire testified that: I think one of the key things that's going to be gained from this potential floor price and Mr. Smith alluded to that is the stability of the price to the producer. We have no say in what we get and that's been true for years and years, but in this day and age of tight margins we really need to plan on a certain price. We're making borrowing decisions on variations of ten, twenty and thirty cents a hundred and the last two months we dropped 2 dollars and I don't know what the figure is--$2.50 with a little over a month warning that was coming and it's really a farce that we have to make long range plans based on that type of marketplace. \26\ \26\ Holmes 12/17/96 at 92-93. --------------------------------------------------------------------------- Jim Jenks, a farmer from Danville, Vermont, testified: I regret that I'm not a more prudent businessman but one thing I know is if we're going to make a good decision with respect to putting my family's equity on the line, we need to know something about the stability of our markets and our future. So with regard to the Compact Commission and the price that they could set, one thing that we're really looking for is stability. We need price. And there's a lot of other factors. But stability and a price that goes with it is really critical.\27\ \27\ Jenks, 12/17/96 HT at 153. --------------------------------------------------------------------------- Ralph McNall, a dairy farmer and a Director of the Vermont St. Albans Cooperative Creamery testified that: Price stability is the greatest potential benefit of the Compact. Within our own business costs have increased dramatically in the last five years. The improvements or expansions have been difficult to justify or prepare for with the fluctuations of the price paid for milk. I fully support the Compact and its potential to stabilize the milk price to allow my business to plan its future.\28\ \28\ McNall, 12/17/96 HT at 221. --------------------------------------------------------------------------- Charles Telly, a dairy farmer from Dunstable Mass testifying on behalf of the National Grange: ``I am increasingly concerned about the fluctuating prices * * * It is difficult for me to plan out--to financially plan out my future three, five or ten years in advance because of the uncertainty I face each month with the ever changing milk price''.\29\ \29\ Telly, 12/19/96 HT at 123. --------------------------------------------------------------------------- These comments are persuasive, and they demonstrate the need for price stability in the region in order to avoid the harmful effects of price volatility. (3) Failure of Milk Prices to Account for Inflation Both economists and farmers identified the failure of milk prices to keep up with inflation as a factor contributing to farm financial stress. A recent study conducted and submitted by University of Vermont dairy economist, Rick Wackernagel presented a comprehensive analysis of the impact of these two variables--price insufficiency and inflation-- upon farm profitability.\30\ Because of its comprehensive approach, the Commission finds this study persuasive and relies on it extensively. --------------------------------------------------------------------------- \30\ Wackernagel, 1/2/97 W/C at 467 et seq. --------------------------------------------------------------------------- The Wackernagel study analyzes the economic effects of three different price trajectories for two different farm sizes--an 80 cow herd and a 350 cow herd. Wackernagel's first trajectory used a macro- economic model developed by the Food and Agriculture Policy Research Institute (FAPRI) for 1997 modified to reflect local price levels and yields as a base. The base scenario is premised upon a Class I price of $16.17 per hundredweight at Zone 21 and a blend price of $14.70 per hundredweight. Under this scenario, both farms operate at low to modest levels of profitability. They are stressed financially during several periods of price instability and by a general downward trend in price, however. The financial results for these two farm sizes are ``marginal to somewhat unattractive'' at these price levels, providing ``an extremely modest return on investment of 0.4 to 3.0%''.\31\ --------------------------------------------------------------------------- \31\ Wackernagel, 1/2/97 W/C at 473. --------------------------------------------------------------------------- The second trajectory attempts to moderate price instability by holding the Class I price constant. Wackernagel estimates that the Class I price accounts for about forty percent of the variation in the blend price and that stabilizing the Class I price could potentially reduce the variability of the blend price by about half. The economic impact of this approach upon farm income and survival, however, was similar to the base (first) trajectory, suggesting that price instability is not the only factor placing financial stress on these farming operations. Inflation, was a factor as well, as Wackernagel explains: ``The Consumer Price Index (CPI) shows a third source of financial stress for these farms, inflation. In contract to its steady upward progression, the first two trajectories have downward trends.\32\ --------------------------------------------------------------------------- \32\ Wackernagel, 1/2/97 W/C at 473. --------------------------------------------------------------------------- Wackernagel's third price trajectory raises the Class I price to $17 per hundredweight (Zone 21), yielding a project blend price of $15.45, and increases the Class I price by one-half the rate of inflation in subsequent years. This price trajectory has the greatest positive impact on retention of equity, net farm income and survivability, even though its upward slope is less than that of the CPI. Farmers also identified inflation as a significant source of financial stress. Ellen Paradee, a dairy farmer from Grand Isle, Vermont testified that: Since 1985, our property taxes have increased two hundred percent. Our grain costs have increased one hundred percent. And our utility costs have increased one hundred and twenty five percent. In 1985, the average blend price for Zone 25 was $12.57 per hundredweight. In 1995, the average blend price was $12.56 per hundredweight. Essentially, there has been no increase in the blend price. If the price of milk had kept pace with inflation, it would be approximately $26 per hundredweight.\33\ \33\ Paradee, 12/17/96 HT at 232. --------------------------------------------------------------------------- Ralph McNall commenting on his own farm finances and inflation said: * * * utility cost, electricity, for example, has gone from, in the year 1991 it's gone from $3,600 to $5,800 for an increase of fifty two percent. Purchased feed is another example--$37,000 to $76,000 for an increase of one hundred and five percent. Fertilizer--$4,900 to $8,100 for an increase of sixty six percent . . . It is important to note that steps have been taken to reduce electricity costs, for [[Page 23036]] instance through plate coolers and heat reclaimers within the milk house and yet as I said before the cost went up fifty percent. Reliance on purchased fertilizer has been reduced, supposedly, through the installation and utilization of liquid manure.\34\ \34\ McNall, 12/17/96 HT at 222 and 223. --------------------------------------------------------------------------- John Mordasky, dairy farmer and Legislator from Stafford, Connecticut, said: I lost from eight to ten thousand dollars a year in the last four years and I feel that this has come about because the relative price of milk has stayed the same. Fuel has gone up, grain has jumped out of sight and it just--all the other costs that are involved--equipment, parts--have gone very, very, high and they're not relative anymore.\35\ --------------------------------------------------------------------------- \35\ Mordasky, 12/19/06 HT at 12. --------------------------------------------------------------------------- (4) Structure and Health of the New England Dairy Industry The comment received also makes clear the devastating impact that chronic price insufficiency, price instability, and the failure of milk prices to keep up with inflation over the last decade has had, and will continue to have, on the structure and health of the New England dairy industry absent intervention through regulation by the Compact Commission.\36\ --------------------------------------------------------------------------- \36\ One commenter felt that the Commission should not take action because he believed that other regions of the country were losing dairy farmers at a faster rate than New England. See Tipton, WC 1/2/97 at 462. A finding that New England is losing farmers faster than any other part of the country is unnecessary to establishing an over-order price regulation. --------------------------------------------------------------------------- According to the extensive testimony by University of New Hampshire Extension Specialist Michael Sciabarrasi, the character of the New England dairy industry is still predominantly family owned and operated, made up of mostly small to medium sized producers, and is heavily dependent on family labor.\37\ Maintenance of this market structure premised on family farms is precisely the express purpose of the Compact. See Compact Article I, Sec. 1.\38\ --------------------------------------------------------------------------- \37\ Sciabarrasi, 1/2/97 WC at 309. \38\ Three commenters expressed the opinion that the market should be left to work without regulation, even if this meant continued farm loss. (Baker, 12/17/96 HT at 185, Schnittker, 1/2/97 WC at 313 and Vetne, 12/19/96 HT at 269.) As one Commenter recognized, this is essentially a question of public policy. In response, the Commission refers to the Compact's Statement of Purpose, that ``dairy farmers are essential to the region's rural communities and character'' and are ``an integral component of the region's economy.'' Compact Article I, Sec. 1. --------------------------------------------------------------------------- Mr. Sciabarrasi's conclusions were corroborated by much of the evidence adduced at the hearings. There is abundant evidence that many of the region's farms are small to medium-sized. Likewise, there is substantial anecdotal evidence of heavy dependency on family labor, much of which often goes unpaid.\39\ --------------------------------------------------------------------------- \39\ See 12/17/96 HT: Mason at 87; Olson at 146; d'Boer at 192. --------------------------------------------------------------------------- The testimony of Robert Smith, with the Yankee Farm Credit Bank and Farm Credit of Maine, described the effect of the industry's chronic distress upon this basic market structure. According to Smith, ``The number of dairy farms in New England declined by 41% over the past 10 years. (1985-1995) During this period the number of cows has declined 24%, total production has declined 4% and land used in farms fell by nearly 600,000 acres.'' \40\ According to another commenter, New England has lost dairy farmers at a rate of about 40% faster than the national average, between 1987 and 1992.