EU Proposals for the Dairy Industry

Written evidence submitted by NFU Scotland (DRY 02)

· Last year the EU’s High Level Working Group on dairy concluded that producers are exposed to unreasonable risk compared with processors and retailers resulting in producers receiving a poor return from the dairy supply chain.

· NFUS believes we must introduce compulsory contracts that are fit for purpose between producers and processors. If the EU Commission allows Member States flexibility, the UK should take the compulsory route, or allow producers to demand a contract.

· Dairy producers must have the ability to form Producer Groups of the scale to allow sufficient negotiating powers to realise effective contracts, include pricing mechanisms that react to the real market, are transparent and reasonable to buyers and sellers.

· An adjudicator must be installed to investigate proactively any abuse of power which undermines the short- and long-term sustainability of the dairy supply chain.

· With effective contracts, a more ambitious processing sector and realistic controls on retailers, the dairy sector will thrive, reducing the reliance on imports and improving our food security. If this opportunity is missed the current decline in milk production is inevitable.

1. The serious decline in the price paid by milk processors to European dairy farmers in 2008/2009 led to a crisis in the European dairy sector. The EU Commission initiated a High Level Experts Group (HLG) to investigate the issues and recommend solutions.

2. The HLG was very clear that producers were exposed to unreasonable risk compared with processors and retailers resulting in producers receiving a poor return from the dairy supply chain. They concluded that there was an urgent need for greatly improved contractual arrangements between producers and processors and that this was only possible if producers could increase their negotiating position.

3. The subsequent Commission proposals recommended that current competition law was inadequate and measures were required to rebalance the bargaining position in the supply chain and improve contractual relationships They proposed that contracts must include four fundamental issues, namely price, volume, seasonality of delivery and contract length.

4. On Competition law the Commission is critical of the notion of ‘the relevant market’ which they believe is not defined, can only be judged retrospectively on a case by case basis and lacks certainty. The proposal is that producers should legally be able to form Producer Groups up to 3.5% of EU production or 33% of Member State production.

5. Twenty years ago there were more than 5000 dairy farms in Scotland. Today there are fewer than 1100. The decline is not due to poor efficiency; a recent study undertaken by ADAS and SAC concluded that Scottish dairy farmers were amongst the most efficient in Europe and have one of the highest average EU herd sizes, with major levels of restructuring.

6. In 2009 milk production in the UK fell below 13 billion litres, the lowest level of production since 1971. This is in the context of a buoyant global dairy sector, with global prices historically high and likely to benefit from a growing and more affluent world population. Responding to this opportunity, world dairy production has risen by 20% in the past decade; the EU has increased production by 4%, while the UK has reduced production by 10%.

7. Yet, the UK imports around 40% of its dairy requirements; this equates to roughly 5-6bn litres of milk, a trade deficit of around £1.3billion. UK dairy farmers can produce a substantial amount of this milk, if they are given the incentive.

8. In the past year world dairy prices have increased dramatically. The value of the most commonly traded products of powder, butter and cheese are historically high, and it is generally accepted that these values will become the norm. In Europe and New Zealand producers have benefited from the real market drivers with substantial price increases now reaching over 30ppl. In the UK, price rises to producers have been much slower and much less significant, with producers only recently achieving prices up to an average of 26ppl. The cost of producing a litre of milk is now on average 30ppl. It is more important, however, that producers receive a price that truly reflects the value of their product as indicated by the markets, rather than a price that is simply higher than the cost of production.

9. The reasons for this situation are also clear. The UK market does not react to global market indicators quickly or accurately enough. The current structure of power and competition within the UK supply chain is only possible because of the inability of producers to negotiate reasonable contracts which reflect the true value of dairy products. In broad terms, the balance of power between and within the broad retail and processor sector has driven farmgate prices below their true value and below the cost of production.

10. The retail sector recognises the value of dairy products to attract customers into their stores. Constant and excessive discounting is used to compete to offer the lowest prices. Processors are unable or unwilling to withstand the pressure to reduce prices to the big retailers, as even the biggest processors cannot afford to lose volume sales of the scale controlled by retailers. In turn, processors big and small are offering unrealistically low prices just to retain their market share, but at unrealistic margins. They can do this as long as producers have no effective contracts or sufficient bargaining power to negotiate fair and reasonable terms and conditions.

11. DairyCo figures confirm that the retail sector retained 44% of the liquid margin in 2010 compared to 7.8% in 2000, and as much as 51% of the cheese margin in 2010 compared with 34% in 2000. The retail sector has sufficient margin to allow a fairer distribution of the end value without consumers paying more.

12. The UK processing industry is underpinned by low producer prices, which they control. There is huge potential for processors to access more of the UK market and there are clearly growing opportunities to export more dairy produce, as added value product and as commodity. UK commodity market indicators indicate the value of powder, butter and commodity cheese products are over 32ppl. Currently, UK processors produce small percentages of these products, preferring to produce liquid milk and mature cheese, but due to the dysfunctional UK market these are realising lower values. Processors lack ambition as, although they are unable or unwilling to demand fairer prices from retailers, they can manage margins through cost control, largely raw milk. UK processors have paid the lowest prices for the vast majority of the past decade compared to Europe. In recent years they have also benefited from a very favourable exchange rate, and yet our balance of trade deficit continues to accelerate.

13. NFU Scotland’s position is clear:

· We must introduce compulsory contracts that are fit for purpose between producers and processors. If the EU Commission allows Member States flexibility, the UK should take the compulsory route or allow producers to demand a contract.

· Dairy producers must have the ability to form Producer Groups of the scale to allow sufficient negotiating powers to realise effective contracts that include pricing mechanisms that react to the real market, are transparent and reasonable to buyers and sellers.

· An adjudicator must be installed to investigate proactively any abuse of power which undermines the short- and long-term sustainability of the dairy supply chain.

· With effective contracts, a more ambitious processing sector and realistic controls on retailers, the dairy sector will thrive, reducing the reliance on imports and improving our food security. If this opportunity is missed the current decline in milk production is inevitable.

2 March 2011