Download Factors Determining the Price of Butter

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milk pricing
and the
dailY. farmer
Factors Determining
the Price of Butter
ROBERT A. CROPP AND HUGH L. COOK
Changing butter prices have often concerned and sometimes puzzled people in the dairy industry. This is especially
so when price changes have been unusually large or frequent,
as they have at ti mes in recent months.
Wisconsin is the second largest butter producing state,
accounting for about 20% of the nation's production. Only
about 12% of Wisconsin's milk is used in buttermaking.
Nevertheless, the butter price directly affects what the
farmer gets for his milk (although probably not as much
as do the prices of cheese and even nonfat dry milk solids).
Butter marketing is handled at three levels: (1) the manufacturer, (2) the primary receiver, and (3) the retailer.
Manufacturers usually do not take a very active part in
butter marketing. Most single-plant operations do not even
have full-time sales personnel, much less a sales department.
A large percentage of butter produced at country plants is
simply sold at a price based on current quotations. The primary receivers who buy it usually assemble butter from
several manufacturers, print and package it, and distribute
it to retail outlets.
THE ROLE OF THE MERCANTILE EXCHANGES
Wholesale butter prices are largely a reflection of buying
and selling at two large exchanges: the Chicago Mercantile
Exchange and the New York Mercantile Exchange. Even
though little of the bulk butter from manufacturing plants
is actually sold on these exchanges, the bulk price is based
in large part on what happens there.
The two mercantile exchanges provide facilities for
cash trading of butter each business day of the year. Trading
is conducted by voice on the exchange floor. Offers to sell
or bids to buy are posted along with grade. When an offer
matches a bid, a sale is made.
Less than 1% of all U.S. butter is traded on the Exchanges. Their purpose is not to meet all commercial needs
for butter; they are primarily a mechanism the trade can
use to keep stocks in balance. For example, wholesalers
(including chain store buyers and cooperative sales agencies)
may sell or buy a few cars of butter through an exchange to
bring their working stocks to the desired level, or they may
sell an odd lot that fails to correspond with the usual salt
content or color in which they specialize.
Among the factors discouraging a large volume of trade
on the Exchanges are the lack of premiums for high quality
butter, lack of detai led specifications for butter, and the
inconvenience of delivering or accepting delivery in New
York or Chicago for butter to be retailed elsewhere in the
country.
Despite the small share of the nation's butter bought and
sold through the Exchanges, the trade has a strong interest
in seeing that Exchange prices properly reflect supply and
demand. Nearly all butter purchase and sales agreements
are based on exchange quotations.
Exchange prices are quoted by two commercial publishers, Urner-Barry for New York and Aberdeen Press
(Chicago Price Current) for Chicago. There can be some
change in quotations from day to day even if no trades have
taken place: a bid changes the previous day's quotation if
it is at a higher price and an offer to sell if it is at a lower
price.
The Market News Service of the U.S. Department of
Agriculture issues a more complete price report than
Urner-Barry or Aberdeen, because besides the Exchange
prices it reports the range of prices for other representative
wholesale transactions in New York and Chicago. The
trade tends to prefer settling its commitments on the basis
of the Exchange quotations from Urner-Barry and Aberdeen because they are stated as a single price, rather than
from the Market News Service, which usually reports a
range of prices. Hundreds of manufacturing plants and
primary receivers sell and buy butter on the basis of the
commercial quotations.
ANDREW M. NOVAKOVIC
AGRICULTURAL ECONOMICS
HOW ACCURATELY DO THE EXCHANGES INDICATE
PRICE?
Butter trades on the Exchanges are primarily between
the primary receivers and a small number of large central
market wholesalers. These firms handle a large proportion
of the nation's butter supply, and are usually in good
position to know the current supply and demand situation.
(They sometimes make mistakes; for example, some
recently underestimated what butter supplies would be.)
As long as butter is moving through all the ordinary
market channels without unusual shortages or excessive
supplies, these large firms do most of their trading outside
the Exchanges. When supply exceeds demand, receivers and
wholesalers enter the Exchanges with offers to sell, and
this depresses the butter price. When normal supplies are
inadequate, their bids to purchase wi II push the butter
price upward. Thus even though little of the nation's butter
flows through the Exchanges, they have a real role in price
formation by helping to determine the prices at which
buyers will be willing to buy and sellers willing to sell in
the ordinary commercial market.
PRICE SUPPORTS
Butter is one of three dairy products the Commodity
Credit Corporation (CCC) buys at announced support
prices in order to keep the price of manufacturing milk
between 75 and 90% of parity. The government's announced purchase price sets a floor under the market
price of butter _And whenever the market price rises to
a specified level above this floor, the government releases
butter from its storage stocks for sale on the commercial
market at a price slightly higher (in recent years about
317 a pound) than the support price.