\41\ --------------------------------------------------------------------------- \40\ Smith, 12/17/96 at 34. \41\ Ed Barron, 12/17/96 HT at 60. --------------------------------------------------------------------------- Statistics cited by another commenter indicate these problems are particularly severe in the southern portion of the Compact region. Massachusetts, the most populous state, has seen the greatest effect, showing a 35% decline in cow numbers and a 20% decline in milk production during the period of 1986 through 1995. Each of the two other southern New England states, Connecticut and Rhode Island, have also shown substantial declines in farms, cow numbers and production See New England Agricultural Statistics, 1995-96, USDA, Page 68.\42\ --------------------------------------------------------------------------- \42\ William Zweigbaum, U-NH Extension 3/31/97 AC. --------------------------------------------------------------------------- The economic literature submitted into the record addressing this issue likewise concludes that inadequate milk prices threaten the long- run survival of small and medium-sized farms. Quiroga & Bravo-Ureta, ``Short- and Long-Run Adjustments in Dairy Production: A Profit Function Analysis,'' 24 Journal of Applied Economics 607-16 (1992).\43\ In this study, the authors extracted data from Vermont farms between 1966 and 1988 and applied that data to econometric models to test the effects of milk price reductions on several factors, including farm size. The results of their analysis were consistent with the view that low milk prices threaten the economic viability of small- and medium- sized dairy farms in the short run, and continue the trend towards fewer, and larger, dairy farms over the long run. Yet, it is precisely this fear of continuing attrition among the region's small rural dairy farmers that led to the enactment of the Compact, and prompted the Commission to undertake this proceeding. See, e.g., Compact, Art. I, Sec. 1. --------------------------------------------------------------------------- \43\ Bravo-Ureta, 1/2/97 WC. --------------------------------------------------------------------------- (5) Comments and Testimony From Farmers In the language of economists, the Commission was told that a farm can continue to operate in the short term only if market prices cover variable costs. In the long term, it must cover the total cost of production and marketing or the farm will cease operating. (WC 282 Pelsue) Farmers were more likely to describe this situation as living off their depreciation or living off their equity, in terms evidencing both frustration and humor. Connecticut dairy farmer, Mavis Collins, testified that: People in fact used to ask us ``what will you do with all the money from selling your development rights'' and we jokingly would reply, ``We'll farm until the money is all gone.'' And unfortunately, that's almost what's happened. This year alone we had to use $24,000 of our savings plus $11,000 from creditors in order to keep up with current bills. * * * \44\ \44\ Collins, 12/19/96 HT at 56. --------------------------------------------------------------------------- Wendy Kennedy a farm wife and owner of a farm accounting and tax service told the Commission: I pulled out the full time dairy farmers from my files. (25 files) The average income from their Schedule F which is where you report farm income was a negative $5,263 for last year. (1995) * * * With a negative bottom line of $5,263 these families are living off their depreciation or selling off their assets to live * * * You can't run a business like that and be in business next year.\45\ \4\ Kennedy, 12/19/96 HT at 239-240. --------------------------------------------------------------------------- Nowhere was the gap between cash receipts and costs of production more apparent than when farmers talked about family living expenses or any return for their family's labor: A Massachusetts dairy farmer testified: ``My brother Edward and I milk about one hundred cows in Westhampton, Mass. Ed and I take a draw of $300 per week and each of us work about one hundred hours per week (6 a.m.-8 p.m. 7 days).\46\ --------------------------------------------------------------------------- \46\ Parsons, 1/2/97 WC at 236. --------------------------------------------------------------------------- Jan d'Boer who milks 95 cows with his family told the Commission: ``We looked it over and we came up with about 35 hours of family labor a day * * * And the wages per hour we came up with after we figured it all out is $2.55 an hour.'' \47\ --------------------------------------------------------------------------- \47\ d'Boer, 12/17/96 at 192. --------------------------------------------------------------------------- John Potter, a Washington, Connecticut dairy farmer: ``My costs show $7.17 to produce milk, January through November. That's not including anything for family living. That doesn't include anything for depreciation or paying back debt.'' \48\ --------------------------------------------------------------------------- \48\ Porter, 12/19/96 HT at 226. --------------------------------------------------------------------------- [[Page 23037]] Joanne Reynolds, nurse and farm wife: ``In 1996, our milk price averaged $14.88, but our expenses averaged $12.73. These expenses do not reflect depreciation, debt principal or family living expense. What other segment of society works 4000 hours a year, has a $500,000 investment and is basically living off of depreciation.'' \49\ --------------------------------------------------------------------------- \49\ Reynolds, 1/2/97 W/C at 293. --------------------------------------------------------------------------- John Mordasky testified that: ``In the last four years, in order to support my wife and myself we lived on our depreciation and my legislative pay.'' \50\ --------------------------------------------------------------------------- \50\ Mordasky, 12/19/96 HT at 10. --------------------------------------------------------------------------- John Devine of Devine farms of Massachusetts testified, `` * * * we had the accountant pull off the facts from April to November and we had a net loss of $12,877.23.'' \51\ --------------------------------------------------------------------------- \51\ Devine, 12/19/96 HT at 220. --------------------------------------------------------------------------- Wayne Bissonette a dairy farmer from Hinesburg, Vermont told the Commission that: * * * long term decisions * * * [are] becoming increasingly difficult as milk prices swing more dramatically with no apparent link to other costs and market forces * * * ``I consider myself to be a fairly efficient farmer,'' he said, ``and I believe that I could make money with a blend price of $14.50. This does not allow for much return on my equity but at this level I would be paying income tax.'' Alice Allen a dairy farmer from Wells River, Vermont said: In 1973, when my husband and I first began shipping milk, we were receiving $7.50/cwt (federal Order 1) for milk. We were paying $60 a ton for excellent quality 2nd cut hay and $80 a ton for 20% protein. In 1996, we are receiving $15.37/cwt and paying $145 a ton for second cut hay and $250 a ton for 20% protein concentrate.\52\ \52\ Allen, 1/2/97 W/C at 3. --------------------------------------------------------------------------- Scott Mason, a registered jersey farmer from Coos County testified that: I'm looking at a break-even cost for my farm of $14.31. This price does not include any figure for return to equity or family labor. So 14.31 is I work 70 hours a week for nothing, my wife works approximately 30 hours a week on the farm for nothing, and we risked every last penny that we have for no return.\53\ \53\ Mason, 12/7/96 HT at 87. --------------------------------------------------------------------------- Leon Berthiaume the general manager of the St. Albans Cooperative in St. Albans Vermont testified in summary with respect to the members of his cooperative that: * * the average size farm for the St. Albans Coop Creamery produces 1.6 million pounds of milk per year and through these statistics [UVM and USDA] we know the net cost of production, not including return on investment would be in the range of $13.50 to $14.25 per hundredweight.\54\ \54\ Berthiaume, 12/17 HT at 93 et seq. --------------------------------------------------------------------------- The strength and consistency of the evidence in the record with respect to the impact on farmers of their inability to cover their costs of production provides stark evidence to the Commission of the severity of the problems facing the region's dairy farmers, as well as the consequences of inaction. B. Issue: Prevailing Pay Prices Received by Dairy Farmers in the New England Region The issue of the pay prices received by New England dairy farmers is important because it bears directly on determining the necessary level of any Compact Over-order Price Regulation that might be imposed. According to a review of the statistical data and the comment received, prevailing farm prices are a function of two computations: federally regulated uniform (or ``blend'') prices and net or ``mailbox'' price. Statistics published by the Market Order # 1 Administrator provide comprehensive and complete data to address the first part of this issue--the market structure of federal, minimum, price regulation. These statistics are compiled by the Market Administrator as part of the regulation of the federal order, by law, and are published monthly, annually, and in ten-year compilation form. See 7 C.F.R. Sec. 100.3(c)(4), (9). They serve as the common basis for all New England regional dairy marketing analysis and, together with similar statistics supplied for other regions, form the basis for national analysis.\55\ --------------------------------------------------------------------------- \55\ submitted for reference by De Geus and Gilmeister, 3/3/97 AC. --------------------------------------------------------------------------- These statistics report the precise minimum uniform or ``blend'' prices paid to dairy farmers under federal regulation. According to the statistics, these prices are announced and paid monthly, using one hundred pounds (cwt) of milk as the unit of measure. General managers and economists employed by cooperatives of dairy farmers which operate in the region described in comprehensive detail the integration of market forces at work in the regulated marketplace. According to these commenters, farmers receive from the marketplace a ``mailbox'' or net pay price, which accounts for a variety of market payments received and costs incurred for the sale of the milk they produce. \56\ --------------------------------------------------------------------------- \56\ According to Wellington et al, (AC 3/31/97) and pursuant to federal Market Order # 1, the cost of transporting the bulk fluid milk from the farm to the processing plant is a key cost to farmers which reduces the prevailing farm price. This issue is discussed in more detail in the next finding section. --------------------------------------------------------------------------- The following chart illustrates these two price computations of prevailing pay prices of the region's dairy farmers. [[Page 23038]] Class I, Blend and Mailbox Prices 1995-1996 [Per CWT] ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ 1995 ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Class I.................................................. 15.10 14.62 14.59 15.03 15.13 14.4 14.36 14.66 14.47 14.79 15.32 15.85 Blend.................................................... 