Did we really need the Milk Package?

On 25 September last, the Commission organised a dairy conference in Brussels with 400 stakeholders to discuss the evolution of the EU dairy sector after the end of dairy quotas at the end of March 2015. In his opening speech, Commissioner Ciolos noted that the conference was taking place in a favourable context in terms of the milk market but raised the question whether the market management toolbox now available under the CAP post-2013 proposals is sufficient to enable the sector to adequately anticipate and react to crises in the future.

Commissioner Ciolos referred back to the 2009 milk crisis which led to the establishment of the High Level Expert Group on Milk and ultimately to the introduction of the Milk Package in 2012. This has been incorporated into the revised single Common Market Organisation regulation now waiting for approval by Council and Parliament.

What the 2012 ‘Milk Package’ does

The Milk Package contained two mandatory elements and three optional elements for member states. Member states are required to recognise dairy producer organisations (POs) meeting minimum criteria that can jointly negotiate contract terms, including price, for the delivery of raw milk to first purchasers as long as they do not exceed more than 3.5% of EU production or 33% of national production by volume. And there will be mandatory monthly reporting by first purchasers of the volume of raw milk that they collect.

In addition, member states optionally can make it compulsory for dairy processors to have written contracts with (and/or provide written offers to) dairy producers covering certain key elements, including a price or price formula, the delivery volume, the duration of the contract, and the timing of collections; can permit the establishment of interbranch organisations bringing together operators from along the supply chain to improve transparency and promote best practice; and can set down binding rules to regulate the supply of cheeses with protected designations of origin (PDO) and protected geographical indications (PGI) if this is requested by the dairy producers themselves.

The Milk Package entered into force in October 2012 and its implementation is underway. 11 member states have introduced mandatory contracts while a further four are planning to do. Countries may decide not to implement the voluntary contractual provisions either because there may be non-legislative solutions in place (e.g. an industry code of practice) or because the bulk of milk is supplied to cooperatives where similar provisions are already in place.

POs can negotiate contracts for milk delivery

POs provide dairy farmers with the opportunity to improve their bargaining power within the supply chain. Groups of producers have more power in a bargaining situation with processors than individual producers because, as the size of the volume supplied increases, it becomes more difficult for the processor to source from alternative suppliers. Due to their improved bargaining position, members of POs may be able to secure improved contracts and contractual conditions and perhaps improve the price received by members.

Giving POs the right to negotiate contracts and prices directly with processors was a controversial part of the Milk Package as it partly relaxed competition law in favour of dairy farmers. The particular approach adopted in the Milk Package was opposed by European competition authorities who warned against any proposal that would enable dairy farms to jointly fix milk prices without appropriate limits established by reference to the relevant markets, and without requiring any corresponding efficiency-enhancing forms of cooperation between agricultural holdings. Their concern was not to prevent farmers strengthening their bargaining power but that the absence of any requirement for efficiency-enhancing structural reorganisation to accompany this would lead to higher consumer prices.

Linkage between EU and world market dairy prices

Recent developments on milk markets shed new light on this debate. Two graphs are of interest. The first one tracks the evolution of EU producer milk prices relative to world market prices from January 2000 to July 2013. We can divide the graph into three periods.

Source: DG Agri, Milk Market Situation 19 September 2013

During the first period, from January 2000 to May 2006, world and EU prices were on a downward trend. EU prices were slightly above world market prices but with a lot of seasonal volatility. Between May 2006 and May 2009 there was a period of intense volatility on both world and EU markets; however, the response of EU producer prices was dampened relative to world market prices in both the upward and downward directions. Since May 2009, world and EU prices have trended upwards but again with significant volatility towards the end of the period. Again, EU producers did not fall by as much as world market prices in May 2012 and have risen more slowly than world market prices since the beginning of this year.

There is thus evidence of imperfect price transmission, or ‘stickiness’, in the transmission of world market prices to EU producer prices. This may be due to fixed contract prices in processor sales of dairy products to food manufacturers and retail chains or to risk-sharing contracts between processors and producers whereby the producer price paid may be only partly linked to world market price developments (as in UK supermarket contracts described here).

Trends in producers’ share of the milk price

The evolution of internal EU prices along the dairy supply chain during this period is shown in the second figure. This shows the evolution of the farmgate raw milk (producer) price, dairy commodity (processor) prices and consumer prices for milk, cheese and eggs over the same 2000 to 2013 period. Again we can identify the same three periods as before.

