EU fails to respond to booming global dairy market

The EU has largely failed to respond to a booming global dairy market. Milk deliveries actually fell by 1.5 per cent in 2006 despite an increase in quotas. All sorts of explanations are being trotted out such as the threat of high super-levy penalties and even the expiry of the transitional period in the A10 countries (this allowed for domestic marketing not to comply fully with EU criteria).

An alternative explanation is that the quota regime has ossified the structure of the dairy industry in the EU, holding back the more efficient and protecting more marginal farmers (which indeed is one of its intentions). Quota can be transferred in some countries (the rules differ), but despite the existence of an internal market, it cannot be transferred across national borders. The consequence is that the EU's dairy processing industry has been handicapped in responding to new opportunities on the world market.

What is driving these opportunities? The key factor is increased demand from the emerging economies. As people become more affluent, they consume more products that make use of milk. The increased demand for milk powders, for so long the sump of the industry, illustrates the fact that the major force underlying the price boom is increased demand for processed food ingredients.

Moreover, as demand expanded particularly in fast-growing Asian economies, exportable supplies were limited by drought in Australia and strong domestic consumption in the US and EU. The EU market is likely to be dominated by the expanding demand for cheese. Projections by the European Commission suggest that EU-27 cheese production is likely to increase by a total of 10 per cent during the 2005-13 period and will be likely to use nearly 85 per cent of the additional increase in milk expected to be delivered ober this period.

Can the price boom last? The OECD is relatively optimistic. Even though current exceptionally high prices are unlikely to be sustained, it is confident in its 2007 Agricultural Markets Report that milk powder and dairy product prices are likely to stay at relatively high levels at least until the middle of the next decade. Over the 2007-16 period it expects prices to remain at about US $50 to $100 per 100 kg (milk equivalent) higher as compared with the previous decade.

Compared to the level of average prices in nominal terms over the period 2001-5, world butter prices are preducted to increase the most, rising by 42 per cent. It wasn't so long ago that 'ageing' butter was being sold off from EU intervention stores to grateful Soviet consumers, a trade that made the intermediaries a lot of money. Skimmed milk powder prices are expected to rise by 33 per cent.

Much of the new output needed to meet demand will not come from the OECD area where production is expected to remain relatively stable, with the main production gains coming in Oceania and the United States. The OECD expects India, China and Pakistan to account for more than 50 per cent of the likely global milk production gains.

The one caveat is the quetion of economic growth. If economic growth continues at the rate predicted by the OECD, an average of 4 per cent for Asia, South America and Africa, then increased consumption and high prices will persist. Any faltering in growth would leave large quantities of milk from developing country producers looking for a market which would have a big knock on effect on the EU.

Why are British dairy farmers still in trouble? For historical reasons relating to imports from the British Commonwealth, the UK market is still dependent to a larger extent than elsewhere on the liquid market. This is still very price sensitive in the sense that supermarkets in practice treat milk as a 'loss leader' (whatever they might say to the contrary). However, they have been increasing prices to farmers recently, although input costs have also been going up.

Quotas are to be phased out, not before time, as they made it difficult for new entrants, despite special schemes in a number of countries. The UK in particular had insufficient quota to meet all its potential production needs. A freer market should benefit both producers and consumers.