Page 1       TOP OF DOC

House of Representatives,
Subcommittee on Livestock,
Dairy and Poultry,
Committee on Agriculture,
Washington, D.C.

    The subcommittee met, pursuant to notice, at 10:05 a.m., in room 1300, Longworth House Office Building, Hon. Richard W. Pombo (chairman of the subcommittee) presiding.
    Present: Representatives Goodlatte, Smith of Michigan, Lucas, Blunt, Pickering, Jenkins, Peterson, Holden, Johnson, Condit, Dooley, Farr, Boswell, and Stenholm [ex officio].
    Also present: Representatives Minge, Livingston, Solomon, Klug, and Gutknecht.
    Staff present: John Goldberg, professional staff; Christopher D'Arcy, subcommittee staff director; Callista Bisek, Wanda Worsham, clerk, and John Riley, minority staff consultant.
    Mr. POMBO. The meeting of the Subcommittee on Livestock, Dairy and Poultry to receive testimony on the USDA's proposed rule for the reform of the Federal Milk Marketing Orders will come to order.
 Page 2       PREV PAGE       TOP OF DOC
    Mr. POMBO. Today's hearing is designed for this subcommittee to continue to exercise its oversight responsibilities with regard to the ongoing reform of America's dairy industry as outlined and mandated under the Federal Agricultural Improvement and Reform Act of 1996, more commonly known as the farm bill.
    America's current dairy policies are a complicated patchwork involving many economic and regional variables. The reform of the Federal dairy policy, in the desire to transition to a more market-oriented approach to dairying, consumed most of the attention of this subcommittee during the farm bill debate.
    It has now been nearly 2 years since the farm bill became law. Today the Department of Agriculture will be explaining to this subcommittee its proposal to consolidate Federal Milk Marketing Orders and to alter the basic formula price to better reflect the value of milk components.
    We have a good cross section of America's dairy industry here today, from the Federal and State levels, producers, processors, and the respected academics. All can weigh-in and be heard and all should be prepared to engage in the kind of give-and-take that will hopefully provide America with a final rule that everyone can live with.
    In addition to addressing the specifics of the proposed rule, I hope that both witnesses and members can share with this subcommittee their vision of the future of the dairy industry in America. Understanding the big picture is especially critical when dealing with issues this complicated.
    I need also to reiterate a common theme of this subcommittee's activities over the past 2 years. We are not here today to redebate the farm bill. Our discussions today need to be built upon the framework established 2 years ago as we continue to move this process forward.
    As I have said before, I know it is unrealistic to expect America's dairy industry to speak with one voice, at least currently. I do continue to hope, however, that at least those different voices can be more harmonious. Parochial, regional, and often narrow perspectives have too often deluded the ability of the dairy industry to influence and contribute to the national debate on the future of American agriculture.
 Page 3       PREV PAGE       TOP OF DOC
    I hope we can change this. I know that we should.
    As most of you know, under the leadership of Chairman Bob Smith, the Agriculture Committee has focused during this Congress on expanding the international trading opportunities for American agriculture and we have all worked hard to push open markets and expand trading opportunities for America's farmers.
    I agree with Secretary Glickman that exports represent the real safety net for our Nation's farmers. Increased cooperation and consistency in America's dairy policy will give us greater opportunity to take advantage of international trading possibilities.
    Clearly, we are entering into an era of increased dependence on both domestic and international market forces, instead of Government supports and antimarket protection. The goal of the dairy reforms initiated in the farm bill were to enhance our ability to remain competitive internationally. The Agriculture Department's Foreign Agricultural Service has concluded that, as a result of the Uruguay Round subsidy reduction requirements, there will be a potential for U.S. expansion into 17 percent of the world market for nonfat dry milk, 23 percent of the world cheese market, and 31 percent of the world butter market by the year 2000.
    I am committed to working with America's dairy industry, as well as the Department of Agriculture, to make the potential a reality. I know from my colleagues in Congress to my neighbors in Tracy, California, that dairy reform is not an easy process, and that many of America's dairymen are uncertain as to what tomorrow holds.
    It is my hope that today's hearing will shed light on the outlines of a road map that point the way to a prosperous national export-oriented dairy industry for the 21st century.
    I look forward to receiving today's testimony and I welcome all of our witnesses and guests here this morning.
    In light of USDA's rulemaking process, all members and witnesses should be advised that a full transcript of today's hearing will be entered into the permanent record of USDA's formulation of the rule on the Federal Milk Marketing Order reform.
 Page 4       PREV PAGE       TOP OF DOC
    At this point, I would like to turn to the ranking member, Mr. Peterson.
    Mr. PETERSON. Thank you, Mr. Chairman. I want to thank you for holding this hearing today and I want to welcome all of our distinguished witnesses and guests and especially our other members from the Rules Committee and Appropriations Committee. We very much appreciate them being here with us today and taking part in this process and look forward to working with them on this as we try to move ahead with this whole process.
    I think it is critical that we continue to have an open dialogue with all regions of the country. It is no surprise that dairy is often a topic that we avoid here on Capitol Hill because of what we get into when we raise the issue in both the dairy pricing scheme and the politics of this beast are at times volatile and extremely complicated and the more that our different regions of the country can begin to understand each other and try to refrain from all of this controversy, I think the better off all of our farmers are going to be.
    I can't stress enough how important it was for me to be able to travel to all the different parts of the country and listen to producers in New York, in the Southeast, in California, to help me better understand what those farmers are up against and understand the circumstances they are in.
    I very much understand the pressures that are on dairy farmers in New York, Louisiana. They are the same pressures that my dairy farmers in Minnesota are under. But I understand very much the unique problems that high class I utilization areas face, and I want to make it very clear that those of us in the Midwest are not against a system which would allow class I milk to be produced in that area, a system that will make sure that your farmers can continue to operate and produce that class I milk and also a system that will allow you to bring in milk when you have a deficit, like in the Southeast. I think that it is extremely important that we make sure that that continue.
 Page 5       PREV PAGE       TOP OF DOC
    What we have a problem with in the Midwest is when we have a situation where these orders are creating additional manufacturing milk that may not make economic sense and that is what has happened, unfortunately, with the system up to this point and what we're trying to get changed. We're not really after the class I differentials; what we're after is that that system not go to the extreme that it creates additional manufacturing plants, additional manufacturing milk, that are really not economic, because the way we see this is that we're being asked to get into the world market. We're being asked to be more competitive, to be more market oriented in the whole scheme of things, but yet the way we see the Federal Milk Marketing Order System is that we're sending out signals that are not market-oriented.
    And so we think that what the Department has put forward is very minimal reform. We support the 1B option, which is not anywhere near as far as we would like to go in reform of the system, but it is at least moving in the right direction. The 1A option that has been put forward is really no reform and we think runs counter to what the 1996 farm bill asked us to do and basically is a status quo situation.
    There has been a lot of information put out by different people, including one group that is putting out information that the impact of the 1B proposal is a reduction of $365 million in annual income for dairy producers. I think you need to understand that what they're talking about there is only the class I part of this proposal. And USDA's numbers themselves say the overall decline in that particular proposal is $89 million when you combine the class I and the manufacturing impacts together. So, from a Midwest point of view, we want to make sure that we don't just focus on class I, but we also focus on what this is going to do to the manufacturing end of the situation and I hope that we can continue that as we go through this discussion.
    I very much want to commend the people in the Department for putting these proposals forward, and we think that they are heading in the right direction by saying that 1B is the preferred option of the Department. We would agree with that. We think it moves in the direction that the farm bill asked us to move, and, again, we look forward to working with all of the different parts of the country and hope that we can come up with, out of this whole process in April of 1999, we can come up with a more market-oriented system, a system that does not distort the marketplace, especially as it relates to manufacturing milk and a system that will serve not only our dairy producers, but also the country for the long term.
 Page 6       PREV PAGE       TOP OF DOC
    Thank you, Mr. Chairman. I look forward to hearing from our witnesses.
    Mr. POMBO. Thank you.
    At this point, I would like to ask unanimous consent that Mr. Solomon, Mr. Livingston, Mr. Gutknecht, and Mr. Klug be allowed to sit on the dais with the committee.
    I'd also like to ask unanimous consent that Mr. Solomon and Mr. Livingston be allowed to give an opening statement out of order. They both are involved with negotiations on the supplemental appropriations bill and are extremely restricted in time.
    Without objection. Mr. Solomon.
    Mr. SOLOMON. Mr. Chairman, I'd be glad to yield to my senior colleague here, Mr. Livingston, first.
    Mr. LIVINGSTON. Go ahead.
    Mr. SOLOMON. Are you sure? I was here first? [Laughter.]
    Mr. Chairman and Mr. Peterson and members of the committee, again we do thank you for taking us out of order. Bob and I both have to get to a very important meeting to try to expedite the legislation that we need to get out of here next Wednesday so that members can go back home to spend the district work period with their families.
    I really appreciate the opportunity myself to speak today on the reform of the Federal Milk Marketing Order program. It is a program of extreme economic importance to the dairy farmers in my district, in northeastern New York, and to producers in the many other milk-producing regions of this country.
    Among the many components of the USDA's reform proposal, none, ladies and gentlemen, are the greater concern to me, or more important to the regional marketing of fresh milk, and that's the issue here today, of fresh milk, than the class I pricing structure which is where I will focus my comments today and, with all due respect to other views, in the Northeast we are only class I producers. That's what this whole fight is about.
 Page 7       PREV PAGE       TOP OF DOC
    As we consider the USDA's proposal, let us not forget the circumstances which initiated the current reform effort. Twice in the 104th Congress, during the 1995 budget reconciliation and again in the 1996 farm bill debate, congressional supporters of the Federal order system mobilized to ensure that the basic pricing structure provided by the Federal order system was not haphazardly scrapped as budget cuts were made and farm commodity programs changed. The final House vote on the dairy title to the 1996 farm bill confirmed the importance of the Federal Milk Marketing Order structure in the regional marketing of fresh milk.
    The 1996 farm bill called for reforms, yes, it did, and both Mr. Pombo and Mr. Peterson spoke to them. Government product purchases are phased out; marketing orders are consolidated, and there's nothing wrong with that; pricing adjustments are made. However, it is important to distinguish between the Federal order structure and the very different budgetary phase-down of farm commodity payments.
    The farm bill clearly did not call for the removal or reduction of the basic pricing structure of the Federal marketing order and, as you all know, I was the author of that legislation that was overwhelmingly adopted in this House by almost two-thirds vote.
    To that end, USDA's option 1A reflects the importance of maintaining local milk supplies and effectively addresses regional differences in the marketing of fluid milk. And it also, again, ladies and gentlemen, reflects the specific legislative intent of the dairy section of the 1996 farm bill, and I would invite you all to go back and read that debate that took place on the floor of Congress with that overwhelming vote of over 250 votes in favor of maintaining the Milk Marketing Order System.
    And I would at that time, Mr. Speaker—you're not Mr. Speaker yet, maybe I'm looking the wrong way over there. [Laughter.]
    I'm going to get myself in more trouble here today.
    Given the overwhelming support and the sound economic analysis behind option 1A, I am extremely disappointed with Secretary Glickman's decision to endorse option 1B, an option which promises to significantly lower class I differentials and reduce total industry income by over $1 million per day, gentlemen, per day. Do you know what that means in northern New York?
 Page 8       PREV PAGE       TOP OF DOC
    These reductions will be felt in all regions of the country with the possible exception of some areas in the upper Midwest. According to the proposed rule, my New York farmers would lose 48 cents per hundredweight under option 1B. Forty-eight cents per hundredweight, do you have any idea what that means to those people? A loss that would annihilate the already tight margins of most farmers. And we've just gone through one hell of an ice storm up there where we lost cattle, dairy cattle, and they will never be able to be replaced. Those most severely affected will be small farms, and that's all we have in upstate New York.
     We don't even have it—I have the 20th largest dairy-producing district in America and there's not one farm that has more than 500 head of cattle; most of them have less and don't give me this argument, well, we ought to have 5,000 heads all over. We don't have that room in upstate New York and we will always have under 500 head of cattle for most part.
    As the author of the dairy title to the farm bill, I'm sure it was never our intention to force dairy producers out of business, nor was it the intent of almost two-thirds of the House when they voted to preserve that structure, and that is what that vote was all about.
    The Secretary has proposed phase-in plans to shield the effects of the lower option 1B differentials. We'll hear testimony on that today, I'm sure. It is clear to me that these phase-ins are no more than a carrot for our dairy farmers to swallow in the first few years before crippling, long-term price reductions are finally imposed. It is wrong to try to mask the long-term implications of option 1B on our dairy producers with short-term buyouts. I've never been for those short-term buyouts. They never work. Some of my upper Midwest colleagues here today—and they are very distinguished gentlemen who I have great respect for—as they have in the past, will say that the Federal order system divides our Nation's dairy farmers into regions of haves and have-nots. They will contend that the USDA proposals do not go far enough. You'll hear that testimony today, I'm sure.
    The facts simply do not support that claim, ladies and gentlemen. Class I differentials do not translate to higher producer-paid prices. As the USDA mail box prices indicate, upper Midwest producers consistently receive higher farm-gate prices than nearly all other regions of the country, and I'd like to see that refuted. It cannot be, ladies and gentlemen.
 Page 9       PREV PAGE       TOP OF DOC
    Over the last 3 years, Wisconsin milk prices have averaged 35 cents per hundredweight higher than the prices received by my New York dairymen in New York. My Chairman, Mr. Chairman, and members of the Federal Milk Marketing Order System, it is the lifeblood of the dairy farmers of this country when you talk about small dairy farms. Without it, they will not exist.
    The rapid loss of dairy farmers is a critical issue in my district, as it is in much of the rest of the country, and when you take money out of the pockets of dairy farmers, it is not the intent of this Congress, and it will only accelerate dairy farm attrition and reduce local supplies of fresh milk.
    No one, not dairy farmers, not consumers, benefits from depressed farm milk prices. Please know, and I would say very much so, please know that the Federal Milk Marketing Orders are not about keeping marginal farms in business. Rather, it is a matter of giving good, hard-working dairy farmers and their families the opportunity, not to succeed, gentlemen, but to survive. And that is what this argument is all about today.
    In a recent speech to Harvard University, Secretary Glickman maintained that his dairy proposal represented an approach of a reasonable person. I could not disagree with that more. Secretary Glickman's proposal to drastically phase down an important component of the marketing order system to the benefit of one region is clearly not reasonable. The Secretary must know that Congress does not agree with that decision. I urge this committee to join me in again insisting that Secretary Glickman secure the implementation of option 1A, a pricing system that is a fair and stable option for all regions of the country.
    And again, Collin Peterson, in his opening summation of his remarks, said that milk marketing orders are not market-oriented. Well, they are not supposed to be milk market-oriented. We are not talking about a cost of the taxpayers of this Nation. We're talking about maintaining price support.
 Page 10       PREV PAGE       TOP OF DOC
    And let me give you an example of just how serious this is. We have in New York State, unlike most other States, we have several political parties which are official political parties. One is the Republican Party. One is the Democratic Party. But we also have a Conservative Party and you run on a separate line. And one is the Liberal Party, and I never agree with them on anything. But you know what? They have endorsed 1A. These are primarily people who live in New York City. And you might say, well, what do they care about upstate milk farmers? What they care about is the fact they want fresh milk and they want it at stable prices; they don't want those farmers to go out of business, because they know if you do then there is going to be a monopoly and milk prices are going to skyrocket. So, even people like Chuck Schumer of New York City supports our position on this.
    Think about that, ladies and gentlemen, and I apologize for taking so much of the time and delaying my good friend, Mr. Livingston, who has to go back and testify.
    Mr. POMBO. You were almost convincing me until the end there. [Laughter.]
    [The prepared statement of Mr. Solomon follows:]
    Thank you, Mr. Chairman, members of the committee, for the opportunity to speak today on the reform of the Federal Milk Marketing Order Program, a program of extreme economic importance to the dairy farmers in my district in eastern New York and to producers in the many other milk producing regions of the country.
    Among the many components of USDA's reform proposal, few are of greater concern to me or are more important to the regional marketing of fresh fluid milk than the Class I pricing structure, which is where I will focus my comments today.
    As we consider USDA's proposal, let us not forget the circumstances which initiated the current reform effort. Twice in the 104th Congress, during the 1995 budget reconciliation and again in the 1996 farm bill debate, supporters of the Federal order system mobilized to ensure that the basic pricing structure provided by the Federal order system was not haphazardly scrapped as budget cuts were made and farm commodity programs changed. The final House vote on the dairy title to the 1996 farm bill confirmed the importance of the Federal milk marketing order structure in the regional marketing of fresh milk.
 Page 11       PREV PAGE       TOP OF DOC
    The 1996 farm bill calls for reforms—Government product purchases are phased out, marketing orders are consolidated, pricing adjustments are to be made. However, it is important to distinguish between the Federal order structure and the very different budgetary phase-downs of farm commodity payments. The farm bill clearly does not call for the removal or reduction of the basic pricing structure of the Federal order system.
    The Class I pricing structure has been effective in ensuring consumers an affordable, steady supply of fresh fluid milk in nearly all regions of the country. To that end, USDA's option 1A reflects the importance of maintaining local milk supplies and effectively addresses regional differences in the marketing of fluid milk. Option 1A was originally proposed by USDA's own Price Structure Committee and has gained overwhelming support within the dairy industry.
    Congress has also recognized the importance of option 1A. In October, Secretary Glickman received a letter signed by 113 House Members and 48 Senators, clearly expressing the broad-based support for option 1A. I would like to submit a copy of that letter for the record.
    Given the overwhelming support and sound economic analysis behind option 1A, I am extremely disappointed with Secretary Glickman's decision to endorse option 1B, an option which promises to significantly lower Class I differentials and reduce total industry income by over $1 million per day. These reductions will be felt in all regions of the country, with the possible exception of some areas in the upper Midwest. According to the proposed rule, my New York farmers would lose 48 cents per hundredweight under option 1B, a loss that would annihilate the already tight margins of most farms. Those most severely affected will be small farms.
    As the author of the dairy title to the farm bill, I am sure that it was never our intention to force dairy producers out of business.
    The Secretary has proposed phase-in plans to shield the effects of the lower option 1B differentials. It is clear to me that these phase-ins are no more than a carrot that for our dairy farmers to swallow in the first few years before crippling long-term price reductions are finally imposed. It is wrong to try and mask the long term implications of option 1B on our dairy producers with short term buyouts.
 Page 12       PREV PAGE       TOP OF DOC
    Some of my upper Midwest colleagues here today may argue, as they have in the past, that Federal order system divides our nation's dairy farmers into regions of ''haves'' and ''have nots.'' They will contend that the USDA proposal does not go far enough.
    The facts simply do not support this claim. Class I differentials do not translate to higher producer pay prices. As the USDA mailbox prices indicate, upper Midwest consistently receives higher farm-gate prices than nearly all other regions. Over the last 3 years Wisconsin milk prices have averaged 39 cents per hundredweight higher than the prices received by my New York dairymen.
    Mr. Chairman and Members, the Federal milk marketing order system is the life blood of the dairy farmers of this country. The rapid loss of dairy farms is a critical issue in my district, as it is in much of the rest of the country. Taking money out of the pockets of dairy farmers is not the intent of this Congress and it will only accelerate dairy farm attrition and reduce local supplies of fresh fluid milk. No one—not dairy farmers, not consumers—benefits from depressed farm milk prices.
    Please know that the Federal milk marketing orders are not about keeping marginal farms in business; rather it is a matter of giving good, hard-working dairy farmers and their families the opportunity to survive.
    In a recent speech to Harvard University, Secretary Glickman maintained that his dairy proposal represented an approach of a reasonable person. I could not disagree more.
    Secretary Glickman's proposal to drastically phase down an important component of the marketing order system to the benefit of one region is clearly not reasonable. The Secretary must know that Congress does not agree with his decision. The industry is again mobilizing and Congress will again communicate this to the Secretary.
    I urge the members of this committee to join me in again writing to Secretary Glickman to secure the implemention of option 1A, a pricing system that is the fair and stable option for all regions of the country.
 Page 13       PREV PAGE       TOP OF DOC
    Mr. POMBO. Mr. Livingston.
    Mr. LIVINGSTON. Thank you very much, Mr. Chairman, Mr. Peterson, members of the committee. Thanks for having us here; thanks for giving us the time. I'll try to be brief. I want to associate myself with most of the comments of my friend, Mr. Solomon, maybe with the exception of that last comment and his reference to the speakership.
    But at any rate, I appreciate your giving me the opportunity to be here. I, too, am concerned, as he is, because the farmers, the milk farmers, of the Southeast, face basically the same problems as those of the Northeast. And, while I hate to see us involved in any controversy which pits sections or regions of the country against one another, the fact is that the impact of this particular rule-making procedure as it appears to be going is going to have a devastating effect on my dairy farmers as well as the people of the Northeast.
    And it departs from the compromise, the Solomon-Dooley compromise, last year that got 258 votes from members all over the country. And just recently some 113 House members and 48 Senators from every region of the country, except, the Midwest, signed a letter last October supporting the option 1A as opposed to option 1B, and I'd asked unanimous consent that the letter be made part of the record. We'll make that available to you.
     We don't quarrel with consolidating the number of Federal marketing orders. That was intended in the law of 1996. But what concerns us is that the impact on class I or fluid milk prices—and, by the way, I am not aware of the circumstances in the Northeast but my friend says they only produce class I. The same is primarily true of the people in the Southeast. We're only talking about class I milk here because that is really all they produce.
    But the preferred option by Mr. Glickman, option 1B, would mean that in every region of the country but the upper Midwest the differential would be reduced and the basic formula price would mean yes a $365 million reduction in income.
 Page 14       PREV PAGE       TOP OF DOC
    We have two charts available, I'd like to make these a part of the record as well, charts 1 and 2, which demonstrate that reduction in income on a regional and statewide basis.
    The first one shows the annual income losses to dairy producers of class I milk in every region of the country except the upper Midwest.
    The second one shows the cost of production, what the cost of production is in the various regions after implementation of option 1B. And it's very clear from that chart, the second chart, that the small farmers in most regions of the country can't meet the cost of production today, and that farmers in these regions will be hurt even further by additional reductions in option 1B. And I've seen personal evidence of that time after time after time visiting with the dairy farmers in my area.
    What's disturbing is that the preferred option is still being put forth as being preferred for discussion in the proposed rule. When most regions can't meet their current costs of production, I don't see how proposing this proposal, option 1B, becomes market-oriented. The level of class I differentials under option 1B are such that small businesses, particularly producers, would experience significant economic impact, and all producers, with the exception of the upper Midwest, would face reduced income due to lower class I prices and producers of the Northeast and Southeast would experience the greatest decrease.
    In the USDA's proposed rule, it states that it may be necessary to set a temporary floor on milk prices because of the volatility of milk prices in the interim by adopting option 1B. There's nothing free market or market oriented about that. You start setting floors in the operation, you're way out of the market. And I have 400 dairy producers in my district, ranging not in the thousands of cows, but rather 70 to 90 per farm. These really are small farmers.
    And they are the hardest-working people I've ever met. I want to tell you, I mean, they've got to go back there and milk their cows regardless of what day of the week it is; they've got to do it at last twice a day. I've never met folks that work that hard, and I feel absolutely personally obligated to come before you and say that this is going to pose a tremendous hardship on these people.
 Page 15       PREV PAGE       TOP OF DOC
    In fact, I'm not alone. USDA, the day before they announced the proposed rule, the National Commission on Small Farms said in their report we are now even more convinced of the necessity to recognize the small farm as the cornerstone of our agricultural and rural community.
    And, finally, in the press release announcing the dairy rule on January 23, Secretary Glickman himself said that there is not a great deal of national consensus on this issue. Well, he may be right on that. But comments from industry, and Congress, from all regions of the country, express opposition to 1B which now is the preferred option. And they support option 1A.
    So, I thank you for giving us the time to speak to you. I realize that there are just some issues that aren't easily resolved, but I just hope that we don't rush willy-nilly into a system that's not free market oriented but that selectively favors one segment of the population over the other.
    Thank you very much, Mr. Chairman.
    Mr. POMBO. Thank you. Mr. Holden.
    Mr. HOLDEN. Thank you, Mr. Chairman, for holding this hearing today and for the opportunity to comment on USDA's proposed rule for reform of the Federal Milk Market Ordering system.
    And thank you, also, to USDA's Agricultural Marketing Service, in particular, for their hard work in trying to create a consensus reform package. I know that has not been very easy.
    Mr. Chairman, in my home State of Pennsylvania, dairy is the largest agriculture enterprise, representing a $1.5 billion industry. Pennsylvania is the fourth largest dairy State in the country, with dairy products accounting to 40 percent of agriculture outputs in Pennsylvania.
 Page 16       PREV PAGE       TOP OF DOC
    In the last 10 years, the number of dairy farms has declined by 3,200 to 10,500 and the number of dairy cows has declined by 90,000 to 640,000. In Pennsylvania, it has been estimated that 17,000 jobs are tied directly to the dairy industry and another 12,500 jobs in the building industry, trucking, banking, et cetera, are indirectly tied to the dairy industry.
    It has been estimated that a 2 percent decline in Pennsylvania's dairy industry would translate into a loss of almost 600 jobs. Dairy is important to Pennsylvania, and the entire Northeast, because of the economic contributions it makes both in dollars and in jobs.
    While I'm pleased with some aspects of USDA's proposed rules such as the proposed class I price driver, which partially decouples fluid prices from cheese prices, I must voice my concerns about USDA's preferred option with regard to class I differentials.
    Under option 1A, the projected annual income of dairy farms would increase by $32 million. This is less than one-half of 1 percent of total dairy farm income. However, under option 1B, U.S. dairy farmers would lose $365 million per year, or $1 million per day, as Mr. Solomon has stated.
    I have heard estimates that option 1B could reduce mail box prices by as much as 85 cents to $1.25 per hundredweight in the Northeast. The pricing structure for class I milk is extremely important to dairy farm income, rural community economic stability, and regional supply of fresh fluid milk.
    The phase-down of farm income proposed by option 1B will clearly hurt the financial condition of farmers with small family farms bearing the greatest burden. In fact, the proposed rule states that small businesses, particularly producers, would experience significant economic impacts. This runs counter to USDA's recently released National Commission on Small Farm Report, ''A Time to Act'' which states the small farm is the cornerstone of our agricultural rural economy.
    As demonstrated by the 113 House members and 48 Senators who signed the October 1997 letter to Secretary Glickman, there is tremendous support in Congress for option 1A in the pricing of class I milk. This option has broad, bipartisan geographic support from major dairy-producing regions of the country. Therefore I'm hopeful that USDA's final rule will have a class I pricing surface which resembles option 1A.
 Page 17       PREV PAGE       TOP OF DOC
    Thank you very much, Mr. Chairman, for the opportunity for the opening statement.
    Mr. POMBO. Mr. Smith.
    Mr. SMITH. Mr. Chairman, I'd like to make a short statement, if I may, and then request permission to submit the rest of the statement in the record.
    Mr. POMBO. Without objection.
    Mr. SMITH. I've always been a dairy farmer. As we observe what's happening in Michigan now, we're seeing the smaller dairy farms, those farmers with less than 150 cows, slowly being forced out of business.
    My kids, who have been milking for the last 7 years, are having their auction next week, so I am very personally concerned about the future of the dairy industry in this country. Also, I'm very concerned about the fact that other countries are now being allowed to subsidize their dairy industry to the detriment of our ability to expand dairy exports.
    I would hope that we have the kind of a milk marketing process that is going to allow this country not just to look at the benefits of lower consumer prices, but the changes that must be made if we are going to have the dairy industry in this country survive.
    So, Mr. Chairman, with that, I'll leave time for the questions and comments of the panel.
    Mr. POMBO. Mr. Stenholm, did you have an opening statement that you wanted to make at this time?
    Mr. STENHOLM. No, Mr. Chairman. Thank you.
    Mr. POMBO. Mr. Johnson.
 Page 18       PREV PAGE       TOP OF DOC
    Mr. JOHNSON. Mr. Chairman, I appreciate your holding this hearing and your leadership on this issue and I would like to welcome our Wisconsin agriculture secretary here today and representatives from the University of Wisconsin.
    In 1996, this committee began what started out with a valiant effort to reform dairy policy. Recognizing the regional interests that may have prevented this committee from providing meaningful dairy policy reform, the committee decided it wasn't in the good interest of the country to reform the national dairy policy by directing the Secretary of Agriculture to do so and provide him with guidelines to reform this system.
    It was our hope USDA would supersede the regionalism and parochial interests that were plaguing not only Congress but it would also develop an equitable national policy, one that wouldn't discriminate against dairy farmers on the basis of their proximity to Eau Claire, WI, and also how their milk was used after they sold it to a local cooperative or handler and a policy that would make U.S. dairy products globally more competitive.
