EU Proposals for the Dairy Industry

Written evidence submitted by the Department for Environment, Food and Rural Affairs (Defra) (DRY 08)

Executive summary

1. The Government recognises concerns in the UK dairy industry, but is optimistic about its future. It aims for a profitable, thriving, and competitive sector that protects natural resources and safeguards animal welfare. It has reinvigorated the Dairy Supply Chain Forum, and is introducing a Groceries Code Adjudicator. The UK is actively engaged in negotiations on the Commission Milk Package. These would enable dairy producers to enhance their bargaining power through the formation of producer organisations. However the Government considers that the proposed exemptions from competition law are not the best way to strengthen the European dairy industry. The UK agrees that Member States should be free to make contracts compulsory or not, but the detail of contracts must be freely negotiated. The Commission in its report on the dairy market notes positive market developments and states the soft-landing is "on track" in most member states. The Government is sceptical about introducing compensation for reducing production.

Overview of the UK dairy industry

2. The UK has a strong dairying tradition and natural farming advantages. In 2009/10, 16,400 farmers produced 12.83bn litres from 1.9m cows. There are six major processors in the UK dairy industry. Three are UK co-operatives (First Milk, Milk Link and United Dairy Farmers) each processing some and selling on some of their members’ milk; and three are private companies (Dairy Crest, Robert Wiseman Dairies, and Arla Foods which is owned by the Scandinavian co-op) each supplied by their own pools of contracted producers and supplemented as necessary by milk purchased from others, in particular the co-operatives. There are many other smaller processing companies, some with their own dedicated producers.

3. Of UK production in 2009/10, around 53% went into liquid milk, while the rest went into cheese (27%), milk powders (7%), condensed milk (3%), yoghurt (2%), cream (2%), and butter (2%). Other dairy products accounted for 2% of production. Wastage also accounted for 2%. Exports amounted to about 16% of production with the industry in Northern Ireland particularly reliant on export markets. Imports represent about 25% of total goods consumed in the UK. Overall the net trade balance in 2009 amounted to a net import of products worth about £1.27bn. UK production has been constrained by quotas.

4. Over the last decade, producer numbers have declined by a half but milk production has fallen, in the same period, by only 9%. This is due to increases in both the average herd size (currently 113) and annual yields per cow (around 7,000 litres). This trend is replicated across industrialised countries. After a number of years of decline production increased about 5% in 2010. Farm gate prices vary between purchaser and the use of the milk. The highest prices (about 28ppl) are currently paid for major retailers’ drinking milk, with the lowest (around 23ppl) for milk for general cheese manufacture.

5. UK farmgate prices in 2010 averaged 24.66ppl. Average prices in EU Member States ranged from 45.34ppl (Cyprus – a long way above the second highest average of 32.99ppl in Greece) to 21.18ppl (Romania). The EU average was 27.10ppl [1] .

6. Prices are not the only factor determining the viability of the industry. Costs are also relevant. Production costs and farmgate prices vary substantially. The average farm business income from agriculture for dairy farms in England in 2009/10 was over £24,000, not including income from agri-environment and diversification schemes, or the single payment [2] . However, the least efficient will struggle if input costs are high and returns are poor. During 2010, input costs, especially feed, increased notably.

7. The UK market has a range of formal contracts in place. They may contain aspects such as production parameters including quality and other milk characteristics, collection arrangements and how prices may be varied, for example, according to standard of milk delivered. Bonuses may be paid in addition.

8. Other than established cooperatives (which have around 3,500 members) there are no groups recognisable as producer organisations or equivalent. There are dedicated supply chain arrangements, mainly for drinking milk, linking approximately 1,500 producers (around 10%) directly to retailers whilst each of the major processors has producer groups. Each of these groups can enhance knowledge exchange and have some influence on contractual conditions.

Defra approach and activity

9. The Government aims to support and develop British farming and sustainable food production. A dairy sector that produces for the market, is profitable, thriving, and competitive is an integral part of this. Its future lies in meeting consumer needs while protecting and enhancing natural resources and safeguarding high standards of animal welfare. Because of its strong natural dairying advantages, the UK is well placed to exploit domestic (particularly added value), and export markets to the benefit of all parts of the industry. Investment is required to succeed in these markets. The potential in export markets is set to increase with growing world incomes, and an expanding world population.

10. However the Government recognises that parts of the industry are currently struggling and that there could be a better balance of bargaining power between producers and processors. It is aiming to address the issues both domestically and in the EU. It cannot however intervene directly on prices or discuss prices collectively with the industry.

Domestic action

11. The Government is taking a number of steps domestically:

· The Government is carrying out an evaluation to monitor labelling of meat, meat products and some dairy products both for existing legislative requirements and voluntary labelling. The food industry developed a set of voluntary principles, which were launched on 24 November. These have been agreed by trade associations representing manufacturers, retailers and the food service sector (British Retail Consortium, Food and Drink Federation, British Hospitality Association, British Services Association, Dairy UK, British Meat Processors Association). All the major supermarkets have signed up to the approach.

