The document discusses the complexity of the US dairy market and the need for digitalization. It notes that dairy production has unique characteristics that result in highly volatile prices. The US system of Federal Milk Marketing Orders adds further complexity by establishing pricing classes. Despite record milk prices in 2022, dairy farmers struggled with high costs. The document advocates for the use of futures and derivatives to manage price risk, but notes spreadsheet-based systems cannot adequately handle large hedging programs. It argues that digital platforms are needed to provide visibility, optimize decisions, and improve profitability in volatile markets.

1. US DAIRY MARKETS
DIGITALIZING TO ADDRESS
COMPLEXITY AND VOLATILITY
WHITEPAPER
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2. A ComTechAdvisory Whitepaper
INTRODUCTION
US dairy markets are one of, if not the most, unique and complex commodity
markets. Dairy production has unique physical characteristics not found in any
other agricultural commodities, including continuous production, rapidly spoiling
milk inventories, and multiple derivative products with a varying ability to store over
time (i.e., fresh milk vs. cheese products).
US Dairy Markets – Digitalizing to address complexity and volatility
These factors, when combined with changes
in seasonal demand, the impacts of variable
weather conditions that can affect both
production and the ability to transport that
production to processors, and changes in
productive herd levels that will impact supply
on any given day, result in highly volatile prices
for producers and cooperatives.

3. A ComTechAdvisory Whitepaper
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A COMPLEX MARKET
Unlike most commodity markets in which the value producers receive for their production is
based almost entirely on the forces of supply and demand, most US dairy production falls into
a complex regulated pricing scheme called the Federal Milk Marketing Orders (FMMO) system.
This program was originally designed to provide some level of price stability for producers of
what is considered a highly nationally valuable resource and to help offset the risks inherent in
the unique nature of milk production (continuous round-the-clock daily production vs. seasonal
harvesting, and the inability to store rapidly spoiling inventories at its source). In its current
iteration, the scheme does help limit downside exposures for producers, but may also limit their
ability to maximize the value of the product they produce. Even though some of the products
produced from milk, such as cheese, can be stored/inventoried for longer periods, high levels
of price volatility in this market persist.
Under the FMMO, milk is priced based on four classes
of end use for the milk they sell to processors:
Class I – Liquid milk processed for direct
consumption. In any given year, that volume can
account for 25 – 35% of total production, though
the percentage has fallen in recent years as more
consumers turn to alternative plant-based milk.
Class II – Milk that is used in the production of
soft dairy products like yogurt, ice cream or sour
cream. This class usually makes up about 10-15%
of production.
Class III – Milk used for most types of cheese
and whey. This is the largest class, accounting for
anywhere between 40-45% of production.
Class IV – This is the remaining products class,
including butter, butter-based spreads and dry
products like powdered milk (can be whole mild or
nonfat). This class usually accounts for 10-15% of
production.
Adding to the complexity of pricing, milk sold under the
Class I designation is priced on a formula driven by the
prices of Class III and IV, the more highly processed
classes, and the Class I price for a given month is
announced before the start of that month’s production.
Prices for the other classes (II, III and IV) are based on
average prices of commodities or products produced in
those classes, with the price of the milk consumed to
produce the products under those classes announced
in the following month. That means processors of milk
in Class II, III or IV won’t know what they will pay, or
producers know what they will receive for their milk,
until the month after they received/produced it.
Additionally, given that the prices paid for milk sold to
any individual processor is calculated on a regionally
based pool price, which is an average across the region
in which the milk is sold and processed, the producer
has no real ability to affect their revenues by negotiating
among processers.
US Dairy Markets – Digitalizing to address complexity and volatility

4. Operationally, dairy producers can do little on their own
to address this margin squeeze short of selling their
herds and operations. They face a broad array of fixed
and variable costs over which they have little control
- from amortization of the cost of their farms’ capital
equipment to highly variable costs for feed to maintain
their herds which can be more than 50% of their total
operating expenditures.
Though milk prices reached record highs in 2022, the
margin on the milk produced and sold by dairy farmers
and coops declined. With inflation hitting all corners
of the economy in 2022, dairy farmers struggled to
remain profitable as their costs of production increased.
As noted by the American Farm Bureau in July of that
year, “Analyzing production and operating costs on the
dairy farm more deeply further highlights this margin
problem….Though numbers for
2022 will not be available for
some time, 2021 can serve
as a proxy for describing the
extent to which operating costs
have largely outpaced market
values of dairy production
under more recent market
conditions… Feed, including
purchased feed, homegrown
feed and grazed feed has
taken up the largest portion
of expenses, ranging from
$9.28/cwt in 2017 to $14.04/cwt in 2021- a shift
from 45% of total expenses to 52%...In 2021 capital
recovery cost dairy farmers an average of $4.62/cwt
or 17% of all expenses. Hired labor…has increased by
12% since 2016…”. 1
Though prices did peak in mid-2022, the perishable
nature of milk limits the ability to build buffering
inventories and dairy markets continue to be highly
sensitive to changes in supply and demand, and prices
have quickly fallen back. Despite some price support
from FMMO market rules, highly volatile pricing has
and will continue to be a significant issue in this market,
exacerbating the difficulties in managing budgets and
maintaining profitable operations for both buyers and
sellers of dairy products (Figure 1).
US Dairy Markets – Digitalizing to address complexity and volatility A ComTechAdvisory Whitepaper
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1
https://www.fb.org/market-intel/strong-dairy-prices-overshadowed-by-farm-operating-expenses
Source: https://fred.stlouisfed.org/series/WPU01610102