    With that in mind, we also must look at what this issue means to our Nation's farmers, whether they are in Longmont, CO, or Rutland, VT, or Ellsville, WI. We need to determine how we can reform the system so the farmers can compete equitably without congressional and administrative intervention every few years, although sometimes in the confusion, and there is some, and sometimes a lot, we lose sight of options that may be the best and more solvent solutions to the industry.
    By maintaining the status quo, making only fractional changes in this policy, we are not guiding the industry by our shared values or commitment to family farms, but we're forestalling real change and precipitously eliminating farms by programs that were intended to save the farms.
    These small steps are not helping the dairy industry or the consumers, but prolonging the needed reform that we must provide.
 Page 19       PREV PAGE       TOP OF DOC
    Most of you know during the 1930s when the system was conceived, many argued that farmers and consumers needed this system to supply areas outside the Midwest with fresh milk. I don't dispute that. I support the legislators of that time for their commitment to the nutritional value of milk. But significant advances in transportation, refrigeration, and milking systems, have made the cost of supplying fresh milk to anywhere in this nation significantly less.
    Today we have the interstate highway system, computers, satellites guiding deliveries, technology on the farm, lowering bacteria and somatic cells which had spoiled milk in the past, and a transport refrigeration network that is second to none in the world.
    Today, we can move milk faster and farther and keep it fresher longer. There is no reason to maintain artificially-inflated transportation subsidies for milk in our country.
    Some will make the argument that they need to have or maintain a higher class I differential or a compact just to preserve family farmers. I think that is a misleading picture.
    The bulk of the industry is leaving dairy farming not in the Northeast or Southeast, where compact and artificially high class I differential proponents are, but in the upper Midwest. For example, last year Vermont lost 200 dairy farms. That is a loss for their State, and I sympathize with the farmers in that State. Wisconsin lost that many last month. That is five a day.
    Also with phase-out of the price support program, a shift in national dairy policy, it seems, would be more consistent with the rest of the farm bill which exchanged supply-side support programs with a commitment to a future in trade. We can see by New Zealand, for example, you can support an entire industry without distorting programs that discriminate like ours does. While New Zealand may have a more active STE than the CCC, it has no domestic support programs or regional pricing schemes.
 Page 20       PREV PAGE       TOP OF DOC
    Finally, I'd like to reiterate my disappointment in the Department's lack of initiative on providing reform to class I differentials and the size of the orders. In light of Judge Doty's decision in Minneapolis, there was no excuse not to provide adequate and economically defensible reforms for class I differentials.
    The rule provided the Department with an opportunity to move beyond the regional limitations and provide the industry with a system that will make the U.S. dairy products globally competitive. Unfortunately, there have been other choices made to promote and maintain the status quo.
    I would like to express my appreciation to Secretary Glickman for supporting 1B and demonstrating leadership and willingness to overcome regionalism that plagues the ability of all of our farmers to compete.
    I'd also like to include, Mr. Chairman, this chart from USDA National Agricultural Statistics on the number of farms in America, State by State, for the past 20 years and the change over the years and have this on the record. Thank you.
    [The prepred statement of Mr. Johnson follows:]
    Thank you Mr. Chairman for holding this hearing and your leadership on this issue. In 1996 this committee began what started out to be a valiant effort to reform dairy policy. However, having recognized the regional interests that may have prevented this committee from providing meaningful dairy policy reform, this committee decided that it was in the best interest of our country to reform our national dairy policy by directing the Secretary of Agriculture to do so and providing him with some guidelines to reform the system. It was our hope that the USDA could supersede the regionalism and parochial interests that were plaguing the Congress and develop an equitable national policy. One that would not discriminate among dairy farmers on the basis of their proximity to Eau Claire, WI, how their milk was used after they sold it to a local cooperative or handler, and a policy that would make US dairy products more globally more competitive.
 Page 21       PREV PAGE       TOP OF DOC
    With that in mind, we must also look at what this rule means to our Nation's farmers, whether they are in Longmont, CO; Rutland, VT; or Ellisville, WI. We need to determine how we can reform this system so farmers may compete equitably without Congressional and administrative intervention every few years. Although, sometimes in the confusion, and there is plenty in this business, we lose sight of options that may be the best and most solvent solutions for this industry. By maintaining the status quo and making only factional changes in the policy, we are not guiding this industry by our shared values or our commitment to family farms, but forestalling real change and precipitously eliminating farms by programs that were intended to save them. These small steps are not helping the dairy industry or the consumers, but prolonging needed reform that we should provide.
    As most of you know, during the 1930s when this system was conceived, many argued that farmers and consumers needed this system to supply areas outside the Midwest with fresh milk. I do not dispute that and support the legislators of that time for their commitment to the nutritional value of milk. However, significant advances in our transportation, refrigeration, and milking systems have made the cost of supplying fresh milk to anywhere in this nation significantly less. Today, we have an interstate highway system, computers and satellites to guide deliveries, technology on the farm to lower bacteria and somatic cells (which spoiled milk in the past), and a transport-refrigeration network second to none in the world. Today, we can move milk faster and farther and keep it fresher longer. There is no reason to maintain artificially inflated transportation subsidies for milk in our country.
    However, some will make the argument that they need to have or maintain a higher class I differential or a compact to preserve their family farmers. Unfortunately, that's a misleading picture. The bulk of the industry is leaving dairy farming not in the Northeast or Southeast where compact and artificially high class I differentials proponents are, but in the upper Midwest. For example, last year Vermont lost approximately 200 dairy farms—and while that is a loss for that state and I sympathize with their loss—Wisconsin lost that many last month. That's nearly five a day.
 Page 22       PREV PAGE       TOP OF DOC
    Also, with the phase out of the price support program, a shift to a national dairy policy, it seems, would be more consistent with the rest of the farm bill, which exchanged supply side support programs with a commitment to a future in trade. And as we see by New Zealand's example, you can support an entire industry without distorting programs that discriminates like ours does. While New Zealand may have a more active STE than the CCC, it has no domestic support programs or regional pricing schemes.
    Finally, I would like to reiterate my disappointment in the departments lack of initiative on providing reform to class I differentials and the size of the orders. In light of Judge Doty's decision there was no excuse to not provide adequate and economically defensible reforms for Class I differentials. This rule provided the department with an opportunity to move beyond regional limitations and provide an industry with a system that will make U.S. dairy products globally competitive. Unfortunately, there have been other choices made to promote and maintain the status quo. However, I would like to express my appreciation to Secretary Glickman for supporting 1B and demonstrating leadership and willingness to overcome the regionalism that plagues the ability of our farmers to compete. Thank you.
    Mr. Chairman I would like to include a chart from USDA's National Agriculture Statistics Service (NASS) on the number of farms in America by state for the past 20 years that shows the change over the years in to the record. Thank you.
    [The charts follow:]
    "The Official Committee record contains additional material here."

    Mr. POMBO. Mr. Blunt.
    Mr. BLUNT. Thank you, Mr. Chairman. I have a statement for the record and I'd like to make some brief remarks, just to followup on the remarks, particularly that have been made already by Mr. Solomon.
 Page 23       PREV PAGE       TOP OF DOC
    Certainly we see dairy in America, the dairy industry, in decline in terms of numbers and decline in terms of production. Missouri lost 28 percent of our dairy farmers and dairy farms in the last 7 years. As recently as 2 years ago, the seventh district in Missouri that I represent was still in the top 10 districts in production of dairy products. I don't think that can possibly be true any longer. We've lost 700 dairy farms in the last decade.
    In 1996 and in 1997 both, domestic consumption of dairy products for the first time in the history of the country exceeded domestic supply of those same products in a product that we've always had a commitment to as a domestic, fresh, accessible product. We're losing that, and the consumption numbers and the production numbers show that.
    I certainly want to express appreciation to those folks here today from USDA for putting the southern third of Missouri, really the dairy-producing part of our State, in the Southeast order. Our milk goes to the Southeast. To have us in the order where the milk actually goes meets all the criteria that we should be meeting and I was glad to see that.
    I would also like to mention that I would like to encourage the Department to look seriously at a floor of $13.50 at a time when we're very close to that price. I think the February price was $13.32. This would be a great time to move forward with the discussion on a floor. And in the remarks that I'm submitting for the record, I'm vigorously supporting, along with Chairman Solomon and Chairman Livingston and others, option 1A. I think it is much more representative than the current system. I think it provides more stability to the market place and to dairy farmers. I also think it provides much less need for transition costs and transition plans.
    I also believe it is more likely to ensure a geographically-balanced supply of fresh milk. I'm confident, that if 1B becomes the option that we adopt, it will be very, very clear in the short term and incredibly clear in the long term that 1B will not only reduce prices in many areas, but 1B will lead to a smaller number of producers, not nearly as well located to provide a fresh supply of milk around the country as we have had for the last several years.
 Page 24       PREV PAGE       TOP OF DOC
    I'm urging that we look carefully at 1A, but I'm also very interested in the testimony that you are going to be having brought before us today, Mr. Chairman, and am grateful to you for having this hearing.
    Mr. POMBO. Mr. Klug.
    Mr. KLUG. Thank you, Mr. Pombo, and thank you for the opportunity to be with you this morning. And, like several of my colleagues, I will have to excuse myself because, unfortunately, I have two hearings going on in Commerce simultaneously right after this one gets done, but I want to come by and give you a longer statement for the record and briefly say hello and welcome to my friend Ben Brancel, who is with us today, who is the Wisconsin agriculture secretary. He has a unique perspective on the comments in front of us today because he was a dairy farmer for 22 years before he served in the Wisconsin Legislature for 11 years, and sometimes serving both as a dairy farmer and a member of the State Legislature.
    Ben, like I, has long, lingering doubts about reform plans submitted by the U.S. Department of Agriculture. We're going to hear more about that later today.
    My colleague from Wisconsin, Mr. Kind, and Mr. Peterson, and others from the Midwest have already expressed our frustration with the Northeast Dairy Compact and with the absolutely brutal rate of attrition among upper midwestern dairy farmers. Ten thousand dairy farms in Wisconsin have gone out business since I first arrived in Congress in 1990. And it's unfortunate my colleague Mr. Livingston isn't here any longer. Wisconsin and upper midwestern farmers aren't subsidized because it is difficult to grow shrimp in Wisconsin while it's relatively easier in Louisiana, and while upper Midwest farmers don't get paid extra to grow oranges because you can't do that in the upper Midwest, that, unfortunately is not the case in the Southeast where they can do it without Government subsidy.
 Page 25       PREV PAGE       TOP OF DOC
    That's the basic line that markets should rule. And I respectfully say that the kind of plan we have in front of us in the USDA is exactly the kind of plan that got Boris Yeltsin's economic team fired earlier this week. It has absolutely nothing to do with free market economics; it's outdated, old-line, socialist subsidies, and it should come to an end as quickly as possible.
    And, thanks again for the opportunity to be with you this morning. I'll submit a longer statement for the record, as I said. And again, my thanks to Ben Brancel for coming today who will lay out the case for the upper Midwest much more eloquently than I can.
    Mr. POMBO. Thank you. Mr. Dooley.
    Mr. DOOLEY. Thank you, Mr. Chairman. I wasn't going to make an opening statement until I heard Mr. Solomon's opening statement, and as of one of the coauthors of the Solomon-Dooley dairy reform bill last year, I have a little bit different interpretation of what the intent of that legislation was. [Laughter.]
    I think that, clearly, my assessment of what I was trying to achieve with that legislation and what a majority of Members of Congress voted for last year, or 2 years ago, when we passed that, was to move dairy policy in a more market-oriented direction. And that is why we phased out the purchase programs for butter and powder and cheese, because we wanted the industry to respond more to actual market conditions. And we deferred on having Congress act specifically on reforming the Federal Milk Marketing Order.
     But I would say this, it would be totally inconsistent with the other components of the dairy reforms to suggest that we were not going to move in a more market-oriented direction as we were dealing with the pricing of fluid milk.
 Page 26       PREV PAGE       TOP OF DOC
    And I would just like to make a statement that I think that USDA, in their evaluation of what is going to be the appropriate reform of our milk marketing orders, should also be embracing those proposals which are, in fact, going to send the appropriate market signals to dairy producers.
    I also find it somewhat interesting that another one of the gentlemen that made the presentations today made the statement that putting in place a temporary emergency price floor is not market-oriented. I thoroughly agree with him on that count, but I think it's intellectually a little bit inconsistent to then imply that differentials are in fact market-oriented.
    I think we have reached the time where the differentials have to be assessed and identified for what they are, and they are in many ways vestiges of a failed system that is outdated, and that any reform that moves forward when we look at differentials, ought to be modified, so they do, in fact, reflect what true market conditions are.
    Mr. POMBO. Any submitted statements by Members may be included at this time.
    [The prepared statements of Members follow:]
    I want to thank the chairman of the subcommittee, Richard Pombo, for holding a hearing on this important issue.
    Over the last 2 years, the USDA has been implementing various provisions of the Federal Agriculture Improvement and Reform Act of 1996—known to most people as the farm bill. Under this act, farmers were afforded the opportunity to decide on their own, free of Government mandates, when to plant the commodity of their choosing. In addition, producers were encouraged to seek opportunities to improve their incomes by producing based on demands of the market rather than those of bureaucrats.
 Page 27       PREV PAGE       TOP OF DOC
    The FAIR Act also did something very important for today's hearing. It provided an opportunity for dairy farmers all over America to break free from the dictates of Government regulation. Since the passage of the Clayton Act of 1914 and the Capper-Volstead Act of 1922, dairy has become the most regulated of all agricultural commodities. After more than 80 years of control, it is no wonder that producers are concerned, and possibly a little frightened of change. While I can understand the apprehension, American producers need to keep in mind that relying on an antiquated system of government controls has made their commodity one of the least competitive in the world market.
    Due in part to regional concerns, Congress was not able to settle on a specific plan for Federal Milk Market Order reform in the 1996 farm bill. However, with the consent of more than two-thirds of the House and three-quarters of the Senate, a compromise was agreed to which requires the USDA to reform the system and facilitate the evolution to a market oriented industry.
    Today, the subcommittee will hear from our colleagues, representatives of the Administration, producers and processors. I hope the comments will be productive and help all interested parties settle on a plan that will achieve the goal of the FAIR Act.
    "The Official Committee record contains additional material here."

    Mr. POMBO Our first panel is the administration panel with Dr. Enrique Figueroa, who is the Administrator of the Agricultural Marketing Service. He is accompanied by Dr. Kenneth C. Clayton, Mr. Richard McKee, Mr. John Golden, and Mr. Alex Amofal.
    Doctor, if you are prepared you may begin.
    Mr. FIGUEROA. Mr. Chairman and members of the committee, we appreciate the opportunity to appear before your committee to address the proposed rule for Federal Milk Marketing Order reform.
 Page 28       PREV PAGE       TOP OF DOC
    Accompanying me today are Dr. Kenneth Clayton, Associate Administrator of AMA; Mr. Richard McKee, Deputy Administrator, AMS Dairy Programs, and Mr. John Golden and Mr. Alex Amofal, Office of the General Counsel.
    As you know, Mr. Chairman, the Department is currently involved in rulemaking proceedings on milk order reforms and a reform of basic formula price of milk. Therefore, a transcript is being made of these proceedings which will be placed in the rulemaking record.
    Until we can review our proposal and draft a final rule, in light of all the comments we receive, it would be premature for us to attempt to predict today what the Department will eventually come out on any issue in rulemaking.
    In the interest of time, I will limit my remarks. However, I would like my full testimony entered into the record.
    Mr. POMBO. Without objection.
    Mr. FIGUEROA. As you are aware, Secretary Glickman announced on January 23, 1998 the Department's proposal for the reform of the Federal Milk Market Order Program which was mandated by the 1996 farm bill. This proposal will streamline the program by sharply reducing the number of milk marketing orders and revamping other provisions to introduce more market orientation to the program.
    U.S. agriculture is transitioning to a more market-oriented sector, free from traditional Government involvement, typified by price and income support programs. The Federal Milk Market Order Program is being restructured to be consistent with this trend toward a more market-oriented dairy sector in which dairy farmers respond to market signals.
    The proposed Federal Milk Marketing Order rule, which was published in the Federal Register in January 30, 1998, consolidates the 31 orders into 11, replaces the basic formula price with pricing formulas that reflect the values of milk components used to produce and manufacture dairy products, provides two options for replacing the way that minimum fluid milk prices are determined, including one option that closely reflects the current program, and a second preferred market-oriented option for fluid milk prices that could be accompanied by transition assistance for dairy farmers.
 Page 29       PREV PAGE       TOP OF DOC
    During the past year of developing this proposed rule, USDA exerted considerable effort to encourage the active participation of all segments of the dairy industry, academia, and the public. We received nearly 3,700 comments, participated in 250 meetings with over 22,000 individuals, and issued 9 reports, and participated in numerous congressional briefings.
    We also set up an extensive website on the Internet which includes the proposed rule, the regulatory impact analysis, numerous fact sheets that address various components of the rule and other pertinent information and reports.
    To maximize public input, the Secretary announced extension of the comment period to April 30, 1998, and four listening sessions will be held next week in Georgia, New York, Texas, and Wisconsin to receive additional public input.
    Let me turn now to the content of the proposed rule which addresses consolidation of the orders, the basic formula price, classified pricing, and streamline language and provisions.
    In the area of order consolidation, the proposed rule recommends 11 market order areas. Some areas of the country will remain unregulated areas under the Federal Milk Order System, but may have State programs. For the basic formula price, the proposed rules recommend a replacement. As all of you are aware, the current BFP is based on the Minnesota-Wisconsin price for unregulated grade B milk and a formula update to reflect current competitive conditions for manufactured products.
    There has been widespread agreement in the industry for some time now that the BFP needs to be replaced. Because the supply of grade B milk has dwindled in Minnesota and Wisconsin, as well as nationally, the BFP is becoming out of date and less reliable as a statistically-valid indicator of competitive market for milk. The proposed rule recommends that a class III price based on multiple component pricing replace the BFP, whereby the value of milk would be determined based on the values of protein, butterfat, and other nonfat solids used in the manufacturing products.
 Page 30       PREV PAGE       TOP OF DOC
    In the areas of classified pricing, the proposed rule suggests two options for reforming class I pricing which covers milk used for fluid products. Both options 1A and 1B recognize that milk used for fluid purposes should be valued higher than milk used for other products. However, the two options differ in their approach for establishing minimum values for fluid milk.
    Option 1A would establish a minimum price that reflects existing market conditions and the current value of milk used for fluid purposes. Option 1B, on the other hand, would reduce Government intervention in the milk markets by providing more room for market forces to determine the value of class I milk.
    Option 1A closely resembles the current class I price surface but makes adjustments for recent changes in economic conditions.
    Option 1B is the preferred option of the Department since it would introduce more market orientation and reduce the Government presence in establishing minimum class I prices.
    While option 1B still provides minimum prices that reflect the higher value fluid use of milk, it relies more on the market to generate whatever higher prices may be needed to attract milk away from surplus areas into deficit areas to satisfy demands.
    Option 1B would involve, in many instances, significant reductions in the level of class I differentials. Therefore the Department has proposed that option 1B differentials be phased in over a 5-year period. The use of a phase-in program would provide dairy farmers and processors the opportunity to adjust production and marketing practice to the more market-determined class I prices.
    The proposed rule provides three possible alternatives for phasing in option 1B which are discussed in detail in my submitted statement. Regardless of the final outcome with respect to options 1A or 1B, the method of establishing the minimum class I prices would be very similar to the current method in which class I differential is added to the BFP.
 Page 31       PREV PAGE       TOP OF DOC
    Under the proposed reformed Milk Marketing Order System, the class I differential will be added to a base price. The proposed class I base price would be a 6-month moving average of the value of milk used to produce manufactured dairy products, which could reduce the volatility in class I and produced lower prices will lend stability to the market.
     Finally, the proposed rule suggests streamlining order language and provisions, harmonizing language across orders where duplication currently exists, eliminating obsolete provisions, restructuring order provisions in a more logical format, simplifying the way shrinkage is classified, and modifying the way in which milk components are priced.
    Under the proposed rule, the Federal milk order system could continue to have uniform classification provisions, but with some modifications that would provide for four classes of use which are similar to the use provisions contained in the current orders.
    When the comment period closes on April 30, we will consider all comments that were received from the industry and other interested parties in preparing a final rule. The implementation phase will begin after the final rule is published in The Federal Register. We plan to conduct informational meetings around the country to inform producers and handlers of the newly-consolidated orders.
    Then, in each new order area, dairy farmers will vote in a referendum. Following the referendum a final order implementing the approved orders will be published in The Federal Register. We expect to meet the 1996 farm bill implementation deadline of April 4, 1999.
    Mr. Chairman, this concludes my statement. My colleagues and I will be glad to respond to any questions that you or members of your committee may have.
    [The prepared statement of Mr. Figueroa appears at the conclusion of the hearing.]
    Mr. POMBO. Thank you, Doctor.
    Am I correct in assuming that none of the other members of the panel had opening statements?
 Page 32       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. That is correct, Mr. Chairman.
    Mr. POMBO. Thank you. Are you still planning on having a final order completed by the end of the year for a vote by the different regions?
    Mr. FIGUEROA. Mr. Chairman, our target is to have a referendum vote sometime by the end of the year in order for us to meet the April 4, 1999, deadline mandated by Congress.
    Mr. POMBO. Do you still believe that you can realistically have this completed by April of 1999?
    Mr. FIGUEROA. As of today, Mr. Chairman, that is our target, yes.
    Mr. POMBO. One of the two proposed reform options, option 1A, by USDA's own account, is very close to the status quo with respect to the class I differentials. Is option 1A a viable option in light of the recent court decision that current differentials are arbitrary and capricious and should not be enforced?
    Mr. FIGUEROA. Mr. Chairman, it is our judgment that option 1A is indeed viable, given Judge Doty's decision. If we did not feel that that was an option, then we would not have included it as one of the proposed options in the proposed rule.
    Mr. POMBO. I'd like to for a moment turn to the California situation as part of the farm bill that allowed California to become a Federal order. Can you tell me what the current situation is with discussions between California and USDA on California becoming part of the Federal order system?
    Mr. FIGUEROA. Mr. Chairman, we received a petition from a group, or an entity, representing California farmers I believe in December. We looked at that proposal. The entity that submitted it, after we published our proposed rule on January 30, asked that they have that back because they wanted to put some revisions in their petition. We have received that and we are in the process of evaluating and analyzing that petition.
 Page 33       PREV PAGE       TOP OF DOC
    Mr. POMBO. So you have received it back and you are in the process of analyzing that at this time?
    Mr. FIGUEROA. That is correct, yes.
    Mr. POMBO. And you have not had any further discussions other than that?
    Mr. FIGUEROA. I personally have not. I was made aware yesterday that an another group also submitted their support for the original petition, but, other than that, I've had no extensive discussions with any members of the California dairy industry.
    Mr. POMBO. Besides California, we made it possible in the farm bill for other regions to reject becoming part of the order system. In your opinion, what is the possibility of some of the regions rejecting the amended order?
    Mr. FIGUEROA. I want to make clear that I understand your question. Are you asking me whether one of the proposed marketing orders could be voted down.
    Mr. POMBO. Correct.
    Mr. FIGUEROA. I have no way of assessing that probability today. Certainly, theoretically it's possible, but myself, nor members of my staff, have embarked in any analysis to try to establish that probability.
    Mr. POMBO. What would happen to a particular region if it were to reject the amended order, if they voted no?
    Mr. FIGUEROA. That region would become unregulated, unregulated as far as the Federal Government is concerned.
    Mr. POMBO. So they would be absent from a Federal Milk Marketing Order and all the milk would be unregulated within that region?
    Mr. FIGUEROA. Unless another jurisdiction, i.e., a State jurisdiction, would choose to regulate it.
 Page 34       PREV PAGE       TOP OF DOC
    Mr. POMBO. What would be the effect on the entire system if several regions rejected the amended order, thus creating pockets across the country where the milk was unregulated?
    Mr. FIGUEROA. As of today, I cannot, Mr. Chairman, tell you what that effect would be, but certainly if, after the referendum, if in our judgment a number of the orders [sic] chose not to implement the Federal Milk Marketing Order System in their regions, we would look at that outcome and evaluate its impact.
    Mr. POMBO. So that would kind of be a process of analyzing it as it happens? You've not done any analysis to determine what the effectiveness would be on the entire system?
    Mr. FIGUEROA. No, Mr. Chairman, we have not.
    Mr. POMBO. Recently, the Department had a hearing on implementing a floor price on milk. What prompted the Secretary's decision to hold the hearing? And, I believe it was somewhat a change in policy to determine that USDA had the authority to implement a floor price.
    Mr. FIGUEROA. We received a petition from a group, representing a significant portion of the dairy industry, requesting that the Department consider having a hearing on flooring both class I and class II prices. We evaluated that petition through our normal process of evaluating such petitions. Given the information that was provided to us, we concluded there was sufficient merit for conducting a hearing.
    With respect to your second component, whether there was authority or whether there was a change of policy, as I understand it, prior to this the discussions address flooring all classes of milk, whereas this hearing that we conducted specifically was in class I and class II milk.
    Mr. POMBO. Can you tell me what the current status is of that process, at this point?
 Page 35       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. We received testimony on February 17 through the 20th. The process required that briefs be submitted by March 11. We have received those. We are in the process of evaluating the testimony and analyzing what has been presented to us, and we'll put it through our normal course of evaluation and analysis and proceed from there.
    Mr. POMBO. When do you anticipate issuing a report on the hearing?
    Mr. FIGUEROA. It is difficult for me to say today when that time will be. I can only say that we are moving expeditiously and one of the requests for the petition was for a determination to be made whether there was an emergency in existence. So we are in the process of making that determination, and as we make that determination, we'll proceed accordingly.
    Mr. POMBO. Thank you. Mr. Peterson.
    Mr. PETERSON. Thank you, Mr. Chairman. First of all, Dr. Figueroa, this $365 million that has been talked about, as I understand it, that is only the impact on class I, and then I've been told that your own estimates are that this is actually $89 million, when you combine the whole effect overall. Do you agree with that?
    Mr. FIGUEROA. I'm going to defer to Mr. McKee. I'm not as versed at numbers as he is.
    Mr. MCKEE. Thank you, Dr. Figueroa.
    We have not seen the study that you refer to. We've obviously heard about it; it's been discussed. I'm aware of an organization that's putting that figure out. We're anticipating that will be included in their comments on the proposed rule. We would like to take a look at that when that comes in from that organization.
    So, whether it is specifically right as relates to class I or to all milk, I couldn't answer at this point in time.
 Page 36       PREV PAGE       TOP OF DOC
    Mr. PETERSON. Well, do you have a number on what the overall impact might be with 1A and 1B to dairy producers? Because they say 1A is actually a $32 million increase. Rather than take up my whole time, if you could take a look at this and give us the information because we've had four or five speakers talk about this $365 million hit, which I don't think is accurate and I think we need to get people to understand that they are only looking at one part of the system, it appears.
    Mr. MCKEE. Yes, sir. Mr. Peterson, we did put together a regulatory impact analysis. The Department put numbers together, and we can discuss what we think the farm cash receipts would be with respect to our 1A and 1B proposals. While I can't comment directly on the $365 million, the Department's estimate, option 1A, over a 6-year average, we would estimate, increasing farm cash receipts by $68 million. Option 1B, phased-in, would have a negative 6-year average of $117.3 million decrease. Option 1B, with the offsetting transitional option, is a decrease of $40.1 million for an annual average of the 6 years, and option 1B, with the additional phase-in amount, would add $34.9 million increase in farm cash receipts. This only relates to the producers that would be covered under the proposed Federal Milk Order areas.
    Mr. PETERSON. So, anyway, your numbers are substantially lower than what is being put out here?
    Mr. FIGUEROA. That's correct.
    Mr. PETERSON. That's the point I wanted to make. The second thing I'd like for you to do, in the March 25 issue of the Hoard's Dairyman is an article that I just got this morning where it shows that, under their analysis, the class I price mover over the last 3 years would be higher than the basic formula price has been. I would you to take a look of that article and give me an analysis of it and tell me if you agree with that, when you get time.
    Mr. FIGUEROA. We will do that.
    [The Department responded:]
 Page 37       PREV PAGE       TOP OF DOC
    In ''Proposed order reform raises prices but doesn't level the field'' by Hoard's Dairyman staff (page 253, Hoard's Dairyman, March 25, 1998), a graph appears of the proposed class I mover and the current Basic Formula Price (BFP) for January 1994–December 1997. The accompanying text indicates that the mover was consistently and significantly higher than the BFP during the 4-year period.
