Hold your nerve, Commissioner!

An extraordinary meeting of the Agriculture Council will be held tomorrow Monday 7 September to discuss the difficult situation on agricultural markets. The Luxembourg Presidency has floated a number of ideas for discussion to address problems in the dairy, pork and fruit and vegetable markets, and the Commissioner is expected to table a package of measures.

Farmers will be out in force in Brussels to make their case for further assistance to the sector. In this post, I look at the options being discussed to address the dairy situation in particular. In a separate post, I examine the background to the milk market situation to explain why farmers will be protesting in Brussels tomorrow.

The Presidency proposals of particular relevance to dairy farmers include:

• Returning “at least part of the funds collected by way of the 2014/15 milk super levy to the sector to ease its situation”.
• Enhancing promotion measures
• Extending safety net measures such as private storage aids
• Temporarily increasing the intervention price for dairy products.

In addition, some farm groups still yearn after supply controls as a means of raising prices by limiting supply.

Why supply controls are not a good idea

Some, such as the European Milk Board, have blamed the crisis on the ending of the milk quota regime. The ending of quotas will encourage a restructuring of EU milk production, but there is no reason to believe that it has contributed to the drop in milk prices to date; the timing does not support this.

The contraction in milk margins began in January 2014 when the quota system was still in place. Milk production responded strongly in the EU under the quota system to the high prices at the end of 2013 (an increase of 4.5% in deliveries). Milk production has increased in the first six months of this year, which includes three months post-quota abolition, by a further 0.8% compared to the same period last year, and the Commission’s estimate for the full year is for an increase of around 1%.

While this is ahead of the increase in EU consumption (estimated at 0.3% in 2015), such an imbalance would not force a fall of 20% in the EU milk price. It is the cyclical situation on world markets (exacerbated for some countries by the impact of the Russian ban) which is responsible for the fall in the EU producer price, and the continuation of quotas would not have prevented this.

However, in a situation where the market is over-supplied, a reduction in EU milk deliveries would help to limit the fall in producer prices. Despite the fact that many dairy farmers are losing money by producing milk, EU milk production continues to increase. This can be evidence that there are sufficient low-cost producers who can produce milk profitably and who are expanding production free of quotas to more than compensate for those who are cutting back.

Member states are themselves partly to blame. Nineteen member states have introduced coupled support for milk producers, worth around €820 million (according to the Irish Examiner, €74 per cow in France and €300 per cow in Hungary). One estimate is that every second dairy cow in the Union now receives coupled support. So instead of allowing a market correction to take place, member states are wilfully preventing this and paying farmers to maintain production, thus contributing to the price collapse.

The European Milk Board has proposed a Market Responsibility Programme to address periods of market disruption. In crisis periods, it envisages a bonus payment to producers who reduce production financed by producers who increase production. This proposal was supported by the European Parliament in the negotiations on the 2013 CAP reform. It is similar to the Milk Diversion Programme operated in the US in the 1980s which compensated farmers who contracted their output. That was accompanied by a Dairy Termination Program which paid farmers to slaughter their cows and exit the industry on condition that they could have no interest in milk production for a five-year period.

A problem with supply management schemes is that they are expensive for the expected return in terms of higher prices, at least in open economies. To the extent that lower production in the EU translates into higher prices, farmers in other countries find it more profitable to ramp up production which offsets some of the positive effect for EU producers (see Keane and O’Connor’s analysis of the COMAGRI proposal during the 2013 CAP negotiations).

Interestingly, the EMB supports an uncompensated obligatory reduction in supply by all producers in the case of extreme crisis which, in the case of an open economy, would make all dairy producers worse off (prices would be unlikely to rise sufficiently to offset the volume reduction so producer revenue would fall).

Raising intervention prices

Supply management is not on the Presidency agenda for next Monday. One of the proposals that has made it on to the Presidency’s list is a temporary increase in the intervention price for dairy products. This proposal has been supported by a number of Ministers prior to Monday’s Council meeting. It has been strongly pushed by farm groups (as in this paper from the Irish Farmers’ Association), by a number of think tanks, and also by the dairy processing industry.

