Uncapping dairy competitiveness.pdf - Food and Drink Industry Ireland

Un-CAP-ing dairy competitiveness
Optimism returns to the dairy industry
1. The current quota year has been one of strong dairy markets, product scarcity and
increasing farm gate prices. Reductions in global supply due to drought, reduction of
global stocks and redirected investment to the development of a bio-fuel sector has
culminated with an inability to meet the growing global demand for dairy products.
The slow lead-time necessary for the dairy industry to react to markets through
increased herd size is leading many to believe that the current market strength will
not be a short-term factor.
2. The EU’s stated policy not to renew the milk quota regime after 2015 has created an
opportunity for Europe’s young farmers to enter dairy farming without the cost of
purchasing milk quotas. For the first time since the introduction of milk quotas in
1984, consideration is being given to green field development of dairy farming.
3. Irish dairy exports continue to grow in value with sales for 2006 exceeding €2 bn.
Given that milk output is limited by milk quota, the higher value exports reflect a
switch to higher value added dairy products and strengthening world prices. The
established linkages with secondary processors such as the Infant Nutrition sector has
assisted Ireland’s entry to new markets and its association with the manufacture of
high quality dairy ingredients.
4. Ireland’s dairy processors are currently investing in excess of €300 m in a state
assisted investment programme in new processing technologies. This initiative is
aimed at enabling companies switch from traditional CAP assisted product mixes
towards higher value more complex dairy products.
Reforming the CAP
5. The CAP reforms of 2003 were initiated with a view to making European agriculture
more market orientated and less influenced by support mechanisms. The reforms
were also aimed at the achievement of a WTO trade deal that would primarily assist
developing and less developed countries. The main change for Europe’s producers is a
switch to decoupled farm payments (single farm payment), which issues payments
based on historic production levels and enables producers to switch to the production
of products demanded by the markets.
6. The single farm payment received strong support from farming lobbies as it presented
a “freedom to farm”. In theory it enables producers to switch to more profitable or
suitable agricultural enterprises without compromising the level of subsidy payments
from Europe. However the contribution of this payment to farm income is not
recognised when evaluating market returns for farm output and is leading to calls for
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stronger prices for farm output, irrespective of what the marketplace can deliver. The
current strength of dairy markets has meant that this debate remains largely within
the beef and lamb sectors to date. The annual reduction of this payment through
modulation and its lack of indexation will reduce the value of this payment in time.
7. The EU offer to phase out export refunds by 2013 was a monumental step in a
process towards freer international trade and a clear signal that the EU is prepared to
do its part in supporting the developmental aspect of the current WTO trade
negotiations. But irrespective of the WTO process, it has become increasingly difficult
for Europe to justify continued subsidisation of exports as consumer food prices
increased and reform of the refund system was always on the cards. However the
EU’s WTO offer has not been matched by others and while a deal has not been
achieved, Europe continues to work towards the complete abolition of export refunds
by 2013. Future exports will therefore be possible only when the internal price is
equal to the world price less tariffs.
8. The intervention system has been a strong component of market management by
Europe for the past number of years. Ireland used this system heavily to partially
offset the costs of its seasonal milk production and it has served the market in
absorbing excess production and easing supply shortages. But this mechanism is
being removed as part of the CAP reforms and market forces will now be felt at
producer level as little remains to cushion market fluctuation. The loss of intervention
will introduce a seasonality cost to Irish production systems and lead to increased
price volatility requiring a review of working capital required at farm level.
9. The most significant reform of the CAP for the dairy industry is the decision by the
Commission to phase out milk quotas by 2015. The lifting of production restrictions
has received a broad welcome as it will remove quota rental and purchasing costs and
potentially enhances Europe’s relative global competitiveness. However with increases
in European production come the concerns of oversupply leading to weakened
commodity prices. This concern is not unjustified given the removing of market
management measures to insulate against market depressions. The cyclical nature of
international dairy markets will mean times of weakened prices and without subsidies
and market intervention, many producers will not have adequate financing to weather
prolonged periods of market weakness. The management of quota abolition is
therefore crucial for the evolution of Europe’s dairy farmers to an unmanaged
marketplace.