    The observations by Hoard's Dairyman are consistent with the data contained in the Department of Agriculture's proposed rule for the consolidation and reform of Federal milk marketing orders. These data show for the 48 months during the 1994–1997 period the proposed class I mover would have exceeded the actual BFP in 8 out of 12 months in 1994, 10 out of 12 months in 1995, and all months in 1996 and 1997 for a total of 42 out of the 48 months. During these 42 months, the proposed mover would have exceeded the BFP by 3 cents to $3.08 per hundredweight of milk for an average difference of 88 cents. Overall, the proposed mover would have averaged $13.09 and the BFP averaged $12.32 in 1994–1997, an average difference of 77 cents per hundredweight of milk.
    Mr. PETERSON. The other thing I'd like to know is, in light of what Mr. Solomon and Mr. Livingston, and some of the other Members who generally are market-oriented-type people, that it appears to me this morning that they are kind of taking a different position. I'd like to know what you think the purpose of the Federal Market Order System is, because apparently they think that the class I differentials are the market, and that it somehow or another is correct, and that if we change it and it's not market-oriented by changing it. I didn't get a chance to have a visit with them. I mean, as I understand it, these things were put in by legislative action in 1985, and the judge in Minnesota took a look at it and said that he couldn't see where the economic justification was there; that's why we are in the situation with the lawsuit.
    So what I'd like to know is, what do you think the purpose of the market orders are? Are they to provide price supports, as Mr. Solomon is indicating, to keep his farmers in business or are they to try to make sure that all farmers are treated equally and we have a level playing field within the market as it exists in this country?
 Page 38       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. The purpose of market orders is to provide for orderly marketing of milk, milk products and to ensure adequate supplies of milk, fluid milk. We believe that option 1B, which is a preferred option, is a more market-oriented option that will provide for that orderly marketing of milk and milk products as well as ensure an adequate supply of milk, milk products.
    Mr. PETERSON. Do you think the purpose of the market order system is to make sure that all farmers stay in business?
    Mr. FIGUEROA. It's my understanding that there is nothing in the language of the 1937 act that specifically says that. So my answer would be that it provides for orderly marketing.
    Mr. PETERSON. I'd like to ask you about the Northeast Compact a little bit. It's going to be expiring in April 1999, whenever this goes into effect? I would imagine, judging from the response we got here this morning, that we are going to see an effort to extend the Northeast Compact. What will your position be if that is, in fact, pushed?
    Mr. FIGUEROA. As of today, Mr. Peterson, the Department has not taken a position whether to support or not support the extension of the Northeast Dairy Compact. At some point in the future, we may; I certainly cannot speak for the Secretary, but, as of today, we do not have a position on that.
    Mr. PETERSON. There's, apparently yesterday—apparently, Mississippi now signed a bill to bring them into a compact. So it looks like there is going to be an effort in the Southeast to develop a compact. What would be your position on that?
    Mr. FIGUEROA. We also have not taken a position with regard to a Southeast Dairy Compact.
    Mr. PETERSON. When they set up a compact—if I could just followup; I've got two more questions—they established several criteria, among those were prohibiting compensatory payments, or limiting the marketing of milk into the compact areas. My understanding is that the Northeast Dairy Compact limits the marketing of the milk. So what is the Department doing to ensure compliance with that provision?
 Page 39       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. I'm going to defer to Mr. Clayton. I can't answer that directly.
    Mr. CLAYTON. Mr. Peterson, as a general statement we are monitoring the implementation, operation, if you will, of the Northeast Compact. I'm not sure that the way it's constructed that there is necessarily a limitation on milk coming in from outside. However, I think there are certain pricing provisions that apply in those cases where milk does come in from the outside.
    Mr. PETERSON. As I understand it, the provision in the farm bill required the compact, the Compact Commission, to compensation the Commodity Credit Corporation for any additional costs incurred as a result of the compact. So, I would assume there has been additional costs because those farmers are getting more money. So, has the Department estimated what these costs are, and, if you have estimated them will you release those costs, and just where are you with that whole process?
    Mr. CLAYTON. Mr. Peterson, my understanding is that a sister agency, the Farm Service Agency, which has the Department's connections through the Commodity Credit Corporation, is the responsible agency for determining whether or not there has been an impact on CCC removals. I think the review of that impact is ongoing, and my understanding at least is that, by the end of the year, that calculation will be racked-up and, I presume, would be made public, but I'm not precisely sure of the process there.
    Mr. PETERSON. So you think by the end of the year?
    Mr. CLAYTON. End of the fiscal year, yes.
    Mr. PETERSON. By September 30?
    Mr. CLAYTON. Yes, sir.
    Mr. PETERSON. Well, I would request that that be made available to myself and the committee whenever you get that information together.
 Page 40       PREV PAGE       TOP OF DOC
    Mr. CLAYTON. We will provide that, Mr. Peterson.
    [The Department responded:]
    USDA's Farm Service Agency has the responsibility for estimating the impact of the Compact on CCC purchases of dairy products under the Dairy Price Support Program. FSA is currently working on making the estimates necessary to meet the 1996 farm bill requirements. USDA will be glad to provide the results of this analysis to the House Committee on Agriculture as soon as it is available.
    Mr. PETERSON. Thank you. Thank you, Mr. Chairman.
    Mr. POMBO. Mr. Smith.
    Mr. SMITH. Following up a little bit on Mr. Peterson's question, why do you feel a Federal milk pricing system is necessary?
    Mr. FIGUEROA. It's been the position of the Department that the pricing system provides for orderly marketing.
    Mr. SMITH. What does that mean?
    Mr. FIGUEROA. That there is no large volatility, that it provides that milk in surplus areas moves to deficit areas when the time of year requires that.
    Mr. SMITH. And you think the market wouldn't do that without the Federal Government having a pricing system in place?
    Mr. FIGUEROA. The 1937 act provides for the current system as well as for the proposed system that we have before the public for comment.
    Mr. SMITH. No, no. The question is, do you think milk would flow like, essentially, all other products and commodities without the Federal Government intruding with Federal pricing?
    Mr. FIGUEROA. I can't——
    Mr. SMITH. The answer is eventually it probably wouldn't. Here's my understanding, and correct me if I'm wrong: As we started out with we had many small farmers producing with their dairy herds and sending it to each manufacturing plant. Because of the tremendous amount of power in negotiating that the plant had with a lot of small farmers, we came up with a system in the early 1930s designed to level out this playing field so there's fair price negotiations between all of the small producers, and the few processors. By that time the processors had already been taking advantage of small farmers by paying the small farmers less than they would pay the larger farmers.
 Page 41       PREV PAGE       TOP OF DOC
    So, it seems to me that one of the goals of the pricing system is to create a level playing field, if you will, for the negotiations between the producer and the processor so that producer can get an amount that's justified in relation to what the ultimate consumer is going to pay for those milk products. Another goal is to allow the small farmer to receive the same price as the large farmer.
    Do you agree with that?
    Mr. FIGUEROA. Yes, sir. We believe that our proposal indeed proposes to price milk on its components, i.e., butter fat, protein, and——
    Mr. SMITH. No, no, no, no, no. Do you agree that the reason we're doing this is to have a more equitable playing field to assure that the producer is getting a fair price for his milk?
    Mr. FIGUEROA. Yes, we believe that option 1B indeed provides for more open market negotiations between producers and——
    Mr. SMITH. So is the answer yes? Is this part of your goal in designing this proposal to make sure that the producer is able to negotiate in the best possible way to get a fair value for his milk?
    Mr. FIGUEROA. We believe that option 1B provides for that, yes.
    Mr. SMITH. Let me ask you another question. What is the cost of per hundredweight of transporting milk across the country.
    Mr. FIGUEROA. I don't have that number. Approximately 35 to 45 cents per hundredweight.
    Mr. SMITH. Per how many miles?
    Mr. FIGUEROA. Per hundred miles.
    Mr. SMITH. Thirty-five cents per hundredweight.
 Page 42       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. Thirty-five cents per hundredweight per hundred miles.
    Mr. SMITH. Let's see, 2,000 miles. That can't be right, can it?
    Anyway, check that and let me know, but it seems like that is a crucial computation in trying to decide what prices are going to be in your proposed 11 milk marketing orders. Is there a different degree of demand for whole milk in different areas of the country?
    [The Department responded:]
    In its proposed rule for the consolidation and reform of Federal milk orders, USDA indicates that Cornell University's U.S. Dairy Sector Simulator Model was used in analyzing and developing options for modifying the class I price structure of Federal milk orders. According to a July 1997 paper describing Cornell's model, the model specifies a cost of transporting milk of 40 cents per hundredweight per 100 miles. Thus, for example, it would cost approximately $5.87 per hundredweight to haul milk from Madison, Wisconsin, to Miami, Florida, a distance of around 1,467 miles.
    Mr. SMITH. Will consumers more readily pay a higher price for fluid milk in some parts of the country as opposed to others?
    Mr. FIGUEROA. As far as I know, today, Mr. Smith, we don't have very good information as to what the demand structure is across regions of the country. We do know that milk is priced differently, as you also know, by its location value of fluid milk.
    Mr. SMITH. What do you think are the long-term and short-term impacts of having four different classes of milk for pricing?
    Mr. FIGUEROA. I think the short-term impact, in our assessment, is it provides for a more market-oriented kind of pricing system for those particular classes. The long-term, I think, it provides for more orderly marketing and more stable marketing.
 Page 43       PREV PAGE       TOP OF DOC
    Mr. SMITH. And, again, what we're talking about is trying to assimilate a market-type structure where if the negotiations were fair and if transportation was readily achievable, there could be a fair market pricing for milk without the Federal order. Is that what we're trying to do? We're trying to create a situation where all farmers can receive the price set in the marketplace.
    Mr. FIGUEROA. We believe that option 1B in our proposal, indeed, does that, or approaches that.
    Mr. SMITH. Can I just ask, even though the light's red, what percentage of the milk in this country is sold with a payment to farmers that is above the current order price now?
    Mr. FIGUEROA. It is a high percentage, Mr. Smith. We don't have the exact number. We'll provide that number for you.
    [The Department responded:]
    We estimate that the proportion of total class I use that receives an over-order charge is currently around 85 percent. Over the last few months, the all-market monthly weighted average over-order charge on class I milk has ranged from $0.85-1.10 per hundredweight on that milk receiving a charge.
    Mr. SMITH. And do you assume that either under 1A or 1B that there would be a like situation where that similar percentage, whatever that high percentage is, would still be sold above the order price?
    Mr. FIGUEROA. We would assume that we would have order pricing, but it would be different, whether it's 1B or 1A.
    Mr. SMITH. Thank you, Mr. Chairman.
    Mr. FIGUEROA. Thank you.
    Mr. POMBO. Your analysis is that it would be different between 1A and 1B. Can you provide that for the record?
 Page 44       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. We can provide that for you, Mr. Chairman, yes.
    [The Department responded:]
    Baseline data in the model reflects over-order payments on class I milk reported by Market Administrators. Specifically, these data reflect average over-order payments as announced by the major cooperative in the marketing area but exclude any competitive credits. Although we are aware that over-order payments are made on milk used in class II and class III milk, sufficient data are not available to reflect such payments in the model's baseline data.
    In the analysis of option 1A, no adjustments were made in the level of over-order payments, since option 1A differentials for the most part were not greatly changed from the current levels except in areas where little or no over-order payments existed, i.e., the New Mexico-west Texas marketing area.
    The analysis of option 1B differentials showed three areas where adjustments in class I over-order payments were necessary to realign all-milk prices and assure milk movements to supply class I needs. The lowering of class I differentials in the mid-section of the country left the all-milk price in Florida at a level that was thought would encourage an excessive amount of milk to become associated with that market. Therefore, the over-order payment on class I milk in the Florida market was reduced. A second adjustment was made in Texas and New Mexico. The price incentive to move milk from west Texas to east Texas appeared too small, therefore, the over-order price in Dallas, TX, was increased and the already small over-order price in Albuquerque, NM, was eliminated. No changes in over-order payments for other markets were made.
    Mr. POMBO. Thank you. Mr. Johnson.
    Mr. JOHNSON. Thank you, Mr. Chairman. Doctor, which option do you think is most consistent with the overall farm bill objectives?
    Mr. FIGUEROA. We believe that option 1B, if you are specifically talking about classified pricing, we believe that option 1B is more consistent with the 1996 farm bill. It is market-oriented, and we believe that that is indeed more consistent.
 Page 45       PREV PAGE       TOP OF DOC
    Mr. JOHNSON. Why in the end did the Department, if you are seeking real reform, even include option 1A when, in fact, option 1B is the real preference?
    Mr. FIGUEROA. We felt that there were sufficient comments that I mentioned in my statement, that we received over 3,500 comments in the process of formulating the proposed rule and it was our judgment that we wanted further public comments both on 1A and 1B. As you know, Mr. Johnson, there were other options on the table during this 2-year process that we chose not to include in our proposed rule, but we felt that we needed more comments on both 1A and 1B.
    Mr. JOHNSON. The Minnesota lawsuit has been referred to by the chairman. How do you think this is affecting your work on the reforms, and do you have any opinion as to which option Judge Doty's ruling might point to as a preference?
    Mr. FIGUEROA. With respect to your first question, Mr. Johnson, we proceeded with our proposed rule with relatively little, if you will, attention to Judge Doty's rule in the sense that it has not influenced our proposal.
    With regard to your second question, I will defer to my general counsel, Mr. Golden, to answer that.
    Mr. GOLDEN. Thank you, Dr. Figueroa.
    I think our position with respect to the litigation is that the basis of Judge Doty's decision is that the analysis that the agency had gone through at the time of the decision, the analysis that was at issue in the decision, did not take sufficient account of, and did not show a sufficient evidentiary justification to be properly considered all of the supply-and-demand factors required by the statute.
    So, the decision was not a decision against the, with regard to the issue per se, but it had more to do with the analysis and the adequacy of the analysis and we believe that the agency is taking those factors into account in these proposals, in both proposals, and that if that is the case neither of them is suffered by the, from the infirmities that Judge Doty concluded the earlier analysis suffered from. I would point out, however, that that case is on appeal in the eighth circuit.
 Page 46       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. Let me modify my earlier statement, Mr. Johnson, and that is, we believe that both option 1A and 1B would indeed meet the test that Mr. Golden specified with regard to the Doty decision.
    Mr. JOHNSON. So you look at both option 1A and 1B as being reform? That meets his objectives?
    Mr. FIGUEROA. Yes, sir. That is our position.
    Mr. JOHNSON. But under option 1A, the class I differentials, it is my understanding they don't really change that much. Would you agree that, in effect, this is kind of a status quo 1A?
    Mr. FIGUEROA. We state in our proposed rule that option 1A more closely mirrors the current system. However, as you are well aware, that is one of the reasons why we are preferring 1B, because it does make the system go to a more market orientation.
    Mr. JOHNSON. You've been asked about the $365 million loss figure on income under 1B. Does that include over-order premiums? Maybe Dr. Clayton?
    Mr. CLAYTON. I would just say, Mr. Johnson, given that we've not seen the analysis, it is very difficult to know what is included in that. So I think as soon as we see that, we'll be able to react to it. But we haven't seen it.
    Mr. JOHNSON. Mr. Dooley says that it——
    Mr. DOOLEY. No. [Laughter.]
    Mr. JOHNSON. I guess not, I'm sorry.
    I'm wondering why you vigorously relied on the Cornell model for option 1B but not for option 1A.
    Mr. FIGUEROA. Excuse me. Could you please repeat that?
    Mr. JOHNSON. Yes. I'm wondering why you vigorously—it appears you relied on the Cornell model for option 1B, but not for option 1A.
 Page 47       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. Mr. Clayton will answer that, given that I've been here 4 months and he knows more about what model was relied upon.
    Mr. CLAYTON. Mr. Johnson, actually the Cornell model was utilized in developing both options. It was probably relied on a bit more closely with respect to option 1B, but it was certainly a factor that played in the development of both options.
    Mr. JOHNSON. Just a final thing: What's the latest timetable now for making the final decision for the referendum?
    Mr. FIGUEROA. April 30 is the deadline for comments. We will analyze and evaluate those and our target sometime later on in the fall of this year is when we will provide for our final rule to be voted upon in a referendum.
    Mr. JOHNSON. Thank you very much. Thank you, Mr. Chairman.
    Mr. POMBO. Mr. Gutknecht.
    Mr. GUTKNECHT. Well, thank you Mr. Chairman. I appreciate the opportunity to be here. I'm sorry, I have three other meetings going at the same time and I congratulate you and your staff for putting together really some really distinguished panels today. This is an extremely important issue. I feel a little bit at the outset like David after listening to our powerful and distinguished colleagues from the Appropriations and Rules Committees, but, on the other hand, as John Adams once observed, facts are stubborn things.
    And let me share a couple of facts with the subcommittee and some of the people who are here today, that I'm somewhat surprised to hear my champions of free markets talking about essentially maintaining the status quo. When you look at the fact, since 1995, in my home State of Minnesota, we've lost more than 11,000 dairy farmers, and nationwide we have lost over 152,000 dairy producers under the very system which today so many people are attempting to save.
 Page 48       PREV PAGE       TOP OF DOC
    I won't use all of my remarks here. I would hope that you'd allow me to submit them for the record. But I want to cover a couple of other points.
    I think we need to start with a more market-oriented system. We've got to reject the harmful compacts and price floors and other schemes that have been created over the last several years and are continuing to grow.
    We need to implement an options pilot program that eventually can become a national model in scope. We need to authorize forward pricing to shift risk away from the producers.
    On that note, I seriously doubt if anyone in this room would say that green farmers shouldn't have the right to forward contract to protect against price volatility. Yet, we do exactly that to America's dairy farmers. It's bad policy and we in this room have the power to stop it.
    Now, Mr. Chairman, when the Kremlin collapsed, the newspaper editorial commented that markets are more powerful than armies. Because history has demonstrated this time and again, I'm convinced that fluid milk will be sold according to the dictates of supply and demand. If you don't believe me, just look at the editorials in the Washington Post, the New York Times, and the Wall Street Journal. It's really only a matter of time.
    The question before this subcommittee and the folks at the USDA is, will we in the agriculture community accomplish reform on our own terms and at our own pace or will this change be forced down throats, after we've surrendered yet more farmers and potential markets? The choice, Mr. Chairman, is ours to make.
    And I thank the chairman for allowing me to be on the panel, and if I could, I'd like to ask a couple of quick questions of this group.
    Dr. Figueroa, I'm not an economist, but let me just give you this scenario: If fluid milk prices increase and farmers in high fluid milk areas do what most people will do, and that is increase production, in response to these higher prices, consumption will decline or at least level off. As a result, more milk from high fluid areas will flow into cheese production, both driving down the percentage of milk used for fluid use in those areas and reducing the basic formula price nationwide. Dr. Ken Bailey, a noted dairy economist from the University of Missouri says, ''most economists already know this.'' Would you concur with Dr. Bailey and most economists on this point? And if not, why are the laws of supply and demand suspended with regard to milk?
 Page 49       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. If I understood your question correctly, that is, that you would have high prices for fluid milk and then you would then have a supply response from the producers, which would provide more milk because of the high prices of retail. There would be less consumption of fluid milk, which means that there would be more product orientated toward the cheese or manufactured market, which, because of the excess supply in that market, would then translate into lower prices for that. Is that the scenario that I understood you to say?
    Mr. GUTKNECHT. I think you've got it exactly right.
    Mr. FIGUEROA. I would say that in general economic terms that appears to be the forces of supply and demand working, that's correct. When you have excess supply, you generally have declines in price.
    Mr. GUTKNECHT. Well, let me just say that I do appreciate what Secretary Glickman has said and most of what you have said this morning. And that is, that given the choices between 1A and 1B, 1B is the much more market-oriented system. And long term, I think markets will prevail, as I mentioned in that editorial.
    I want to thank you for being here today and I would yield back the balance of my time, and I look forward to staying with the committee.
    Mr. FIGUEROA. Thank you.
    Mr. POMBO. Mr. Dooley.
    Mr. DOOLEY. Thank you, Mr. Chairman. I'd like to proceed what I would call more of a chronological order here.
    And the first issue I'm most concerned with is one that might be made earliest, and that deals with putting in a temporary emergency price floor. In reading your testimony, Dr. Figueroa, you mention that we should continue on the trend toward a market-oriented dairy sector in which dairy farmers respond to market signals. How does the Department justify an arbitrary price floor as being consistent with that statement?
 Page 50       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. Mr. Dooley, as you know, we indeed have not come out with a position whether we're going to floor the price or not, which is currently still in——
    Mr. DOOLEY. Though, how would then you justify though, even regardless of the decision that you would make or might make, how would that be consistent with your statement that we ought to be moving towards a more market-oriented system?
    Mr. FIGUEROA. What I could say with regard to that is that, we're in the process of evaluating all the comments that we received in the testimony. If that commentary leads us to conclude that there is some justification, we would indeed then go forth accordingly. Again, I want to stress that we have not made a decision with regard to that.
    Mr. DOOLEY. Then I'll restate my question. How is a temporary price floor based on a arbitrary number, consistent with a statement that you had—moving towards a market-oriented dairy sector which dairy farmers respond to market signals?
    Mr. FIGUEROA. Theoretically, I could answer in the following ways: As you know, we asked for in the testimony for individuals to address the issue whether an emergency situation exists. So, as you might think that, if an emergency situation exists, then perhaps we could address a short-term solution to that emergency for that. Again, I want to be very clear that we're in the process of making a decision, of evaluating the testimony, and when that time arises that we would make a decision, then we would announce that and perhaps address the justification, the question that you have.
    Mr. DOOLEY. Also, one of the criteria, is the determining—I think you made a statement in an earlier question—if an emergency exists. I would ask, what is your response to determining that there is an emergency currently, when we have in February, the highest recorded BFP price in history?
    Mr. FIGUEROA. Again, that is only one of the criteria that we would use.
 Page 51       PREV PAGE       TOP OF DOC
    Mr. DOOLEY. Is it a critical criteria?
    Mr. FIGUEROA. It is one of four or five criteria that we would use. I have not personally looked at the testimony to be able to tell you that this is how the testimony's coming forth. But I will answer that we would look at all of the testimony, consider seriously, and render our decision some time in the future.
    Mr. DOOLEY. Well, I just guess I'll express a little frustration. I know the testimony's important, but it's also the responsibility of USDA to be making their decisions based on some of their stated policies. And I think, as I understand, some of your stated policies are that we are moving in a more market-oriented direction and that we're also determining another criteria to determine whether an emergency exists. And I just find it very, very difficult to—how the Department could ever justify putting in a temporary emergency price floor at this time, when we have the highest BFP prices, which appears totally inconsistent with the Department policy.
    Mr. FIGUEROA. I can say that we are, indeed, going towards more market-orientation in the dairy sector. So I would agree with you. I can't give you a definitive answer how we're going to come out in the BFP today.
    Mr. DOOLEY. Moving to another issue that's of critical importance to California, it appears that we might be almost getting into a Catch–22, in that when we drafted the 1996 farm bill, the intent was to allow California producers to make a decision whether or not they wanted to join the Federal Milk Marketing Order. My concern is that just in terms of the timing. As I understand it, USDA is making a determination that their authority to reform Federal Marketing Orders expires on, I think, April 1, 1999. The final rule or regulations will be published, I think, in January or February proceeding that April 1 deadline. My concern is, are California producers going to be in a position where they are going to have to make a determination on how to—make a decision whether to enter the Federal order and abandon their State order within what might be a 1-month period of time?
 Page 52       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. We have not set a firm date, for example, your choice of January 1999. Our target as I said earlier is sometime during the fall that we would come up with a final rule and that the referendum then would take place. It is our position as well that the California producers, as some of them have already exercised that right, submitted a petition to us and we're in the process of evaluating that. Whatever our analysis of that petition is, we would make a decision as to whether we want to provide California producers to exercise a vote on that.
    Mr. DOOLEY. I'll wait for the next round, Mr. Chairman.
    Mr. POMBO. Mr. Blunt.
    Mr. BLUNT. Thank you, Mr. Chairman. Again Dr. Figueroa, I want to thank the Department for being open to all of the input on the marketing map, and I'm particularly grateful that you and Mr. McKee and others were able to look at the information that came in and where the milk was being used. I want to thank you for that.
    I think our friend, Mr. Peterson, asked if one of the purposes of the marketing order structure was to help keep farmers in business, if I'm close to the question. Now, what was your answer to that?
    Mr. FIGUEROA. My answer was that the purposes of the market order system is that we wanted to provide orderly marketing of milk and milk products and to assure the adequate supply of milk to consumers.
    Mr. BLUNT. Do you have programs at USDA whose purpose is to help keep farmers in business?
    Mr. FIGUEROA. I believe there are such programs in other agencies in the USDA, yes, sir.
    Mr. BLUNT. Do you think that one of the purposes of the Marketing Order is to ensure a fresh supply of milk?
 Page 53       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. Yes sir. We would like assure adequate supplies of fresh milk products across the country.
    Mr. BLUNT. I really don't have any problems with programs that do both of those things and I don't see any reason to be defensive about a program that produces those two results. The numbers that I saw in the last few days that I mentioned earlier where that our domestic use is exceeding our domestic supply, is that likely to be the case again for 1998? I believe that was the case in 1996 and 1997.
    Mr. FIGUEROA. I'm going to defer to Dr. Clayton.
    Mr. BLUNT. Dr. Clayton.
    Mr. CLAYTON. Congressman, I'm not sure that that is completely on track. I think the—bear with me 1 second, if you would, sir.
    Mr. BLUNT. Sure, I think I got those numbers from the Department, but I'd like you to confirm them. if you can or not.
    Mr. CLAYTON. It looks like actually there will be some minor surpluses this year—surpluses relative to USDA activity. There will be some relatively small surpluses this year, and I think next year they look to be going down a little bit.
    Mr. BLUNT. Going down a little bit. And then in 1996 and 1997, am I right that our consumption exceeded our supply of dairy products?
    Mr. CLAYTON. I don't think our figures suggest that, sir.
    Mr. BLUNT. I've got some figures on that; I'll get back with you after I check and see if my figures are right or they're wrong, or maybe I'm just misinterpreting the figures I have.
    But part of the purpose of this is to insure a fresh supply. I also believe part of the purpose of the transition, however long it takes, is stability. And as we look as these two options, I continue to think that 1A provides the most stability. But in 1B, what kind of transition plans do you have in terms of any kind of thoughts about buyouts or other things that would be part of the transition to 1B?
 Page 54       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. Mr. Blunt, the proposed rule offers 3 transitions in the 1B situation. There is, as far as I'm concerned since I've been here, no discussion with regard to buyouts. There is nothing like that in the proposed rule. The three transition periods are over that 5-year period with one without any bump, one with the bump, and then one with what we call the double bump, if you will.
    Mr. BLUNT. No bump, the bump, and the double bump are the options.
    Mr. FIGUEROA. In blunt terms, yes.
    Mr. BLUNT. ''Blunt terms'' are OK. You can do that. [Laughter.]
    On the question going back to your hearings on the concept of some kind of floor, does 1B or 1A preclude the idea of following up on the hearing you had a floor? Would that really be inconsistent with either or both of those options, or would it be consistent with either or both of those options?
    Mr. FIGUEROA. The flooring hearing is intended to, if we decide to go with the floor price, just to be in effect until Federal milk market order reform would be implemented, whether it's 1A or 1B. And our target, as I mentioned earlier, would be April 4, 1999. So it will only be in existence to that day.
    Mr. BLUNT. Going back to Mr. Peterson's earlier question, you don't believe that one of the purposes of the Milk Marketing Order structure would be to put farmers out of business, do you?
    Mr. FIGUEROA. I could not sit here and tell you that that's our intent, that's correct.
    Mr. BLUNT. Thank you. Thank you, Mr. Chairman.
    Mr. POMBO. Mr. Pickering.
 Page 55       PREV PAGE       TOP OF DOC
    Mr. PICKERING. Just to followup on Mr. Blunt's question, that may not be the intent, but will that be the result?
    Mr. FIGUEROA. It possibly could be the result. In our impact analysis that we have in our proposed rule, we'll provide an assessment of what we think may be the outcomes of 1A and 1B.
    Mr. PICKERING. And what is your impact assessment on the Southeast and other regions as to what will happen to our farmers and our ability to supply fresh milk?
    Mr. FIGUEROA. There is nothing as far as I'm aware of that specifically addresses the number of farmers. We look at prices and incomes, but I'll let Mr. McKee answer that more directly, sir.
    Mr. MCKEE. Yes, Dr. Figueroa is correct. We're not looking at numbers of dairy farmers but we are looking at the revenue impacts on a regional basis. It looks like the phase-in of option 1B would result in a 6-year average of about minus 13.9 million in pounds of marketing, so we would see——
    Mr. PICKERING. Could you repeat that one more time?