It is argued that it is possible both to increase somewhat the intervention price while still retaining its role as a safety net mechanism, given the gap that that now exists between the ‘normal’ level of milk prices and the current safety net milk equivalent price. Farm Europe, for example, have proposed an increase from 21.7c/litre to 25c/litre, as has the IFA paper. Note that intervention prices are set for butter and skimmed milk powder (SMP); the intervention price or safety-net price for milk is a shorthand way of describing the milk equivalent price derived from the intervention prices for these two products.

Commissioner Hogan has expressed his opposition to an increase in intervention prices (for example, in the French newspaper La Tribune on 11 August and at a press conference on 26 August). He warned that raising intervention prices could quickly result in milk lakes and butter mountains but with no significant effect on the price of milk, while at the same time it would make exports less competitive in global markets.

Increasing the intervention price would make intervention more attractive. Even at the current price, some 8,859t of SMP have been sold into intervention in recent weeks – in Belgium, Germany, Lithuania, Poland and the UK. An intervention price equivalent of 25c/litre is close to current market prices so one could expect sizable purchases to take place, particularly of SMP. Just how much would have to be bought to support this floor price and whether there are sufficient funds in the EU budget to make these purchases cannot be known with certainty; this will in part depend on the evolution of world market prices for dairy products over the next twelve months.

The legislative procedure to raise the intervention price is also cumbersome. The Single CMO Regulation specifies that ‘reference thresholds’ (intervention prices) should be updated according to the ordinary legislative procedure. According to Commission sources in a story in the Irish Farmers Journal, raising the intervention price for dairy products would take 18 months. It means re-opening the basic act through the co-decision process with the European Parliament, and would require public consultation and an impact assessment, meaning that any move to change the intervention price would not come to fruition before early 2017. If this is indeed the case, it is hardly an attractive instrument if the objective is a ‘temporary’ increase in intervention prices. By 2017 world market prices will be recovering and the crisis will have passed.

It should also be remembered that the fixed intervention price for dairy products only applies to the first 109,000t of SMP and 50,000t of butter bought into intervention. Once these volumes are exhausted, intervention continues with a tendering system. So the Council and Parliament could go through a time-consuming process to raise intervention prices, which might not hold in practice if intervention volumes exceed these thresholds.

Using the superlevy fine money to fund the dairy measures

Concern about the funding of any crisis measures that might be agreed on Monday has focused attention on another issue on the Presidency’s agenda, namely, the return of the 2014/15 superlevy fines to the sector (for which €440 million was entered into the 2016 draft budget presented by the Commission in June, though other estimates put the figure as high as €850 million). This proposal is made to avoid the need to make use of the crisis reserve (which is funded from farmers’ direct payments and thus not an attractive solution from the farm organisations’ point of view).

The superlevy fines in 2014/15 reached a record level. Those dairy farmers liable for a fine have already been allowed to pay their fine in three annual instalments in 2015, 2016 and 2017. However, the member states affected have to pay the full amount to the Commission in 2015 which enters as revenue in the 2016 budget. In other words, they borrow to provide their dairy farmers with an interest-free loan for the deferred two-thirds of the outstanding fines. In addition to this state aid (in the form of interest foregone), the proposal would take (at least part) of the money to be paid by the member states to the EU budget to redistribute it to affected farmers.

But this is an unlikely scenario. The superlevy fines paid by the member states are entered into the Guarantee Fund (EAGF) budget as ‘assigned revenue’. As a result, the appropriations requested for the EAGF in the EU budget are reduced below expenditure needs by this amount. If the superlevy funds were ‘reassigned’ to fund the dairy market crisis measures, the missing revenue would have to be made up by means of a supplementary budget later in the year. Because this brings the powerful finance ministers in the ECOFIN Council into the picture, it is far from clear that such a proposal would be approved.