Source: Commodity Price Dashboard No. 15, August 2013

During the first period, from January 2000 to around May 2006. EU producer prices closely followed processor prices but lagged behind consumer prices. Put in other words, during this period the producers’ share of the final price of milk was falling. In itself, this tells us nothing about the profitability of milk production or of the retail chains because the former depends on the evolution of dairy farm gross margins, i.e. the difference between producer price and input cost developments taking productivity improvements into account, and the latter depends on how the costs of the associated services in selling milk (primarily labour, energy and rents) evolve relative to the price of dairy commodities and the consumer price.

Declining producer prices during this period was expected given that this was the period of the Agenda 2000 and Fischler 2003 CAP reforms which lowered support prices for dairy commodities. Producers were compensated by increased direct payments. However, this fall in producer and processor prices was not reflected in consumer prices. The producers’ share of the final milk price was falling even though producers were strongly criticising supermarkets for using fresh milk as a loss leader, which would normally have the effect of squeezing supermarket margins.

The second period of intense price volatility between May 2006 and May 2006 shows up clearly on the diagram. Producer prices did not rise by as much as processor prices on the upswing, but did not fall as much as processor prices on the downswing, possibly reflecting the existence of risk-sharing contracts as mentioned above.

But critically important to the way dairy policy has evolved is the comparison of the evolution of producer and processor prices, on the one hand, and consumer prices, on the other. During the price upswing, consumer prices for milk products increased in line with the increase in prices of processed dairy products, but during the downswing in late 2008 and early 2009 consumer prices barely responded to the sharp fall in dairy product and producer prices at that time.

Against that background, the Commission set up the High Level Expert Group to study, inter alia, price transmission along the dairy supply chain amid allegations that the final purchasers (supermarkets) were able to make super-normal profits due to their market power. The data to the end of 2009 available to the High Level Group which reported in 2010 seemed to support this allegation.

However, with the benefit of a longer view and taking into account developments in the third period in the chart, from May 2009 to July 2013, arguably the recommendation of the HLG that it was desirable to relax competition law was an over-reaction which failed to take into account the ‘stickiness’ of price evolution in the dairy supply chain. Since May 2009 producer and processor prices have increased at a faster rate than consumer prices (although with considerable volatility).

By mid-2013, the producers’ share of the milk price was restored to where it was just prior to the outbreak of price volatility in May 2009. Processor shares seem to have recovered even more sharply. And this has occurred before producer organisations were given the power to negotiate contracts with processors.

The Milk Package may also have focused on the wrong problem. It addresses price bargaining between producers and processors, even though the graph shows a broad co-movement between producer and processor prices. The diverging trends which stand out in the figure are the long term decline in producer and processor shares of the milk price in the first half of the period, and the gradual increase in their shares in the second half of the period. More research is needed on what has driven this turnaround in the evolution of the producers’ and processor’ shares of the final milk price.

Again, it is very important to underline that there is nothing magical about maintaining a constant producer share of the milk price. A rising (or declining) share can be consistent with either a rise or fall in producers’ profitability depending on how producer prices evolve with respect to input costs and productivity improvements.

Market observatory

Various initiatives are now underway to improve market transparency. DG Enterprise and Industry (which is responsible for supervising the operation of markets between processors and retailers) launched a European Food Prices Monitoring Tool in collaboration with Eurostat following the publication of their report on A Better Functioning Food Supply Chain in Europe. This is designed to increase transparency along the food supply chain, encourage competition and improve resilience to price volatility.

At the dairy conference last week Commissioner Dacian Ciolos announced that the Commission will strengthen its capacity to monitor the dairy market following the end of dairy quotas. It plans to set up an internal observatory in charge of analysing the evolution of the market in the short, middle and long term. The Observatory will work in close collaboration with member states and operators, who have access to first-hand market information.

The idea is that this observatory will provide an early warning of the risks of imbalances on markets, taking into account the diversity of dairy products, and on the other hand carry out prospective analysis in the context of price volatility.

An early task for the observatory could be to throw light on the reasons for the diverging trends in the shares of producers, processors and retailers in the final milk price over the past 13 years.

Picture credit: Stephanie Booth, Flickr

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