    Mr. MCKEE. We would see a reduced marketings of 13.9 million as a 6-year average as a result of the phase-in option 1B.
    Mr. PICKERING. And 1A? What would be the impact?
    Mr. MCKEE. With 1A, it would appear that we would see an increase of about 4.8 million pounds of marketings over the 6-year average. These are all contained in the preliminary regulatory impact analysis that was published along with the proposed rule on the 23rd of January.
    Mr. PICKERING. So under 1A, you would have a net increase of supply and income?
 Page 56       PREV PAGE       TOP OF DOC
    Mr. MCKEE. Of marketings.
    Mr. PICKERING. And under 1B you would have a 13.9 million reduction?
    Mr. MCKEE. That's correct.
    Mr. PICKERING. There's an old saying, ''milk the cow, but don't pull off the udder,'' and I'm afraid that what we're doing could, in essence, pull the udder off or cause us to lose our ability to produce and have a consequence of what we've seeing over last 10 to 15 years in my region. My family had a dairy farm for two generations and we participated in the buyout program in 1987. Between my sophomore and junior year in college I'd worked on the dairy farm and it gave me a high motivation to go on and do other things in life.
    But this is a trend that we've seen in my district in my State. We had probably 10 years ago 1,000 dairy farmers; now we only have 100. And so I am concerned about the trends and I hope that we can in this transition period, possibly accomplish multiple objectives, as Mr. Blunt laid out. I am concerned that we could become a net importer; that our consumption would be in excess of our production. And if there is a way—and let me ask you this question: Is there a way to combine 1A and 1B so that we could minimize the disruption, displacement, and at the same time, move to a market-oriented system?
    Mr. FIGUEROA. Let me just mention, Mr. Pickering, that you are correct in that the number of farms has declined but the production of milk has increased.
    Mr. PICKERING. But under 1B you would reduce production, correct?
    Mr. CLAYTON. Mr. Pickering, compared to the USDA's baseline, it is true, it would come down some. I think the point that Dr. Figueroa was making is that if you look over summaries in the full expanse of time, what you notice is that farm numbers have come down; yet, overall production has increased.
 Page 57       PREV PAGE       TOP OF DOC
    Mr. PICKERING. But under 1B, what is the impact assessment—production would go down?
    Mr. CLAYTON. Yes, sir.
    Mr. PICKERING. Dominant production would go down?
    Mr. CLAYTON. Slightly. Compared again to the baseline.
    Mr. PICKERING. And as you look around now, would our Nation become a net—that we would—our consumption would exceed our production over the next 5 years?
    Mr. CLAYTON. No, I wouldn't think so, Mr. Pickering. I don't think that would happen.
    Mr. PICKERING. Even though Mr. Blunt said in the last 2 years that was the case and then we're right on the edge today?
    Mr. CLAYTON. Well, I think we need to clarify the statistics that Mr. Blunt was citing. Certainly you can have movements in production in a given year, movements in consumption, but I think you have to step back and look at all of that as a package, which we weren't really able to do in the discussion here.
    Mr. PICKERING. Going back to my last question and this will be my last one, is there a way to combine 1A and 1B to maximize on multiple objectives in this case and combine the emergency order—the emergency floor price—during this transition?
    Mr. FIGUEROA. I think—in a rulemaking process, Mr. Pickering, we could conceivably get comments that would lead us to conclude that there would be components of 1A or perhaps 1B that could be fused together.
    Mr. PICKERING. Thank you.
    Mr. POMBO. Mr. Peterson.
    Mr. PETERSON. Thank you, Mr. Chairman. I want to pursue this floor price thing a little bit because I think what they tell doctors when they are working on a patient is that first do no harm.
 Page 58       PREV PAGE       TOP OF DOC
    I would argue that in my particular part of the world, we do have an emergency situation because we're continuing to lose producers even with the prices being what they are. In fact, in Stearns County, which is the largest dairy county in either Minnesota or Wisconsin, where we haven't seen people exiting, we are seeing young farmers and some of our better farmers exit the business. So we have a serious situation.
    The problem that I have with this that people I don't think understand is that we've done an analysis of this proposed price floor, and it helps Florida net amount of 84 cents a hundreweight; it helps the Southeast 67 cents a hundredweight. But our analysis is in the upper Midwest, it costs us 22 cents a hundredweight. So don't give us that kind of help. That's why we're opposing this. It raises the class I price, but we don't have any class I milk. And we think the effect of this is going to be to reduce the manufacturing price, which will mean that our producers are going to lose money. Now you're going to hear that from other people here today and they're going to put some information in.
    I would like you to take a look at the analysis that has been done by the Upper Midwest Coalition in conjunction, as I understand, with the University of Wisconsin, and give us your take on whether what they've put together is actually true. Because it's very disturbing to me that you had put out a proposal that purports to help dairy farmers that's actually going to cost us money. It's very hard for Mr. Johnson and I to go home and explain that to anybody. So if you would take a look at this and give us some information back, we'd appreciate it.
    Mr. FIGUEROA. Yes, sir, we will.
    [The Department responded:]
    We have requested input from the public on the proposed rule. The University of Wisconsin study on Federal milk order consolidation and reform was included in the testimony of the representative of the Upper Midwest Dairy Coalition at this hearing before the Subcommittee on Livestock, Dairy and Poultry of the House Committee on Agriculture. The record of this hearing is being included by USDA as part of the Federal milk order reform proceedings. As such the Wisconsin analysis will be given full consideration as we continue the process of consolidating and reforming Federal milk orders. Because we are now in the process of evaluating the rulemaking record, we will not be able to give you a detailed explanation of how Wisconsin's analysis may differ from USDA's Preliminary Regulatory Impact Analysis of the proposed rule on milk order reform.
 Page 59       PREV PAGE       TOP OF DOC
    Mr. PETERSON. Also, on the forward contracting, in the unregulated part of the country, forward contracting has been very popular. In fact, some of these plants where there's no regulation, they have 100 percent of their producers have signed up and are very happy with it. As you understand, we're having trouble getting it done because apparently somebody thinks it conflicts with the order system where we have a regulated area. My question is, do you support the concept of forward contracting?
    Mr. FIGUEROA. The information that I have today is that we are aware that there is some proposed language to be included in the research bill——
    Mr. PETERSON. I think that was dropped out and so whatever—it was not included. And as I understand it, the research bill is closed up, so I think that's maybe a moot issue at this point. My concern is, if we try to move this forward and try to make it available, would you support working with us to try to make forward contracting an option that people could use?
    Mr. FIGUEROA. We will certainly consider your points of view and anybody else with regard to the issue. I'm not prepared today to tell you that we will support or not support it. We have to look at the details and how it impacts our proposed rule, and we would then make that judgment.
    Mr. PETERSON. There's been some question about whether you have the authority to do this or not, and whether it would take legislation. Do you know the answer to that? Can you do this or does it take legislation?
    Mr. FIGUEROA. I'll defer to our legal counsel on that.
    Mr. GOLDEN. We don't believe that new legislation is required.
    Mr. PETERSON. So you could adopt this through your own process?
    Mr. GOLDEN. Adopt one or the other options of the basis of the rulemaking process that's going on?
 Page 60       PREV PAGE       TOP OF DOC
    Mr. PETERSON. No, no, no. I'm talking about forward contracting, allowing for forward contracting. Do you have the authority to do that or does it take legislation?
    Mr. GOLDEN. Yes, we do believe that it can be done, under current statutory authority.
    Mr. PETERSON. Then why are you not doing it? I mean, it's been highly successful where we have an unregulated area, and as I understand it, they're getting resistance from within the Department. What's the reason for that? What harm do you think it's going to do to the order system?
    Mr. FIGUEROA. Dr. Clayton is going to answer that, Mr. Peterson.
    Mr. CLAYTON. I think there are probably more questions than answers on this one. I would observe that forward contracting in fact can now be carried out outside the order program; nothing to prevent that. Even in a regulated area, if folks choose not to pool their milk, they can——
    Mr. PETERSON. Well, they have to basically get out of the order to do it. I don't understand why there's a resistance to doing it. What do you think this undermines within the order system?
    Mr. CLAYTON. Well, I think what the issue comes down to is the whole basis of the order program, is that we enforce minimum prices, and if there's sort of a technical issue, it probably relates to consistency between a group of farmers being treated one way and all the rest of the farmers being treated another way.
    Mr. PETERSON. Well, but, we haven't been at minimum prices with the order system for—I mean, it's very seldom we ever hit that.
    Mr. CLAYTON. Under the order program, we are required to enforce the minimum prices. I mean, it is our responsibility and——
 Page 61       PREV PAGE       TOP OF DOC
    Mr. PETERSON. Am I taking this that you're opposed to this idea?
    Mr. CLAYTON. We don't have a position on it because we're not precisely sure what changes folks would contemplate in the order program to apparently allow this to work.
    Mr. PETERSON. If I could, Mr. Chairman, I was going to switch to one other thing. I just wanted to know what your reaction was to Mr. Solomon sitting up here saying that what you're doing is in violation of what he thinks the congressional intent was? Because I think it's pretty clear that he thinks that the congressional intent was that the current system is market-oriented, and I don't agree with him, but I just want to know, do you agree with what he said, that the Congress was sending you a signal that the current system was fine the way it is? Apparently, you don't, putting forward a 1B proposal——
    Mr. FIGUEROA. Well, that's correct, Mr. Peterson. We believe that both the proposed rule indeed meets congressional intent and the 1996 farm bill and whether——
    Mr. PETERSON. But he claims to be author and says that it's going against his intent.
    Mr. FIGUEROA. I just want to reiterate that it's our position that——
    Mr. PETERSON. You've only been here 4 months, right? [Laughter.]
    Mr. FIGUEROA. That's correct. Also, Mr. Dooley said he was going to write that. [Laugher.]
    Mr. PETERSON. Well, I think he disassociated himself from authorship, didn't you, Mr. Dooley?
 Page 62       PREV PAGE       TOP OF DOC
    Anyway, thank you, Mr. Chairman.
    Mr. POMBO. Mr. Johnson.
    Mr. JOHNSON. No questions.
    Mr. POMBO. Mr. Dooley.
    Mr. DOOLEY. I just want to revisit the concern that a lot of California producers have. And that deals with a very compressed timeframe to make a decision whether or not to enter into the order. And here's my concern:
    I think there is a interest out there for people to—in California producers—to make an informed decision on the merits of entering into the order. My concern is while you're looking at a deadline to have the regulations in place by fall, is what you hope, is that I am concerned that if that slips and it becomes January—and my reasons for being concerned on that, I think I'm not convinced that the Department now has been able to engage in the analysis of how we would handle the integration of the California order with how we would handle the quota, how we would handle our higher fortification, higher solid standards. There's a whole lot of issues out there that have to be resolved before I think the Department can offer the producers in California a clear choice.
    My concern is that, if this does slip until January, producers are going to be faced with making the decision with maybe only 1 month. And I can guarantee you that the outcome of that will be that California will vote no. The Department has to be very much aware of this because if there is not the certainty and the time to reflect on this, it's no question I think what the majority sentiment of the California producers will be, if there's not enough time. So what I'm asking, does the Department have the authority to extend and allow California to make a decision later than the April 1, 1999 deadline?
    Mr. FIGUEROA. I am going to refer to Mr. Golden, our General Counsel, with regard to authority within the Department.
 Page 63       PREV PAGE       TOP OF DOC
    Mr. GOLDEN. Thank you, Doctor.
    With respect to the California issue, as you know, the statutory language provides that the Secretary shall implement the amendments not later than 3 years after April 4, which would be April 4, 1998. The California provision is an amendment and the authority for it lies within the amendment section of the statute. And so, the California—in our view, the California order would have to be announced and, therefore, there would have to be the steps to get up to that point, of course, by April 4, 1998. If the State of California did not follow that course, then it would have to come under the regular provisions of the AMAA, which would not authorize the quota system that's particularly authorized in the amendment section here and would not authorize the use of the informal rulemaking processes that are also created by the statute.
    Mr. FIGUEROA. John, you used the year 1998; you meant 1999, is that correct?
    Mr. GOLDEN. That's correct. I'm sorry, I misspoke.
    Mr. DOOLEY. So unless we took legislative action to extend the deadline, there would be no authority for USDA to administratively take action that would give more time for the consideration?
    Mr. GOLDEN. That's correct.
    Mr. DOOLEY. Well, that is something that I think many of you are well aware, that the decision of California is going to also have impacts on some of the other States—in Oregon and Washington, the surrounding areas—about the decision they're going to be making to participate in the Federal order. And I would hope that if your time line does slip and we in fact see the regulations not being published in time to give adequate time for consideration by the California dairy producers, is that the Department would consider supporting a legislative effort to extend the time for consideration.
    Mr. FIGUEROA. Well, we certainly would consider that request and that point in time when it's appropriate we'd make that decision.
 Page 64       PREV PAGE       TOP OF DOC
    Mr. DOOLEY. I'm sorry I had to step out while Mr. Peterson was asking some of the questions on the forward contracting. I just need one clarification. You can do this—you can currently forward contract if you go outside the pool, as I understand it. Now, if you go outside the pool, does your milk become classified differently? Is it grade A, grade B, or is it——
    Mr. FIGUEROA. I'll let Dr. Clayton answer that.
    Mr. CLAYTON. Mr. Dooley, whether it's grade A or grade B is a different issue actually. That's going to have to do with sanitation procedures and such, under which the——
    Mr. DOOLEY. So there's no inference that there's any—there's nothing that would have any impact on that being if it pulls out of the order?
    Mr. CLAYTON. That's correct. It would just be unregulated milk and it's either grade A or grade B by definition of how it was produced.
    Mr. DOOLEY. So here's nothing in issue if you de-pool that you become grade B—nothing at all?
    Mr. CLAYTON. No, it's a fact of the milk itself.
    Mr. DOOLEY. Thank you.
    Mr. POMBO. Mr. Gutknecht.
    Mr. GUTKNECHT. Thank you, Mr. Chairman. Listening to this discussion of the questions, it just reinstates in my mind how frustrating this issue really is when we talk about trying to move to a market-oriented system.
    Mr. Dooley mentioned earlier that we currently have among the highest, if not the highest, basic formula prices. For the sake of discussion, using your 1A analogy, let's say we have an emergency and you set a floor price. I ask this question in part for Mr. Pombo's benefit. When the emergency is over, let's assume that prices decline. I think it's probably logical to say that dairy farmers would begin to cull their herds if we saw decline from whatever that floor price was set. Has the Department considered what the impact will be if we start seeing serious culling of the dairy herds, what impact that would have on beef prices?
 Page 65       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. I cannot refer to a specific study off-hand, but if there is a study out there that some other agency has other than AMS that I'm not aware of, I'll bring that to your attention, sir.
    [The Department responded:]
    We do not expect to see a large increase in the culling of dairy herds under either option 1A or option 1B. During the 1999 to 2004 period, milk production is expected to increase slightly under option 1A from the base line resulting in less culling. Milk production under option 1B, phased in, is expected to decline each year during the 1999 to 2004 period from the baseline, part of which would likely result from increased culling of dairy cows by milk producers. However, the changes in milk production and dairy cow numbers are relatively small. Even in 2004 when milk production under option 1B, phased in, was down the most during the period, the decline of 242 million pounds of milk output from the baseline would represent only around 0.1 percent of estimated milk production and milk cow numbers for that year. Even if all the drop in milk production came from dairy cow culling, total beef production would be increased by only about .04 percent. A change of this amount would be expected to have a negligible impact on beef cattle prices.
    Mr. GUTKNECHT. Well, let me just suggest hypothetically, would the Department then consider setting some kind of floor price for beef?
    Mr. FIGUEROA. I don't believe that we have the authority to do that, sir.
    Mr. GUTKNECHT. That was not really a serious question, for the record. [Laughter.]
    Mr. POMBO. It's an idea, though. [Laughter.]
    Mr. GUTKNECHT. Don't get into it.
    Several years ago—a couple of years ago, Mr. Volkmer authorized a study on small farms, and I think I'm correct in assuming that most of the losses we've seen in dairy producers are the smaller ones. Is that correct?
 Page 66       PREV PAGE       TOP OF DOC
    Mr. CLAYTON. That is probably correct, sir. I'm not aware of any quantitative analysis in the distribution of size as far as the number of farms that exited.
    Mr. GUTKNECHT. But if we are correct and still we're not really clear—there have been some questions and there have been some answers, but I'm still not really clear what the ultimate goal of Federal dairy policy really is. But if on one hand, as one of my colleagues said, that the goal ought to be to produce—to protect—smaller producers, wouldn't it make some sense then to pool the proceeds from class I and class II prices under some kind of a price floor and then give it to smaller producers?
    Mr. CLAYTON. Mr. Gutknecht, that is an innovative concept. I would say, on behalf of the table here, a couple of reactions possibly. I think, one, I'm not absolutely sure we have authority under the 1937 act to do that. In any event, the way that the Federal order program works is to basically direct the levels of payment made by handlers to farmers who supply milk to them. The Milk Order Program does not involve direct payments as it might be the case with another Government program directly to farmers. So, the targeting issue would be another aspect of all that which I think would need some careful thought.
    Mr. GUTKNECHT. Well, again, I may not seriously think that that's a proposal, but I think we need to think how complicated this could become if we try to—the more we try to protect people. But it seems to me the worst things have become.
    In a July 9 letter last year, Secretary Glickman stated, ''establishing a price floor under the Federal Milk Marketing Order System would be inconsistent with the rationale for establishing minimum prices under the Federal orders.'' The Secretary went on to say, ''I also believe that establishing a price floor under Federal Milk Marketing Orders would be inconsistent with congressional intent.'' Has anything changed in the Secretary's mind concerning the law?
    Mr. FIGUEROA. It's my understanding that, though that letter was referring to all classes of milk, the current hearing—that we conducted and the testimony we're evaluating all refer to class I and class II prices.
 Page 67       PREV PAGE       TOP OF DOC
    Mr. GUTKNECHT. Let me go on and there has been some discussion about forward pricing and I'm really happy to hear some of the clarification, because there are producers who would like to do more of that. In view of the Secretary's admonition, ''the administration and the Congress must find additional tools to help dairy producers cope with volatility.'' Am I right in assuming that the Department will implement the Dairy Options Pilot Program in all 100 counties, as is authorized in the 1996 farm bill?
    Mr. FIGUEROA. The pilot program is under the Risk Management Agency of the USDA, which I'm not prepared to discuss and I'm not familiar with what their plans are. So I can't answer that, sir.
    Mr. GUTKNECHT. OK, as soon as you can, would you please let us know about that? Because we're very interested in allowing folks in the upper Midwest to participate there.
    [The Department responded:]
    The new Dairy Options Pilot Program is the Risk Management Agency's first use of futures markets as a risk management tool. At this time, the program is limited to 36 counties in six States. The 36 counties recommended, combined with the participation caps in the program, equate to roughly 7 percent of national milk production and so reach a significant number of producers in a wide variety of regions while allowing for flexibility to change the program as needed in its early stages. By beginning with seven percent of production, RMA is able to promulgate the program using a Notice of Availability, rather than the more time consuming rulemaking process. The Notice of Availability process will allow RMA to fine tune the program in its first year of operation and then expand it if it is deemed successful. Because the pilot program will strain the human resources of not just RMA, but also our private sector partners, if expansion is warranted later, more resources will need to be added to the effort.
    Mr. GUTKNECHT. And finally, as the yellow light goes on, you've been asked and I've heard some answers and maybe I can get a little more direct answer on this—can I also assume that the administration is in full support of our dairy farmer's right to enter into forward contracts and protect themselves from risks, just as our green farmers do? And I think I heard that yes, they can go ahead now and enter into forward contracts.
 Page 68       PREV PAGE       TOP OF DOC
    Mr. FIGUEROA. That is correct. If they do, however, within a Federal milk market or regulated area, they are not members of the pool.
    Mr. GUTKNECHT. Thank you, Mr. Chairman. My time is expired.
    Mr. POMBO. I just had a couple of quick followup questions. In regard to the floor price, would it make any sense to place a floor price below the cost of production or would you theoretically place a floor price above the cost of production in an emergency situation?
    Mr. FIGUEROA. We would look at the information that has been submitted to us in the testimony. We asked for testimony with regard to whether we should set a floor price, and if the testimony agreed with that, then we also asked for testimony on what level it should be placed. So we would look a the testimony and evaluate it with regard to whether it makes economic sense to put it either above or beyond the cost of production. I'm sure that you're aware that the cost of production varies, as I've been told, across regions of this country.
    Mr. POMBO. And throughout States as well. But the question is, would it make any sense to put in a floor price if you're going to go below the cost of production?
    Mr. FIGUEROA. The way that I could answer that, Mr. Chairman, is, as I stated, and you concurred, is that the cost of producing varies across regions and even within States. So the question becomes, what is a representative cost of production across the country? And I don't think we would be prepared to address that number at this point.
    Mr. POMBO. Let me go on. To followup on the forward contracting discussion, I would like you to provide for the committee what the statutory authority is of USDA to implement that, what provisions you're looking at that allow you to do that, as well as what changes would have to be made in the order system in order to allow that to happen.
 Page 69       PREV PAGE       TOP OF DOC
    [The Department responded:]
    Forward contracting in Federal milk order markets is not prevented under the Agricultural Marketing Agreement Act of 1937 that provides authority for Federal orders. However, provisions in Federal milk orders requiring the payment of uniform minimum milk prices by handlers and the receipt of uniform minimum prices by dairy farmers would prevent forward prices from falling below these minimum prices.
    A Federal milk order promotes orderly marketing conditions by applying a uniform system of pricing in a specified marketing area. Terms for the purchase of milk are spelled out in the order and are known in advance to both buyers and sellers, thus facilitating orderly marketing. By requiring that payments for milk be pooled and that a uniform price be paid to each dairy farmer or the dairy farmer's cooperative association, orders prevent handlers from exploiting dairy farmers to their overall detriment. Handlers benefit through the assurance that their competitors are not paying less for their milk than the minimum prices set by the order. Consumers also benefit through the assurance of an adequate supply of milk throughout the year at reasonable prices to meet their needs.
    Mr. POMBO. And finally, although I don't claim authorship of the bill, I can claim authorship for 30 of the proposals that we looked at, or at least co-authorship, and I was not a potted plant when the final bill went through. And I think that Mr. Dooley and I would probably have some questions about what the congressional intent was and what your interpretation of the congressional intent was in terms of California being brought into the system and the option of bringing California into the system and there will be questions provided for you on that in the future.
    [The Department responded:]
    Producers in California have petitioned USDA for the establishment of a Federal milk order for California, and USDA currently has the petition under review. As part of this review, USDA is evaluating the degree of support for a Federal milk order among California's producers. If California is to become a Federal order under the current process, USDA must issue an amended proposed rule incorporating an order for California prior to the issuance of a final rule. If USDA issues a final proposed rule containing an order for California, producers in California would be given an opportunity to vote on their proposed order. Under the provisions of the Agricultural Marketing Agreement Act of 1937, cooperatives must be allowed to bloc vote for their member producers. At least two-thirds of the voting producers during a representative period must approve the proposed order prior to implementation.
 Page 70       PREV PAGE       TOP OF DOC
    Mr. POMBO. We don't have any further questions of this panel at this time. I would encourage you to have someone available to answer questions from the Department throughout the day, throughout the hearings, because I'm sure there's going to be other questions that come up. It would be very helpful if somebody from the Department who is authorized to answer a question would be here that could do that.
    We are going to dismiss this panel at this time.
    Mr. FIGUEROA. Mr. Chairman, let me just add we will leave two members of my staff here to answer questions throughout the day and I indeed will provide you with your last question—the authorization that we have on this issue.
    Mr. POMBO. Thank you, and this panel is dismissed.
    I'm going to go ahead and call up the next panel and they're going to check on the vote. I was told we were going to have a vote shortly and they're going to check on that.
    I'm going to go ahead and call up the next panel, and maybe we can hear their testimony. Mr. Ben Brancel, Dr. Ronald Knutson, and Dr. Mark Stephenson.
    Mr. Brancel.
    Mr. BRANCEL. Mr. Chairman and members, I am Ben Brancel. I am the Secretary of the Department of Agriculture, Trade and Consumer Protection in Wisconsin. I represent 23,000 dairy farms in Wisconsin, with an average herd size of 57 cows per herd. And I appreciate this opportunity to comment on the issue of the Federal Milk Marketing Order reforms and the price structure. And we take it in all seriousness.
    Some people say, ''Why do we get excited in Wisconsin when somebody says 'cow'?'' It is because our industry is the engine of our economy and the agricultural sector—57 percent of it is in the dairy industry. Cheese is the name of the game in our State, but we recognize the value of all dairy products.
 Page 71       PREV PAGE       TOP OF DOC
    We like to talk about our cheese, especially since the World Championship Cheeses Contest just took place, where 933 entries, 15 nations, 20 States participated. Wisconsin was able to garner 27 separate awards, 8 best class. So we are very, very sensitive about the dairy industry and the quality there of.
    We have lost 10,000 farms under the existing dairy price structure Milk Marketing Order System since 1990. It's really a wonderful system that's really working on behalf of Wisconsin. We've not only lost farms, we've lost production. Pretty much nowhere else in the United States can they say that they've had a loss of production because of the existing system, and yet in the upper Midwest that is true. Our dairy industry contributes $17 billion per year to our State's economy.
    I, first off, want to applaud the Secretary for his suggestion of a dairy pilot project and the options program. I'm a little surprised that the right hand doesn't know what the left hand is doing here; the last panel said they weren't sure about the Options Pilot Project because that was in another part of the agency; yet, it all affects the milk pricing system.
    The U.S. needs a national strategy. No wonder it's regionalized; it's been that way since the 1930s and, in fact, it has driven us apart rather than together. How can we compete in the next century if we're running under a 1930's system? Everything in America has changed, except for a marketing system dealing with milk. Transportation, technology, all components of the dairy industry have changed, except for pricing.
    I sat here and wondered this morning, how many times government has outsmarted the market? And I get frustrated when I go back through the system, to no one's blame, except that the system worked and it worked to the disadvantage of the farmers. We ended up with surpluses, assessments, buyouts, all under the existing system. And yet, we're led to believe that under some modifications that were made in recent years to the old system, it now might work.
 Page 72       PREV PAGE       TOP OF DOC
    Mr. Solomon talked about fresh milk. I agree with him. Every person that would like a glass of milk ought to have a glass of milk. And yet it is the system that we have now that allows that to happen, no matter where it's produced, no matter where it's delivered to.
    I'm a little frustrated that under option 1A, which is the status quo, that those who proposed the status quo sit at the table and argue over and over that they have lost farms. If they're losing farms, why hang on to the old system?
    It is our belief that option 1B is a very restrained form of reform. We do hope, however, that the USDA will honor their original selection and follow through with option 1B. It is not radical; it is true reform—going from a system that's over-regulated and over-governed, headed towards a system of deregulation and marketplace orientation.
    We are very, very concerned with the temporary floor that was suggested for class I and class II, because under our analysis, in fact, temporary floors send the wrong signals. They do not let market forces work. They encourage production. And nowhere in the United States is milk only produced for one use. Mr. Solomon said that every ounce of their milk went for fluid use. They have cheese factories in New York. That milk comes from somewhere.
    It is our hope, through your efforts on this committee and your working with the USDA, that you will allow us to, in fact, reach the marketplace, work with the marketplace, and have a successful national dairy industry.
    I will conclude my remarks by saying I look forward to your questions that you might have. And I appreciate the opportunity to be here today.
    [The prepared statement of Mr. Brancel appears at the conclusion of the hearing.]
    Mr. POMBO. Thank you. Mr. Knutson.
 Page 73       PREV PAGE       TOP OF DOC
    Mr. KNUTSON. Chairman Pombo, I'm Ron Knutson. I'm the director of the Agricultural and Food Policy Center at Texas A&M University. We along with our colleagues at Cornell University have completed two studies of the dairy reform options. Our work at Texas A&M is concentrated on two main issues. One of them is the pricing of milk used for manufacturing. this is an issue that has received relatively little attention here and deserves more than it's received. Second, the farm-level impacts of these 1A and 1B policy proposals has been studied.
    With regard to the proposal for pricing milk for manufacturing, we find that, first of all, that proposed component pricing procedures for class III milk represents a significant positive step in the pricing of milk for manufacturing.
    A major problem, however, with the proposed class III and class IV pricing procedures is that the prices generated are too high relative to California. There's been a lot of discussion of the California issue as it relates to California coming into the system. Obviously, if California comes into the system than this is not a problem. But if California elects not to come into the system, it's extremely important that the prices of class III and class IV correlate with comparable classes in California.