13.12 13.13 13.25 13.19 13.27 12.84 12.83 13.24 13.32 13.7 14.24 14.43 Mail box................................................. 11.83 11.86 11.98 11.93 11.92 11.39 11.35 11.71 11.88 12.42 13.14 13.20 ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ 1996 ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Class I.................................................. 16.11 16.15 15.97 15.83 15.94 16.33 17.01 17.16 17.73 18.18 18.61 17.37 Blend.................................................... 13.79 13.63 13.55 13.53 13.84 14.53 15.25 15.48 15.96 16.04 15.65 14.37 Mail box................................................. 13.38 13.23 13.14 13.08 13.49 14.08 14.77 15 15.55 15.83 15.37 14.12 ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ [[Page 23039]] C. Issue: The Balance Between Production and Consumption of Fluid Milk Products As noted, the finding analysis regarding the price calculation simultaneously accounts for the level required to ensure the region's local supply of fluid milk products and the amount needed to cover cost of production. Section 9(e) of the Compact specifically requires the Compact Commission to consider the balance between production and consumption of milk and fluid milk products in the regulated area. Inquiry under this issue assisted the Commission in determining whether the region presently is being supplied locally or has become dependent upon supply from distant sources, notwithstanding any present price disparity between cost of production and the pay price. This understanding allowed the Commission to determine the degree to which price regulation is needed to sustain current, sufficient, local supply, and the degree to which it is also needed to encourage and ensure new and added local supply. According to data, the six state, New England, region draws approximately seventy percent of the raw product supply needed for the consumption of all milk products, fluid and manufactured, from New England farmers. The total volume of milk supplied for the region is approximately five billion pounds. The predominant remainder is supplied by New York farmers, who have traditionally made up a substantial portion of the New England milkshed. Less than three percent of the raw milk supply for the New England market is produced outside of the six state/New York milkshed. According to the Market Order statistics, approximately fifty percent of this raw product milk supply is processed for consumption as fluid, or drinking milk, in the New England region. The raw product supply for this in-region fluid production and consumption draws from both the New England and New York farmers comprising the New England milkshed. At present, approximately 98 percent of the fluid milk products consumed in the region are produced by fluid processing plants located in New England. The remaining two percent of fluid milk consumption is supplied by packaged milk products imported by plants nearby to New England. A small percentage of the in-region fluid production is similarly exported for consumption in the immediate areas adjacent to New England. The Market Order statistics also describe with particularity that the remainder of the raw product milk supply is processed within New England into manufactured dairy products. In contrast to fluid milk products, these manufactured dairy products are consumed both within and outside the New England region. It is universally understood that the same raw product supply can be used for both fluid, processing and manufacturing purposes. Given this substitutability, and assuming reliance upon farmers in New York State as part of the milkshed, the Commission concludes that New England is, overall, presently in stable balance of regional production and consumption of fluid milk products. At the same time, the Market Order statistics describe a marked decline in production over time in every individual New England state except Vermont.\57\ --------------------------------------------------------------------------- \57\ See also New England Agriculture statistics, submitted by William Zweigbaum, A/C 3/31/97. Receipts of Milk From Producers, By States [Thousand Pounds] -------------------------------------------------------------------------------------------------------------------------------------------------------- Year CT Me MA NH NY RI VT All States -------------------------------------------------------------------------------------------------------------------------------------------------------- 1985............................................ 594,785 345,956 540,143 338,028 1,284,015 39,722 2,256,595 5,399,244 1986............................................ 574,279 333,124 506,773 343,806 1,280,331 36,912 2,266,222 5,341,447 1987............................................ 541,118 293,373 450,524 301,738 1,313,635 36,198 2,236,238 5,172,824 1988............................................ 515,512 262,059 418,055 281,403 1,391,994 34,490 2,214,116 5,117,629 1989............................................ 502,716 217,437 400,105 268,453 1,388,680 29,651 2,167,758 4,974,803 1990............................................ 494,619 216,586 407,704 280,201 1,455,463 29,805 2,229,961 5,114,341 1991............................................ 504,516 253,383 412,990 294,185 1,545,890 30,056 2,268,174 5,309,194 1992............................................ 525,702 260,759 427,407 307,159 1,560,245 28,853 2,367,566 5,477,691 1993............................................ 504,282 288,776 424,836 310,463 1,443,447 28,266 2,345,423 5,345,493 1994............................................ 491,495 296,500 398,271 299,911 1,283,684 27,161 2,301,044 5,098,521 1995............................................ 487,493 346,443 400,501 314,610 1,417,034 28,536 2,375,518 5,370,135 1996............................................ 457,230 388,684 388,227 312,293 1,459,469 26,850 2,350,348 5,383,101 -------------------------------------------------------------------------------------------------------------------------------------------------------- Source: New England Market Order Administrator's Statistical Summaries. Milk Marketed by Producers: Sold to Plants and Dealers: by State [Million Pounds] -------------------------------------------------------------------------------------------------------------------------------------------------------- YR CT ME MA NH RI VT Total NE -------------------------------------------------------------------------------------------------------------------------------------------------------- 1986......................................................... 575 670 535 362 36.0 2405 4583.0 1987......................................................... 540 654 480 314 36.0 2370 4385.0 1988......................................................... 515 620 437 296 35.0 2350 4253.0 1989......................................................... 500 585 422 286 30.0 2295 4118.0 1990......................................................... 495 590 436 297 30.2 2330 4178.2 1991......................................................... 505 600 440 313 33.4 2370 4261.4 1992......................................................... 526 623 454 328 32.3 2474 4437.3 1993......................................................... 527 645 452 320 31.9 2470 4445.9 1994......................................................... 514 621 431 308 31.2 2422 4327.2 1995......................................................... 508 625 426 322 32.1 2507 4420.1 -------------------------------------------------------------------------------------------------------------------------------------------------------- Source: MILK: Annual Quantities Used and Marketed by Producers, 1986-1995 New England Agricultural Statistics, 1995-1996. [[Page 23040]] This statistical picture of decline is further corroborated by the previously cited testimony of Smith and Baron. According to Smith, ``The number of dairy farms in New England declined by 41% over the past 10 years. (1985-1995) During this period the number of cows has declined by 24%, total production has declined 4% and land used in farms fell by nearly 600,000 acres.'' \58\ According to another commenter, New England has lost dairy farmers at a rate of about 40% faster than the national average, between 1987 and 1992.\59\ --------------------------------------------------------------------------- \58\ Smith, 12/17/96 HT at 34. \59\ Barron, 12/17/96 HT at 60. --------------------------------------------------------------------------- According to statistics cited by another commenter, problems are especially severe in the southern portion of the Compact region. Massachusetts, the most populous state, has seen the greatest effect, showing a 35% decline in cow numbers and a 20% decline in milk production during the period of 1986 through 1995. Each of the two other southern New England states, Connecticut and Rhode Island, have also shown substantial declines in farms, cow numbers and production.\60\ --------------------------------------------------------------------------- \60\ See New England Agricultural Statistics, 1995-96, USDA, Page 68. --------------------------------------------------------------------------- Another commenter indicates that milk production in New York state, the supplemental portion of the New England milkshed has also declined. Citing USDA statistics, this commenter states that ``New York milk production was down 4 percent in February 1997 compared to one year ago.'' \61\ --------------------------------------------------------------------------- \61\ Wellington et al, 3/31/97 AC at 6. --------------------------------------------------------------------------- This commenter also indicates that the milkshed has expanded in area as production closer to the production centers has declined: The milk supply area for the New England market has steadily increased over time as dairy farmers in the region have gone out of business. When the New England Order was promulgated more than twenty years ago, the supply area, or milkshed, covered all the six New England states and a dozen or so eastern New York counties. Recent information provided by the Market Administrator's Office shows that the New England market now receives milk from thirty four New York counties as far west as Ontario County. Ontario County is about 360 miles distance from Boston. This distant milk is primarily needed to satisfy the daily Class I needs of New England bottlers during the peak demand period in late summer and fall when schools go back into session and milk supplies are seasonably at their lowest level. The New England milkshed has increased in size by approximately 10 miles.