Overview of the Canadian dairy industry Gilles Froment, M.Sc., P.Ag. Senior Director, Policy and Corporate Affairs Canadian Dairy Commission, Ottawa March 26, 2009 DM146846

Outline The Canadian marketing system and its component 3 pillars of supply management Seasonality programs Milk pools Marketing and innovation initiatives Current issues

The Canadian Milk Marketing System and its Components

Snapshot of the Canadian Dairy Industry 14,036 farms producing more than 80 billion litres of milk (8 million tonnes) 445 processing plants Milk sales: $5.2 billion Adds a net $9.7 billion to the GDP Processed products sales: $11.6 billion Supports $30 billion of economic activity Sustains more than 160,600 jobs

Major Milk Producing Countries (cow milk, 2007) Pale brown: EU 15 Green: 10 new EU member countries dark brown: Bulgaria and Romania Source: International Dairy Federation

Canada’s Milk Marketing System Producer Marketing Board (provincial) Processor Further processor Consumer Retailer All producers sell their milk to their marketing board (mandatory) who then sells it to the processors (even coops).

CMSMC Canadian Milk Supply Management Committee Permanent body of signatories of the National Milk Marketing Plan - NMMP (voting members) – One vote per province Dairy Farmers of Canada, Dairy Processors Association of Canada and Consumers’ Association of Canada (non-voting members) Responsible for policy determination and supervision of the NMMP provisions Meets 4 times a year Virtually all decisions require unanimity Signatories include : Federal gov, Provincial governments, provincial marketing boards Establishes the Market Sharing Quota Oversees the functioning of the agreement that allows the pooling of revenues from Special Classes. Most decisions need to be unanimous. The CDC chairs the CMSMC, provides Secretariat services as well as technical expertise and advice.

to coordinate actions of provincial producer boards and governments The CMSMC directs the implementation of the National Milk Marketing Plan (NMMP) to coordinate actions of provincial producer boards and governments Sask (3) Quebec (4) Non-voting members DFC DPAC P.E.I. (3) CAC CDC chair Ontario (4) N.S. (3) Alberta (3) Newfoundland (3) B.C. (3) N.B. (3) Manitoba (3)

NMMP National Milk Marketing Plan Federal-provincial agreement Regulates marketing of industrial milk Balances supply and demand Sets out the establishment, distribution and adjustment of industrial milk quota The key document that regulates the milk marketing system since the 80s.

The Canadian Dairy Commission Crown corporation created in 1966 Reports to Parliament through Minister 3 commissioners, 63 employees Generally deals with industrial milk Total budget for 2007-2008: $7.8 million Funded by government, dairy producers and the marketplace

Legislated Mandate Provide efficient producers of milk and cream with the opportunity to obtain a fair return for their labour and investment. Provide consumers of dairy products with a continuous and adequate supply of dairy products of high quality. These are the objects of the Commission as stated in The Canadian Dairy Commission Act.

Overview of Key Activities Chair the CMSMC Calculate Estimated Requirements (demand) Recommend Market Sharing Quota Establish Support Prices Administer Revenue and Market Sharing Agreements (pools) Administer Special Milk Class Permit Program Carry out external audits Create and administer marketing programs Remove surplus production Administer Seasonality Programs

Milk Categories Industrial (Classes 2-4) Fluid (Class 1) used in the manufacture of butter, cheese, ice cream, yogurt, milk powders longer shelf life federal responsibility – interprovincial movement of product Fluid (Class 1) used in 1%, 2%, skim milk, etc. and creams short shelf life provincial responsibility – historically made and consumed in province of origin

3 Pillars of Supply Management controlled prices controlled imports controlled production

Pillar 1: Controlled Prices Industrial milk prices Are determined by provinces based on CDC support prices and vary depending on the end use of the milk Support prices are the prices at which the CDC buys and sells butter and skim milk powder under its various programs. Support prices are announced in December by the CDC to be effective February 1. Support prices are adjusted annually. In their deliberations on the establishment of support prices, the Commissioners consider cost of production results and other economic indicators as well as market impacts. On February 1st, 2009, the support price for butter was $7.10/kg and $6.18/kg for skim milk powder.

Support prices 1997-2009 ($/kg)

World Prices for Cow Milk (2007, US$/100 kg) Source: International Dairy Federation

Balancing Supply with Demand prevents Price Volatility DM116898

Pillar 1: Controlled Prices Fluid milk prices are determined by provinces according to a formula 40% indexed COP 30%CPI 30%PDI/capita Valid until Jan 31, 2010 Currently negotiating a new formula with all 10 provinces The Eastern formula kicks in once per year. Western provinces are currently using the eastern formula twice a year.