    There are a number of ways to deal with that issue. One is to increase the make allowance. And there are studies which suggest that the make allowance in the proposed rule is too low for class III and class IV.
    An important additional aspect of bringing prices into correspondence involves using the mass block barrel price for cheese; in other words, calculating an average price for cheese for both 40 pound blocks and barrels, This would reduce the level of that price as well. If you did the combination of the two, our calculations indicate that the prices would correspond very closely between California and the rest of the order system. This is a problem that certainly deserves the attention of USDA and the industry.
 Page 74       PREV PAGE       TOP OF DOC
    With regard to the farm level impacts, my statement I contains runs on a number of farms which covers most of the members of the committee in their States or in States adjacent to them. These analysis indicate the impacts of the proposals on the net cash farm income for these representative farms. This is where the choice between 1A and 1B is a very significant decision. You'll notice that in a number of regions—Texas, New York, Missouri—the levels of net cash farm income declined significantly. These areas are near some of the new basing points that exist under option 1B. Those lower levels of income do not exist under 1A because its prices are relatively close to the current baseline.
    Now from an economic perspective, that I have some sympathy for the 1B proposal in the sense, as has been stated by a number of people here, that it is a more market-oriented proposal.
    On the other hand, what you're hearing is the sizable negative impact on the regions identified in our study. When the pricing system has not been changed for 30 years, you expect the amount of adjustment will be very substantial. But clear enough, there's going to be substantial impacts on production in certain farm areas associated with the 1B option. On the other hand, there's the positive impact in the upper Midwest, in Idaho, in some of these regions that have very low fluid utilization and are not near a basing point.
    That basically covers my comments and I'll be looking forward to questions that you might have.
    [The prepared statement of Mr. Knutson appears at the conclusion of the hearing.]
    Mr. POMBO. Thank you.
    Dr. Stephenson.
 Page 75       PREV PAGE       TOP OF DOC
    Mr. STEPHENSON. Thank you, Mr. Chairman and members of the committee. I would like to, I think, talk about a few of the things that have been brought up this morning as well. My comments contain most of these particular pieces, but let me just talk about a few things.
    Work at Cornell and other places will show that milk does have location value, depending on where it has been produced, and to some extent the end use that it is put to. However, in our Federal order system, the way that we have traditionally recognized that location value of milk has been to place all of that value on class I and ask class I to carry the location value. Our research would also indicate that, of course, there is location value for milk in other class categories.
    One of the real questions that's been bandied about a bit this morning is whether or not markets under a option like 1B would hold prices through market premiums. We have done a fair amount of research over the past few years in an area that's known as economic experimentation that allows us to be able to ask questions for things we simply can't observe. We haven't had an unregulated dairy market for so many years that we simply can't look outside to see what might happen within our own domestic marketplace. But we can conduct experiments that would allow us to see what might happen with products that have the same characteristics that milk does—in other words, a highly perishable, bulky commodity and, in fact, relatively fewer buyers in the marketplace for that commodity. And our indications are that we would not achieve what an economist would call a competitive market price. And economists do get sweaty palms thinking about a market price that's derived under a competitive equilibrium situation.
    We also found through that piece of research that regulation, much like the Federal order system, does allow us to achieve something fairly close to that competitive market situation. So, we can mitigate some of the effects of an imperfect marketplace with the regulations that we have had in place.
 Page 76       PREV PAGE       TOP OF DOC
    Now Cornell's fingerprints have been really all over most of or much of the proposed rule, particularly with regard to the class I pricing options. And I'd like to at least talk a little bit about how can Cornell's model results give us option 1A and Cornell's model results give us option 1B.
    Preliminary model results, that we had given to the Price Surface Committee, were taken and looked at with fairly close scrutiny at the county-by-county level to indicate where they thought they had some differences.
    Now, I would also suggest that model results probably should be considered just that, model results. It's a simplification of reality. There are some locations where there are probably going to be problems with the prices that the model suggested and need to have the professional judgement of the marketplace decide whether they need to be changed somewhat or not.
    But the general characteristics of our model results indicated there were regions of the country where our current Federal order prices probably were not right. One large example of that was the upper Midwest. We felt that the current class I differentials in the upper Midwest simply were not high enough, were not supported by our model results. To some extent, the Southwest was also an area that indicated that perhaps the current differentials were a bit too high, and the Northeast also indicated to us the differentials might be slightly too high.
    And we should take that as a starting point to think about which directions you may want to move in. That was really the genesis of the 1A option, I believe. Option 1B was really from the final results of our research and work, and it was a literal interpretation of what came out of the model.
    Now, the model gives us what we call shadow prices. And to that we need to add a fixed increment everywhere to give us something that looks like class I. We're asking class I to carry all of the value of milk. We need to do that. And without any clear directive as to what that fixed increment should be, our choice from Cornell, as we reported the model, was to report it as revenue-neutral—in other words, across the country to generate the same total dollars to the dairy system as was generated at a recent point in time. Now, that doesn't mean that every region would be generating the same amount, but, nevertheless, in total the system would. However, what was actually reported as option 1B was a fixed price at Minneapolis.
 Page 77       PREV PAGE       TOP OF DOC
    Currently, the differential we feel is probably too low. And the model results applied across the country relative to that fixed point in Minneapolis. The relationship from Minneapolis to, say, New York or Dallas, Texas, or any other location, is correct as far as our model would be concerned. But we feel as though the absolute value of the class I differential is probably lower than would be warranted, and probably would not be held in the marketplace in the way of premiums.
    I would concur with Dr. Knutson that we, in looking at California, feel that California may have some problems from two different directions: one, that manufacturers outside of California with the proposed replacement for the basic formula price would probably be disadvantaged. But in like manner, we feel that California processors for fluid milk will be facing continued challenges from milk from the outside Federal order regions, given the price differential that we would look at there.
    One of the things I think the committee could do that may be a real help to the industry is some clarification. What really are the goals of this Federal order reform process? And I've heard many this morning, as we had people discussing that. And with that, I'd like to close my comment.
    [The prepared statement of Mr. Stephenson appears at the conclusion of the hearing.]
    Mr. POMBO. Thank you. I'm sure you'll get a lot of different opinions about what the intent was.
    Dr. Knutson, you indicate that the class IV pricing proposal holds the potential for making U.S. dairy products more competitive internationally. How would that occur?
    Mr. KNUTSON. When you set a lower price for milk for use for powder and for butter, that price adjusts to market forces. The only thing that's going to prevent it from going to the world market level is the tariff rate quotas that exist currently. And the point I was making is that if we get into situation where we've got an oversupply, prices will tend to be forced down to world marketing levels. Having four classes, will allow butter and nonfat dry milk, to be more competitive internationally.
 Page 78       PREV PAGE       TOP OF DOC
    Now, I'm not saying that we will be big in the export market, but what it will certainly allow us to do, is to take a fixed amount of DEIP dollars and use it over a larger quantity of commodity. So that's the point I was really trying to get at.
    Mr. POMBO. And in the absence of DEIP?
    Mr. KNUTSON. In the absence of DEIP, we're going—even with four classes—we're going to have a problem being competitive in international markets as long as we have protection around the U.S. dairy industry in terms of tariffs on imports. I mean, that's just the reality of the situation.
    Mr. POMBO. If we went to a completely unregulated dairy industry, could we compete on the international market at a price that was above the cost of production?
    Mr. KNUTSON. I think that's a very, very good question. I don't think we really know the answer to that question. There are a number, two or three, very good studies that are currently going on, that are designed to provide insight into that question. And I think the answer relies heavily upon what happens in EU. If the European Union maintains it's current policy, the answer is no. If you're talking about a situation where everybody gets out of the subsidy business as far as dairy is concerned, there will be adjustments in the United States, but we'll still have a dairy industry, and we'll be a very competitive factor in the world market.
    But free trade will require a substantial amount of adjustment in our industry to get to that point. That kind of adjustment is going to occur in the rest of agriculture, too, as we move toward freer markets.
    Mr. POMBO. Since I've become chairman of this committee, I've had the opportunity to travel to a few different foreign markets and, in particular, I had the opportunity to go to New Zealand and go through their dairy industry. Their dairy industry is under the impression that our DEIP program and the subsidies in Europe are keeping down the price of milk on the international market. Would you concur with that?
 Page 79       PREV PAGE       TOP OF DOC
    Mr. KNUTSON. Yes. I think any time we subsidize, it has a price depressing effect on the international market. I would argue that state trading organization——
    Mr. POMBO. We did mention that.
    Mr. KNUTSON [continuing]. Also has a negative impact on the world market in those products that they export. New Zealand is an astute state trading country, just like Canada is in wheat. I would not want to go to a free market where New Zealand is a state trader and we don't have any level of protection at all. So when I say we need to clarify the EU policy in terms of free market policy, we also have to deal with New Zealand and Australia in that regard as well.
    Mr. POMBO. I'd like to also ask you that one of the things that I noticed in going through grocery stores in these countries is there's—in Asia and in other places—there's very little in the way of U.S. dairy products that are on their shelves. And when you talk to the dairy manager, the store manager, in that particular store, and ask them why? I got a surprising answer, at least to me. He said that U.S. products, U.S. branded products, command a premium price. And when he has those products in his store, he can command a premium price for those products. And it seems like our effort to compete on the international market has been in nonfat dry milk, in bulk butter, bulk cheese. It's been in bulk products versus going after specific branded product. Could you comment on that?
    Mr. KNUTSON. I think you're exactly right. I mean, I think that our effort internationally has tended to be taking products that are effectively acquired or subsidized through export subsidies, butter and nonfat dry milk, and shipping them to Mexico and places like that. That's an important outlet for surplus commodities. It's a support outlet if our prices get low.
    But the thrust of any commercial market development has to be very different than that. And I'm not saying firms aren't making an effort in that regard; there are efforts being made. But when we have a situation in the United States where our prices are maintained above world market levels, it does make it more difficult for us to compete, even on value-added products.
 Page 80       PREV PAGE       TOP OF DOC
    Mr. POMBO. Dr. Stephenson, would you like to comment on that as well?
    Mr. STEPHENSON. Yes. I do think that maybe there's some understatement of the amount of product that we probably are actually exporting. You were looking for consumer sort of packages on store shelves. There is a fair amount of value-added product that's being sold in the way of—specialized whey products is a good example at fairly high prices per pound.
    So, I do think that the United States is in the process of moving toward thinking about becoming a major exporter of dairy products. We aren't there yet, but we aren't too far away from it.
    Mr. POMBO. And what would that thrust be or should it be, in your opinion?
    Mr. STEPHENSON. Part of what we're seeing, I think, is exactly what Dr. Knutson had indicated, is that world prices have risen over the past several years. Our prices have remained domestically relatively stable. Ten years ago, our commodity prices were probably three times world prices, or what we call world prices. And at this point in time, we're competitive occasionally with nonfat dry milk and butter, and we aren't really very far away from being competitive with cheese. It will take us a few years before we're in that marketplace on a regular basis.
    But I still think that a big portion of it is going to be a continual rise of world market prices. I believe that the EU is having a hearing just this past week, with regard to the level of support that they were going to be giving for agriculture and, in particular, dairy products.
    Mr. POMBO. You state that we are almost competitive in the bulk products and sometimes we are competitive in the bulk products. And yet with the premium being offered or being able to be obtained on U.S.-branded products in foreign markets, would it not make just as much sense if not more sense for us to put a real effort into the export of those branded products and the promotion of those branded products overseas?
 Page 81       PREV PAGE       TOP OF DOC
    Mr. STEPHENSON. Surely. I would agree with Dr. Knutson there as well, that I suspect that our real future is not in bulk commodity products, but in value-added products. Name brand recognition is something that probably has the greatest promise for us in many of the countries that would be able to afford high value-added products.
    Mr. POMBO. Thank you. Mr. Peterson.
    Mr. PETERSON. Dr. Stephenson, you said that you thought the class I prices in the Midwest were too low.
    Mr. STEPHENSON. Yes. Our research would indicate that they probably are too low relative to the rest of the country.
    Mr. PETERSON. So, I'm trying to understand what you said. So you think that, as I understood what you said, you think that, in your view that 1B should have had a higher price established for the Midwest and then everything should have been adjusted upwards. Is that what you said?
    Mr. PETERSON. What I had indicated is that if you look at the price in Minneapolis as an example, in comparison to any other geographic location, Minneapolis' price is probably not high enough and that that should probably come up. Now option 1B chose to say, we're going to fix Minneapolis where they are today, and we'll move everybody else from that point. We'll pivot off of Minneapolis, if you want to think of it that way. Which effectively lowers prices everywhere else. Our revenue neutral calculation, if you will, I think would add something like 77 cents on hundredweight to class I milk everywhere.
    Mr. PETERSON. So you think that they should have maybe started off some other way. What I'm curious from both of you, do you agree that if you price fluid milk too high, you're going to impact the price of manufacturing milk, or the amount of manufacturing milk?
    Mr. STEPHENSON. Yes. I would certainly agree that that's probably true. The mechanism for doing that was elucidated by one of the committee members over here fairly well. I think that if we have class I prices that are too high, we will depress class I consumption. We may stimulate local production of milk in ways that we haven't seen in the past and it will probably find its way into manufactured product markets.
 Page 82       PREV PAGE       TOP OF DOC
    Mr. PETERSON. Well, don't you think that that's already happening? I mean, don't you think the current system has caused that to happen in the Southwest for example?
    Mr. STEPHENSON. In answer to your question, if I turned that around just a little bit, if we were to lower class I differentials everywhere, there would be portions of the country, Northeast as an example, that would lose milk supplies in my estimation. And the fluid markets would continue to have claim on those first supplies of milk. It would be the manufactured products that would be losing in different regions of the country, example cheese.
    Mr. KNUTSON. Let me go at it in a little bit different direction. And that is that over the past 30 years we've had tremendous change in the efficiency of milk production in different regions of the country. Wisconsin continues to be a low-cost region, but new low-cost regions have developed. Idaho is an excellent example as is New Mexico, California and western New York. Those are all regions that come out in the Cornell analysis as suggesting we probably ought to lower class I prices. And if you don't lower class I prices, and we haven't, it fosters more milk production in those regions. And that does, indeed, lower the level of cheese price, powder price, and butter price for upper Midwest producers. There's no doubt from an economic standpoint that those relationships exist.
    Mr. PETERSON. What changes have you seen in the Texas class I utilization since the 1985 farm bill?
    Mr. KNUTSON. Oh, it's gone down.
    Mr. PETERSON. And couldn't much of that change be attributed to the increased class I differentials that they received under the 1985 bill?
    Mr. KNUTSON. That's certainly part of it. The other part of it is that we've become more efficient in producing milk. Our size of herd has increased; our output per cow has increased. The combination of price incentives plus the cost benefits that come with larger herd sizes results in us increasing milk production. So the answer is yes. But it's not just the increase class I differentials.
 Page 83       PREV PAGE       TOP OF DOC
    Mr. PETERSON. But you're losing producers like crazy and you're closing plants.
    Mr. KNUTSON. What we're losing is a lot of producers in east Texas; there's no question about that. And east Texas is not an area that's really conducive to high output per cow, which you've got to have to be competitive in today's industry. It's humid; it's hot. You know what happens in Wisconsin when you get July and August humidity along with 100 degree temperatures. It's not conducive to high milk production.
    And in central Texas I think it's a number of factors. You probably know that EPA and Texas water quality people moved in very strongly into that area and basically imposed about a $150,000 investment on each dairy to control animal waste. There's no doubt in our minds that that regulatory change resulted in a number of smaller farmers with that minimum amount of investment that you have to put on them, going out of business. And as you continue to see more regulation of animal waste, you're going to see more pressure on moderate and smaller size dairy farms. Because there are economies of scale in waste management.
    Mr. PETERSON. I understand that. But it's clear to my mind that we sent a signal to Texas that got you guys over producing. That's our whole concern about this. I mean, I have no problem giving the Southeast their differentials, because I understand what the situation is. And they're not going to have manufacturing milk anyway. What I'm concerned about is that we not push production beyond what that fluid need is and create artificial manufacturing production that's going to come back and haunt us. And I think we've done that.
    I mean, I had one of my neighbors move to Texas. Picked up his whole herd and went down there, because after the 1985 bill, he could make a lot more money in Texas than he could in Minnesota. That's reality. And now, all of a sudden, he's out of the business down there, because things changed.
 Page 84       PREV PAGE       TOP OF DOC
    So, that was the point I was trying to make. And I think what we're trying to accomplish here is to figure out some way where these class I differentials can be neutral in terms of market distortion. And then try to get some kind of a level playing field in the manufacturing area, which is going to be tough to do unless we get California to come in, so that we're all on the same page, which is a whole other issue, but——
    Mr. KNUTSON. Very important.
    Mr. PETERSON. Right. Thank you, Mr. Chairman.
    Mr. POMBO. Mr. Dooley.
    Mr. DOOLEY. Yes. I'd just be interested in your perspective on—if we're looking out in 10 and 20 years in drafting our reforms that we're considering today in the way that we're pricing product, and with the assumption that I make, and maybe it's incorrect, that we're going to have greater opportunities in the international marketplace during that time frame, which of the proposals that are currently being considered are going to provide the appropriate incentives to oil producers to increase efficiencies in productivity, so that we can be more competitive in the international marketplace? Dr. Stephenson?
    Mr. STEPHENSON. Well, first of all, producers will respond to milk price. Prices moving up, cost of production goes up. It follows milk price. Prices come down, cost of production comes down. So, really what you're asking, I think is, how do we find that delicate balance between the correct price that fills our domestic needs and perhaps allows us to be able to produce milk at a competitive cost that we could export dairy products? I think that we are not far from having those kind of costs available at this point in time. We have dairy producers in all regions of the country that are competitive producers and those that are not competitive. We have them in those size categories that may be described as small to those that may be described as large. I'm not sure that we need to institute something that is going to change the price signal substantially to dairy producers. They're going to adapt technologies, and they're going to continue to change their farming operations as technologies are available and are cost efficient to employ.
 Page 85       PREV PAGE       TOP OF DOC
    Mr. DOOLEY. Would you accept, though, that if we put in place, pricing mechanisms that maintain perhaps a higher price, that we in some ways impede the incentives for the adoption of measures that might enhance productivity.
    Mr. STEPHENSON. Well, if we have a higher price in place, we're going to produce the milk on a farm-by-farm basis to meet that milk price. In other words, if a price is high enough, we're going to be able to think about employing additional factors of production on those farms, not necessarily the lowest-cost production. That's true. If we have a price that's very low, we are going to be lower-cost producers. They're going to have to do that to meet that. But we may not have any dairy products to be thinking about exporting at that lower price. The marketplace will determine what the price is. I mean, we simply couldn't squash the price low enough not to have dairy products available. The market will make that happen. And if the price is low enough will we be exporting lots of products? Not necessarily. We're going to find equilibrium somewhere.
    Mr. DOOLEY. Another point I'm kind of moving towards—I mean, we basically accept that we have over-order premiums being paid now in many—most—well, many parts of the country. Would you agree with that?
    Mr. STEPHENSON. Yes, we do. I think it would be a real mistake to institute a minimum price that's so high that we wouldn't have premiums paid.
    Mr. DOOLEY. Exactly. And so the over-order premiums are basically a reflection of the market at work.
    Mr. STEPHENSON. That's correct.
    Mr. DOOLEY. And so, if we are going to do anything we must obviously err on the side of having prices which might be instituted as being lower, certainly rather than higher?
    Mr. STEPHENSON. Yes. But again I would caution that if you're going to be instituting prices at all, minimum prices, they probably need to be somewhere in the ball park, or there's no need to have a system at all. For example, I think, as we look at the upper Midwest in our model results, we find some of the highest over-order premiums being paid in the upper Midwest. A dollar twenty a hundredweight on class I milk, probably would not get milk in a plant. And in areas of the country where we find the lowest note premiums being paid are the areas where our model would suggest perhaps our class I prices are also high.
 Page 86       PREV PAGE       TOP OF DOC
    Mr. DOOLEY. Dr. Knutson, do you want to——
    Mr. KNUTSON. I think we've got to be a little bit careful about talking about over-order premiums. You don't want to imply that over-order premiums exist on all classes of milk. I mean, they tend to be predominate on class I milk. There's some on class II, but relatively little on milk used for manufacturing.
    Mr. DOOLEY. Well, what's happening in Wisconsin? I thought that there's no over-ordering premiums on manufacturing milk up there?
    Mr. KNUTSON. I don't think so, I'll defer to the——
    Mr. DOOLEY. In the Midwest—OK, so that was just—you were just referring then to class I?
    Mr. KNUTSON. Exactly. And so we don't want to be confused as to where the over-order premiums, in fact, exist.
    I'd be a little bit more direct than Mark was, maybe get myself in trouble back home, but that's life of a university economist. 1B is clearly a more market-oriented option. I mean, I think that's clear enough. And if the policy goal is to move the industry toward a more market-oriented system, then you ought to prefer 1B. But then realize in the process that you're going to have some substantial political pain and economic pain out there that was reflected in the statements of some of the members of the committee, and will probably be reflected in some of the statements here as we go on in the hearing.
    Mr. DOOLEY. Just one final line of questioning.
    Mr. BRANCEL. Mr. Chairman?
    Mr. DOOLEY. Sure, go ahead, yes.
    Mr. BRANCEL. Do you mind, Mr. Dooley, if I answer.
    Mr. DOOLEY. Sure.
    Mr. BRANCEL. Some of the things that happen in the upper Midwest—and there were some comments earlier about cost of production and where you establish the price and the class I differentials. I don't think that you can argue that under option 1A you're even considering cost of production. It's location, and not where the producers are efficient, and not necessarily what's going on. It's strictly location. And in Wisconsin, the only reason we have the mail box prices we have is not because of other mechanisms; it's pure competition. When you have a demand for the product that you need to supply, then the competition is there and the mail box price gets pushed up. So in the State of Wisconsin, it's strictly been the competitive nature of the business and not necessarily the support mechanisms or the differentials. Even though we feel the differentials are kind of based against us, it is been the marketplace.
 Page 87       PREV PAGE       TOP OF DOC
    Mr. DOOLEY. Mr. Brancel made a comment in his testimony about the concern with the Northeast Compact. I'd be just interested, Dr. Knutson and Dr. Stephenson, is there any economic justification or benefit for this Congress to allow continued balkanization of the dairy industry in the United States by the formation of additional compacts?
    Mr. KNUTSON. Well, we don't have a State special legislature in session. We have one every 2 years. I expect it's going to be an issue when they come into session.
    But from an economic standpoint, the worst scenario that I can think of is having a series of compacts with Federal orders across the country, because the result is a division regionally that's very divisive with Federal orders not being able to establish a national policy. And it seems to me we're moving toward a global dairy industry. That implies at least a national policy toward dairy rather than a series of regional policies. So if we're going to have compacts all over the country, I'd suggest we pull Federal orders and let them survive on their own. I rather doubt they'll survive on their own, but I think there's a serious potential problem developing in the industry by the move toward compacts.
    Mr. STEPHENSON. I would echo most of what Dr. Knutson said. I think that the tools that a compact uses to think about prices are very much the tools that the Federal order has in place. They're implemented a bit differently, and if you feel we have a problem in milk prices—if they aren't high enough in one region or another—we probably have the tools within the Federal order to think about answering that question rather explicitly. I do have a concern for a series of compacts that try to think about how they send market signals that have rather abrupt walls between the compact areas to producers and buyers of milk alike. I think it's going to be a difficult thing to conceptualize.
    Mr. DOOLEY. Thank you.
    Mr. BRANCEL. Mr. Chairman, on the remarks of the compact, the original compact was an interim; temporary floor and class I and class II are interim. We're really nervous about the temporary floor because as the interim compact was proposed and agreed to here, now it's talk about extending it, and temporary becomes permanent, and if you have a compact and you have a market order system both, and they both have safety nets, all of sudden they're both out of kilter because they're playing off each other and the marketplace isn't even taken into account. So, I think you have to be very, very careful with the proliferation of compacts, as Mr. Knutson said, and then if you allow that, forget the marketing order system; it isn't even needed. Everybody's set up their own walls, their own barriers, and now you really have regionalism and not a national policy.
 Page 88       PREV PAGE       TOP OF DOC
    Mr. POMBO. Well, thank you. When you say it was agreed to here, I hope you are using that term very loosely.
    Mr. BRANCEL. I am. Very loosely. [Laughter.]
    Mr. POMBO. Mr. Peterson.
    Mr. PETERSON. Yes, first of all, I'd like to correct—I think I'm right—that the over-order premiums in Minnesota, at least, are mostly on manufacturing milk—I think I'm right on that. So, I just wanted to correct that.
    The question I had for the two economists on the price floor issue, the Upper Midwest Coalition has done this study that shows that it will—in their judgment—this price floor will cost us money, because it will stimulate production which will actually reduce manufacturing prices. Do either of you look at that issue? Do you agree with that or haven't you looked at it?
    Mr. KNUTSON. We've not studied that issue, but you're intuitive reaction is right from an economic standpoint. If you provide a price floor that's effective, it's going to, indeed, tend to foster milk production which is going to force down the prices of cheese, butter and non-fat dry milk.
    Mr. PETERSON. If you floor class I, it's going to cut the manufacturing, and that means that we'll lose money. Do you agree with that, Dr. Stephenson?
    Mr. STEPHENSON. Yes, I do.
    Mr. PETERSON. Thank you.
    Mr. POMBO. Well, thank you very much for your testimony and for answering the questions. If any of the members do have further questions for you, they will be submitted in writing and if you could answer those in a timely fashion, it would be greatly appreciated.
    I'm going to dismiss this panel. The committee is going to recess temporarily. I believe that we have a series of votes on the floor. So we're looking at recessing for about, approximately 20 to 25 minutes, and then the committee will come back, and we will call up the third panel, but thank you very much for your testimony, and we will return as quickly as we can.
 Page 89       PREV PAGE       TOP OF DOC
    Mr. POMBO I'll call the hearing back to order. I'd like to invite up panel No. 3. Mr. Robert Wellington, Mr. Jack Laurie, Mr. Douglas Marshall, Mr. Will Hughes, Mr. Jerome Kozak, Mr. Paul Halnon, and Mr. Donald De Jong. Thank you.
    I'd, first off, like to apologize for the delay. Unfortunately, we can't control the votes on the floor, but we'll try to avoid that as much as we possibly can. Mr. Wellington, if you're prepared, you may begin.
    Mr. WELLINGTON. Thank you, Mr. Chairman. I am going to refer to some tables in my written testimony—I'm not going to read it, but I will refer to some tables. I appreciate this opportunity and on behalf of the farmers in New England and New York that we represent to testify before you today.
    We welcome order merger. We, as a group of coops in the Northeast, met even prior to the 1996 farm bill to look at order merger and see how we can bring the three Northeast orders together, so it is something that we feel that has a very positive effect on—in fact, we tried to get a number of our positions in a common manner even though we had tremendous differences between the whole region. The Northeast region would represent about 20 percent of all the milk in the Federal order system and all the class I milk, and we were dramatically different within the Northeast region. For example, the New York order was different from the New England and the Middle Atlantic order, but we made a lot of compromises. We worked closely with the USDA staff and with the Market Administrator's offices, and so we were very optimistic giving our comments to USDA and were disturbed that, basically, USDA ignored many of the comments that we put in. But in particular, our comments relating to 1A versus 1B is what I want to talk about today as well as the other class prices.
 Page 90       PREV PAGE       TOP OF DOC
    I'll go right to the first table that I have, and I know this has been discussed already today, and it's the table 1 of my testimony which is on page 3, and it's an analysis of the options 1A and 1B on the USDA's January 1998 proposed rule, and that's the source of this $365 million that's been quoted all along, and, in fact, the source of those numbers of from USDA's 800-page document, pages 336 and 104; there are two tables that are incorporated in there. What this table does is look at the straight impact of lowering class I differentials under 1B relative to what they would occur under 1A, and we don't believe that we should be looking at transition payments, because our farmers hope to be in business 5 years from now. The transition payments were particularly disturbing to some of our young farmers who plan on being in business, so we felt we had to look at what it would look like at the end of the process on 1A versus 1B, and this is a clear determination of it. If you lower the class I differential by a dollar per hundredweight and half your milk goes into class I fresh milk, producers are going to be impacted by 50 cents, and in the Northeast you see the impact is 48 cents.
    Which sort of leads into table 2 which looks at the analysis of the cash margins for Northeast dairy farms, and this was put together by the, basically, farm credit bank who does financial analyses for our farmers throughout the Northeast, and these are usually some of our better farms, and you can see the cash margining in table 2 was very, very small throughout the 1992 to 1996 period; in fact, it was negative in 1995. If you take 48 cents out of that via lowering the class I differential, you're now negative in every year for the last 5 years, and we believe that will be the case moving forward. When the better farms cannot make money on average, you have a very serious problem in the area.