\62\ \62\ Wellington et al, 3/31/97 AC at 6. --------------------------------------------------------------------------- From the comment and statistics, therefore, the Compact Commission concludes that production and consumption in New England, though presently in balance, are operating in a balance that is under tremendous stress. The supply most local to the population centers, or that provided by southern New England farms, has been greatly diminished and is in fact disappearing. Production at the outer reaches of the milkshed has been able to replace this loss of the most local supply. Yet this more distance supply is itself under stress and is in fact in decline, causing the outer boundaries of the milkshed to be expanded. The Compact Commission consequently concludes that the present stress on the balance between the region's production and consumption must be relieved if the region is to continue to be provided an adequate, local supply of fluid milk. The Commission concludes that the present balance likely will not be maintained and could soon begin to significantly erode, which would threaten the region's supply, if the stress is not relieved. To ensure a continuing balance, the present, local supply must at least be stabilized, if not increased. Furthermore, the present, distant supply itself must be stabilized as well, to ensure that the milkshed does not reach further west. D. Summary Analysis of Costs of Production and Sufficient Price Based on this summary of comment and analysis under issues (1), (2) and (3) above, the Commission concludes the chronic loss of dairy operations in the region, and thereby the stress on the region's local supply of milk, is a direct result of the volatility of farmer milk prices and their chronic insufficiency, including the failure of prices to adjust for inflation. The Commission further concludes, accordingly, that price regulation is necessary to address the chronic pricing problems and to continue the assurance of an adequate, local supply of milk for the region. Price Volatility, Cost of Production and Chronic Insufficiency of Price, and the Failure of Price To Adjust for Inflation 1. Price Volatility The concern with price volatility is described in detail above. The Commission concludes that this price volatility can and should be addressed directly by Compact Over-order price regulation. Compact Over-order price regulation can minimize and even eliminate price volatility by establishing a level, Class I, floor price that combines the Federal Order minimum price with a ``floating'' Over-order price. Such a combined floor price will serve to eliminate the volatile swings in federal Class I pricing. More specifically, the precise amount of the ``floating'' component of the Compact Over-order Price Regulation will be the difference in amount between the federal, regulated, price that is announced monthly and the amount of Compact Over-order Price Regulation itself. As explained below, the Commission is adopting a combined, federal Order and Compact Over-order, Class I price of $16.94 (Zone 1). The ``floating'' or ``Over-order'' component of the Compact price regulation will be the difference between the announced Federal Order, Class I, Zone 1 price for each month and $16.94. 2. Cost of Production and Chronic Insufficiency of Price The evidence in the record suggests that the costs of production in the New England states, within the meaning of the required finding, is best defined as a range. The Compact Commission draws this conclusion for two reasons. First, both the farm testimony and that of the region's dairy economists indicates that costs of production vary from farm to farm. Second, the testimony of the dairy economists themselves define a wide range of values. The range presented in their study data varied widely, between approximately $13.50 and $17.24 per cwt. Leon Berthiaume testified that costs of production among members of a substantial Vermont cooperative ranged from $13.50-$14.25; on behalf of the Vermont Department of Agriculture, Reenie De Gues testified that Vermont production costs were $14.06; University of Vermont economist Rick Wackernagel testified that costs were at $15.00; Neil Pelsue testified of costs equaling $16.41; Bob Smith described costs of $15.37; The Economic Research Service provided an estimate of at $16.46; Milligan and Knoblauch concluded that production costs were as high as $17.24. These variances can be explained by several factors, including the different time frames surveyed, the different data relied upon, and the different costs included in the survey evaluations. Despite the recognized, inherent, limitations resulting from this variability, this data base is still most comprehensive, and allows the Commission to settle upon a range of cost of production that is most reliable. To establish its range, the Compact Commission has referred to the above series of summary numbers and eliminated the high and low values. The [[Page 23041]] Compact Commission then matched this range against the variety of anecdotal statements presented by dairy farmers in testimony and comment. Accordingly, the Compact Commission determines that, for purposes of analysis under this rule, the range of New England cost of production is reliably understood to be somewhere between $14.06 and $16.46 per cwt. As described earlier in detail, the data, comment and testimony received demonstrated overwhelmingly that New England farmer pay prices are and have been chronically below this defined range of cost of production. The Compact Commission further concludes that the amount of this insufficiency is also best described as a range. As described earlier, the USDA Economic Research Service estimate that during the 1985 to 1990 period, cash receipts of Northeastern dairy farmers rose from $13.96 to $16.00 per hundredweight while the cost of production increased from $12.06 to $16.46. This describes a deficiency in price range of $1.90-$0.46. Vermont Department of Agriculture economist Reenie De Geus provided testimony indicating that: In 1995, the most recent year, costs of production averaged $14.06 for the group. (Vermont Dairy farmers) This is $0.83 lower than the actual milk prices received of $13.23. In fact, in each of the last 5 years, milk price received was lower [sic] than the cost of production by an average of $1.08.\63\ \63\ De Geus, 1/2/97 WC at 74. --------------------------------------------------------------------------- Using the figures here identified, the Commission accepts this comment and concludes that cost of production exceeds farmer pay price by an amount in the range of $0.46-$1.90. As cited earlier, Ms. De Gues provides some context for this apparent range in deficiency: In good years, we find that the cost of production tends to rise with the price of milk. With the extra cash farmers replace worn out equipment and make repairs that may have been delayed for years. When the price of milk drops below cost, they consume some of the equity in their farms to meet family living expenses and cash flow demands.\64\ --------------------------------------------------------------------------- \64\ De Geus, 1/2/97 WC at 75. --------------------------------------------------------------------------- 3. Adjustment for Inflation--Determination of Specific Price Amount and Formula As described earlier, the chronic insufficiency in price can be traced to a number of sources. The Compact Commission has determined that the single most readily identifiable basis of price insufficiency is the failure of farm prices to adjust to inflation over time.\65\ Given this readily apparent concern from the hearing record, in the subsequent Notice of Comment, the Compact Commission specifically sought comment as follows: --------------------------------------------------------------------------- \65\ The Commission here specifically notes the determination of Professor Wackerngel's analysis regarding the significance of inflation. Wackernagel, 1/2/97 WC at 473. The Commission is considering a possible Compact over-order price regulation that will be based, at least in part, on an adjustment for inflation to the Class I, fluid milk price, over time. The Commission seeks comment on the advisability of such an approach, as well as possible methodologies for determining the impact that such an adjustment would have on the Class I, fluid milk price, over time.\66\ --------------------------------------------------------------------------- \66\ 62 FR 12252. --------------------------------------------------------------------------- In response, the Commission received a combined comment from Reenie DeGeus and Bill Gillmeister, dairy economists for the Vermont and Massachusetts Departments of Agriculture, respectively, providing a detailed analysis on this point. They proposed a one-time adjustment of the Class I price, (Zone 1) using 1991 as the base year for the adjustment. They proposed using the 1990 CPI as the base index, given that the Compact expressly uses this base year for adjusting the cap on its regulatory authority. See Compact Section 9(b). They suggest further using the CPI-U Boston as the appropriate, more local indicator of the inflation factor. This equation yields a Class I, Zone 1 price of $16.94 per cwt. for 1997. The Commission accepts the recommendation of these two state agriculture department economists. 1991 is a reasonable year to use for the historic period; 1991 prices were markedly low, following an historic year of high prices. This erratic fluctuation in prices was of similar type to the recent swing of November, 1996-January, 1997, and thus provides a recent and analogous, relevant time period for the inflation adjustment. In addition, as the commenters note, using the low point, 1991, of this last pricing cycle ensures that the inflation adjustment will be appropriately limited. Wellington, et al. also submitted comment in response, indicating concern with the use of an automatic inflation adjustment. They indicated that inflation must be accounted for as a dynamic factor of retail prices as well as farmer cost of production. They indicated that the price regulation, including all relevant factors, should be assessed every six to twelve months, rather than made to adjust to a single static indicator.