Milk Prices in last 12 months February 2008 – January 2009 Average in-quota revenues : $72.20 Average price for fluid: $85.41 Average price for industrial: $63.53 Average price for industrial milk includes Special Classes. Canadian price is standardized for 3.6 kg butterfat/hl.

Example - Prices per component Class $/kg BF $/kg protein $/kg other solids $/hl standard @3.6 kg Fluid milk 1(a) 7.37 66.01 $/hl for SNF 92.53 Cheddar 3(b) 7.65 13.31 0.85 75.51 Butter 4(a) 5.27 74.66 Cheese as ingredient 5(a) 3.54 9.36 0.0001 43.05 These prices are the prices charged by the FPLQ in February 2009. The prices per component and per class may vary from province to province.

Pillar 2: Controlled Imports Most dairy products are protected by Tariff Rate Quota (TRQs). Above TRQs, dairy products have a tariff of almost 300%.

Pillar 2: Controlled Imports Examples of TRQ and over-quota tariffs Product TRQ (t) Tariff (%) Skim milk powder 201.5 Dry whey 3.2 208.0 Butter 3.3 298.5 Cheese 21.4 245.5 Ice cream 0.484 277.0 66% cheese TRQ is allocated to the EU 2000 t of the butter TRQ allocated to New Zealand. The CDC imports the TRQ for butter.

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Pillar 3: Controlled Production Provincial milk marketing boards allocate production quota to their respective dairy farmers. This quota combines both fluid milk quota and industrial milk quota. Fluid milk quota is established by provincial marketing boards and equals demand. Industrial milk quota is established nationally by the CMSMC and is called Market Sharing Quota (MSQ). Quota is calculated and expressed in kg of BF. Newfoundland still has separate quotas for fluid and industrial milk.

Establishing MSQ The CDC calculates the Estimated Canadian Requirements - ECR (demand) on a monthly basis. ECR= Production + Opening Stocks + Imports – Closing stocks – exports – DDPIP – Class 4(m) MSQ is adjusted every two months when ECR increase or decrease.

The 7 steps in sharing quota adjustments among provinces 1 Skim-off 2 The 10:90 rule 3 PEI’s share 4 DDPIP 5 Growth allowance 6 Exports 7 Fluid quota

Evolution of MSQ 1% and 2% milk more popular; lower butter consumption Low butter stocks Quota cut of 1976 The curve is MSQ on July 31. Current MSQ= 180.57 million kg BF (March 2009)

Respecting production targets Provincial production targets: Upper limit: 0.5% Lower limit: 1.5% Provinces are free to have their own policies to adjust their farm quota or not, however, provinces will be penalized if they over or under produce their share of quota. Over production: no payment for the milk Under production: lost opportunity to produce

CDC Seasonality Programs While milk production is quite stable year round, people consume more dairy products in the fall/winter and less in the spring. To offset this, the CDC buys and stores butter and skim milk powder in the spring and puts those products back in the market in the fall/winter. These transactions are done at support prices.

Seasonality Programs - Butter Plan A Becomes the property of the CDC 25 kg blocks Plan B Must buy back within one year of production of the product One-pound prints ready for retail sales. The marketplace pays the carrying charges (storage, insurance) for “normal” butter stocks (12 million kg). Carrying charges for any stock above “normal” level are paid by producers through the pools.

Managing Surpluses Production is managed on butterfat basis. Surpluses of milk solids non fat (SNF) arise because consumers want the fat portion of the milk more than the SNF portion. The CDC buys the surplus SNF and disposes of it by exporting it or selling it for animal feed. Both these markets yield a lower return to producers than regular sales. The CDC continuously strives to find new markets for SNF surplus on the domestic market and to develop new WTO compliant ways to sell it on the export and domestic markets.

CDC Import / Export EXPORTS Subsidized exports according to WTO limits (none to USA) SMP (CDC exports to Cuba and Mexico) Permits for private exporters including non-contingent classes IMPORTS According to WTO (3,274 mt) Butter : sold to further processors Cheese: private sector imports (21,800 mt) CDC administers the butter TRQ of 3,274 tonnes NAFTA prohibits to export subsidized products to the US

The Milk Pools

Pools were established in the mid-1990’s in response to… Increased concentration at the retail and processing levels New trade rules (FTA, NAFTA, WTO) Differing provincial policies (for ex. Milk allocation to plants) Fluid milk moving between provinces Inequities in producer returns 3 national committees recommended the creation of a national all milk pool. In the end, the results was somewhat different, and more complex.

