26 February 1999

Outlook for

dairy quotas

is uncertain

The London Group proposals

to phase out milk quotas,

though unlikely to be adopted

at this stage, have

triggered the likelihood of a

fundamental review of quotas

in the longer term.

Teresa Dent and

Jonathan Small, farm

business consultants with

Strutt and Parker, predict

the likely effects of the

changes to come

LAST September the London Group (consisting of the UK, Denmark, Italy and Sweden) called for an end to dairy quotas after 2006, challenging Agenda 2000s silence on this point.

It was a firm stand by the British government and its then new agriculture minister Nick Brown and has forced EU member states to consider the London Group point of view. As European farm ministers throw themselves into the last couple of months of intensive negotiation, the four countries have the voting power to block agreement on Agenda 2000, assuming that none of them can be persuaded to drop out.

As far as Agenda 2000 goes, Mr Brown claimed that while this proposal would be a step in the right direction, it does not go far enough because the quota regime would be left intact.

The London Groups alternative approach aims for reforms that will allow the EU dairy industry to participate fully in world markets. The British government says it wants to liberate the UK dairy industry from the "bureaucracy and unfairness" of the quota system and adapt the regime in preparation for EU enlargement.

"I have also been concerned to enable consumers to have access to dairy products at competitive prices, while keeping expenditure within the financial guideline for agriculture," added Mr Brown. "Our proposal meets this aim."

In essence, the proposal involves a six-year period leading up to the removal of milk quotas in 2006. There would be a 30% reduction in intervention prices for butter and skimmed milk powder over that period, together with an extension of the direct headage payments to farmers proposed under Agenda 2000. The payments are intended to compensate for the greater price reduction and would be accompanied by a phased 4% increase in quotas.

The government believes it would make for a relatively easy transition to a quota-free regime, and would introduce greater flexibility into the dairy market.

The third way

It now seems unlikely that the London Group proposals will be accepted as part of the Agenda 2000 reforms. Italy is seen as the weak link in the blocking minority group. If its support is lost during the course of the final negotiations the proposal will founder.

However, a trade-off seems to be developing. The compromise might be to agree the Agenda 2000 proposals as they stand at the moment but to make a commitment to review the future of milk quota before 2006, say in 2004. At that stage the principles of the London Group reform may well make an appearance.

A likely scenario could be, say, a further 15% reduction in price after 2006 coupled with an increase in quotas, with the aim of gradually making quotas an irrelevance to producers. Whether the EU will go as far as abandoning the quota system remains to be seen. More likely it will retain quotas in their weakened form to protect existing ring-fences of production and disadvantaged areas.

Therefore dairy producers need to be thinking both about the Agenda 2000 proposals as they stand and also about the possible impact of further reform after 2006.

Impact of reforms on

profitability

Lets look at Agenda 2000 first. The proposed 15% cut in milk price is to be compensated for from three sources, all phased in over four years starting in 2000. There will be a dairy cow headage payment (apparently based upon litres of quota held in the previous year) worth around 100 ECU (£70), a beef premium of 70 ECU (£49) and a further 45 ECU (£31) from the National Envelope for those who qualify. This compensation, even if paid in full, does not fully compensate producers if farm gate milk prices reflect the full 15% cut in intervention prices. Subsidy will be paid on each notional (or, as it has been dubbed, "virtual") cow.

A producer with, say, 125 cows yielding 6000 litres (feeding 0.28 kg/litre) and leasing-in 10% of his quota requirements (which is quite typical) will, if he takes no remedial action, be around £1150 worse off annually from year four onwards. This does not take into account what may be happening to calf and cull cow prices over the same period.

For the bigger producer the amounts are larger but the remedies the same. A 180-cow herd at 7000 litres, for example, is around £2000 worse off.

This doesnt sound too bad except that it is a drop in income from an already low base. Remedial action by cost cutting (for those who have any left to do) or increasing production ought to be able to accommodate the fall. For example, the producer described above will need to increase production by around 340 litres a cow after paying for extra feed (but maintaining his 0.28 kg/litre feed rate) and quota costs. Dont forget too that the economics of milk production at 16 pence per litre will be very different to those at 19 or 20 pence.

The main imponderable is whether the 45 ECU from the National Envelope will be available to all producers or whether it will be used to support what are deemed to be more desirable methods of production, ie extensive or even organic systems. Given New Labours emphasis on consumers it will not be at all surprising to find the National Envelope excluding many producers. In that case our two producers above are £2230 (needing 850/cow litres more) and £3750 (needing 1000 litres/cow more) worse off.

As for the London Group proposals, you should ask yourself about the cost benefit of some of your current decisions if they were to result in milk worth the average 12 pence/litre that would prevail then.

The effect of quota values

Transfers of milk quota last year accounted for about 12% of the national quota and 10% the year before that. This market totals about 1.5 to 1.6 billion litres and is split roughly into 2/3 leased and 1/3 permanent transfers.

Any change in the demand for quota will impinge upon this market. If just 30% of producers elect to recover their lost profit by increasing production (each by around 14%) the increased demand will be equal to about 40% of the marketplace. That would be bound to affect values even if falling milk prices are pushing them the other way. We take the view therefore that quota values are unlikely to fully reflect the fall in milk prices with the gap between the two narrowing.

Whatever else you say about the London Group proposals, they do at least provide for a very significant increase in quotas. This would not only have enabled producers to respond to falling prices by increasing production but would also have reduced quota values in such a way that the financial impact of the reforms would have been lessened without need of further compensation.

If the London Group proposals are ever adopted they could spell a definite end to quotas. The effect on quota values would be profound, with a divergence between temporary and permanent values as the faint-hearted sell early and the more bullish hang on to try to benefit from higher lease values in the short term (while their asset depreciates). Meanwhile milk prices heading for world levels at around 12 to 13 pence per litre would exert a strong downward effect upon quota prices.

Under both proposals subsidy is to be based upon a "virtual cow", derived from quota held in the previous year (quota divided by 5800 litres is the proposal). There may well be an increase in demand for quota because it would effectively carry a subsidy with it.

LONDONGROUPPROPOSALS

&#8226 Over six years.

&#8226 30% cut in intervention prices for butter/skimmed milk.

&#8226 Extension of headage payments.

&#8226 4% increase in quotas prior to removal.

&#8226 Replacement of intervention with, for instance, a private storage scheme.

AGENDA2000

&#8226 Over 4 years.

&#8226 15% cut in dairy support prices.

&#8226 New headage payments.

&#8226 Quotas to remain.

&#8226 Siphon on transfers without land.