CAP reform amidst WTO negotiations
10. For Ireland’s export oriented dairy industry, a successful WTO deal is important to
develop international trade. Tariff levels act to prevent profitable access to many
international markets and create an additional administrative burden on exporters.
Ireland has many offensive interests and could benefit from a reduction in global
trade tariffs which could act to offset the effect of the removal of export refunds.
11. Non-tariff barriers act in a similar manner, with countries having differing
interpretations of international sanitary and phytosanitary (SPS) requirements. SPS
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considerations also reflect domestically emotive policies such as hormone usage and
genetically modified foodstuffs. A properly constructed international trade deal can
act to work around such issues and enable a freer movement of goods. Ireland’s dairy
industry would be a key beneficiary of such a deal.
12. The WTO Draft Modalities Paper, issued by Crawford Falconer, Chairman of the
Committee on Agriculture in July 2007, does not however propose a structure that
would facilitate this balance. The proposed tariff cuts will imbalance world markets by
trying to achieve too much too soon. A longer lead in time is required to achieve tariff
reductions of this magnitude without risk of destabilising dairy farmers around the
globe. This extension in timelines is entirely justified as the main dairying areas of the
EU and the US will need to implement internal reforms to enable their industry to
operate to a new era of reduced tariffs and increased trade flows.
13. The WTO process offers some mechanisms designed to assist product groups that
could be severely undermined by an unbalanced trade deal. The sensitive products
mechanism was designed to reduce the tariff reductions for such products at the cost
of allowing a predetermined quantity of imports at a reduced tariff rate (Applying a
tariff rate quota (TRQ)). However the TRQ methodology as currently proposed
renders this tool redundant as the proposed TRQ for seeking sensitive product status
is excessive. For potential sensitive dairy products such as butter and cheese,
increased market access TRQ’s of 100% and 400% respectively are offered. This
degree of market access will destabilise the internal market to such a degree that
Europe cannot consider sensitive product status for dairy products.
14. The special safeguard mechanism can be used to insulate exposed products for a
limited period of time. This system merits evaluation but must be implemented in a
manner that ensures coverage for the duration of a market slump. This requires a
balanced approach in nominating a product as “special” but even still it could be a
contentious issue for many. This therefore may not be a sustainable position and
product groups may lose in the long term.
15. Given that there are effectively no stabilising measures that can act to assist the
market if required, the current tariff reductions are excessive and if left unchanged
will act to destabilise global dairy markets. The WTO process must review its
timelines to reflect the dynamics of the dairy sector to ensure that the overall goal of
trade liberalisation is not lost.
Quota policy in the CAP Health Check
16. The CAP Health Check will serve as the mechanism by which the EU Commission will
assess the efficacy of the CAP reforms to date. It will also set out how the
Commission proposes to abolish milk quotas. IDIA has made the case for policy
certainty in its publication “Business Perspectives on Future Dairy Policy” 1 . The
principle of stating in the Health Check the mechanism of quota reform was welcomed
by industry and the Commission has since adopted this principle.
1
Business Perspectives on Future Dairy Policy was published in January 2007
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17. The IDIA strategy for seeking an annual increase in milk quotas as the mechanism to
phase out milk quotas is in line with the Commission’s viewpoint. An annual increase
of 2% in milk quotas until the quota year 2014 is widely seen as being the
appropriate figure, however with the increasing influence of external factors on global
dairy prices; this may mean that a predetermined additional quota increase may not
always be the appropriate allocation.
18. Some advocate a flexible approach in allocating additional quota, proposing that the
allocation amount could be decided in the preceding autumn based on market
strength. It is unclear if this proposal would result in a more accurate allocation of
additional milk quota but it would mean that quota management would become a tool
in attaining market stability. However using quota allocation in market management
would make it more difficult to remove the quota system in 2015 and introduce an
additional degree of uncertainty and speculation into the marketplace.