Until recently butter was viewed as the "balance wheel"
in dairy pricing_ Milk that could not be utilized in other
ways was turned into butter, a product which is cheap
to store in proportion to its value. Through most of the
1950s and 1960s the relatively large government holdings
of butter meant that the price was primarily influenced
by the support level.
Since 1972, when milk production fell sharply, the output of butter has dropped, government holdings have
become smaller, the supply-demand situation has tightened,
and butter prices have fluctuated more widely.
CAN THE PRICE OF BUTTER BE RIGGED?
Sometimes the claim is made that a few large firms
could either depress or raise the Exchange price of butter
to their advantage without regard for the actual supply and
demand situation. Actually, this would be possible only if a
substantial share of the butter supply were in the hands of
relatively few firms which had essentially the same financial
interest (that is, nearly all would have to benefit when the
price went up or nearly all would have to benefit when the
price dropped).
These conditions for price-rigging almost never exist,
particularly in light of the small share of the nation's
butter traded on the Exchanges. Efforts to rig the price .
have been reported only once or twice in history, for only
a few hours and usually at heavy financial loss to the
attempted rigger. Other traders correct the price quickly,
and he must pay up and back down.
It should be noted that the newly-created Commodity
Futures Trading Commission, an autonomous body
established in 1974, watches closely all futures trading,
thus providing another powerful force to keep spot trades
in butter free of price rigging.
Butter prices in retail outlets are less closely related to
day-to-day fluctuations in Exchange quotations than
those at any other level of the marketing system. Retail
stores do not customarily make daily changes in the price
of butter. They frequently use private label and processor
brands, and tend to base their retail price on average cost
of a product line. By demanding private label butter and
raising the possible threat of vertical integration, food
chains have gained considerable power over the merchandising of butter.
In summary, there appears to be no successful rigging
of butter prices. The price support program, large cooperative sales organizations, the existence and regulation of
two large exchanges , and the general availability of butter
price information all prevent any person or group from depressing or inflating butter prices beyond supply and demand conditions, at least for any length of time. In the
very short run abnormal price changes could conceivably
occur, but competition and market knowledge would
quickly correct them.
SUPPLY-DEMAND FACTORS AFFECTING THE
BUTTER PRICE
The price of butter is directly influenced by the amount
of butter produced, the stocks of butter in storage, the
amount of butter imported, and the amounts of butter
sold for consumption. How these interact was clearly
reflected during 1975. Butter production was up 1.4%
from 1974, but still only at about the 1973 level. Butter
stocks at the end of the year were about the lowest on
record. Butter imports were up slightly but not substantial-
Iy. Butter sales were about 1.5% greater than in 1974.
It was this tightening supply-demand situation which
pushed prices up in the latter half of 1975 (see Table 1).
It is worth emphasizing that whenever stocks of butter
in storage are low, whether in commercial or governmental hands, the purchase or sale of on Iy a few cars may
abnormally lift or depress the price, For several decades
we have been accustomed to heavy butter stocks in storage;
we haven't had much experience until lately with what the
trade calls a "thin" market in which stocks are low.
The price of margarine also affects butter sales and
therefore price. The favorable retail price relationship be-
tween butter and margarine in 1975 brought a 1.5% increase
in butter sales and a per capita consumption increase of 2.2%.
The Christmas holiday season significantly increases the
demand for and the price of butter. Sales normally slow
down again after the holidays, and prices drop.
During the first six or seven months of each year, the
post-holiday drop in demand and the normal seasonal increase in milk production bring a buildup in butter stocks.
This is followed by the hot summer months, lower milk production, and less cream for buttermaking because of the
seasonal increase in ice cream sales. These forces push the
butter price up into the next holiday season.
Table 1. Butter Production, Stocks, and Prices
Production
1975
January
February
March
April
May
June
July
August
September
October
November
December
1976
January
February
March
April
May
June
July
August
September
October
Stocks
(in millions of pounds)
Chicago
Exchange Price
(Grade AA)
97.4
9004
96.3
101.0
102.0
88.3
7004
58.9
57.0
67.0
65.0
82.9
53
61
61
66
85
100
98
79
40
27
15
11
65.5¢ a pound
67.0
67.0
68.1
68.3
68.9
76.9
83.2
88.1
92.0
98.1
103.8
94.3
85.0
89.3
87.6
94.0
84.0
7204
66.0
63.4
N.A.
10
16
31
45
69
81
83
82
68
60
87.6
82.0
88.8
90.0
90.8
96.3
105.7
105.0
94.3
90.95
Additional information about the structure of dairy markets is provided by S. Williams,
D. Vose, C. French, H. Cook, and A. Manchester in Organization and Competition in
the Midwest Dairy Industries (Iowa State University Press. Ames Iowa: 1970).