5. US Dairy Markets – Digitalizing to address complexity and volatility A ComTechAdvisory Whitepaper
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MANAGING PRICE VOLATILITY FOR
IMPROVED PROFITABILITY
Given the financial exposure created by this volatility, the dairy industry has increasingly adopted
a more proactive approach to managing price risk.
With the availability of a mature and liquid futures
market across multiple classes of milk-derived
products; processors, coops, and large producers
are increasingly availing themselves of these hedging
tools (including futures, swaps, options, and derivative
instruments such as accumulators) to help mitigate
some of their price exposures. Additionally, many of the
inputs of production, including costly feed, fuels and
electricity are also being actively price managed via
hedging programs to help offset volatile and escalating
production expenses, providing increased price surety
to help improve operating margins.
Unfortunately, without a systematic approach to
managing hedging programs, it is difficult to “right
size” hedging volumes and value open positions,
particularly if that hedging portfolio includes
options or accumulators. Additionally, as the size of
a cooperative’s and/or processor’s business grows,
so does the complexity of the operation and the need
to scale beyond the capabilities of commonly used
spreadsheets.
Relying on brokerage statements introduces latency
that can lead to wrong decision-making in volatile
markets; and accurately tracking intraday price
movements, updating volumetric data and valuing
positions using spreadsheets is time-consuming and
error prone. Their use can potentially result in wrong-
sized hedges which will lead to sub-optimal outcomes
or worse, increase financial exposures leading to
significant losses.
For cooperatives that offer price risk protection
programs to their members, improving the
communication with those producers and providing
timely visibility of open positions, market prices, and
accumulator volumes helps ensure they can make the
best decisions relative to their operations and better
manage their own exposures as prices move in these
volatile market conditions. Relying on spreadsheets
or older, non-web enabled systems offers little or no
ability to provide this type of critical and timely market
information outside of phone conversations between
member producers and the coop’s risk management
team, an inefficient process and one that adds latency
in the decision-making process.

6. US Dairy Markets – Digitalizing to address complexity and volatility A ComTechAdvisory Whitepaper
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THE NEED TO DIGITALIZE
Price volatility, complex derivatives management and elaborate supply chain in the dairy industry
is driving digital transformation across its value chain. Pressure to reduce risk, settle effectively
and decrease reaction times, and forge stronger relationships with trading partners, cooperatives,
and milk producers is at an all-time high.
Though traders hedge the risk with the use of
derivative products such as futures, options, swaps,
and accumulators, managing the operation becomes
difficult at times because of the intricacies involved.
Scaling the operations of dairy products such as milk,
butter, cheese, and whey is difficult without a robust
and scalable platform that provides a single source of
truth.
Eka’s Trading and Risk Management (TRM) solution
provides a single source of truth for the dairy industry
with salient features such as:
• Cloud native application reduces total cost of
ownership.
• An integrated solution to manage position and
exposure and derivatives including forwards, futures,
swaps, options, and accumulators etc.
• Forecast member production to accurately predict
volume.
• Allowing members to lock the price/hedge to avoid
price fluctuations and tracking the price locks.
• 65+ types of data via connectors for seamless
integration ensuring faster configuration within
weeks vs months.
Additionally, with the post-Covid surge in inflation
and price volatility across all inputs into the dairy
value-chain, Eka provides producers, processors and
coops the required capabilities to hedge and manage
exposures across all relevant commodities, including
energies (diesel, gasoline, and electric power) and
feed. By adopting a fully featured commodity trading
and risk management solution, like Eka, these market
participants will gain increased visibility and accelerate
decision making to better optimize the value of their
products, and those of their suppliers, and improve
bottom line performance in a volatile market.
“Volatility in the dairy industry is driving
the need for more sophisticated hedging
programs which include an array of resting
order types and complex instruments such as
accumulators. This increased sophistication
requires greater technological capabilities to
be successful. A cloud based, digital solution
eliminates the pressure of hosting costs or
limitation of spreadsheets allowing coops to
amend their hedging programs as the dairy
markets dictate.”
Brian Quinn, SVP Global Revenue

7. ABOUT EKA
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Advisory
LLC
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