    Now, one of the concerns, I know, is on class I differentials: Why are they higher in the Northeast and the Southeast than other areas? Is that a subsidy based on location or is there some rhyme or reason or some logic to it? And we believe there was logic in the Cornell model, but it has to do with the cost of serving a higher class I market, and that was very clear in USDA data. Table 3, on page 5 of my testimony, looked at the hauling and marketing costs the USDA reported on average for the 1995, 1996 years which was the latest data available, and you'll see that in the Northeast those combined costs were $1.19 a hundredweight; the Southeast, they were $1.49, and in the upper Midwest, they were 52 cents. It really has to do with balancing the class I markets; the additional cost of bringing milk in often from several hundred miles into the large metropolitan markets in the Northeast and in the Southeast. So, there are substantially higher marketing and hauling costs that we relate to a higher class I market.
 Page 91       PREV PAGE       TOP OF DOC
    That sort of feeds into the next table which is table 4 which looks at the mail box prices. Those are some key numbers for us, because that shows that relative to Wisconsin, our mail box prices, at least in the New York-New Jersey order, were below Wisconsin every time period. In fact, it ranged from about 30 to 50 cents a hundredweight, so all producers are not benefiting by the higher class I differentials. It goes to cover an actual cost. We cannot get that cost out of the marketplace because of our competitive price relationship. In fact, I do want to mention an issue of Dairy Profit Weekly that was the March 23 issue. There was an article about the concentration of class I dealers around the country, and it reports that a new dealer, Suiza, now has 9 percent of the market; they had nothing 3 years ago. They now have 9 percent of the market. Dean Food has 8 percent of the market. Suiza says in the next 5 years it wants to be 30 percent of the market. We do not have the bargaining power in the Northeast to try to get the money out of the marketplace. That's why we have to use the Federal order to do this.
    The last piece I wanted to talk about—and I'll do it very quickly—was on the manufacturing side, and that is that one of the reasons the option 1B looks so good was because they inflated the class III and class IV prices for movers for 1B, and in many ways that's smoke and mirrors. That's why when you say there's an impact of $89 million or $117 million and mine comes to $365 million, the marketplace cannot support that. I'd be happy to answer any questions when we get to the time period. Thank you.
    [The prepared statement of Mr. Wellington appears at the conclusion of the hearing.]
    Mr. POMBO. Thank you. Mr. Laurie.
    Mr. LAURIE. Thank you, Mr. Chairman. We thank you for the opportunity to comment on the proposed rule for the reform of the Federal Milk Marketing Orders that's been developed by USDA. I am a dairy farmer. My name is Jack Laurie. I also serve as president of the Michigan Farm Bureau, and I'm a member of the executive committee of the board of directors of the American Farm Bureau Federation.
 Page 92       PREV PAGE       TOP OF DOC
    We're in a bit of a unique position in the American Farm Bureau Federation. We are the Nation's largest general farm organization and consequently represent producers of a lot of different commodities, all commodities, in fact, but included in that membership are a large portion of the Nation's dairy farmers, and so we bring this unique perspective to the milk order reform process of representing producer members. We don't buy; we don't sell, and we don't process any milk. Our sole interest is in representing producer members, and we are the only national organization that's in this position.
    During the debate of the 1996 farm bill, we supported efforts to include reform of the Federal Milk Marketing Orders in the legislation, and we asked that that reform be done through an expedited hearing process at USDA rather than as a legislative undertaking. This is the direction that was ultimately taken and the FAIR Act of 1996—since that legislation was passed, the Farm Bureau's been actively involved in the reform process. We've not been back to Congress seeking additional dairy legislation, but we rather focused on working with USDA to assure that the process that was outlined in the FAIR Act does, in fact, work to reform the pricing system of our Nation's dairy producers.
    Shortly after the 1996 farm bill was signed, we in Farm Bureau established a Milk Order Reform Working Group to assist our organization's effort in this area. That group is comprised of nearly 30 producers representing our standing dairy committee, our board of directors, the various regions of the country, and two additional representatives—one from Wisconsin, one from California—overall, we represent 25 States in this working group. We've met a number of times with the group and also twice with other producer organizations, the most recent of which was just last week in Chicago when we had about 20 organizations at that session. Included in my written comments are copies of the comments that we've previously submitted to USDA as well as an evaluation of the proposed rule that was done by the members of the working group, and we're still in the process of developing our final comments to USDA on this proposed rule that are due on April 30.
 Page 93       PREV PAGE       TOP OF DOC
    Our executive committee met via conference call yesterday regarding several of the actions that were taken during the Working Group meeting in Chicago, and I would submit these for the record, if I might, and they are incorporated into the text of my oral statement. Several of the recommendations deal with areas to be included in the new orders. The Working Group recommends that all unregulated areas in the Northeast be included in a Federal order and the central area of Missouri be included in the Central order. Both of these suggestions bring in areas not currently regulated. We suggest doing this to assure that producers are treated fairly. If they're regulated under different systems, they're likely to played off against each other in an effort to lower prices. If they're under that same system, this will not happen. In addition, we recommend that the proposed Western order be divided into two orders. The primary reason here is the disparity in class I use between the areas. In the proposed rule, southwest Idaho, eastern Oregon has an 18 percent class I use while the Great Basin was at 35 percent. Data from western Colorado was restricted due to a limited number of plants in the area, but it would be substantially higher than this. The price surface for class I differentials has a major impact on a minimum producer prices that are established under the Federal orders.
    The proposed rule includes the two options, 1A and 1B. USDA has indicated they prefer 1B, but it's been indicated that, as you just heard, it could reduce producer income by over $1 million a day, and Farm Bureau along with most other producer groups that I'm aware of are supporting option 1A, and this results in higher estimated gross cash receipts for many dairy farmers. Option 1A seems to best meet the objectives of the authorizing legislation for the orders. It helps to assure an adequate supply of milk and prevents disorderly marketing. The differentials in 1A recognize the location value of milk and would facilitate the movement to meet fluid needs when required. We feel it will best serve the needs of consumers, processors, and producers.
    In regard to your own State, Mr. Chairman, California, we believe that we should make sure that all of the information that's available is made accessible to the producers of California so that they can make the right decision. They have all the information that they can have to make the determination as to whether or not they are included in the Federal order process. We're going to be making additional comments to USDA on the rule, but we're generally satisfied that it's moving in the appropriate direction. We're committed to working with others in the industry to assure that we have a system that's going to serve the needs of our Nation's dairy producers for the future. We thank you for this opportunity and look forward to any questions that you might have.
 Page 94       PREV PAGE       TOP OF DOC
    [The prepared statement of Mr. Laurie appears at the conclusion of the hearing.]
    Mr. POMBO. Thank you. Mr. Marshall.
    Mr. MARSHALL. Thank you, Mr. Chairman. My name is Doug Marshall. I'm from Seattle. My cooperative, the Darigold Organization, is the largest dairy marketing cooperative in the Pacific Northwest.
    I did not come here today, Mr. Chairman, to take you through all the details of our position on the Federal order proposal. I came here just to highlight two things which I'd like to do in summarizing rather than reading from my prepared testimony.
    First, I think that the USDA deserves, perhaps, a little bit more positive reaction than it's received from the industry and, perhaps, somewhat here today. They've done a lot of things well. They've had a very good process, and they've made a lot of giant steps towards changing the Federal order system; rethinking it, and putting it on a sounder foundation. All of us, myself included, tend to focus on the few things that we think they did wrong, but in general I think they deserve some positive plaudits for their efforts.
    I'd also like to thank Professors Knutson and Stephenson who testified in the last panel and the academic community that worked with them. I particularly want to thank Mr. Knutson for setting the stage for my testimony. As he said, there's been too little attention paid to the problem of price alignment on manufactured products between California's existing price level and that which was proposed for the Federal order system, and I'd like to focus entirely on that in the remainder of my time.
    As I've outlined on pages 2, 3, and 4 of my testimony, cheese is the driver of the western dairy industry in the Federal order areas, and so I've used cheese as an example, although I could have expressed some of the similar concerns about butter and powder. The USDA proposal does do the right thing in moving towards end-product pricing which is where California's been for some time. That is the best way to determine supply and demand conditions for milk. However, the proposed formulas would increase the Federal class III price by approximately 45 cents from where it's been at a time when that Federal order class III prices has been about 80 cents per hundredweight under the Federal order class III price has been 80 cents over the California 4B price that corresponds for milk used to produce cheese, and that proposed a $1.20 difference per hundredweight. And I want to make the point here that that is a huge difference. It equates to 12 cents per pound; it equates to 8 to 10 percent of the selling price of cheese, and, in effect, would give California processors the ability to compete with lower net costs all the way across the country even in spite of the transportation costs that would be involved to move cheese from the west coast to even the Washington, DC area.
 Page 95       PREV PAGE       TOP OF DOC
    Now, the problem for those of us in the western Federal order then is that we have to sell against the California competitors. The California system is not wrong. What would be wrong would be to force us to have an arbitrarily higher price; that is our concern, and I sincerely believe that if that price disparity is not corrected, the first result would be to seriously jeopardize the existing cheese industry in the West and, in fact, would force any new cheese plants to go to California instead of a Washington or an Idaho or other western States.
    And the second concern—and, really, it's the point that Professor Knutson made—is that if we don't address those price disparity issues, it will threaten the Federal order system in the west, and that, in turn, will threaten the California order. I don't think the California order would be viable if there were not Federal orders around it.
    And I'd like to address, if I could—and, by the way, looking ahead to the next panel, I see Mr. Tillison's prepared remarks agree with me that price alignment is important; I think that that's good, he and I usually do agree—but I would like to comment on one of the issues raised earlier and that is, should California be given additional time to look at the Federal order proposal and then make a decision? I think that is entirely the wrong approach. If the California industry is serious about a Federal order, they should be here in Washington, DC now helping to shape what comes out of this reform process, and if they do that, it's more likely that we will have a system that is acceptable to all of us in the western dairy industry. So, I would urge them to do that, and I urge USDA to work with them, and, in fact, to negotiate a Federal order for California that would be acceptable to Californians, and in doing that, I think it will solve any of the price alignment problems that we—that the rest of the western dairy industry would have.
    So, Mr. Chairman, with that, I want to say that I appreciate, again, the invitation to be here, and I look forward to answering any questions you may have.
    [The prepared statement of Mr. Marshall appears at the conclusion of the hearing.]
 Page 96       PREV PAGE       TOP OF DOC
    Mr. POMBO. Thank you. Mr. Hughes.
    Mr. HUGHES. Thank you, Chairman Pombo and other members of the committee. My name is Will Hughes. I work for the University of Wisconsin, but I am representing the Upper Midwest Dairy Coalition today. The Upper Midwest Coalition consists of 18 dairy and farm organizations representing about 34,000 dairy farmers in midwestern States. The need for Federal order reform is why this organization exists, and we've been at it about 10 years, and maybe people in this room can help me explain why it's taken so long.
    I'm going to refer to two tables at the back of my statement, and the message in these tables is this—and I don't think any economist or anyone who's looking at the common sense of it can deny that Federal orders, that what they do is distort markets. A way of saying it is that they change what the market results are from what they would otherwise be in a free market environment. Now, we're not here arguing for a free market environment. What we want to point out is that the Federal order system does, for the benefit of producers, distort markets, and our problem from the Upper Midwest position is that the result of that distortion is to put downward pressure on manufacturing prices and also, in effect, as we enter an unsupported—meaning having no Federal dairy price supports left in the system—it puts the manufacturing sector more as a shock absorber for what you do on fluid pricing. As you look at temporary price floors or enhanced differentials, dairy compacts, and so on, you leave the manufacturing sector as the shock absorber.
    Now, what Federal orders do in distributing the pie is distribute monies between fluid consumers and fluid producers; between fluid and manufacturing, and between regions, and we have a model at the University of Wisconsin called the Dairy Inter-regional Competition Model that tries to break down, on a regional basis, and between all the uses of milk what Federal intervention does in the way of affecting the distribution of the revenue pie. And, so the first table gives you an indication of the effects of both Federal order and the California program on farm level prices on a regional basis and in aggregate; on farm level production and revenues, and you'll note that if we were to eliminate the whole system, this model is saying that $423 million less in farm income would be the result.
 Page 97       PREV PAGE       TOP OF DOC
    Now, this model has limitations like others. This model differs from the Cornell model in that the Cornell model says we have existing milk production; how can we best allocate that milk? This model says, how can we best produce milk in this country to meet the kinds of demands from the marketplace?
    And I just want to point out that this $365 million number that's been touted today is in direct conflict with what USDA's own estimates say in their preliminary impact analysis which I'll put on the record as appendix table 6, the net impact on all dairy farmers, and this includes what Mr. Wellington was referring to factoring in the increased prices that USDA has put in their proposal on all classes. It washes out, the market doesn't handle artificial pricing without an effect. We're saying that the net impact is $–82.9 million in the Federal order system In New York-New Jersey order—where Mr. Solomon this morning was referring to the loss in New York at $1 million a day for dairy farmers—this model of USDA says that New York would get 6 cents more in the New York-New Jersey Milk Marketing Order on a per hundredweight basis or $5 million.
    Now, we're talking about very small impacts from changes from option 1A to 1B, and that's our point—this is modest reform. It's a small step towards more market orientation, and the Upper Midwest Coalition believes that the long-run, best interest of the dairy industry will be served if we have orders serving as only as minimum pricing, and allow market conditions and producer associations to establish effective local prices. If Government always comes in and when people say that we can't do this ourselves, they always have an excuse to say that, and we believe that the upper Midwest is virtually deregulated now. That's why we have higher pay prices. Competition from California forces us to be innovative and that makes a stronger dairy industry long term.
    Now, in California, my only point on that is it is important to the rest of the country as it produces 20 percent of the milk. We would encourage USDA and the support of this subcommittee in the time frame that we have, to allow USDA to put a proposed federal order for California on the table. It mirrors the framework that's already there and let California decide to get on the same framework that we have for the rest of the country, and that will unify our pricing and help us prepare for the international marketplace. Thank you.
 Page 98       PREV PAGE       TOP OF DOC
    [The prepared statement of Mr. Hughes appears at the conclusion of the hearing.]
    Mr. POMBO. Mr. Kozak.
    Mr. KOZAK. Good morning, Mr. Chairman and other members of the subcommittee. I'm Jerry Kozak, the chief executive officer of the National Milk Producers Federation in Arlington, VA. I've been in my position 6 months, so I'm a rookie as far as this panel is concerned.
    National Milk is the national voice of 75,000 dairy producers. We develop and carry out policies that advance the well-being of the U.S. dairy producers and the cooperatives that they collectively own.
    We believe that the USDA's rule has complied with the congressional directives of the 1996 FAIR Act. I'd like to commend the Secretary and his staff for developing a reasonable proposal. Moreover, we believe that the USDA has established a solid framework for the Federal order system and one that makes significant changes to reflect the realities of the marketplace both domestically and internationally.
    I'd like to outline where our members see the need for change in the USDA rule and the ones that we believe will make the system more market oriented and more workable for dairy producers and manufacturers as well as others involved in the milk marketing system. It's important to point out that the diverse membership of the National Milk Producers Federation is solidly behind our position. Once the USDA rule was published in January, the Federation formed a task force of dairy cooperative representatives to review the proposal. Our task force consisted of the full spectrum of our membership both by size and geography. We overwhelmingly endorsed most of the rule and we approved changes that we feel are necessary. Today, I am offering the majority perspective of the National Milk Producers Federation membership throughout the United States. If I may add that we heard some talk about the upper Midwest this morning—Land O'Lakes, Foremost Farms, and Dairy Farmers of America,which we believe represent a majority of producers in the upper Midwest—are solidly behind the National Milk Producers Federation proposal.
 Page 99       PREV PAGE       TOP OF DOC
    National Milk supports the following basic changes proposed by USDA: a reduction in the number of orders; the creation of four product classifications; establishing class III and IV prices based on the market value of manufactured products; providing for multiple component pricing using the class IV price plus the differential as the mover of the class II price, and the use of a six-month declining average of the higher of either class III or class IV price to establish the class I price. We are proposing these modifications and the formulas used to establish the prices for classes III and IV. As proposed by the USDA, the make allowances are too low based our manufacturing numbers, experience, and cost. What we are proposing is a more market-oriented pricing regime that will ensure that there are not untenable regional disparities between the cost of milk used to produce manufactured dairy products made in Federal order regions and those coming from other State orders particularly California.
    Finally, we strongly support USDA's option 1A with respect to a reform of class I differentials. The reason we support option 1A as proposed, is that it modifies the existing differentials and alters the price surface where necessary. We fully support the need for differentials to be changed and amended as conditions warrant, but we cannot and will not support a proposal that calls for their wholesale elimination, which is tantamount to what is proposed under option 1B. Such a development would be devastating for producers and detrimental for the long-term interests of consumers across the country. In fact, in one of the department's academic consultants who testified earlier, I quote from his testimony, ''We would never suggest that the model results be strictly applied to industry regulations''—he's speaking about 1A, 1B. ''Option 1A is the product of the model results adjusted with professional judgment. Option 1B is a strict application of our model results fixing class I differentials at $1.20 in Minneapolis.'' As previously mentioned, fixing the Minneapolis differential denies the industry nearly $0.5 billion annually in regulated class I revenues.
    Mr. Chairman, we realize times have changed and so to must the Federal order program. I have with me a milk bottle that I brought illustrative of the central point that I'd like to leave with this committee today, namely, that even though the Federal Order Program is a producer program, today's dairy producers receive less than 32 percent of the total U.S. consumer expenditures for all dairy products. That's the portion of this bottle that's filled with milk. The majority of the consumer's dairy dollar does not go to dairy producers, so I'd like to point out, in closing, that while the critics of the Federal order system may argue that farmers are paid too much under the program, the fact is that dairy producers today receive less than one-third of the consumer's dollar, a share that has been declining for years. Cutting farm income is not a sure-fire way to save consumers money. What's more, farmers are receiving the same nominal price for their milk as they were back in 1980. Adjusted for inflation, the all-milk price is over one-third less in real dollars today compared to 1980. Dairy farmers have become increasingly cost efficient even as their numbers dwindle and as they are largely responsible for ensuring that milk and dairy products are even more economical today than 15 or 20 years ago.
 Page 100       PREV PAGE       TOP OF DOC
    In closing, our dairy producers do support a transition into a more market-oriented system, but transition is the key word. The old adage that ''it takes a great leap to cross the chasm'' doesn't apply when you're dealing with the livelihood of hard-working farmers who not only provide society with wholesome and nutritious products but also serve as the stewards of our agriculture heritage. We commend this committee for its efforts in spurring the needed changes, and we look forward to working with you and the U.S. Department of Agriculture to ensure that the Federal Order Program continues to serve producers, processors, and consumers in the next century. I'd be happy to answer questions after.
    [The prepared statement of Mr. Kozak appears at the conclusion of the hearing.]
    Mr. POMBO. Thank you.
    Mr. Halnon.
    Mr. HALNON. Thank you, Mr. Chairman. My name is Paul Halnon. I represent a number of organizations that market milk throughout the Southeast. These are listed in my prepared statement. I would like to add, however, that I inadvertently left two off, and so I'd like the record to show that I also represent the Valley of Virginia Milk Producers Association and the Piedmont Milk Sales, Inc.
    We appreciate the opportunity to be here today and testify on the reform process. When I testified before this committee earlier, I expressed concern that in their rush to standardize the orders, the Department was making—was proposing some substantive changes that would impact on interested parties, and I expressed some concern about that. I am happy to say that most of our concerns were recognized, and the final document, in most respects, is something that we can truly live with, and I think the Department did a very good job in resolving these complex issues. The proposed consolidated markets has some people in the south concerned and I suspect that one or two organizations down there will be responding with respect to the boundaries of some of the areas, but I'm not going to get into that today.
 Page 101       PREV PAGE       TOP OF DOC
    The one remaining issue, as we all know, that needs resolving is the classification pricing of milk. The Southeast does not produce significant amounts of manufacturing milk. In fact, other than during very few months of the year, a limited time of the year, we produce none. So, I'm going to not get into the class III and class IV pricing, and I would like to spend the time that I have with you here today to talk about class I pricing.
    As you can well imagine the class I pricing proposed under option 1B is of some serious concern to the South. We're fighting for our economic lives here, and we have—we're urging the Department to adopt 1A. Early in the process there was a good deal of regional division among the cooperatives in what should be done in the reform process, and I have to admit the Southeast was riding a different train many times itself, but, as Mr. Kozak points out, cooperatives now are on the same page and are supporting a single proposal, proposal 1A, and this should greatly simplify the Department's task of resolving this issue in the final decision.
    In the Southeast, option 1B would decrease the Atlanta price 62 cents a hundredweight; that's a substantial decrease. Eighty percent or more of Atlanta's—of the milk in the Southeast goes into the fluid market, so we're talking about a reduction in farmer income here in the neighborhood of 50 cents per hundredweight on all of this milk. Why is that of concern to us? Well, obviously, getting less money is concerning, but, importantly, the Southeast—and this is contrasted with the rest of the country—has been losing production over the years. Sure, we're all losing producers, and that's to be expected as producers become more efficient and larger, but in the Southeast we are losing production.
    Let me give you a few figures as an example. In the 2-year period between 1995 and 1997, the six major producing states in the Southeast other than Florida—Florida has maintained production pretty well—the six states other than Florida have lost 9 percent of their total production in the last 2 years. Alabama lost 13 percent; Kentucky lost 10 percent; North Carolina lost 10 percent; Louisiana lost 12 percent, and the region as a whole, as I say, lost 9 percent of their production. Now, when they're losing their production, where does this milk come from? Well, it has to come from higher cost, distant sources. And why are these distant sources higher cost? The answer simply is it costs more to ship milk than it does to produce it down there.
 Page 102       PREV PAGE       TOP OF DOC
    There were some figures this morning referred to of the fact that it costs between 35 cents and 40 cents per hundredweight per 100 miles to ship milk. That means when milk comes from, say, middle of Wisconsin and shipped to Atlanta—a distance of about 1,100 miles; 1,000 to 1,100 miles—it costs $3.50 to $4.50 a hundredweight to ship that milk. The difference between the Atlanta price and the Wisconsin price is $1.83. So, that additional $1.50 to $1.70 has to come out of consumers. If the processors have to pay that much more to get their milk, that cost is passed on to consumers.
    I suggest that 608(c)(18) of the act requires the Secretary to set minimum prices at levels that will ensure an adequate supply and be in the public interest. The Administrator, this morning, said that he would like to do that. I suggest that 608(c)(18) requires him to set prices, and when you reduce prices in a deficit market, our position is that you're not complying with section 608(c)(18).
    Mr. Chairman, we appreciate the opportunity to be here and be glad to answer questions.
    [The prepared statement of Mr. Halnon appears at the conclusion of the hearing.]
    Mr. POMBO. Thank you.
    Mr. De Jong.
    Mr. DE JONG. Chairman, members of the subcommittee, I thank you for giving me the opportunity to talk on behalf of the Texas Association of Dairymen. My name is Donald De Jong, and I appear before you today as past president of the Texas Association of Dairymen, a membership organization dedicated to dairy farmer direct involvement in both political and regulatory processes.
 Page 103       PREV PAGE       TOP OF DOC
    Since 1991, I have owned and managed Rising Sun Dairy, a 1,400 cow milking facility in Dublin. In addition to being one of the few dairy producers appearing before you today, I am also founder and president of the Elite Milk Marketing Incorporated, currently 17 members shipping about 0.5 billion pounds a year.
    The Texas dairy industry is going through one of its most dramatic changes. We have seen 16 percent of our farmers lost in the last—well, since 1995. At the same time, Texas' population is growing faster than any State in the country. Presumably, the demand for fluid milk in Texas should be growing concurrently, yet, on a percentage basis we are losing our industry faster than any other State, and the final outcome of the Federal order reform will heavily influence the future of the Texas dairy industry.
    For the last 2 years, TAD has been involved in the development of a proposal submitted to the USDA and Congress by the Western States Dairy Producers Association. Upon submission to the Department in January 1997, the Western States' proposal developed a bona fide dairy farmer—by bona fide dairy farmers had the support of dairymen producing about 47 billion pounds or 30 percent of the milk produced nationwide. The plan called for decoupling class I and II milk from the BFP by using a 12-month rolling average of a cheese-based price formula. The plan also proposed using a modified product value formula price for hard products which would have incorporated the competitive bidding influences of cheese milk prices not currently captured by the basic formula price. Overall, the Western States' proposal was market-oriented, but would have brought badly needed stability to fluid milk.
    Upon reading the Department's proposed rules, I have to wonder why we spent so much time trying to develop such recommendations. The Western States' plan was designed to reduce the growing discrepancies between prices paid by consumers for fresh milk and the prices received by producers. By moving exclusively to a multiple component pricing system which ignores the competitive bidding influences in the upper Midwest for cheese milk, the Department's proposal will not help recapture these dollars already spent by consumers.
 Page 104       PREV PAGE       TOP OF DOC
    By indicating its preference for option 1B class I differentials, the Department proposes to even further reduce dairy farmer income dramatically, lowering class I differentials ignores important market realities of the dairy industry which is vastly different from marketing conditions of storable products.
    Federal milk market orders mandate minimum prices which all regulated plants must pay into the pool. In Texas, all plants are regulated, so minimum prices are truly set. Federal orders do not, however, mandate minimum prices paid to the dairy farmers by their cooperatives. The fact that cooperatives do not have to return Federal minimum prices to their members causes cooperatives and many instances to forego market premiums for market share and the illusion that a market monopoly by a cooperative will ultimately return higher prices by forcing plants to pay more for milk.
    The system today provides us some protection from this by higher class I differentials that put more dollars into the pool. This puts the burden on class I plants, which within our order class III manufacturers get a free ride. The system is not fair to all buyers of milk. It is a system that we, unfortunately, have. Lowering differentials quickly would do nothing but create disorder and producer loss in the short run, only to have the industry rebuild its production base after the shakeout.
    I'll go on here—the Texas Association of Dairymen is not afraid of neither risk nor change. We recognize Government ultimately wants out of milk pricing policy, but in reforming Federal orders, Congress and the Department must realize that any policy change which injects additional milk price volatility will accelerate the trend towards fewer and larger dairies. We submit that option 1B exceeds the rate of change accessible to the U.S. dairy industry. We applaud Congressman Stenholm and Congressman Solomon for their recognition and leadership at this critical point and their apparent support for option 1A.
    One final issue, for many years Congress and the USDA—I think everybody's touched on it today—have struggled how to get California into the Federal order system. I was raised in California and learned how to dairy there. Recently, some have called for lowering manufacturing price levels established under USDA's reform proposal to allow the rest of the U.S. industry to compete with California. TAD suggest that this is absolutely the wrong direction to take the dairy industry. Manufacturers of dairy products must compete for an equal footing whether in California, Idaho, or Wisconsin. The decision should be whether to bring the rest of the country down to California's subsidized cheese prices or bring the California class prices—or cheese prices up to Federal levels. And I would like to state I think we need to get creative on the California issue, and there needs to be some way of resolving the quota issue within California before that can happen and they can come into our orders. I thank you for the opportunity to speak.
 Page 105       PREV PAGE       TOP OF DOC
    [The prepared statement of Mr. De Jong appears at the conclusion of the hearing.]
    Mr. POMBO. Well, thank you. Thank all of you for your testimony. I think all of you mentioned the need to bring California into the system or your desire to bring California into the system. The way—at least my understanding or interpretation of what the Department said earlier today—that's probably not going to happen, and unless we can have some way of changing that because of the unique problems that we have in California particularly with our quota system, I agree with Mr. Dooley and what he said earlier, California's going to vote no, because that is a big problem that we have that we need to deal with, and the way—at least my understanding of their interpretation this morning—that doesn't seem very likely that in that period of time that you're going to have a chance to educate enough dairymen to make a difference in that.
    All of you are talking about supporting 1A as the option that would be the least disruptive to the industry with one exception. [Laughter.]
    When we passed the farm bill, the push was to go into a more market-oriented system, but we also recognized the need that there be a transition, and we knew that that was needed because once dependency has been established on a current system, it's very disruptive to go immediately into a market-oriented system, and we did want to have some kind of a transition. I was wondering if any of you would like to comment on if we go or if the Department goes with a 1A, at what point do we option into something more like 1B? How do we make that transition from a highly regulated industry to one that is more market-oriented? Go ahead, Mr. Marshall.
    Mr. MARSHALL. I'd be happy to try to address that, Mr. Chairman. First, let me say that Darigold does endorse the National Producers Federation position which is to support 1A with a supply demand adjuster built into that formula such that if in a given market there would be additional production of milk and a lower utilization, there would be a downward adjustment in the class I differential.