\67\ --------------------------------------------------------------------------- \67\ Wellington et al at 11. Another commenter expressed similar concern. See Vetne, 12/19/96 HT at 269. --------------------------------------------------------------------------- The Compact Commission accepts this comment, as well. The Commission agrees that the inflation adjustment should not serve as the single, permanent, function of price adjustment. Rather, it serves as the initial, limited, regulatory response to the defined chronic market problems of price insufficiency and volatility. The Compact Commission further agrees that the overall price regulation adopted by this rule must be revisited after the passage of some time rather than imposed permanently. As discussed throughout this summary of comment, the Commission has determined that the duration of the rule will be six months. This will allow the Commission to assess again the broader market circumstances in the manner contemplated by the commenters. Accordingly, the Compact Commission has adopted the price/inflation adjustment presented by DeGues and Gillmeister, which accounts for this six month duration of the rule. Given that this six month period will be from July-December, 1997, the Commission adopts their calculation of price, adjusted for inflation for 1997, of $16.94 (Zone 1). The Compact Commission recognizes that this price level, in itself, will not be sufficient to cover the defined range of deficiency between current farmer pay prices and cost of production. The Commission expects instead the combined benefits of price enhancement and stability to result in the positive impact on the region's milk supply, as contemplated by the finding analysis under this section. The Commission here expressly refers to and relies upon the analysis of Professor Wackernagel, which assessed the impact on profitability of a Class I price of $16.89 (Zone 1) ($16.17 Zone 21). The price analyzed is thus directly in line with that adopted by the Commission. According to this analysis, farms operating in such a stabilized pricing environment would remain under stress financially, but would show some improved financial performance, able to operate at low to modest levels of profitability.\68\ --------------------------------------------------------------------------- \68\ Wackernagel, 1/2/97 WC at 473. --------------------------------------------------------------------------- The Commission, again, concludes that this price level is the appropriate, initial increment to establish, for the defined period of six months. This initial, limited duration of the regulation will allow the Commission [[Page 23042]] soon to revisit again the issues raised by this finding analysis. For that next time, The Commission's inquiry will have the benefit of the performance of the existing price regulation. Such a record will aid the Commission's analysis. II. Finding Whether the public interest will be served by the establishment of minimum milk prices to dairy farmers under Article IV. The Commission referred to the Compact's express Statement of Purpose in determining the intended meaning of ``public interest'', as used in this finding. The Statement of Purpose declares at the outset that: The mission of the commission is to take such steps as are necessary to assure the continued viability of dairy farming in the northeast, and to assure consumers of an adequate, local supply of pure and wholesome milk. The participating states find and declare that the dairy industry is the paramount agricultural activity of the northeast. Dairy farms, and associated suppliers, marketers, processors and retailers, are an integral component of the region's economy. Their ability to provide a stable, local supply of pure, wholesome milk is a matter of great importance to the health and welfare of the region. Compact Art. I, Sec. 1. Section 9(e) of the Compact provides further guidance with regard to the intended meaning of ``public interest''. This section provides a concise but non-exhaustive list of criteria for the Commission to consider ``in determining the price''. Compact Art. IV Sec. 9(e). Pursuant to that section: [T]he commission shall consider the balance between production and consumption of milk and milk products in the regulated area, the costs of production including, but not limited to the price of feed, the cost of labor including the reasonable value of the producer's own labor and management, machinery expense, and interest expense, the prevailing price of milk outside the regulated area, the purchasing power of the public and the price necessary to yield a reasonable return to the producer and distributor. Based on the inclusion of this broad list of criteria, the Compact Commission determined that it must balance the interest of all market participants described by the Statement of Purpose--processors, retailers and consumers, along with farmers.\69\ This necessarily requires a broad inquiry, one that takes into account the common interest of all market participants in the maintenance of dairy farming in the region. --------------------------------------------------------------------------- \69\ Neil Marcus, President of Marcus Dairy, Inc. emphasized the importance of considering the impact of the Compact on all market participants in his testimony. See HT 82-83; 12/19 Marcus. --------------------------------------------------------------------------- The Compact Commission thereby identified four main components of the ``public interest'' contemplated by this Finding: (i) Assuring the continued viability of dairy farming in the region, (ii) assuring simultaneously the continued viability of associated suppliers, marketers, processors and retailers, (iii) benefiting consumers through the maintenance of an adequate supply of milk, reasonably priced, and (iv) maintaining a local supply of milk. Based on this definition of ``public interest'', the Commission sought comment on the following subjects and issues: (1) The balance between production and consumption in the region-- the pay price needed to yield a reasonable rate of return to producers and to ensure an adequate supply of milk for the region. (2) The prevailing farm prices for Class I, fluid milk, inside and outside the New England region, (3) The prevailing processing and wholesale costs for Class I, fluid milk, inside and outside the New England region, (4) The costs of transporting bulk fluid milk products to plants located within the New England region, (5) The costs of delivering fluid milk products processed outside the New England region to outlets within the region, (6) The purchasing power of the general public, (7) The elasticity of demand for fluid milk products, (8) The cost of retailing fluid milk products, (9) The prevailing retail prices for Class I, fluid milk, inside and outside the New England region, (10) The potential impact of a flat, combined, regulated, Federal Order and Compact Over-Order price on the wholesale market for fluid milk products, (11) The potential impact of a flat, combined, regulated, Federal Order and Compact Over-Order price on the retail market for fluid milk products, (12) The potential impact of a flat, combined, regulated, Federal Order and Compact Over-Order price on school lunch programs. (13) The potential impact of a flat, combined, regulated, Federal Order and Compact Over-Order price on the Women, Infants and Children Special Supplemental Nutrition Program of the United States Child Nutrition Act of 1966.\70\ --------------------------------------------------------------------------- \70\ See 61 CFR 65604; 62 CFR 12252. --------------------------------------------------------------------------- A. Issue: The Balance Between Production and Consumption in the Region--The Pay Price Needed To Yield a Reasonable Rate of Return to Producers and to Ensure an Adequate Supply of Milk for the Region This issue is the premise for the remaining discussion of the public interest in regulated milk pricing.\71\ The remaining discussion is triggered by the Compact Commission's determination that such farm price regulation is necessary, both to yield a reasonable rate of return to producers and to ensure an adequate, local, supply of milk for the region. --------------------------------------------------------------------------- \71\ As noted previously, this issue is raised specifically by Compact Section (e). --------------------------------------------------------------------------- This issue was previously addressed in detail in the previous finding section. In summary, the Compact Commission concluded that farmer pay prices must be enhanced, stabilized and adjusted for inflation. The Commission thereby determined that a flat, combined, federal Class I and Compact Over-Order Price Regulation in the amount of $16.94 (Zone 1) per cwt was necessary to accomplish these objectives. B. Issue: Prevailing Farm Prices Inside and Outside the New England Region Compact Section 9(e) provides specifically for consideration of this issue. Mailbox price statistics allow for a determination of present comparison of milk prices in adjacent markets. The following chart submitted as part of a written comment describes these comparative prices.\72\ --------------------------------------------------------------------------- \72\ Wellington et al, 3/31/97 AC appendix. [[Page 23043]] Mailbox Milk Prices for Selected Federal Milk Orders [Dollars per hundredweight] ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ 1995 ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ New England................................................. $11.83 $11.86 $11.98 $11.93 $11.92 $11.39 $11.35 $11.71 $11.88 $12.42 $13.14 $13 NY/NJ....................................................... 12.00 12.02 12.14 11.88 11.82 11.45 11.39 11.74 12.01 12.61 13.17 13 Middle Atlantic............................................. 12.15 12.07 12.06 11.83 11.86 11.50 11.60 12.14 12.26 12.82 13.50 13 ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ 1996 ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ New England................................................. 13.38 13.23 13.14 13.08 13.49 14.08 14.77 15.00 15.55 15.83 15.37 14 NY/NJ....................................................... 13.44 13.29 13.18 13.16 13.70 14.10 14.82 15.05 15.68 15.68 14.82 13 Middle Atlantic............................................. 13.57 13.27 12.86 12.76 13.41 14.40 15.07 15.49 16.05 15.84 15.55 14 ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Source: Exhibit Co-op #1C & #1D, Additional Comment as submitted by Robert Wellington, on behalf of Agri-Mark Dairy Co-op, St. Albans Co-op Creamery, & Independent Dairymen's Co-op. [[Page 23044]] From this chart, it can be seen that 1995 mailbox prices for the New England market were consistently less than those for the New York- New Jersey and Middle Atlantic markets, but by relatively small amounts. This data further indicates that prices throughout the three- market area are presently in relative alignment. C. Issue: Costs of Transporting Bulk Fluid Milk Products to Plants Located Within the New England Region As made clear by comment received, and based on common knowledge, the cost of transporting bulk fluid milk products is most significant to the calculation of the cost of the delivered raw product to the processing plant, because of the significant expense involved. It is thus a critical input of the wholesale and, hence, the retail price.