19. A decision to increase milk quotas as a means to quota abolition is acceptable in the
current strong market environment and it is forecasted that available quotas will be
reached at current prices. Therefore, while the market remains strong, European
production should be expected to increase to new quota levels resulting in a potential
increase in European dairy output by 2% per annum. However this production
increase could be exceeded where production costs are such that profitable
production is possible even with the application of a super-levy fine.
20. An increase in European milk production reflecting strong dairy returns is likely to be
matched by increases in other producing countries where environmental limitations
do not exist. Production increases are predicted in USA, India, Russia, Brazil and New
Zealand. Therefore, it is unlikely that the current supply shortages will be long lived
and expectations are that equilibrium will return to the marketplace , but with a
greater degree of price volatility given the lack of market mechanisms.
Making competitiveness the primary objective
21. The relative competitiveness of Ireland’s dairy industry will determine its ability to
compete in international markets in the absence of CAP market management
mechanisms. Price volatility will present the greatest challenge to the dairy sector
where government intervention in markets is prevented due to WTO commitments.
22. The key questions for consideration are the suitability of food production to
unmanaged market liberalisation. How can Europe continue to deliver its objective of
securing supplies of high quality affordable food for its citizens without some
intervention in the marketplace? Is there a policy conflict in seeking cheap food, for
twelve months of the year, with open access to European markets for all, while
retaining rural sustainability?
23. Ireland’s low cost production system has presented a relative competitive advantage
within the CAP managed agricultural environment. However, the relative
competitiveness of this system must now be re-evaluated within the context of an
open, unassisted marketplace.
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24. Ireland has traditionally put forward its grass based, low cost production system as
its relative advantage. However, as Irelands product mix evolves to the production of
more complex dairy consumer foods and ingredients, the relative competitiveness of
seasonal production diminishes. The seasonal production of basic commodities
benefited from CAP assisted storage schemes; these costs will now have to be carried
by the Irish industry. The production of more complex dairy consumer foods requires
year round supply guarantees, which present a policy conflict with the promotion of
low cost seasonal production systems.
25. Production increases arising from quota abolition will require a re-evaluation of
current processing capacity. Ireland’s seasonal dairy production means that
significant unused processing capacity exists in Ireland for ten months of the year.
This represents a processing inefficiency when compared to dairy industries
processing for 12 months of the year. Seasonal production represents lower asset
utilisation and higher running and regulatory costs, all of which relate to the
maximum throughput of plants; for Ireland all such costs are based on a six-week
production peak that falls dramatically for the remainder of the processing year.
26. There is need for financial evaluation of the most sustainable competitive means to
increase Irish dairy output. Increased asset utilisation will mean higher production
costs and a move away from our perceived low cost production system. Investment in
additional processing capacity to handle peak production will result in additional
capital, operating and regulatory costs which will reduce relative processing
competitiveness.
Conclusion
A. Future dairy policy is being discussed while markets are at their most optimistic stage
B. The Commissions intention to abolish milk quotas by 2015 represents an opportunity
for development of Irelands dairy industry
C. EU policy is to remove all market intervention irrespective of a WTO outcome
D. Dairy prices will be volatile in the absence of any mechanism to absorb troughs or
ease peaks
E. Price volatility will require revised financing structures throughout the industry
F. As an exporting industry, a balanced WTO deal would favour the dairy sector
G. However WTO negotiators will destabilise markets by attempting too much too soon
without retaining any real mechanisms for exposed product groups
H. EU cannot agree to the current proposals in the proposed timetable
I. The CAP Health Check must deliver policy certainty through a detailed roadmap for
quota reform
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J. An annual increase in national milk quota must be set out in the Health Check
K. Ireland will not export unless it retains relative competitiveness
L. Our low cost production system must be re-evaluated in the absence of CAP funding
and increased production of high value consumer foods and ingredients
M. Does relative competitiveness exist through increased utilisation of existing assets or
through development of new capacity with low annual throughput?
N. Quota abolition can be positive for Irish dairying where policy certainty exists and
relative competitiveness of the entire dairy industry becomes its single focus
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