(Crisis) regulation. It appears that European milk production. - Fore and against

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1 (Crisis) regulation - Fore and against Any type of regulation is unwelcomed in agriculture, but three years after the quota was abolished it is clear, that the European dairy production is periodically suffocating itself in overproduction, and some dairy companies have introduced regulations By Landsforeningen af Danske Mælkeproducenter (National Association of Danish Dairy Farmers) It appears that European milk production has increased too quickly, but the time since 2015 has shown that EU dairy farmers have a hard time reducing milk production in low-cost periods to restore a cost-covering settlement price. On this background it has become interesting to look at possible regulation schemes to shorten low-cost periods in the best way possible. Almost all regulatory arrangements within agriculture are based on an A-B price system, where the A-price can be received for the quota and the B-price for the excess production. This is the case for sugar beets, potatoes, seeds, and also for the now abolished milk quotas when the farmer got an A-price for quota and a B-price for the excess production, by deducting an amount of around two DKK in penalty. Another type of regulation used from time to time within the agricultural- and fishing industry is the pay of a termination or reduction aid. This was last seen in the EU-Commission s desperate attempt to reduce milk production back in September LDM s reflection in terms of crisis management or adaptation will focus on a system that should always be able to settle a cost-covering price for A-quantity. There must not be supplier s rights, which can be capitalized, and everyone should have the freedom to produce and expand with the volumes he or she so chooses. An A-B pricing scheme reflects the market An introduction of an A-B pricing scheme is an expansion of the market and the market forces that will include the producers. An A-B scheme is a realistic opportunity because it does not affect taxpayers and it also helps to meet the requests of politicians in terms of unlimited production on market terms. The milk market today consists of dairy companies who operate in an environment where the price is formed from supply and demand. Every single farmer is a simple supplier without a real possibility to influence the market and without the ability to influence the average settlement price by increasing or reducing his own production. If the production of milk is divided into one A-quantity, based on a given reference quantity, and the rest is B-quantity, it becomes possible for the individual farmer to regulate his average farm gate price within a defined/fixed range, and it is solely up to the farmer himself to decide if he wants to produce the entire or only parts of the B-quantity. In this scenario the farmer becomes an active part of the market. Many failed attempts Switzerland was the first country to end the quotas and they were stifling their own producers with failed control systems. The EU followed shortly after with the abolition of the milk quota, and several dairy companies have already begun or introduced different opportunities for individual or collective management. Unfortunately, a lot of the created systems are almost farmer-hostile, for example an A-B-C quota per percent basis of , which does not allow the farmer to avoid producing the C-fraction as it will continue to make out 10 percent of the total delivered quantity. FrieslandCampina propose to introduce fixed quotas along the lines of the abandoned system. The intentions of the schemes mentioned here might be good, but the effect is simply too static for a dynamic production. Cessation aid is not realistic Cessation aid is perhaps the most popular scheme, i.e. a scheme that is activated in crisis situations and compensate the producers who are willing to terminate their production, with a defined amount per kg. The system was tested during the recent crisis in which the Commission eventually offered compensation for termination and reduction. The scheme proved to be very popular, as the amount allocated basically was emptied in the first round of application. The purpose of a termination scheme is to speed up the timing for a planned or considered termination within months or years. The overproduction occurs as a result of too much expansion of production compared to the simultaneous cessation of production. The disadvantage of a cessation scheme is that money is needed to run this scheme. This money should either come from the EU or from savings through a production fee. At the same time, it may seem demotivating watching some farmers expand - maybe even with some sort of financial support - while others receive support to cease or reduce production. Reduction support only provides short-lived efficiency, as production is expected to be re-established. At EU-level a reduction will however be required, partly due to German rules for slaughter of pregnant animals being significantly stricter than required in the EU-legislation. EMB is in favor of an A-B-pricing system The European Milk Board (EMB) has described another example of crisis regulation with warnings and various threat levels, but the EMB proposal is basically also an A-B pricing scheme just topped with a bit more administration and German thoroughness. 1