\73\ --------------------------------------------------------------------------- \73\ The broader issues of impact on the wholesale and retail markets are analyzed at the end of this finding section. --------------------------------------------------------------------------- According to Wellington et al, ``[d]ue to its bulkiness, milk is expensive to transport. Back haul opportunities to lower transportation costs are also more limited with milk due to its sanitary standards and large volume which moves on a daily basis.'' \74\ --------------------------------------------------------------------------- \74\ Wellington et al, 3/31/97 AC at 4. --------------------------------------------------------------------------- According to the reported statistics, the regulated price itself accounts for the transportation costs of raw fluid milk supplies. Market Order #1 establishes a zone differential to account for this transportation cost. This differential is established per cwt. in an amount equal to 3.6 cents per ten miles transported. According to Wellington et al, this rate has not changed since 1982. Market Order #1 uses zone 21 as the representative zone for farm pricing. 7 CFR 1001.50(a). This zone is 210 miles from the Boston, or city, zone. 7 CFR 1001.52(d). The cost of transportation from this representative zone 21 to the city, zone 1, is 72 cents per cwt. 7 CFR 1001.52(g). Further, according to Wellington et al, a 1994 consolidation of federal orders in the southern market established a rate of 3.9 cents/ cwt per ten miles transported. There is no explanation as to whether the higher rate for the new southern order better reflects costs in the Northeast, although that is the inference, or whether the higher cost is attributable to market conditions in the south. The comment does identify with specificity a higher cost of transportation for the Agri- Mark cooperative, which represents approximately half of all New England farmers. This cost is represented as 4 cents/cwt for each ten miles transported. D. Issue: Prevailing Processing and Wholesale Costs for Class I, Fluid Milk, Inside and Outside the New England Region This issue is significant because processing and delivery are the only intermediate stops in the commercial channel for milk between farm and retail outlet other than transport of the raw supply. The delivered cost to the retail outlet can thus be determined as a function of a relatively few variables. Although the Compact Commission requested comment on this issue, it did not receive data regarding processing and wholesale costs specific to the New England market. While two of the fluid milk processors doing business in the New England market did submit comment,\75\ along with a trade organization from New York state,\76\ none of these comments presented data with regard to costs of operation. --------------------------------------------------------------------------- \75\ Neil Marcus on behalf of Marcus Dairy, 12/19/96 HT at 81 and 1/2/96 AC; Donald Turner, Turner's Dairy, 12/19/96 HT at 176. \76\ Bruce Krupke on behalf of New York State Dairy Foods, Inc. 3/31/97 AC; John H. Vetne, on behalf of New England Dairies, Inc. 3/ 31/97 AC. --------------------------------------------------------------------------- A very recent and comprehensive national study of 35 plant operations submitted by a group of dairy economists from Cornell University provides useful guidance to the Commission on this issue. R. Aplin, E. Erba, M. Stephenson, ``An Analysis of Processing and Distribution Productivity and Costs in 35 Fluid Milk Plants'', February 1997, R.B. 97-03, Cornell University. The study is particularly useful because fourteen of plants studied, though unnamed, are identified as being located in the Northeast. The study indicates that the processing and wholesale costs for Class I milk are a function of three variables: (1) the procurement cost for the raw product supply, in significant part, combined with (2) processing, delivery and sales costs for servicing the retail outlet, and (3) return on capital. An extract entitled ``Presentation at IDFA Annual Meeting in Dallas, Texas (October 1996) was also submitted. This extract provides ``estimated costs of marketing 2% lowfat milk through supermarkets, New York Metro Area, $ per gallon, 1995.'' In this extract, the raw product cost is identified as $1.31 per gallon. (This is in line with the net combined regulated and ``over-order'' Class I price for the New England market.) According to the study, there is an additional plant cost of $0.24 per gallon and a package cost of $0.10 per gallon. There are additional delivery, selling and general and administrative costs, totaling $0.22. Finally, the extract identifies a return for cost of capital in the amount of $0.06. The study thus identifies a total, delivered, processing and wholesale cost of $1.93 per gallon. The Economic Research Service of the United States Department of Agriculture also provides a breakdown of wholesale costs, nationally, per half gallon.\77\ According to this study, for 1992, the farm value was $0.597; assembly and procurement totaled $0.058; the processing cost was $0.191; and wholesaling costs were $0.196. Total costs per half-gallon equal $1.042 according to this ERS study. For comparison purposes, assuming equal costs per gallon as the costs per half gallon in the study, this would mean a total delivered cost of $2.08 per gallon, or $0.15 more than shown in the Aplin study. --------------------------------------------------------------------------- \77\ Food Cost Review, 1995/AER-729. (Submitted as reference source by DeGuess and Gilmeister, 3/31/97 AC.) --------------------------------------------------------------------------- The ERS study further notes that ``processing costs have remained stable since 1986 (through 1992), after rising 16 percent from 1982 through 1986.\78\ --------------------------------------------------------------------------- \78\ AER 726 at 26. --------------------------------------------------------------------------- Both the Aplin study and extract, and the ERS study, indicate that processing plants are covering their margins. The Aplin extract also provides a precise indicator of the ``return for cost of capital.'' This amount is identified by the extract as $0.06, or only a three percent return. E. Issue: Costs of Delivering Fluid Milk Products Processed Outside the New England Region to Outlets Within the Region This issue is significant for two reasons. First, these identified costs complete the description of delivered cost to the retail outlet. Second, the issue inquires into whether finished, Packaged milk products transported from plants located away from the region's population centers can serve as a substitute supply for the finished product provided by more local plants. The Compact Commission requested but did not receive data regarding packaged product delivery costs specific to the New England market. The Cornell University study cited above \79\ sheds light on this issue. According to the study, costs of delivery for packaged fluid milk products range from $0.216 to $0.541 per case, with an average cost of 38.8 cents per case, or about $0.097 cents per gallon. (There are 4 gallons/case.) \80\ --------------------------------------------------------------------------- \79\ Aplin et al, R.B. 97-03, Cornell University, February, 1997. \80\ Aplin et al at 21. --------------------------------------------------------------------------- [[Page 23045]] With regard to the possibility of substitution of packaged milk supply, as discussed in the first finding analysis, the Market Order statistics makes clear that the major processing facilities servicing the New England region are currently located nearby the population centers of the region they serve. These plants currently provide for almost all of the market's supply of finished product. At present, then, there is almost no substitution for this local supply of finished packaged product with finished product imported from distant plants. The detailed analysis of the Aplin study provides insight into this settled market pattern. Cost of operating a delivery vehicle contributed an average of 43 percent of the delivery cost per case. The remainder of the cost is attributable to driver labor cost. (Vehicle operating cost ranged from 21 percent to 53 percent. \81\ The study further indicated that these costs were for routes serving large customers, and that route costs for serving smaller customers ``is expected to be much higher.'' --------------------------------------------------------------------------- \81\ Aplin et al at 48. --------------------------------------------------------------------------- Most significantly, route labor productivity was shown by the study to decrease substantially with greater distance traveled and on routes with numerous customer stops. A 1.0 percent increase in miles traveled per month increased direct delivery cost by 2.9 percent per case. A 1.0 percent increase in customer stops made per month increased the cost by 1.1 percent per case. Not surprisingly, the study concludes that plants located in more densely populated areas had lower direct delivery costs.\82\ --------------------------------------------------------------------------- \82\ Aplin et al at 54 --------------------------------------------------------------------------- This delivery cost analysis of the Cornell study thus explains the present market pattern: Plants located near population centers are the most cost effective. According to this pattern, the market should continue to consist of plants located nearby the population centers, plants which are supplied with raw product from the milkshed and which in turn provide finished product to the region's retail outlets. F. Issue: The Price Needed to Yield a Reasonable Rate of Return to Processors of Fluid Milk Products This inquiry is derived directly from Section 9(e) of the Compact and is significant in view of the Compact's emphasis on the financial health of the entire dairy industry. The focus of the inquiry is the determination of a price that ensures a reasonable rate of return. It is of present significance for the baseline determination of whether processing plants are currently covering costs of production. The Compact Commission did not receive information with regard to the price required to yield a reasonable rate of return specifically to New England fluid processors. According to the extract of the Aplin et al, Cornell study cited above, return for cost of capital for the nearby New York metro area plant equaled $0.06 per gallon. The Compact Commission concludes that this data may be relied upon to determine that the region's fluid processors are presently covering their costs with a return on capital, however slight. As noted, the Aplin study was a number of nationally representative fluid plants, of which fourteen were from the Northeast. It is reasonable to assume that a representative number of these region-wide plants in turn were from the New England area, and that the extract chosen by the authors may be understood as representing this group as a whole, including New England plants. G. Issue: The Purchasing Power of the General Public This inquiry is also drawn directly from Section 9(e) of the Compact. The Compact Commission concludes that the Compact focuses primary concern on the consumer interest because milk is a staple product. The impact of price regulation upon the consumer's ability to pay is thus a critical part of the Compact Commission's assessment of the public interest under this finding section. To sharpen inquiry under this broader issue, the Compact Commission sought comment on a number of issues relating to the potential impact of price regulation on consumers. These issues include: The elasticity of demand for fluid milk products, the costs of retailing Class I, fluid milk in the New England region, the prevailing retail prices for Class I, fluid milk, inside and outside the New England region, the cost of retailing fluid milk products, and the potential impact of a flat, combined regulated, Federal Order and Compact Over-Order price on the retail market for fluid milk products.