• ANALYSIS: Cheese market under federal investigation

    Tags: Cheese
ANALYSIS: Cheese market under federal investigation

Pizza operators have questioned for years the way cheese prices are settled at the Chicago Mercantile Exchange (CME), and now the federal government is doing the same.

According to the May 2006 issue of the Milkweed, a dairy industry watchdog publication, the Commodities Futures Trading Commission (CFTC) is actively investigating alleged irregularities in cash cheddar markets. Unnamed dairy industry sources told The Milkweed they had been questioned by the CFTC back in the spring.

But perhaps more compelling than the CFTC's investigation is six U.S. senators want the comptroller general of the General Accountability Office (GAO) to "conduct a study on the cash cheese market at the Chicago Mercantile Exchange and its role in federal milk pricing." A copy of the July 13 letter, obtained by PizzaMarketplace, is signed by Sen. Russell Feingold (D-Wis.), Sen. Arlen Specter (R-Pa.), Sen. Hillary Rodham Clinton (D-N.Y.), Sen. Charles Schumer (D-N.Y.), Sen. Herb Kohl (D-Wis.) and Sen. James Jeffers (I-Vt.)


What's Important

Pizza operators have grumbled for years that the price for cheese sold on the CME was suspect. U.S. senators are asking the same question.

The National Cheese Exchange, which was disbanded in 1997, operated under a cloud of price manipulation concerns.

Analysts believe large dairy producers such as Kraft Foods and Dairy Farmers of America have, in the past, worked to manipulate prices in their favor.

me presumptive, but such an assembly of heavy hitters poking around the li'l ol' dairy business surely hints at something serious. Anyone who's watched the news lately knows this sextet has bigger fish to fry both at home and abroad, so it makes one wonder why the CME issue is on their radars. Apparently it's very important, especially since all six represent big dairy states.

Their letter reads, "There has been concern in the past that this 'thin' market for cheese is susceptible to price manipulation because the price of essentially all cheese is linked to the sale of less than 1 percent of the cheese that is actually delivered in the cash market."

Translation: "We're worried this 'thin' market can be exploited at the expense of our constituents, and we want to know, CME, if you know anything about it."

We've all heard experts say the cheese market roller coaster ride is hilly and harrowing because of shifts in supply and demand, and there's a lot of truth to that. But as a study published in 1996 showed, throughout the 1980s and '90s, big cheese buyers and sellers have successfully steered the market in directions that profited them alone. What's become clearer in the last few years is supply and demand aren't the only entities getting a turn at the tiller.

No one's talking ... yet

Since this is a sticky issue, I'm not surprised no one in the dairy industry wants to talk. One anonymous source's comment was simple but telling: "It's serious business. ... The do-do just might hit the fan."

Even calls to the senators' offices weren't returned. (Well, OK, I can understand that oversight. I can hear them now: "Who did you say called? He's from Pizza what?") Even when times are good, cheese makers say nothing, so their reticence isn't shocking.

So let's turn to what we do know.

The aforementioned 1996 study is called "Cheese Pricing: A Study of the National Cheese Exchange," and was published by the Wisconsin Department of Agriculture. You'll notice it studied the National Cheese Exchange, not the CME, where cheese trading moved in 1997 after years of — you guessed it — suspected price manipulation at the NCE in Green Bay, Wis. The NCE's problems basically boiled down to the issue of "trading against interest." The term describes a situation in which a cash market trader buys and sells, when typically he is one or the other. The study showed how the biggest cheese buyer-seller, Kraft Foods, used its market-dominant position to buy and sell in ways that influenced market prices favorably. When, for its own profit, it needed to depress prices, it flooded the exchange with product. When it helped to keep prices high, Kraft scooped up lots of product and tightened supplies.

The result in either case was some group other than Kraft took a beating. When cheese prices were high, farmers made money, but consumers paid more at the grocery. When cheese prices were low, dairy farmers took the hit and consumers rejoiced.

The study pointed out what many market watchers have believed all along: Such a thin market is easily manipulated by powerful influences that can inflate or depress prices simply by moving product onto or off the selling floor. Such activity violates the intent of a cash market, which exists to deliver product to shorthanded buyers from sellers with excess inventory.

The battleground shifts

In October of 1997, cheese trading shifted to the CME in hopes price manipulation would end. But according to an April 2005 report by John Bunting, titled, "Cheese Trading on the Chicago Mercantile Exchange & the Public Interest," new problems arose with the move from Green Bay to Chicago. New traders against interest arose, chief among them, Dairy Farmers of America (DFA), the nation's largest dairy cooperative.

From late 2001 through early 2003, cheese prices hovered near or below

start quoteThe Chicago Mercantile Exchange is the tide that moves all boats up or down. As that market moves — since that market is the basis on which all people sell cheese — if you can have a positive influence on that market, you can have a positive influence on price.end quote

— Gary Hanman, Former CEO
Dairy Farmers of America
government support levels. But as the nation emerged from the post-Sept. 11 recession and the economy began humming again, demand increased and cheese prices responded. By July of 2003, block cheese rose to an unusual high of $1.60 per pound and held there almost to the end of October. According to Bunting's report, "Coincidental with this strangeness was the need of DFA to establish a credit level necessary to sell some bonds. When that was accomplished, and the bonds were sold, the price crashed."

Interesting, huh?

By the spring of 2004, cheddar blocks were selling at an all-time high $2.20 per pound. Even during the commonly lower-price months of April and May, according to Bunting, "DFA held the price for an extended period at $1.80 per pound" through most of June. But by June 28, a full-blown market crash was underway as block prices fell sharply to $1.45. By Oct. 8 the price was a below-average $1.37.

The market softness was short-lived, however, as blocks soared to $1.79 by Nov. 16. and to $1.95 by Dec. 2. The volatility, dairy watchers said back then, was highly suspect, and attention turned to DFA chief executive Gary Hanman as the man behind the movement.

A Dec. 30, 2004, article in the Chicago Tribune quoted Hanman telling DFA members at an October meeting in Syracuse, N.Y., "The Chicago Mercantile Exchange is the tide that moves all boats up or down. As that market moves — since that market is the basis on which all people sell cheese — if you can have a positive influence on that market, you can have a positive influence on price."

Bunting's report quoted Hanman saying DFA was the main buyer in that bullish June of 2004, when the price held at $1.80. "DFA bought 52 loads of cheese on that market (on June 7), a record number of transactions. After we had bought the cheese that we needed for our market, for our customers, for our demand, we backed out."

The CME gave no in-depth answers to Tribune questions about its activities other than to say it "believes strongly in the integrity of all its markets, including the spot dairy market."

The problem now, however, is six U.S. senators question its integrity, and as their letter states, they want the CME to pull back the curtain on its secretive operation. Among the senators' questions: "How is the CME cheese market structured and operated? How does it facilitate price discovery, fairness, and integrity and deter manipulation and other abuses? ... What are the risks of price manipulation of cheese markets such as those found in the 1996 report? If so, is there any evidence of buyers and sellers acting in the reverse of that expected in bona fide transactions as described in this report?"

And here's the biggie I sincerely hope they find the answer to: "Are there any changes to CME or federal oversight authority or enforcement that would improve the cheese market's price discovery function, fairness and integrity?"

Let's hope for everyone — dairy farmers and consumers alike — this investigation will, once and for all, put the cheese market roller coaster permanently in the station.

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