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ZA7760808 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).