 Page 106       PREV PAGE       TOP OF DOC
    Let me also point out with something that may be fairly obvious but we don't think about it very much, and that is that the class I differentials are constantly being reduced by inflation. They're more or less where they were 30 years ago in absolute dollar terms when they were one-third of the manufacturing value. In fact, more like 50 percent, I think, at one time of the manufacturing value, so we are seeing with inflation a ratcheting down of the relative values of class I differentials. It would be even more the case, of course, if manufactured prices were keeping up with inflation which they're not as Mr. Kozak pointed out.
    I think at some point we have to recognize there's two issues here: one is the surface issue, the inter-market relationships, and that's one reason why so many people are uncertain about 1B; some of the inter-market relationships don't make sense. The other issue is the one that's been commented on earlier on today, it's a question of where you take that surface relative to your class I price mover. You can have the lowest point be 70 cents above the class I price mover or you could arbitrarily raise it or lower it, and I think that's really the issue; not what the surface should look like—the 1A surface or the 1B surface; I think the industry, generally, is going to support the 1A surface—the question is going to be the amount of which that will exceed your class I price mover. Some of the answer to that will lie entirely in the formulas that are revised by USDA for class III and IV. Only when we see those formulas in final form will we know where the relative value of the class I price will be relative to where it is today.
    Mr. POMBO. Mr. Kozak.
    Mr. KOZAK. One of the things I think we have to focus on—and we did this as we developed our position, Mr. Chairman—and that is to take a look at the whole package. We clearly recognize that the issue between 1A and 1B, I would add, is probably more political than it is economic, but the fact of it is, is that for years we heard that the dairy industry was never united. Having worked in the Government for 17 years on the other side and having worked in the industry, both at the processing level and now at the producer level, the one issue that I always heard is, ''Please don't come to us trying to have your—having the solutions here,'' and in the 6 months that I've been on board at the National Milk Producers Federation, when we voted for the first time in our history on the Federal order system—as you heard today at this table—we voted on a package, and the package was basically looking at the fact that if we were dropping the class III and IV prices to become more market-oriented to try to deal with the California situation but at the same time we have to be realistic, as Mr. Wellington has pointed out, that the 1996 FAIR Act didn't direct the Secretary to reduce farmer income.
 Page 107       PREV PAGE       TOP OF DOC
    And so when we put our task force together of our top 10 CEO's representing our membership, what we came up with was a compromise, and that, we think, is more market-oriented. It moves the industry in the right direction in class III and IV prices. We think that the Department did a good job, but they got it wrong. Their prices that they put into their proposal are overstated. When you talk directly to the manufacturer—some of them at this table today—you find out that we could not get out of the market the prices that the Department put in. And, so although 1A, 1B is clearly a significant issue, I ask that the committee look at the entire proposal and the balancing for the entire industry.
    Mr. POMBO. Mr. Halnon.
    Mr. HALNON. As long as transportation costs remain an important part of the ingredient of milk prices, the price surface will always reflect some variation in price. There can be no level playing field that we've all talked about. There will never be a time when Wisconsin farmers receive as much for their milk, for their class I milk, as farmers in the Southeast because it costs money to move milk. What will happen if we go to transition to 1B, obviously, the decline in production in the Southeast will accelerate. Producers will try to the extent they can to get out of the negotiation process some or all of that, but in the Southeast negotiation has not been very successful and partly it's because of the structure in the Southeast with the large number of non-member producers that really don't have negotiating power. So, the transition to 1B will cause disruption in the Southeast, and it will increase prices to consumers simply because every other distant source is a higher cost source of milk.
    Mr. POMBO. Mr. Hughes.
    Mr. HUGHES. There's two transition elements of the 1996 farm bill. One is ratcheting down and then eliminating the price support program, so that transition is under way. There's a world market transition that none of us can do too much about. The option 1A versus 1B issue, I made reference to the fact that Federal orders do distort markets and the economic goals of upper Midwest dairy farmers is to remove some of those economic distortions that disadvantage the Midwest, and we make reference in our testimony according to this model that in a pure economic sense we're losing $235 million a year on average out of the upper Midwest, Minnesota and Wisconsin, because of the distortions. Now, we're not arguing to correct all those, but we are arguing to phase—and USDA has put on the table a organized phasing in from current differentials to the reformed 1B differentials, and we are also working on some improvements to 1B because we respect the fact that years of institutionalized pricing meant that people made investment decisions because of those, and you have to have some organized process to get there. It's not our first choice, but we understand that's the case, so additional transition assistance shouldn't come under the Federal Order Program.
 Page 108       PREV PAGE       TOP OF DOC
    Mr. POMBO. My time has expired. Mr. Peterson.
    Mr. PETERSON. Thank you, Mr. Chairman. I'm sorry I got called out of here, but I think most of you are apparently in favor of 1A. My question is, is if the Department establishes 1B—and as I understand it, what happens is there's a vote on each order—I'd like each of you to tell me what you think will happen in your area if 1B is the plan and there's a vote, will your people vote to vote out of the order system?
    Mr. WELLINGTON. I'll go first for representing New England and probably New York, and, no, we wouldn't vote out of the order system. Our problem in the Northeast is that we don't have competitive relationship, and we don't we have bargaining power. In fact, if you look at the ratio of farmers to milk processors it's greater today than it was in the 1930's when the orders went into effect. In fact, I met with the commissioner in New York yesterday and he was telling me that from 1960 to today, the ratio of farmers to milk plants has increased 3 to 1. There's three times as many farmers going to an individual milk plant than there was about 30 years ago, and, in fact, many of the milk plants, now, owned by one handler, have their own multiple plants, so it's hundreds to one on this ration. It's a terrible situation for farmers, so we would probably take whatever we could out the Federal order system, because it's all we can get.
    Mr. LAURIE. Well, Mr. Peterson, I would speak with two hats: one, representing nationally the producers that we do in the Farm Bureau, and I think it would be a toss-up. It will be difficult to get support from the producers that I visit with across the country, with the exception of the upper Midwest, for 1B. Looking at my own State in Michigan, I'd say it is highly unlikely that Michigan producers would support 1B. I think we would see an accelerated structural change in the industry, one that's——
    Mr. PETERSON. My question is on the vote of whether they want an order or not, what do you think the vote would be?
 Page 109       PREV PAGE       TOP OF DOC
    Mr. LAURIE. I think Michigan would vote no.
    Mr. PETERSON. Vote the orders out?
    Mr. LAURIE. I think they would vote the orders out rather than go with 1B.
    Mr. MARSHALL. Mr. Peterson, we have producers in two of the proposed new orders. I think in the Pacific Northwest the decision would be driven, frankly, far more by the results of USDA's final rule on class III and IV than on class I. I suspect that 1A versus 1B will not be a major decision on voting out the order. It might be in the western order if depending on the pool of qualification provisions that are adopted there, and, in effect, on the utilization of that western order.
    Mr. PETERSON. I know Mr. Hughes——
    Mr. HUGHES. Affirmative.
    Mr. PETERSON. Well, you represent the whole country, so you—right? [Laughter.]
    Mr. KOZAK. I was going to ask you who's going to win the final four?
    Mr. PETERSON. Minnesota, absolutely. [Laughter.]
    Mr. KOZAK. Because answering your question's a difficult one, but all I can say is this in all honesty is that our producers came together in the spirit of cooperation. Out of 29 co-ops, only two voted against our position, so I think for the first time in history we have an overwhelming majority supporting 1A, but as you already know these are regional areas and whether or not somebody would vote out the orders, I can't predict, but I think the point is we fell very strongly about it.
    Mr. HALNON. Class pricing, obviously, is an important part of Federal orders and the level of class I price, certainly. There are a lot of other elements of Federal orders that are of much benefit to producers. The classification of milk; the pooling of market-wide proceeds; are provisions of Federal orders that would, I hope, deter producers from voting out any orders, and I would be surprised even if our good friends from Michigan chose to vote the orders out simply because the price level was not quite what they wanted. So, my guess would be that, with probably very, very rare exceptions, all Federal orders would be voted in. They may not like them, and we certainly wouldn't like 1B, but I think they would keep the orders.
 Page 110       PREV PAGE       TOP OF DOC
    Mr. DE JONG. I'd say the same thing for Texas. We've got—really, there's only four buyers of milk in our State, so we need the milk marketing orders. We need that protection.
    Mr. PETERSON. Mr. Kozak, what is the position of the National Milk on compacts; extending the Northeast dairy compact; allowing the Southeast dairy compact to be created if it's asked for, and, also, what is your position on establishing a price floor in light of the fact that we have testimony from our area and also other people saying that it potentially will reduce income for some producers if we put a floor in place?
    Mr. KOZAK. The Federation doesn't have a formal position either on the BFP or on the price floor and also on the compact.
    Mr. PETERSON. You don't have a position?
    Mr. KOZAK. No, but let me just expound on that. And the reason for that is this: we believe that we're trying to play through the process under the National Milk Producers Federation. Congress directed the Secretary to begin the reform process. They put out a proposal and one of the things that I've tried to keep our members on track is, is to respond to the Federal order reform process, and we feel that if we can get through this process and have meaningful reform that is favored by most of our cooperatives, that the issues for the BFP and compacts will be mitigated, because at a time when the judge's decision eliminates class I differentials and at a time when the Department indicates to producers that we may lose $365 million a year on producer income because of option 1B, of course people are going to look at other areas of how to sustain their income, and I'm convinced that if we can work our way through our process, if the Department will firmly look at the position that we put forward, that the issue of compacts and flooring of the BFP will eventually go away.
    Mr. PETERSON. I wish people would quit using this $365 million figure, because I don't think it's accurate, and, Mr. Wellington—if I could just finish up—I'd like you to make information available to me on your organization; of how you came up with that. And this is just class I, right? You're only looking at—the way you put that together, you're only looking at class I.
 Page 111       PREV PAGE       TOP OF DOC
    Mr. WELLINGTON. Yes, in fact, you'll see in my testimony that I have the pages from the 800-page document of the USDA that I got that from, and the reason we focus in on that, Congressman, was because when you look at what USDA has done, they, basically, under 1B, they lower the class I differential somewhat. Everyone agrees that they do lower it, OK? But they say it's not going to do any harm because they increased the base upon which the new 1B lies using the class III and class IV prices of that base, but it's almost smoke and mirrors where that base is at, because in reality it doesn't increase the price of class III and class IV products. They're going to use it for 1B purposes, but it really doesn't increase the price. In fact, they don't even use that increase in price to tell what it's going to do to producer income. So, I mean, when we look at that increase, it's not going to last; it's going to fall apart.
    Mr. PETERSON. You can say the same thing if you look at this from the other point of view; from our point of view that class I differentials are distorting the manufacturing price. I mean, you could turn this on its head and then make the argument the other way around. I mean, we would say that if we allow these differentials to continue to be distorting the market, that you're reducing the price of manufacturing milk. If we take that out, the price of manufacturing milk will go up.
    Mr. WELLINGTON. What we would respond on that is that our class I differentials go to cover the cost of higher class I markets. That's why when we look at the final mail box prices——
    Mr. PETERSON. Let's look at that because he doesn't think that you have the justification for that. Now having said that, I just want to say that I understand full well why Florida needs the higher differentials; I agree with that. I understand that you need a higher differential, maybe not as high as Florida or Georgia but probably higher than we do, because you have a different situation, but the problem is that this thing was legislated by Coehlo in 1985 when they did this, and it was just a political deal; it was picked out of the air, and we're defending it as though this was some kind of a free market, well thought out deal when it was a political deal that was made behind closed doors, and here we are justifying it as though it's some kind of immaculate market or something.
 Page 112       PREV PAGE       TOP OF DOC
    Mr. WELLINGTON. Well, I think the Cornell study does try to step beyond that, but you should also know that in 1985 when those rates were determined, it was really my counterparts from all the co-ops that looked at those rates and said, ''What could work in the marketplace?'' It was if almost they were testifying at a Federal hearing, but, you're right, it was done through the political process.
    Mr. PETERSON. Well, nobody's going to give up what they have. They're going to come up with whatever justification they can to keep the money that they've got. That's obvious; everybody will do that. But the problem is if we are really going to become market-oriented—and that's what everybody says we were trying to do in 1996—how can we not be market-oriented in the United States and then put everybody in a position where they have to be market-oriented in the world? I mean, that is ludicrous. That's what our people think that you're saying. Take away our supports; put us on the free market; make us compete in the world, but in the United States, we're going to bulkanize this so that we're going to distort the market. I mean, is that going to be our position?
    Mr. WELLINGTON. Well, no, but what concerns me, though, is that on the fresh milk side, on class I side, if we let New Zealand or Europe or someone else drive our price, you're never going to provide a drop of milk to our market, and we're wondering what's the sense in that either. I mean, I understand what you're saying on the free market side, but——
    Mr. PETERSON. I apologize, Mr. Chairman, but——
    Mr. POMBO. We can have another round if you want. Mr. Holden.
    Mr. HOLDEN. Thank you, Mr. Chairman. Immaculate market, that's what we're searching for, OK.
    Mr. Halnon stated what option 1B would cost the average dairy farm family in the Southeast. Mr. Wellington, I'm just curious, what do you predict option 1B would cost the average dairy farm family in the Northeast?
 Page 113       PREV PAGE       TOP OF DOC
    Mr. WELLINGTON. Well, based on that 48 cents a hundredweight, we're probably talking somewhere between $5,000 and $6,000 a year on that net income. Keep in mind that the average dairy farmer in the Northeast is probably milking about 60 to 70 cows, and his net family farm income is probably in the vicinity of around $20,000, so if you take away $5,000 or $6,000, you're now at $14,000, and that's below the poverty level.
    Mr. HOLDEN. Mr. De Jong, how about in Texas?
    Mr. DE JONG. The projections from A&M was that we'd have a average 400-cow dairy on an average income of $20,000 in 1997 and by 2003 it would be zero.
    Mr. HOLDEN. What did you say, $40,000?
    Mr. DE JONG. Twenty thousand. And then by 2003, under 1B option—because we lose about 60 cents a hundredweight—it would be zero.
    Mr. HOLDEN. All right. Thank you. Are there currently uneconomic movements of milk or other disorderly marketing conditions that would warrant such dramatic changes in class I differentials as proposed in option 1B? Mr. Wellington.
    Mr. WELLINGTON. No, in fact, that's part of the issue that we were concerned about, because actually there isn't huge movements of milk. There's some distortions of time, and New Mexico doesn't have a plant and they have to move milk, but, basically, we're not finding that for that much of the country. Basically, milk moves to the Southeast when it's needed during parts of the year, but the rest of the time most of the milk stays local, so there's not disorderly marketing that needs correction at least from our opinion.
    Mr. HOLDEN. Anyone else care to comment?
    Mr. HALNON. Well, there probably wouldn't be uneconomic movement in the sense, but the price of moving that milk or the cost to consumers would increase simply because the milk would have to come from further away if a system of class I prices reduced prices in an area that was already a deficit and it would make the deficit worse. The total cost would be increased.
 Page 114       PREV PAGE       TOP OF DOC
    Mr. HOLDEN. Mr. Hughes.
    Mr. HUGHES. The current differential system, the institution of Federal orders, makes the distance from Eau Claire result in a higher differential. That tends to enforce people to get milk from the lower price sources when there may be other milk available. So, right now, milk is procured in the Southeast from the West, particularly the Southwest, the Mid-Atlantic area, and sometimes you'll go a year without any milk coming out of the upper Midwest. There's no reason to enforce that price surface institutionally, and part of the argument of the farm bill and in this debate over 1A and 1B and why the Secretary prefers 1B is that the debate was to get the system more market-oriented.
    Mr. HOLDEN. Thank you. Mr. Wellington, in your statement, you said cash margins would be negative every year from 1992 through 1996 under option 1B. Does that apply to 1997 and further years out?
    Mr. WELLINGTON. I think for 1997, clearly, because 1997 was not a very good year for dairy farmers, particularly, because when you look at the prices that occurred in the spring and summer of last year, so we're saying definitely in 1997. We anticipate that will probably be the case in 1998 and 1999. Keep in mind, too, that the numbers I use in my statement were from farm credit, and those are people who use very detailed accounting; farmers who use it, and they tend to be better farmers, so we're even more concerned about the average farmer.
    Mr. HOLDEN. And, finally—and this is something I've been trying to grasp for a long time and I'm having some difficulty with—how can class I differentials in the Northeast be higher than in the upper Midwest, yet, farmers receive a lower mail box price? You mentioned it briefly, Mr. Wellington.
    Mr. WELLINGTON. Yes, it goes back to what the costs are involved in serving a higher class I market. There's additional transportation costs. For example, the New York market is really supplied by farmers in central and northern New York, from some in your area, in fact, in Pennsylvania. So, the milk is coming 100 to 200 miles which is a much higher additional cost to do that. In addition, on balancing, in Northeast we have to have balancing plants available in order to do with the fluxing class I sales when schools go in and out. Plus, we don't have protein premiums, to a great extent, in high class I markets. Class I bottlers say there's no additional value to additional protein in fresh bottled class I milk, so only half our producers, probably, receive protein premiums. In the Midwest, I would say it's probably 100 percent. That's really the net what happens with this. Class I differentials are used for covering the cost not to return to farmers.
 Page 115       PREV PAGE       TOP OF DOC
    Mr. HOLDEN. Thank you, Mr. Chairman.
    Mr. POMBO. Mr. Dooley.
    Mr. DOOLEY. Thank you, Mr. Chairman. Mr. Wellington, up in your area, are they paying over-order premiums for class I milk?
    Mr. WELLINGTON. Very small amount.
    Mr. DOOLEY. But they are paying them?
    Mr. WELLINGTON. We have an increase in milk production throughout the Northeast going on right now, so that's impacting some of our over-order premiums. Right now, they basically pay them on quality, the higher quality milk.
    Mr. DOOLEY. Mr. Marshall, are they paying any over-order premiums up your way?
    Mr. MARSHALL. Yes, approximately 37 cents in Seattle; 72 cents, I think, in Portland, and zero in Boise.
    Mr. DOOLEY. And, Mr. Kozak, and most of your membership, I know, is spread over. Is there an area that's not paying over-order premiums on class I?
    Mr. KOZAK. I really couldn't answer that question unless I really looked into it.
    Mr. DOOLEY. You would say, though, that most of them you would say are paying over-order premiums?
    Mr. KOZAK. Most likely.
    Mr. DOOLEY. OK. And, Mr. Halnon, how about your area?
    Mr. HALNON. Yes, over-order premiums are being paid. Florida, traditionally, depends on over-order prices to generate the inadequate milk supply they do have. In the rest of the Southeast, premium structures have varied, largely, because of difficulty in negotiation, but, yes, there's always some premium involved.
 Page 116       PREV PAGE       TOP OF DOC
    Mr. DOOLEY. And, Mr. De Jong, in Texas, are we paying over-order premiums?
    Mr. DE JONG. Right now, they're about 25 cents.
    Mr. DOOLEY. Well, unless I'm missing something here, it seems to be fairly consistent that there's premiums being paid over the class I differential now. Is that what I understood all of you to say?
    Mr. WELLINGTON. Well, keep something in mind, though, that in our order the premiums are being paid on all classes of milk; there's no higher premium date on class I that's being paid to procure the milk.
    Mr. DOOLEY. That's fine. I would also then say that would I be incorrect in making the assumption that these over-order premiums are being paid because of supply and demand situations?
    Mr. MARSHALL. May I address that, Mr. Dooley? In our market, I think it would not be correct to make that assumption.
    Mr. DOOLEY. Then why would somebody even want to pay you an over-order premium. If I didn't have to pay you a little bit more to get a supply, why in the world would a processor bother to do that?
    Mr. MARSHALL. And maybe it was my mistake in using the term premium. What happens in the Seattle market is that we, Darigold, set our service charge where it is, a little under 40 cents, because we calculate the values, the actual cost to a proprietary dairy who has his own producers under contract to handle the cost of field services; the potential cost of having to deal with a bad load of milk and all of that. In fact, that's what we have been told by one of our bulk milk customers is what they see as a more or less cost equivalent between buying milk from a co-op which pays the producers and does all that stuff and then versus doing that on their own. So, it's really not a premium; it's a cost recognition in the Seattle market. In Portland there is an additional dollar amount being charged, and that is because the immediate Portland vicinity is a deficit market, and that cost that's being assessed is actually going for transportation dollars. It's my belief that with a lower class IB, there would simply be lower producer income, and there's no chance in our market because of supply and demand conditions to maintain prices at a correspondingly higher class I premium, if you will.
 Page 117       PREV PAGE       TOP OF DOC
    Mr. DOOLEY. I'm still struggling a bit with a lot of you folks that are saying that the 1A versus 1B is going to have this dramatic reduction in producer income, and, yet, some of the people who are making these statements are also contending that there's fairly consistent over-order premiums being paid which I still—maybe some of it is cost driven, but some of it has to be supply and demand driven, and so if you have the marketplace that's already working, I have a hard time accepting that when you go down and when you see less of a differential, that that supply and demand situation, it hasn't changed. Yes, Mr. Halnon.
    Mr. HALNON. In the Southeast, as I pointed out, there are a large number of producers that deliver directly to processor plants and essentially do not—so we're not able to bargain for their milk. Now, the processor has to assume the cost involved in receiving that milk from producers, when they deliver the milk, and to that extent the co-op can bargain for prices higher than the order all the time, but that's not very much, and that only covers—as Mr. Marshall pointed out—that only covers the cost of supplying the handler. It really isn't a true premium, so with a poorly organized market—and I think in some of the Southeast markets, it probably could be characterized that way because of the larger numbers of non-members—getting any amount over and above the cost of supplying the handler is difficult.
    Mr. DOOLEY. Mr. Hughes, do you want to make a comment?
    Mr. HUGHES. Yes, quickly, in the upper Midwest there is an organized effort to establish over-order premiums and it more or less varies on the time; covers more than cost. There's bargaining power at play. But I was involved in some discussions with Western States' producers and it was after Judge Doty had issued his decision and there was the thought that differentials were all of a sudden going to evaporate, and the opening of the discussion was all of the occurrences to prepare for that through over-order negotiation—or private negotiation in the Northwest; in the Southwest, and in California, and the point was there is an incentive to do it; it can be done more or less. That's not to say that there's perfect bargaining power amongst the producer associations, but the market will work.
 Page 118       PREV PAGE       TOP OF DOC
    Mr. DOOLEY. Mr. Wellington, you gave some figures to Mr. Holden in terms of what would happen to producer income if you had the 1B versus 1A and dramatic reduction. What would you anticipate would happen to production of fluid milk if that situation did happen; if we instituted 1B in your region?
    Mr. WELLINGTON. Oh, I think, clearly, when you have that level of production, you have more farmers going out of business, and, initially, you might even have an increase in milk production, but keep something in mind that farmers struggle with cash flow in this industry. Prices go down and they make more milk, and you say defies economic theory, but farmers have to pay their bills, and they find any way to make more milk, but, over time—over a year or two or whatever—you're going to see absolutely less milk being produced in the area.
    Mr. DOOLEY. And what would you expect, though, if you had the drop in production over time, what would happen to prices?
    Mr. WELLINGTON. It depended on what was going on exactly in the marketplace. Originally, you would think, Gee, if you have less milk, you could bid up the price in the area, but, unfortunately, what we're having is that some of our plants are going out of business and deciding to leave to go out to the west or Idaho or whatever.
    Mr. DOOLEY. So, where is the milk coming—as the consumer demand is going to be relatively constant, would you say? Who's supplying—as the processors are going out, where's the milk coming from?
    Mr. WELLINGTON. The milk's still coming from the producers in the area. It's just that there's no one in the area—there's fewer people in the area to process that milk, and so the supply and demand situation in that area, itself, even though there's less milk—if there's less demand for the milk because of less cheese manufacturers, we have a problem.
 Page 119       PREV PAGE       TOP OF DOC
    Mr. DOOLEY. But I thought we were referring to more class I, aren't we here, in terms of—your projections on price, I thought, were based on class I?
    Mr. WELLINGTON. On those, yes, but you're asking me what would happen on a sequence of events.
    Mr. DOOLEY. You'd have less milk and you would still have the same fluid milk production is what you're saying.
    Mr. WELLINGTON. Oh, yes, without a doubt. You would not have additional milk coming from outside the area, we don't believe at least.
    Mr. DOOLEY. Mr. Kozak, on this, I'm still a little bit struggling with why supply and demand doesn't work quite as well in this industry, and with you folks controlling what I understand as 45 percent of the milk that's marketed in the United States now? Is that what your testimony said, I think?
    Mr. KOZAK. Well, I think we represent about 60 percent, so there's other volume of milk produced in the country.
    Mr. DOOLEY. Now, puts you in a pretty good situation in terms of—it seems, if you folks all hold together as you appear to be on this 1B situation—if you get a situation, if you were representing the folks in the Southeast and your concerned about it, why don't we have a vertical integration there where you folks are capturing some of the dollars that you feel like you're not capturing now?
    Mr. KOZAK. Well, I think that as we get into it, Mr. Dooley, some of the specifics of how each region is affected is something that I don't feel comfortable, at least at this point, of responding, because I do think that given the complexities of the regional disparities that it's hard to do that, but one of the issues that we discussed in terms of our task force was trying to come up with a national perspective on it. I mean, I don't have to tell you, the difficulty is in getting people to agree regionally and we had two meetings, and in those series of meetings, I think that we had the Southeast represented and the upper Midwest and the Northeast and the entire country with the exception of California although we do have membership in California through our co-ops, and it became clear that they were genuinely interested in coming up with something that everybody can live with. That was the nature of our position, and when we came out of that meeting—although it's not a perfect position; some people don't like different parts of it—we feel that it's something everybody can live with.
 Page 120       PREV PAGE       TOP OF DOC
    Mr. POMBO. I'm going to have to cut you off. We have a vote on the floor right now. So, we're going to recess the committee temporarily and go vote and come right back.
    Mr. POMBO. We'll call the hearing back to order. We have just a couple more questions for this panel and then we'll call up the final panel, if I could have everybody join us back at the witness table.
    Mr. Peterson had a couple more questions. I'm going to go ahead and turn it over to him.
    Mr. PETERSON. Thank you, Mr. Chairman. Apparently, during the discussion, there was some discussion about the midwestern people possibly not supporting 1B. I'd like to ask Mr. Hughes, isn't it true that there is a number of the National Milk Producers Federation that are not in favor of 1A, that are actually in favor of 1B? And, if so, who are they?
    Mr. HUGHES. Yes, Mr. Peterson. I believe all of these that I'll mention are members of National Milk. Mr. Kozak can correct me, if I'm wrong. AMPI, Swiss Valley, Ellsworth, First District and the Lakeshore Federation, which is made up of Milwaukee Milk Producers, Manitowoc Milk Producers, and Midwest Dairymen.
    Mr. PETERSON. They're all part of National Milk?
    Mr. HUGHES. To the best of my knowledge.
    Mr. PETERSON. Probably, they don't have votes on the committee or something?
    Mr. HUGHES. I don't know.
    Mr. KOZAK. They are part of National Milk. Manitowoc has a vote and so does North Central AMPI. Those were the two dissenting votes on our position. But, as I pointed out earlier, Land O' Lakes, Foremost Farms, and Dairy Farmers of America, which I believe represent quite a substantial number of producers in that area, were solidly behind it.
 Page 121       PREV PAGE       TOP OF DOC
    Mr. PETERSON. I just wanted to clarify so people understood there are a considerable number of people that belong to National Milk that are not on board with that position.
    Mr. POMBO. Well, thank you, thank you very much. I would like to thank the panel for your testimony. Any further questions will be submitted to you in writing. I would like to encourage all of you to stay as involved as you have been in the past with trying to make this effort work.
    I would also like to clarify, for the record, a statement that was made earlier that, if California was concerned about the Federal milk marketing orders, that they should be back here and involved. I can guarantee you that they are back here and they are involved because they spend half their time in my office. [Laughter.]
    I see most of those guys more often than I see my kids. So, I can tell you they are very involved with this process, very concerned about this process, as all of you are.
    Mr. MARSHALL. Mr. Pombo since I made the statement, may I just comment on——
    Mr. POMBO. Have at it.
    Mr. MARSHALL. I was referring to the statement of Western United, which has been submitted to this hearing today, which urges USDA not to do any work on a California order until after they have finalized a proposed rule for the rest—finalized the actual final rule for the rest of the orders. That's how I read their comment. I think that is entirely the wrong approach. They should be negotiating with USDA now, telling USDA what they need so USDA can see the whole picture as they go from the proposed rule to the final rule.