\83\ --------------------------------------------------------------------------- \83\ See 61 CFR 65604; 62 CFR 12252. --------------------------------------------------------------------------- The Compact Commission also focused specific attention on the potential impact of price regulation on lower income consumers. Specifically, the Commission sought comment on the potential impact of a flat, combined, regulated, Federal Order and Compact Over-Order price on the Women, Infants and Children Special Supplemental Nutrition Program of the United States Child Nutrition Act of 1966, and the impact of such a price on the school lunch program.\84\ --------------------------------------------------------------------------- \84\ See 61 CFR 65604; 62 CFR 12252. --------------------------------------------------------------------------- Each of these issues is addressed in turn. H. Issue: The Elasticity of Demand for Fluid Milk Products Citing recent studies, Wellington et al identify the demand coefficient for fluid milk as 3.1. This means that a ten percent increase in price will result in a 3.1 decrease in demand.\85\ --------------------------------------------------------------------------- \85\ Wellington et al, 3/31/97 AC. --------------------------------------------------------------------------- In response to this comment, Thomas Conway, Esq., former Counsel and former Executive Director of the New York State Legislative Commission Dairy Industry Development, submitted a study of ``Consumer Response to the Unprecedented Rise in the Retail Price of Fluid Milk in 1989-1990'' (Consumer Response).\86\ This study focused on the actual impact on consumption of a relatively large increase in retail milk prices during late 1989 and early 1990. --------------------------------------------------------------------------- \86\ New York State Legislative Commission of Dairy Industry Development, August, 1990. --------------------------------------------------------------------------- The study group was of four regions, including the Northeast. During this time, the price of milk rose to $2.67 a gallon, a $0.34 increase. Directly contrary to the traditional analysis of the elasticity of demand for milk, consumption actually increased rather than decreased in two of the regions studied. In the Northeast, the 15.04 percent price increase in the Northeast was matched by lower sales of only 0.98, or well below that expected based on any of the demand coefficients identified above. The study concludes ``that other factors were more important than price to the determination of consumer demand for fluid milk''.\87\ Other factors included growth in personal income, demographic factors, advertising and increased concerns over health and nutrition. --------------------------------------------------------------------------- \87\ Consumer Response at 11. --------------------------------------------------------------------------- While this study is now dated, the Compact Commission accepts its basic premise that analysis of the impact must account for the market function as a whole, rather than focus upon a strict elasticity of demand equation. Nonetheless, the Commission remains aware of the importance of accounting for the direct impact on consumption that an increase in retail prices may have. I. Issue: Costs of Retailing Class I, Fluid Milk in the New England Region The Commission did not receive comment with specific regard to New England costs of retailing. As noted, the [[Page 23046]] Aplin et al, extract of the Cornell study identified a total delivery cost of $1.93. Adding an identified supermarket cost and return of $0.19 establishes for this extract a retail cost of $2.12. The ERS study identified a total delivered cost of $1.04 and a retailing cost of $0.35, for a total retail cost $1.39 per half gallon. The retail cost component for the ERS study is substantially higher than that for the Aplin study. The ERS study indicates part of this cost may represent wholesaling formerly performed by processors, which would explain at least part of the difference. The Commission concludes that the more recent Cornell extract provides a useful benchmark for assessing New England costs of retailing. J. Issue: Prevailing Retail Prices for Class I, Fluid Milk, Inside and Outside the New England Region There are two significant concerns raised by this issue. First, the inquiry addresses the benchmark question of whether retail margins are covering costs, much as the earlier inquiry addressed whether processor margins were sufficient to cover costs. Second, the inquiry must consider the relative retail costs beyond the area subject to Compact Over-order Price Regulation, as part of the ongoing process of assessment of the potential impact of price regulation on the region's retail prices. James G. Hines, Director of Dairy Services, submitted for the record copies of the tracking studies of retail prices conducted by The International Association of Milk Control Agencies. The Association tracks and publishes monthly price surveys from a number of markets nationwide. The following is an extract from three markets: [[Page 23047]] Retail Prices--Different Markets [1995-1996] ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Jan. Feb. Mar. April May June July Aug. Sept. Oct. Nov. Dec. ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ 1995 ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ MA (Boston)................................................. $2.49 $2.09 $2.49 $1.99 $2.29 $2.39 $2.39 $2.49 $2.49 $2.49 $2.09 $2.49 NY (Albany)................................................. 2.18 2.18 2.18 2.16 2.16 2.15 2.17 2.17 2.17 2.17 2.19 2.23 NJ (North).................................................. 2.55 2.56 2.53 2.53 2.53 2.53 2.54 2.53 2.52 2.55 2.56 2.57 ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ 1996 ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ MA (Boston)................................................. 2.19 2.29 1.99 2.49 2.59 2.29 2.59 2.59 2.29 2.59 ......... ......... NY (Albany)................................................. 2.23 2.23 2.25 2.26 2.25 2.32 2.4 2.42 2.42 2.46 ......... ......... NJ (North).................................................. 2.56 2.57 2.59 2.59 2.58 2.58 2.65 ......... 2.67 2.67 ......... ......... ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Source: International Association of Milk Control Agencies. [[Page 23048]] The Aplin et al extract identified a total, delivered cost of $1.93, and a total retail cost of $2.12, including combined retail cost and return on capital. The Compact Commission concludes from this survey of prices that, as measured against their identified delivered cost, New England retailers are currently covering their costs of production with an adequate return on capital. The Commission further concludes that this on-going Agencies' study of markets both within and outside the New England region provides the basis for the Commission to monitor the impact of regulation on New England retail prices. The Commission will be able to utilize this study data and compare the current, relative alignment in prices between the New England and New York regions against the relative alignment once price regulation is in place.\88\ --------------------------------------------------------------------------- \88\ Retail prices are also being monitored currently in Connecticut, Vermont and Maine. The Commission will have to establish a tracking program in Rhode Island. --------------------------------------------------------------------------- K. Issue: The Potential Impact of a Flat, Combined, Regulated Order and Compact Over-Order Price on the Wholesale Market for Fluid Milk in the Region The purpose of this most critical inquiry is to address the potential impact on the wholesale market of price regulation. Commenters described a number of potential concerns and potential benefits. The benefits described were premised on the value of price stabilization. The concerns raised related to the potential for market distortion and competitive harm to current market participants. In reply comment, Berthiaume \89\ described the benefit of a stabilized pricing as imposed by this rule. He indicated that Compact Over-order price regulation would bring stability to the regulated Class I price, and not merely as a floor price. ``The value of a flat regulated minimum Class I price is that the wholesale cost of milk would and could be anticipated.'' --------------------------------------------------------------------------- \89\ Berthiaume, Reply comment; April 8, 1997 (RC). --------------------------------------------------------------------------- The Commission agrees with this statement and adopts it as a finding with respect to this issue. As discussed above, farm prices have been marked by persistent, erratic fluctuations which translate directly into the wholesale price. The Commission concludes that, while processors are currently covering their margins, minimization of such persistent fluctuations in price can only serve as a benefit to stability of firm participants in the wholesale market. Other commenters expressed concern about the potential for market distortion which price regulation could bring. Wellington et al expressed a concern that price regulation could distort the traditional, market driven, pattern of raw product supply provided by New England and New York farmers. The concern raised is that the Compact Over-order price regulation could create an incentive for increased milk supply from more distant portions of the milkshed in New York. This would represent a market distortion directly contrary to the intended purpose of the Compact. These commenters qualified their concern by noting that processors ``will be reluctant to disrupt their current supply sources in reaction to a Compact program which is officially of limited duration.'' \90\ In his testimony at the hearing, Wellington also stated his opinion that such market change was not likely to occur as long as the Commission did not increase the regulated Class I price above $17.00.