· The Government is committed to ensuring that food and drink procured by Government Departments meet British or equivalent standards of production where this does not lead to an overall increase in costs. We want Government to lead by example and to see top quality British produce on public sector plates, which provides value for money, meets customers' requirements and delivers on sustainability. Government Buying Standards, which will be mandatory for central Government, are to be introduced in March 2011.

· We have reinvigorated the Dairy Supply Chain Forum, challenging key representatives to discuss issues and opportunities, the health and future of the dairy sector, and how the industry might address the trade balance and secure its own sustainability and long-term British milk supply . The first meeting in this more productive format was 20 January 2011. The focus of the next Forum this summer will be how individual businesses and groups of suppliers and customers through the chain need to establish clear strategies to secure the long-term sustainability of British milk supply and the industry as a whole .

· We are establishing a Groceries Code Adjudicator (GCA) to monitor and enforce the Groceries Supply Code of Practice (GSCOP). The GSCOP was introduced so that major retailers with buyer power would be prevented from passing excessive risks or unexpected costs onto suppliers. The GCA will investigate complaints from anyone in the supply chain that is directly or indirectly affected by a breach of the Code and can deal with them anonymously. A Bill is currently being drafted .

· Under the Rural Development Programme for England and the dairy-specific funding agreed under the European Economic Recovery Programme, Regional Development Agencies have since 2008 been delivering projects concerned with boosting the competitiveness of dairy producers in the areas of modernisation of holdings, higher standards of animal health and welfare, improved nutrient management, and diversification into such activities as ice cream manufacture. The Welsh Assembly Government is investing £3.3m into the Welsh dairy industry over three years through the Dairy Supply Chain Efficiency project. The project is funded by the Supply Chain Efficiencies scheme (SCE) through the Rural Development Plan for Wales 2007-2013.

EU developments – High Level Group and Commission dairy package

12. The Commission’s proposals on contractual relations follow the establishment of a High Level Group (HLG) after European farmgate prices tracked the global dairy market boom and bust during 2007-09 with the EU industry then over-producing against significantly reduced demand. Although the UK was somewhat insulated from this by exchange rate and its geographically isolated market, we actively engaged in all HLG discussions. The Commission’s dairy proposals address four of the HLG recommendations - on producer bargaining power, written contracts, inter-branch organisations and transparency.

13. Since the HLG began we have had continuous engagement with industry and devolved administrations to establish and adapt the UK position and we are actively and constructively engaged in the Council discussion of the Commission proposals.

14. The Commission proposals provide an opportunity for producers to enhance their bargaining power by banding together to negotiate contracts with milk processors. However the Government does not consider that the proposed exemptions from normal competition law, allowing contract negotiations to cover up to 33% of member state production are the best way to strengthen European dairy industries and may lead to distortions of competition, particularly in sub-national markets for raw milk. This might harm UK exports of dairy products. Clarifying that it is already possible for producers to collaborate within existing competition law would be a quicker and less risky way of achieving balance. We want producers to have the opportunity to get a fair share of value that is added in the supply chain without distorting competition.

15. We have requested that the legislation enables national competition authorities to continue to act to protect balanced competition within their respective territories.

16. With regard to contracts, the Government agrees with the Commission that Member States should be free to make contracts compulsory or not and the detail of contracts must be freely negotiated. Prescriptive approaches risk damaging the ability of the industry to innovate and operate efficiently. Regional flexibility in the application of this proposal is essential for the UK. However, we take the firm view that this can be achieved without explicit reference.

17. The Government is content with the proposals on inter-branch organisations, transparency and the voluntary establishment of producer organisations as long as these do not increase burdens or have negative impacts on intra-community trade.

18. We remain concerned that the Commission has not conducted an impact assessment. We are pressing for a full analysis.

The Commission’s ‘Soft-Landing’ Report

19. The UK is about 8% below production quota and quota value is close to zero. In its report the Commission notes positive market developments across the EU After a significant fall in prices and producers' incomes in 2008-09 that followed the price spike of 2007, the dairy market situation recovered in the second half of 2009 and continuously improved in the first half of 2010. Overall the milk sector is gradually heading towards market orientation.

20. The Commission conclude that overall the "soft-landing" as quotas are ended is "on track in an overwhelming majority of Member States" and that there is no reason to revisit the quota phase-out agreed in the Health Check, despite not guaranteeing the soft landing in three over-quota Member States.

21. The Commission’s proposed meetings between Management Committee experts and the industry Milk Advisory Group should help the speed and transparency of market developments, situation and prospects. We have no objection to such improved liaison but it must not allow individual commercial interests to undermine proper procedures.

22. However the Government is sceptical about the Commission’s other suggestion of introducing, in exceptional circumstances, compensation for reducing production by 1% to 2%. This might work against our goal of a competitive EU dairy industry.  Such schemes may be very costly, distortionary, open to fraud, and easily defeated by farmers who expand production. The Commission has not tabled any formal proposals or discussions on this measure.

March 2011