Keeping the superlevy fines as ‘assigned revenue’ also means that the scope for market management measures is correspondingly greater because there is now a greater gap between the appropriations requested for the EAGF in the budget and the EAGF ceiling set in the MFF. If the superlevy fines were reassigned, budget appropriations in 2016 would be higher and the margin for market management expenditure would be correspondingly lower.

Private storage aids and promotion

The Commission has already moved to extend the period for private storage aid (PSA) for both SMP and butter, and has also agreed to extend the period of public intervention for the same products. Both measures which had been due to close in September 2015 will now continue until September 2016. To date, 138,510t of butter and 43,637t of SMP have benefited from the PSA scheme which was introduced in September 2014 in the wake of the Russian ban on imports of certain EU products, including all dairy products.

What the Commission could propose here is to re-open PSA for cheese. Also, the new arrangements to increase promotional activities for agri-food products agreed last year will enter into force on 1 December. This envisages an increase in EU spending on promotion from €60 million to €200 million a year over three years. The Commission could propose to accelerate the increase in funding for promotional programmes under this heading.

Increased national payments

A final option is that governments provide national supports to their dairy farmers, as a number already have. Farm Europe reports that several hundred million euros in emergency aid was announced during the summer by EU member states, in particular Belgium, Spain, Italy, France, and Estonia. Spain, for example, has introduced a direct payment grant of €300/cow for farms that are selling milk below profitability.

Normally, when a member state wants to make national payments to its farmers, this constitutes state aid and permission must first be sought from the Commission. However, where the amount given to a beneficiary does not exceed a pre-defined maximum amount and meets other conditions in the applicable Commission regulation, it is considered to fall under the ‘de minimis’ rule and is not considered state aid.

Currently, the total amount of de minimis aid granted per member state to a single undertaking cannot exceed €15,000 over any period of three fiscal years, provided that the global amount of such aid does not exceed 1% of the annual agricultural output. Aid which is fixed on the basis of the price or quantity of products put on the market is not included under this exemption.

While some will argue that condoning national payments would represent the bankruptcy of a common EU policy, they are hardly worse than the voluntary coupled support to dairy farmers that a majority of member states have introduced in their CAP direct payments. In any case, such aids are permitted up to maximum limits under current legislation which was revised as part of the 2013 CAP reform, so one can hardly complain if member states make use of this option.

What to expect on Monday

One view (reported here by Agriland) is that the Commission will present a €300 million dairy support package at the Agricultural Council, geared to improving farm liquidity levels, delivering greater levels of market stability and rebalancing the agri-food chain. Direct aids for farmers particularly in the hard-hit Baltic countries, strengthening of the PSA measures and additional funds for promotion are highly likely to be included; increasing temporarily the intervention price could also be part of the package if the vast majority of Ministers insist on it.

Some measures can be funded from the normal CAP budget for market management measures (such as the cost of PSA aids, promotion and intervention purchases). Others will be funded from the crisis reserve. I find it hard to believe that the Commission will go along with the argument that superlevy fines ‘belong’ to farmers. As noted above, the superlevy fines already play a role by allowing a higher level of market management expenditure than would otherwise be possible under the MFF EAGF ceiling if this is necessary. I cannot see that these funds would be substitutable for the crisis reserve expenditure under normal budgetary rules. Given the high level of funding already received by the farming sector, it is also hard to justify adding to the total transfer from taxpayers when there are so many other demands on the EU budget.

Dairy farmers in the EU do have a difficult time at present and many are producing at a loss. The Commissioner is therefore justified in proposing an aid package at Monday’s Agricultural Council. It looks like the Commission’s proposals will avoid some of the wilder ideas put forward on how the sector should be supported. We can only hope that the Commissioner holds his nerve.

The main drawback with a dairy package is that it crowds out initiatives by the industry itself (both farmers as well as the dairy supply chain) to find permanent solutions to how to manage the risks of volatility (which, as argued in this separate post, are not just occasional, exceptional events but inherent in a narrow-margin sector) without continually resorting to the taxpayer.

This post was written by Alan Matthews.

Photo credit: Wikipedia

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