\91\ --------------------------------------------------------------------------- \90\ Wellington et al, AC 3/3197 at 6. \91\ Wellington, 12/19/97 HT, pages 50-51. --------------------------------------------------------------------------- Neil Marcus, President of Marcus Dairy, Inc., described other potential market distortions that could result from price regulation. His concerns also centered on the alignment of a market subject to combined, Compact, and Federal Order regulation with adjoining markets regulated only under Federal Order.\92\ The particular circumstances of the Marcus Dairy operation heightened his concern. According to the commenter, Marcus Dairy is located in Connecticut, on the border of New York. The commenter described the supply of packaged dairy products subject to price regulation under Federal Order 2 which is sold in New England and expressed concern that this milk must not escape regulations under the Compact. According to Marcus, such uniform regulation is necessary to ensure that the current, market, pattern of the supply of packaged product in the marketplace is maintained. --------------------------------------------------------------------------- \92\ Marcus, 12/19/96 HT at 84-98. --------------------------------------------------------------------------- The Commission concludes that market alignment of prices and uniformity of regulation must be considered in establishing over-order price regulation. Present market patterns within the region and between the region and adjacent areas are derived from the integrated formula of Class I pricing in the federal Market Order System, which includes pricing under more than one federal Order. There is no doubt the Compact will introduce a new feature of market structure by adjusting the Class I price, in effect, for only one Order. At the same time, even given that the Compact will introduce a novel feature of market structure, the Commission does not determine that market distortion will necessarily occur. The technical provisions of the Compact Over-order price regulation are precisely patterned upon the underlying federal Order System in significant part. This provides a structural basis for concluding that such distortion should not occur. Nonetheless, the concerns raised by the commenters with regard to the potential for market distortion were a central consideration in the Commission's deliberations over price regulation. These concerns were also a controlling factor in the Commission's fashioning of the six months', limited duration, for the initial price regulation. The Commission here specifically notes Wellington et al's assertion that a ``limited duration'' of price regulation will minimize the potential for distortion of the market caused by the Compact Commission's initial price regulation. L. Issue: The Potential Impact of a Flat, Combined, Regulated Federal Order and Compact Over-Order Price on Retail Prices for Fluid Milk Products The Compact Commission sought comment on the critical issue of the potential impact, if any, of a flat, combined, regulated Federal Order and Compact Over-order price on retail prices for fluid milk products. After reviewing all of the comments and testimony submitted, the Compact Commission concludes that the price regulation will have a positive impact on retail prices. The Commission determines that preventing further erosion of the milkshed through price regulation will itself have a positive impact on retail prices, in large part because of the avoidance of increased transportation costs. The Commission concludes that the further benefits of price stability will trace through the farm and wholesale markets to the end-point, retail market, and have a further, positive impact on retail prices. The Commission bases its conclusion on the following analysis: 1. Change in the Epicenter of Milk Production and the Impact on Retail Prices The Compact Commission previously determined that there has been a distinct movement away over time of the epicenter of the region's milk supply. The loss of dairy farms in the New England region, and in particular, [[Page 23049]] in the Southern New England region, has forced the epicenter of the region's production further and further from the region's population centers. This movement has involved both the loss of supply by farms closest to the population centers and the replacement of that supply by more distant farms, primarily in New York and Vermont. The location of these more distant farms themselves, in turn, has moved ever father away from the region's population centers.\93\ --------------------------------------------------------------------------- \93\ The 1989 Massachusetts Extension Order, at page 14, cites testimony that the transportation costs for this most distant supply ``would currently run $2.00 to $2.50/cwt (17-22 cents/gal) and would require capital investments that few truckers would be willing to undertake.'' Extension Order at 14. --------------------------------------------------------------------------- This feature of the stressed circumstance of the region's milk supply described in the first finding analysis has had a direct, adverse impact on retail milk prices. The Commission bases this conclusion in part on the determination that transportation costs are a significant input of the retail price for milk. As noted, the federal Market Order System allows 72 cents per cwt to cover transportation costs from the representative ``country'' zone to the Boston, ``city'' zone.\94\ This single cost input, alone, accounts for over three percent of the total delivered cost to the retail outlet, when measured against the Aplin et al extract identification of $1.93 for delivered cost/gallon. (11.6 gallons per cwt). It follows, by definition, that an increase in transportation costs attributable to greater hauling distance will result in an increase in retail prices. --------------------------------------------------------------------------- \94\ The discussion, supra, of transportation costs indicates that this regulated calculation of cost does not fully account for the true cost. --------------------------------------------------------------------------- The Commission's conclusion is also premised on a similar finding contained in the December 29, 1989 extension of the Massachusetts Milk Stabilization Order. This Order found that a 50 mile shift in milk prices causes a three cent increase in milk prices. The evidence in the record thus demonstrates that the epicenter of the region's milkshed has moved away from the population center to a significant degree, and that this shift has had a measurable impact on retail prices. The Compact Commission concludes that this adverse impact on retail prices will continue as long as the milkshed is not stabilized. 2. Risk Avoidance in Commodity Purchasing--The Benefits of Price Stabilization Senator Patrick Leahy submitted extended comment referencing studies in the economic literature of the adverse effects of commodity price uncertainty and, conversely, the utility of price stability.\95\ One article described so-called ``risk avoidance'' pricing strategy in the wheat industry. The analysis indicated that increased price uncertainty and variability in the wheat industry led to significant increases in retail wheat marketing margins.\96\ The article determined both theoretically and empirically that increased price variability results in higher margins. The authors theorized and then demonstrated empirically that the uncertainty created by wholesale price volatility, in essence, drives the retailer to retain a larger margin. The retailer acts to retain such a larger margin to avoid the risk created by the uncertainty in wholesale costs.\97\ --------------------------------------------------------------------------- \95\ Senator Patrick J. Leahy, WC 1/297. \96\ Brorsen, Chavas, Grant and Schnake, ``Marketing Margins and Price Uncertainty: The Case of the U.S. Wheat Market,'' Amer. J. Agr. Econ., (August, 1985) 521-527. \97\ The analysis is confirmed with regard to market conduct and performance in the beef industry. Holt, ``Risk Response in the Beef Marketing Channel: A Multivariate Generalized ARCH-M Approach'', Amer. --------------------------------------------------------------------------- The logical implication of this theory is that price stabilization reduces or eliminates the retailers' need to act in such a risk- avoiding manner, because the volatility and uncertainty that drove that behavior is reduced or eliminated. The analysis of Hahn et al \98\ demonstrates convincingly that price volatility within the meaning of the authors above cited defines market conduct and performance of the fluid milk industry. The pattern of pricing conduct described by these authors is consistent with the risk-avoidance strategy described by Brosen et al and Holt. --------------------------------------------------------------------------- \98\ See Hansen, Hahn, and Weimar, ``Determinants of the Farm- to-Retail Milk Price Spread'', Agriculture Information Bulletin Number 693 (March 1994). See also Kinnucan and Forker, ``Asymetry in Farm-Retail Price Transmission for Major Dairy Products'', Amer. J. Ag. Econ., 285-292 (May, 1987). --------------------------------------------------------------------------- Based on this analysis, the Commission concludes that New England retail prices likely will respond positively to the stabilization of the wholesale price input which will result from imposition of Compact Over-order Price Regulation. The price established by this rule will be a certain one; Berthiaume suggests that the combined, federal Order and Compact Over-order price will not vary for the six month term of its duration. At least for the short-term duration of this price regulation, the uncertainty of price variability in the region's Class I market will have been significantly reduced if not eliminated. According to the analysis described above, the Compact Commission concludes that retail margins and, hence, prices, should positively adjust, accordingly.\99\ --------------------------------------------------------------------------- \99\ The Commission recognizes that at least one comment suggested that the ``impact'' of any price regulation would be a straight dollar-for-dollar ``pass through'' from processors to consumers, resulting higher retail prices. Alan Rosenfeld, December 19, 1996 at pages 183 et seq. The Commission is not persuaded by Rosenfeld's predictions for several reasons. It is, in the Commission's view, contrary to the weight of the comments submitted and the prevailing economic literature and anecdotal evidence. More fundamentally, however, it is not descriptive and provides no reasoned explanation for the conclusion expressed therein. Nor does it respond in any way to the comprehensi [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A97-10831. Public record. Not legal advice.