2 Description of a possible A-B pricing scheme solution The experience since the abolition of the quotas has shown that production increases happen fast, while reductions are, on the other hand, much slower. An A-B scheme could speed up the reductions in milk production. By Landsforeningen af Danske Mælkeproducenter (National Association of Danish Dairy Farmers) Prerequisites, an example for March The A-quantity is 90% of the highest March production within the previous three production years. You will thus not be cut in next year s A-quantity for March, just because you reduce in March this year. The B-quantity is all excess production above the A-quantity. The entire production should be settled with at least 2,50 DKK per kg when possible. If that is not possible, the A-quantity should be settled with at least 2,50 DKK and the rest of the amount the dairy has available for settlement should be distributed on the B-quantity. If the dairy is only able to give a settlement price of 2,45 DKK, it means that the A-quantity will still be paid 2,50 DKK, while the B-quantity will be paid about 2,00 DKK. If you deliver the same quantity as the previous years, you will receive the same average price for the entire delivery as you would if there was no A-B distinction, namely the 2,45 DKK. If the B-price is down to minimum as for example 0,40 or 0,50 DKK per kg further price drop in the settlement must be deducted in the A-price. Hence, there is a maximum bottom for the B-price. A split delivery or delivery to other parties must be withdrawn from the A-quantity. The purpose of an A-B pricing scheme is to motivate for production restraint or reduction in low-cost periods without harming the opportunities to gain in high-price periods and without establishing a system where possible production rights can be capitalized. The foundation of it all is nothing to lose. The global dairy market is very sensitive to even the smallest changes from either a higher or lower production. A minimal reduction of just a few percent in a moderate low-price period will therefore have a big impact. Reductions in short- and long term At a settlement price above 2,50 DKK there will be no distinction between A- and B- milk as the price will be the same for all milk delivered. If the settlement price cannot maintain the 2,50 DKK. the A-B milk distinction will come into play. The method for calculating the A-quantity is based on the past three years. In this way it ensures that one will not risk, that a reduced production in a month or two, or a whole year for that matter, will reduce one s A-quantity for the coming year, and thereby the risk of being caught in a negative reduction spiral. The A-B pricing scheme described in this article allows for the possibility of reducing on a monthly basis. If for example it is known that next month s A-quantity is settled at 2,50 DKK and the B-quantity with 0,75 DKK, it becomes possible to calculate for one s own business, whether it is advantageous to slaughter five or six cows one month prior to original time for slaughter and to make room for an equal number of replacement heifers, that will be ready in a month. If one believes that the low-price period will last longer, one can of course consider culling more cows and thus minimize the amount of milk sold for 0,75 DKK per kilo. By reducing production more than one month ahead implies of course also a risk of cutting off the possibility to sell milk to the A-quantity price. The system gives room for unlimited production, and given an unchanged production, compared to the best of the same month s production three years back, one will get the same settlement price, as if there was no A-B price distinction. Few percentages decide on up or down The milk market is very volatile. This means that even small increases or declines in production in the EU has high impact on the market price. A reduction or increment of two percent is in fact quite large and both scenarios would affect the market price. Even a signal from the EU, or from the dairy industry, implying that you want to adapt production to demand, will have an effect in itself. Find the answer in the spreadsheet An A-B system spreadsheet has been created. Here you can calculate if you will benefit, or not, by culling cows before planned. Examples of calculations in the sheet is shown in the table on the following page. 2

3 A-B- price at different average prices and a limit price at 2,50 DKK in two low-price periods Average price per kg in DKK Average price A-price B-price The figure illustrates a scenario of two low-price periods, first a very deep crisis, where the A-price reaches a level of 2,18 DKK per kg and the B-price has a long period of 0,40 DKK per kg. Then a minor crisis, where the A-price does not come below the limit price of 2,50 DKK per kg, but the B-price takes a dive down to 0,75 DKK then to rise again. Calculation of the financials by culling cows one month earlier than planned. Cows that would have to be culled at the end of the month anyway to make room for new calvers. Eks. 1 Eks. 2 Eks. 3 Stabil and even yearly production Herd size, milking cows, year- long cows Calculated herd size, milking and 10 % dry cows Replacement rate in percentage Replacements per month Weeks of dry period Slaughter value at the time of replacement Slaughter value on month prior replacement Price for 1 month of finishing feeding Yearly yield per cow 34,9 34,9 34,9 Average daily yield at a 360 days calving interval 24,0 24,0 24,0 Yield at the time of replacement 28,0 28,0 28,0 Yield on month prior replacement Yield per cow last month of lactation Present monthly milk delivery and the same month the year before A-quantity (90%) The specific month at an average price lower than 2,50 DKk 2,00 1,00 0,40 Present B-price 2,50 2,50 2,50 A-price 2,30 2,30 2,30 Manufacturing price per kg milk 2,50 2,50 2,50 Price at B-price = A-price 2,45 2,35 2,29 Average price on total monthly production Reduced delivery in kg 2,57 2,57 2,57 Reduced delivery in percentage 2,46 2,39 2,34 Average price, by slaughtering one month earlier than planned One month earlier slaughtering of the culled cows Saved cost for finish feeding Saved manufacturing costs Missing from milk income Missing slaughter value by slaugtering one month earlier than planned Profit/loss by culling 6 cows 1 month earlier The table shows three examples of calculated profitability by accelerating the slaughter of six cull cows one month prior to planned. This calculation is made for a skilled dairy producer with 33 percent replacements, a rolling herd average of kg and manufacturing costs of 2,30 kr. per kg. The higher the manufacturing price, the greater the opportunity to increase profits by reduced production in low-price periods. In Example 1, the A-price has come down to the limit price at 2,50 DKK. The B-price has fallen to 2,00 DKK per kg, which gives an average dairy payment at 2,45 DKK. If six cull cows are slaughtered one month prior, it will improve operating profit marginally by 206 DKK for the respective month. If the B-price drops to 0,40 DKK in Example 3, the same operation will contribute with an improved operating profit of DKK the month in question. Example 2 shows the calculation for a B-price of 1,00 DKK. 3