The CDC administers 3 milk pools The P10 (all 10 provinces) The P5 (in the East) The WMP (in the West) These pools allow dairy farmers to share and balance revenues, markets and in some cases, transportation costs. The P5 and the WMP agreements have been in operation for over a decade and have harmonized the dairy policies within their respective regions.

How does pooling work? Revenue Sharing Market Shares – All Milk Fluid Industrial Pool Region A (hl) 1,000 2,000 Region B (hl) 2,800 5,200 8,000 Total (hl) 3,800 6,200 10,000 Region A 50% 20% Region B 35% 65% 80% Pool (%) 38% 62% 100% Total production: 10,000 hl No over quota production

How does pooling work? Before pooling Average Revenue ($/hl) Fluid Industrial Region A $74.00 $66.00 Region B $79.00 $69.00 Total Revenue (average revenue x market share) Total $74,000 $66,000 $140,000 $221,200 $358,800 $580,000 $295,200 $424,800 $720,000 Average pool price = total revenue/total production Average Pool Price (hl) = $72.00

How does pooling work? After pooling Revenue needed (market share x average pool revenue) All Milk Region A 2,000 $72.00 $144,000 Region B 8,000 $576,000 Resulting Cash Transfers (Equalization Pool Payments) Total $/hl $4,000 $2.00 ($4,000) ($0.50) ($0.00)

What is pooled? Pool Milk Revenue Market Promotion Transport P10 Special Class x East All West When revenues are pooled, each producer gets an average price per unit produced. When markets are pooled, a growth or reduction in market size in any region is felt across the pool. Pooled transportation costs means that all producers pay the same transportation cost no matter how far from the plant they live.

How pools are administered Provinces report production and sales data (by milk class) monthly to the CDC. The CDC calculates money transfers between members to equalize returns. The CDC calculates quota allocations when demand changes. The CDC keeps a bank account for pool operations. The CDC chairs the supervisory bodies of the pools, provides secretariat services as well as technical advice.

Resulting in harmonization of… Multiple component pricing Producer prices Milk classification Quota policies POOL = RISK MANAGEMENT TOOL

Marketing and Innovation Initiatives of the CDC

Some of the CDC initiatives The Dairy Marketing Program The Domestic Dairy Product Innovation Program The Special Milk Class Permit Program

Strong market growth sectors The finished products: - Sports recovery drinks/powders - Meal replacement products (bars, beverages) - Meal / dietary supplements - Organic products - Pet food The dairy components: - Organic milk protein concentrates and isolates, casein, caseinates, peptides The challenges: - Ingredients that are still relatively new or not available from our industry (MPC,MPI) - World market priced/ highly competitive market - Manufacturers/users looking for level playing field conditions

Current Issues

Current challenges Growing structural surplus of SMP - Finding new markets for solids non fat current stocks of 35 million kgs Evolving demand from consumers – substitution from non-dairy ingredients Soy-based products (imitation cheeses) frozen desserts The market for dairy products is fairly mature Effect of the economic crisis on dairy consumption?

Current challenges World Trade Organization: an unknown but so far nothing to help supply management Increase market access? Lower tariffs? Sensitive products? Harmonization issues Milk allocation in the East (P2) and Maritimes Quota policies Transportation Audit rules

Fragility of tariff wall The world prices for dairy products have dropped significantly in 2008 with butter, SMP and cheese trading near support price levels in the US. US milk prices at record low: below $10/cwt Price decline mainly driven by falling consumer demand due to the current economic weakness and to an over supply situation from high prices in 2007.  At current world prices for butter and SMP (both at $1,600 US per tonne), the landed price plus the tariff exceeds the domestic support prices by $1.28/kg and $0.13/kg respectively. 

Cheese Compositional Standards Canadian Food Inspection Agency (CFIA) is responsible Came into force in December 2008 The use of milk protein concentrate and milk protein isolates is limited Processors warn of an increase in production costs which will translate in an increase in retail price Challenged in court by Saputo, Kraft and Parmalat

Future Pricing Issues Impact of current tariff protection Impact of future trade agreements Price sensitivity of particular classes Differential impact of fluid vs industrial pricing Expansion of Special Milk Class Permit Program Should support prices continue to drive industrial milk pricing? Methodology for future price changes Difficulty to reach an agreement with dairy industry stakeholders

A note of interest for students…

CDC Graduate Scholarships (2006-2011) To ensure that Canada has enough specialists in the areas of Food and dairy science Economics and policy (Supply mgt) Animal science M.Sc. and Ph.D. For agricultural economics in Quebec, the program is managed by Université Laval but available to McGill students.

QUESTIONS www.cdc-ccl.gc.ca www.dairyinfo.gc.ca www.milkingredients.ca