    Mr. POMBO. I'm not going to attempt to speak for Western United. But I can tell that I believe that's a misinterpretation of the facts because Western United has been very involved with the process. They have submitted numerous times testimony to the process and have participated with other groups in the west in participating and in trying to find out where California is on all of this.
 Page 122       PREV PAGE       TOP OF DOC
    Mr. MARSHALL. Good, I hope that's correct, sir.
    Mr. POMBO. It is. Thank you very much and I'll dismiss this panel.
    I'd like to call up the fourth panel: Mr. Linwood Tipton, Mr. Jim Tillison, and Ms. Marcia Glenn.
    Thank you very much. To start off with, I'd apologize to the panel for the delay in bringing you up. I appreciate you sticking around through the entire day for the hearing.
    Mr. Tipton, if you are ready, you may begin.
    Mr. TIPTON. Thank you, Mr. Chairman.
    I'd like to summarize several points which are included in my more extensive written comments.
    Point No. 1, we believe that the proposed rule really is more regulation, not less. Instead of reform, we believe that the USDA's proposed rule are more complicated and more intrusive. Each of the proposed formulas, except for 1B, class I differential proposal, would substantially increase minimum class prices which are required to be paid. The magnitude of these increases are detailed in my statement on pages 4 and 5. This clearly makes them more intrusive and will, in fact, set milk prices instead of under market driven prices and will greatly affect the areas where milk is produced and the markets to which it is marketed.
    Additionally, there are more formulas, and the formulas are more complicated than the current system. The formulas are detailed in the attachment to the statement called Issue No. 2, ''the Class I Mover and Manufacturing Prices.'' A quick review of that report illustrates how complicated this whole program has become.
 Page 123       PREV PAGE       TOP OF DOC
    Point No. 2, proposed class price increases are large, not less. The proposed formula with the large price enhancement effects increase the pricing differences between California and Federal order markets. Plants regulated by Federal order markets are currently competitively disadvantaged, and that competitive disadvantage would be greatly exacerbated. The proposed rule must be changed in this regard.
    The Federal order class prices must be aligned with California prices. This is very important. California and several other western States are the source of enormous reserves of milk and the Federal order prices must be aligned with the prices in this area. The pricing formulas for class III and IV need to be changed to accomplish this.
    Point No. 3, proposed price supporting floor is more regulation, not less.
    If the Secretary adopts the price supporting floor, it will set in motion a dynamic series of events which could be devastating to the dairy industry and would take a long time to correct. Our estimates are that the proposed $13.50 floor would increase producer revenue over $550 million during the period from June 1, 1998 to March 31, 1999. The probable higher consumer cost will reduce sales of class I and II products by about 800 million pounds of milk equivalent. This would be milk that was formerly consumed in class I and class II. This would then be used in manufacturing products, i.e., butter, powder, and cheese. This would have the effect of decreasing prices to dairy farmers for milk for manufacturing uses by about 50 cents a hundredweight.
    Milk production would increase as a result of the initially higher prices. This would further decrease prices for class III and IV products. This would be about another 50 cents per hundredweight reduction. This means that the $13.50 floor would reduce the market prices for milk for manufacturing uses by about $1. Thus, markets with high class III and IV uses get hurt badly.
    In fact, in a number of those markets, the net income to dairy farmers would go down and probably, the largest decrease would be in the Idaho-Oregon area, where there would be a very substantial reduction. I believe that even though California is not a part of that hearing process, that the prices to dairy farmers in the State of California would be—it would have a negative impact on them as well, and a substantial one at that.
 Page 124       PREV PAGE       TOP OF DOC
    It is beyond me how the Department of Agriculture could even consider this proposal. The Secretary apparently held the same view a few months ago when the USDA rejected such an idea in a letter to Senator Lugar, and I think that was to others as well. Additionally, the USDA strongly rejected a similar idea in the rationale accompanying the proposed rule. The floor under class I and II prices is a bad idea whose time should not come.
    Point No. 4, compacts are more regulation, not less. There is a major effort being made to extend the Northeast Compact past the date the reform package is adopted. Additionally, there are a number of other states seeking new compacts. This attempt at balkanization of the U.S. dairy industry should be rejected. The New England experience provides the clear basis for rejection.
    The Northeast Compact resulted in decreased consumption, now averaging about 1.5 percent below the year earlier level. It has also increased production in milk. Production in Vermont is now about 4.5 percent above February 1997 and it has been increasing at an increasing rate for several months. These trends have resulted in class III and IIIA uses in that area increasing tremendously.
    Last month, the commission reserved nearly $700,000, about 76 percent, of the $914,000 in the compact pool to pay for the added cost to the Commodity Credit Corporation. This policy makes no sense. It increases costs to consumers, increases milk production, and takes the added money to purchase surplus milk created by the higher prices.
    When you put all of these initiatives into perspective, it's a lot more regulation, not less.
    Thank you, sir.
    [The prepared statement of Mr. Tipton appears at the conclusion of the hearing.]
    Mr. POMBO. Thank you.
 Page 125       PREV PAGE       TOP OF DOC
    Mr. Tillison.
    Mr. TILLISON. Thank you, Chairman Pombo.
    My name is Jim Tillison. I'm executive vice president and CEO of the Alliance of Western Milk Producers.
    The Alliance represents five major cooperatives which would be qualified entities under Federal order, and thus, able to block vote on behalf of their 1,200 producer-owners. These organizations, along with California Gold Dairy Products with approximately 350 producer-owners, have advised USDA that they are not in favor of pursuing a Federal order at this time. Since there are 2,100 qualified producers in the State, we think that this is not insignificant.
    The reasons for the Alliance members are simple. There are a number of questions to which there are answers we need to get from USDA which are a critical part of evaluating the pros and cons of California joining the Federal order system. For example, quota alone is a $700 million question. Handled improperly through the reform process, California producers could very well lose that investment. We also want to see the final proposals, so a thorough evaluation of a possible California Federal order can be made.
    I'd like to respond to comments often made about the potential impact on the Federal order system if California does not join that system. It is obvious that the USDA recognizes the potential impact on the Federal order system the California State order can have. They are proposing a system that is very similar to the California system. Since our product manufacturers and fluid product processors use the same milk under Federal orders as well as the California Order, it makes sense that the value of all uses of milk be based off the hard products that are made from that milk.
 Page 126       PREV PAGE       TOP OF DOC
    Regarding the impact of California staying out of the Federal orders on the Federal orders, I have to disagree with the doomsayers who claim that unless California joins the Federal order system it will be the end of both systems.
    With the proposed reform efforts, the similarity of the two systems makes it much easier for each to adapt to the other. This was not possible when the method of determining the value of the milk or any of the manufactured products was so different.
    With reform, both systems would price milk used to manufacture products based on hard product values. With reform, both systems would use manufacturing costs, commonly called make allowances, and the amount of cheese, butter, and nonfat dry milk powder a 100 pounds of milk will yield to calculate milk prices.
    Because of the similarity of the two systems, whether or not California joins the Federal orders becomes much less important to the long-term survival of the Federal order system.
    California cooperatives and manufacturers realize that our system will have to adjust to the reformed Federal system. I'm confident that California producers will not allow a large discrepancy in the value of California milk used to manufacture products compared to the Federal system to continue. I only need to point to a hearing we had last year in which our class I prices were lowered by 60 cents a hundredweight, so that they would be in line with class I prices in surrounding areas.
    Why hasn't California made adjustments to its manufacturing milk prices before this? In addition, to the reason of the dramatic dissimilarity of the two systems discussed previously, there are a number of other reasons.
    First, section 102 of the 1990 farm bill was passed, and because of the controversy this ill-advised move caused, California made no adjustments in its make allowances until section 102 was done away with in the 1996 farm bill.
 Page 127       PREV PAGE       TOP OF DOC
    Prior to section 102, our make allowances were being adjusted downward on practically an annual basis. In addition to the adjustments required by the farm bill, the cheese make allowance was lowered through the California hearing process just this last October.
    Other reasons change in the California system toward the Federal system hasn't occurred include the reform of the basic formula price, which took from 1992 until 1995, and now Federal order reform.
    When the final Federal reform proposal is put forth later this year, California will finally have a long-term Federal pricing system it can evaluate its milk pricing system against and adjust as may be necessary. Unfortunately, the restriction on being able to maintain our quota system in the 1996 farm bill makes a positive vote in California very unlikely.
    The key point I want to make, however, is that I want to get across the fact that California does not have to become part of the Federal order system. When reform is complete, the systems will be similar enough that California will adjust to the Federal system regardless.
    In closing, I would like to praise USDA for pushing the envelope, for resisting staying with the status quo, and challenging the industry to seriously consider a new path of milk pricing. The proposed system is much more market driven than the old system because all the prices of the various classes of milk are based on dairy product prices that manufacturers are actually receiving for their milk.
    The Alliance has submitted proposals to USDA and will
be submitting comments prior to April 30, and suggestions on adjusting product values, make allowances and yield levels that will facilitate the two systems working in sync if that is what California producers choose. For California producers to adequately evaluate that choice, we believe they're going to need a little more time than what the farm bill currently provides. Thank you.
 Page 128       PREV PAGE       TOP OF DOC
    [The prepared statement of Mr. Tillison appears at the conclusion of the hearing.]
    Mr. POMBO. Ms. Glenn.
    Ms. GLENN. Good afternoon, Mr. Chairman and members of the subcommittee.
    My name is Marcia Glenn and I am vice president of dairy economics and dairy ingredient management at Kraft Foods. In that role, I am responsible for all dairy purchases at Kraft and it's a pleasure to be here today to speak with you about many things that are going on in the dairy industry.
    In our opinion, this is a critical juncture for the dairy industry. Federal and State governments are in the process of deciding whether and at what rate we will continue to move toward our reliance on markets.
    In written testimony, we have identified several Federal order reforms which move in this direction. However, today I would like to focus on a subject that is front and center of every discussion at every industry gathering: risk management.
    So what exactly is risk management? Risk management is when a dairy producer in Minnesota locks in his corn and feed prices before the year begins, when a corn grower in Ohio establishes the price for half of his crop with a local elevator before it's even harvested. Risk management is when a poultry producer fixes his margins before the poults arrive. And risk management at Kraft Foods helps us plan our business by providing more predictable costs, allowing us to focus on what we do best which is building demand for cheese. Risk management provides flexibility and choice to both producers and processors, so that we can plan financially for the future.
 Page 129       PREV PAGE       TOP OF DOC
    All major agricultural industries have risk management capability—cattle, hogs, wheat, corn, soybeans, poultry, fruits and vegetables. Some of these industries have a full array of tools to manage price risk like futures markets, options trading, and forward contracting. Others, like the poultry, fruits and vegetables industries, do not have futures markets, but use a variety of forward contracting methods.
    Every major industry has risk management tools except dairy. Why is this so? Why are risk management tools used so widely outside the dairy industry? They're used because commodity buyers want predictable costs.
    Dairy processors, like Kraft, also need this predictability. Predictability is important because it allows us to reinvest in our dairy business in terms of advertising, new products, research and development. All of this increases the consumption of cheese which, in turn, increases the demand for milk from our producers and suppliers. In times of volatility and without the ability to manage risk, our investment contracts and growth slows.
    Risk management benefits farmers as well. The producers that sell us milk are asking for these kinds of tools so that they can manage their business. Predictability of cost and revenue help producers manage their financial future, provides greater certainty for short- and long-range plans, and strengthens their relationship with their lenders. So why shouldn't dairy have the same choices as other commodities? We think that it should.
    We know there is a broad base of support for risk management across the industry and in government. And we think that these tools can be made available by a minor change in regulation that is entirely compatible with the existing Federal Milk Marketing Order System. This change would permit producers and processors to have the freedom to enter into forward contracts that establish today the price of milk to be delivered in the future.
    Forward contracting is simple. A forward contract is an agreement between a producer and a processor that sets a firm price for a specified volume over a specified period of time. Forward contracts are tailored to individual business needs. The entire transaction takes place between the producer and the processor just like it does today.
 Page 130       PREV PAGE       TOP OF DOC
    Forward contracts require no brokers and no commissions. Producers individually decide and processors individually decide whether or not to enter into these contracts.
    Processors or producers can begin the dialog. In fact, since we've begun extending offers to our producers, we've had producers come us with proposals and prices.
    Under a forward contract, processors, such as Kraft, and producers will know the price of milk months before delivery. Under the Federal order system today, we're in the dark as are farmers as to the price of milk until the month after delivery. This puts the entire dairy industry at a terrible disadvantage when trying to plan for the future.
    Risk management in the dairy industry is in its infancy, but there are no other initiatives that have generated so much discussion and excitement about the future. Already there are number of cooperatives and companies experimenting with risk management programs.
    Kraft has also begun to offer forward contracts in some parts of the country on a very limited basis. In Idaho, our plant is outside the Federal Milk Marketing Order Program, so we have been able to offer contracts there. We began in April of last year and we've had widespread acceptance. In the upper Midwest, where we are subject to Federal orders, we're only able to offer a very limited program. In the rest of the country, we are unable to offer forward contracts at all.
    In conclusion, we believe there is no better alternative than forward contract to lead us in the direction of the course laid by the 1996 farm bill. Only if forward contracts are available can the dairy industry enjoy the risk management benefits currently enjoyed by all other major agricultural sectors.
    Forward contracts pave the way of the future. It gradually modernizes our Federal order system while continuing to move us in the direction of increased reliance on market. Plant by plant, producer by producer, one contract at a time on a purely voluntarily basis.
 Page 131       PREV PAGE       TOP OF DOC
    Thank you, Mr. Chairman. I'd be happy to answer any questions.
    [The prepared statement of Ms. Glenn appears at the conclusion of the hearing.]
    Mr. POMBO. Thank you.
    Mr. Tillison, I know you've been involved with this particular farm bill since the drafting stages earlier on and have been involved with it all the way through. Can you share with the committee what some of the involvement of your organization and the other California organizations have been over the past year or two?
    Mr. TILLISON. Well, as I said, Mr. Chairman, we have participated in meetings across the country. For example, we were at the Farm Bureau meeting that the gentleman from the Michigan Farm Bureau referred to last week. Last spring when USDA was looking for initial proposals, and so forth, we submitted a quite lengthy proposal outlining something similar to the California system, and so forth, and have taken every opportunity given to us to participate in the basic process of establishing a pricing system because we believe that, as my statement says, if we can get the two systems closer together, whether or not California is part of that system will become irrelevant.
    Mr. POMBO. Once the Federal Marketing Order reforms are adopted, how long would it take for California to evaluate that and for the individual members to have an idea—individual producers to have an idea of whether or not they want to join that system?
    Mr. TILLISON. Well, the financial evaluation, as far as the pricing levels and that sort of thing, can happen relatively quickly. How quota will be dealt with, for example, is going to take some answers from USDA.
    For example, we met with Administrator Figueroa yesterday and asked what I thought was a fairly simple question and that is, well, right now California law says that only California producers can own quota. In the Federal order system, a producer in Arizona would be able to pool in a California Federal order and fully participate. Would quota have to be made available to that Arizona producer? That question was not answered.
 Page 132       PREV PAGE       TOP OF DOC
    There are other questions regarding how the pool will be divided considering there is a California system. And, frankly, we don't believe that these are questions that can be answered by us submitting a petition and hoping that they come back to us with the right answer.
    As I said, we've got a $700 million investment in our quota system and our producers use that to secure loans. We need some very clear answers before we would feel comfortable in moving forward on a Federal Milk Marketing Order.
    Mr. POMBO. The current California quota is valued at somewhere between $700 million and $1 billion, depending on the current market conditions. I believe your figure of $700 million is pretty accurate for right now.
    Mr. TILLISON. Right.
    Mr. POMBO. A year ago, we were looking at closer to $1 billion worth of value. Many of the producers have a considerable amount of their total asset tied up in the value of that quota. What would happen to the typical California dairy that has half or more of their total asset tied up in quota value if all of a sudden we wiped that out?
    Mr. TILLISON. Well, obviously, as I said, there are bank loans that are secured by the value of quota.
    Mr. POMBO. And what would the bank do if the quota was all of a sudden worth nothing?
    Mr. TILLISON. Well, I'm not a banker, but I think they would not look very favorably on that loan remaining outstanding.
    Mr. POMBO. As a result of that, this is something that is going to take a little bit of time for the individual dairyman to figure out whether or not we can afford to do it.
    Mr. TILLISON. Well, it's not just a case of the individual dairyman figuring out whether or not we can afford to do it; it's a question of figuring out how the system can be set up to accommodate all the issues that the quota system raises. As I said, ownership of quota within and without California, how the total money generated in the order is divided given that there is California quota, those sorts of questions.
 Page 133       PREV PAGE       TOP OF DOC
    Mr. POMBO. Ms. Glenn, you talked quite a bit in your oral testimony about the idea of doing forward contracting—having that ability to do that. What kind of a response have you received from producer groups, up to this point, in trying to go to that kind of a system or having that option available?
    Ms. GLENN. As I indicated, we began offering these in Idaho last April. So we've basically done four quarters now. The response has been very favorable.
    Naturally, with a program such as this, sometimes we'll be above the market and sometimes we'll be below the market. But the feedback we've had from producers is this is very much a win-win situation, kind of regardless of the market result. They've been able to plan and feel very comfortable about the program, and again, continue to participate in it.
    Mr. POMBO. Thank you.
    My time has expired. Mr. Peterson.
    Mr. PETERSON. Thank you, Mr. Chairman.
    Mr. Tipton, do you think that option 1A is pretty much the status quo?
    Mr. TIPTON. Yes, I think it is.
    Mr. PETERSON. And you don't think option 1B is much more than the status quo?
    Mr. TIPTON. Well, yes, option 1B is—that's about the only thing that I can find that is a bit market oriented in the proposed rule. Most of the other things are, I would say, are not very market oriented.
    However, I think that Mr. Doug Marshall, when he was testifying, kind of hit the nail the head, that one of the reasons that people are having a considerable amount of difficulty with 1B is that the price surface that results from that creates some very severe competitive problems in adjoining areas. There are some areas that the plants may be within 5 miles of each other, but there is a significant difference in the cost of the milk to them. So that creates some real problems.
 Page 134       PREV PAGE       TOP OF DOC
    One of the things that we are looking at, and I know it's been raised at this meeting several times, is there some other way of going about doing it? I don't know as we have to be limited to just the 1A proposition they set forth or the 1B proposition that has been set forth.
    So we've been looking at some possibilities of using the price surface which is set forth with the 1A proposal, but providing some kind of a mechanism to then adjust that over some period of time. We would probably even be willing to do it over a longer period of time than the 1B formula does it, so that it becomes less intrusive but it becomes so over a longer period of time. And at least it leaves the current intermarket competitive situation as it currently is.
    Mr. PETERSON. And lastly, this price floor idea, you agree that this has a potential of actually lowering prices for producers in certain areas depending on their mix of manufacturing and fluid milk?
    Mr. TIPTON. Yes, sir. It will clearly lower producer prices in the upper Midwest and in most of the West. There are some exceptions. It depends on the amount of class I that there is in the market. But it's clearly a proposition that provides enormous benefits for those markets with high class I utilization and detriment to those markets with low class I utilization.
    Mr. PETERSON. Thank you.
    Mr. Tillison, during your testimony there, I thought I heard you say that the 1996 farm bill wouldn't allow you to keep your quota. It was my understanding that the discussion was that, whatever we did, if California came in, you'd be able to keep your quota. Is there something that I missed or did I——
    Mr. TILLISON. Well, what I was referring to was the deadline that, I'll say inadvertently, got put in the 1996 farm bill that basically says that unless California—at least the way USDA interpreted it for us yesterday was—that unless California gets into a Federal order by no later than April of 1999 or, at the worst, by the time they issue a final rule, then our ability to maintain the quota system is gone.
 Page 135       PREV PAGE       TOP OF DOC
    Mr. PETERSON. OK. I wasn't aware that was in there either.
    Mr. TILLISON. We weren't either. We thought that it ran the length of the farm bill.
    Mr. PETERSON. Ms. Glenn, on the forward contracting, we had some discussions with the Department in a meeting we had earlier in the week and I still am not clear why some people apparently think that this is somehow or other is going to undermine the order system. It's unclear to me exactly what it is they're worried about. Do you understand what their concern is and can you explain that to me? Or do you think this is going to undermine the order system or fundamentally change the way producers are treated?
    Ms. GLENN. No, we do not think it undermines the Federal order system. In fact, we very much want to work within the Federal order system. I think we heard in the panel earlier today how important people felt the system was and wanted it to continue, whether we have 1A or 1B. So that has been our goal, to certainly work within the system.
    The basis of the Federal order system, at least to a large degree, is certainly the collection and distribution of class I differentials. We expect that to continue and don't see any affect on that at all from what we're proposing.
    And, frankly, we think it's rather ironic that the only way a producer now can participate in a forward contracting is to not be in the Federal order system, given that the Federal order system was designed to provide some stability, and now we seem to be having to choose between the two. So we very much want to work with the Department and appreciate the support of this subcommittee to try to ensure that we can do forward contracting within the Federal order system.
    Mr. PETERSON. Their position right now is that they won't, at least at this point, go along with it.
    Ms. GLENN. Well, today we heard something different. So I'm very interested to hear what their response to that is.
 Page 136       PREV PAGE       TOP OF DOC
    Mr. PETERSON. Well, yes, it's unclear exactly what it is——
    Ms. GLENN. Yes, it is unclear.
    Mr. PETERSON [continuing]. But, I'm still having a hard time figuring out what it is—what's the danger here.
    Ms. GLENN. We have just begun in the upper Midwest, Congressman. In Minnesota and Wisconsin, again, we're finding tremendous acceptance there but we have a very, very limited program. We have an offer out right now and producers are coming back to us in the upper Midwest, and saying we need this to be for a much larger percentage of our production or it's not worth doing for us. But again, they also need to be in the Federal order. So we really hope that we can make both work.
    Mr. PETERSON. Thank you. Thank Mr. Chairman.
    Mr. POMBO. Mr. Dooley.
    Mr. DOOLEY. Thank you, Mr. Chairman.
    Mr. Tipton, why do some of your members pay over-order premiums?
    Mr. TIPTON. There are probably a number of reasons, but it's usually to get milk delivered to their plant. There might be several reasons as to why its necessary to pay the premium to get it delivered to their plant. If I could, I would like to just explain one element.
    Under the Federal Milk Marketing Order System—this is going to sound silly, but—even if you had class I differentials of $1,000 and even if that was all pooled among all of the producers in the market, you would probably have to pay something more in order to get the milk moved to your plant because all of them share exactly the same. And so, if you are trying to compete with somebody else to get the milk delivered to your plant, you're probably going to pay a premium. That's kind of an exaggeration, but that's why premiums exists.
 Page 137       PREV PAGE       TOP OF DOC
    They sometimes are paid simply because there is a threatened shortage. Last year, when—in 1996, when feed costs soared, many of the companies paid premiums because they realized in order to keep the dairy farmers in production they needed to pay more money to cover the increased feed costs. Ultimately, the marketplace caught up with that and the cheese prices and butter prices increased to reflect it. But it's almost always related to being able to attract enough supply to your plant.
    Mr. DOOLEY. So there is nothing, though, in the order that requires, in this case, say a bottler, to pay an over-order premium to adjust the cost to make sure there's nothing that requires him to do that?
    Mr. TIPTON. No, that's an entirely voluntary matter and many of them do it most of the time.
    Mr. DOOLEY. So then, the last panel where I was exploring this a little bit, is then, why isn't that really a function of supply and demand, is that if you are a bottler, that you have to pay a little bit more to get something to your facility? I mean, that's what it's taking for you to capture that supply, is it not?
    Mr. TIPTON. Yes. I don't know the derivation of the $365 million number that was bandied around. I don't have any idea where that came from. But I think that wherever it came from, it would be a very unrealistic outcome because if you took that much money out of the system you would reduce the quantity of milk that's being produced. And if you reduce the quantity of milk that's being produced, the processors who need that milk would pay more. Because there certainly is not going to be a manufacturer of cheese or the fluid milk processor who wants to say, ''I'm not going to pay more money because I don't want to pay more money and I'm going to let my plant set idle.'' It just doesn't make any sense. It doesn't work that way.
    They do pay premiums. I think if the class I differentials were racheted-down over some period of time, there would be an increased amount of premiums being paid because I think that there are certain amounts of—but it would be at the discretion of what the market is like at that particular time and that particular place. But I think there would be an increase in premiums if that were to occur.
 Page 138       PREV PAGE       TOP OF DOC
    Mr. DOOLEY. In the concern I think that Mr. Marshall had about, if you go to the orders where you have a plant, as I think you might have said in your testimony, that might be separated by 5 miles, two plants, they could be in different orders with different differentials that might cause a problem I think you said. Why wouldn't you see that being adjusted through over-order premiums that would adjust for that disparity that is arbitrary based on who knows what?
    Mr. TIPTON. If you were the plant that had the high differential and if there was, say, sufficient amounts of milk available in that market that you could obtain it. The plant that had the low differential could obtain an adequate supply at that lower differential. In one case, I would have to pay it by regulation, and in the other case, I wouldn't have to, so I would have a competitive advantage. That's the problem that worries people.
    If there is a shortage, then the person who was paying the lower differential would probably pay a premium in order to procure the milk supply and then they'd be on a competitive basis. But it's the reverse of that that really scares people.
    Mr. DOOLEY. Ms. Glenn, when I read your testimony and heard your testimony, you would be able to sign as many forward contracts as you would like if you had producers that would be willing to opt out of the order, right? Why is that a problem? Why don't people just opt-out of the order?
    Ms. GLENN. Well, as we heard a little bit in the previous panel, producers want to participate in the Federal order system. It provides a structure, a classified pricing structure for them. There are competitive reasons why we like to participate in the order in the milk sheds where we do. And so given that both of us want to participate in the Federal order system, we'd like to see these programs work within that existing structure.
    Mr. DOOLEY. Well, I'm still a little bit struggling with this. The intention of forward contracting, which I think has a great deal of merit, is to provide greater certainty to both the processor and a producer. Why isn't it attractive enough that you can reach a strike price outside the order that gives a certainty that—I don't understand then what value, if this is a voluntary agreement that both parties would enter into, what value does the Federal order have?
 Page 139       PREV PAGE       TOP OF DOC
    Ms. GLENN. Well, it's much like Tip was talking about in the example with respect to two regions. If we enter into a forward contract with a producer within an order, then we will have to pay that blend price to secure that milk or something close to that blend price because we operate in very competitive milk sheds. We're going to have to pay that price. The competitive conditions are going to require that. But the benefits that we have participating in the pool will no longer be there for us, to deliver that kind of return to producers.
    Mr. DOOLEY. Yes, Mr. Tillison?
    Mr. TILLISON. Well, in the California system, we're currently working with Kraft evaluating this whole situation. Some of the analysis that we've done, plus it's been done by the Department of Agriculture, would indicate that within a pooling structure, especially like California's and what the Federal order is heading toward, it's kind of unlikely that you would have a lot of forward contracting on butter and powder milk. Most of it is going to be done on cheese.
    Our initial reaction is that if we're going to have forward contracting in California, it's got to be part of the order system. And the reason for that is that with pooling and with the fact that most of the pooling is going to be in cheese milk, which is the second highest or lowest value of milk there is, those producers who operate within the pool but choose not to forward contract can be impacted by producers who would pull out of the pool to forward contract. You would have less cheese milk, less higher-valued milk within the part to be shared by all producers.
    So our goal, and our effort, is to see if we can't develop a system that will operate within the order structure. And I think, as Ms. Glenn said, most producers like to be part of the marketing order system.
    Mr. DOOLEY. You stated that your limitation's in, I thought, the Midwest, where there's only 20 percent of an individual's production that can be——
 Page 140       PREV PAGE       TOP OF DOC
    Ms. GLENN. Correct. That's all that we have been able to do, so that we can still comply with the minimum order prices there that we are obligated to.
    Mr. DOOLEY. And I don't understand. Why is that?
    Ms. GLENN. Well, again, what we are obliged to do under the Federal order system is guarantee a minimum price to our producers. But because of the high premium structure that exists within the upper Midwest, we can contract for a small percentage of the milk and still meet our obligations to the order system. The minimum price within that kind of competitive market structure that you were talking about earlier is well below the market price. That gives us some more flexibility. In the Northeast, for example, where premiums are much smaller, we don't have that flexibility.
    Mr. POMBO. Well, I want to thank the panel very much for your testimony and for the answers to the questions. And again, I'll repeat that there will be further questions that will be submitted to you in writing. If you could answer those in writing for the committee in a timely manner, it would be appreciated.
    Thank you very much and that you for your patience. The hearing is adjourned.
    [Whereupon, at 4:18 p.m., the subcommittee adjourned subject to the call of the Chair.]
    [Material submitted for inclusion in the record follows:]