4 Q & A s Why is the limit price set to 2,50 DKK.? The exact value can be debated. The limit price between the A -and B- prices must be low enough to hurt the majority on the long term, and yet high enough to make it possible for a dairy farmer to survive in medium term. The limit price can also be dynamically determined as a necessary earning to maintain a certain exchange rate. In Denmark you can set the price 0,25 DKK below the average break-even milk price, calculates by SEGES. There are many and perhaps better options, but for the sake of clarity, LDM has set the price to 2,50 DKK. Why is the A-quantity set to exactly 90 percent of the reference period? Again, the exact number is open for debate. The B-quantity must yet be low enough to ensure that a decrease in prices below the limit price, quickly will be reflected in the B-price, to motivate dairy farmers to reduce production before the crisis becomes too deep and too long lasting. Later in the article it will appear that there may be advantages of increasing the A-quantity, and thus decrease B-quantity. There a minimum price on the B-milk, why? The minimum price on B-milk is set to maintain a motivation for supplying the dairy company instead of exploring alternative circumventions. The level of the minimum price needs to be set as low as possible, but still high enough to maintain a wish to supply one s milk to the dairy company. Why is eventual split delivery withdrawn from the A-quantity? That is in order to avoid the sale of B-milk to other parties in form of spilt delivery that would undermine the system. Why is the A- and B-price correlated above the limit price? Otherwise we would quickly face an unintended explosion in prices and B-production, at an average farm gate price above the limit price. I have expanded the herd with 25 cows two months ago, will I be Punished with a B-price for their milk? The A-B-distinction only applies in low-cost periods. If the expansion was made less than a year before a low-price period where the A-B distinction will come into play, it will mean that the milk from the expansion becomes a part of the B-quantity. It is partly because of too many expansions that the supply of milk exceeds the demand, and hereby cause the decreases in price. I have bought a farm with a herd; will I have to start from scratch? No, the calculation of the A-quantity follows the CHR-number (Danish Herd Number) But if the yield has risen significantly within the last year, the result is that a relatively larger quantity would have to be paid a B-price. I just started as a milk producer and have no previous production. Will I only be allowed B-quantity? No, all newly established CHR-numbers will be assigned an A-quantity that reflects 100 percent of the milk production in the first six months (that is A-price for the entire quantity). This will be followed by an A-quantity of 90 percent of the three previous months, with the highest production, for the next 36 months. After these first three years the same scheme will apply to these herds as for the other dairy farmers. My average price will not decrease that much, even if I continue without changes and produce some B-milk. Wouldn t it be safer to continue without reducing? The difference between the A- and B-prices is comparable to the difference between production within the limits of the previous milk quotas and on producing above the quota. At that time, a lot of effort was put into not exceeding the quota. If it was economically interesting to reduce back then, it will also be interesting to minimize production of milk at the B-price. But it will be voluntarily - just as it was the case with the old quotas. What are my options if I am in the transition from seasonal calving to year-round calving? In this specific situation the scheme presented here has a weakness. By introduction of the system it may be necessary to add an alternative option to choose reference period. One must always keep in mind that, that it is a crisis system. It is an option one gets to adapt one s production, i.e. to respond to market forces. There is no built-in punishment. If you continue without altering the production, you are in the same position as always, unless you have expanded recently. 4

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