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BRIEFING: Dairy regulation and floor pricing

Katie McRobert - Thursday, February 21, 2019

Almost 20 years after deregulation of the Australian dairy industry, Labor has flagged a potential return to government intervention in the market. If elected in May, a Labor Government will task the ACCC to assess and test the efficacy of a Minimum Farm Gate Milk Price1 and to make recommendations on the best design options.

The AFI research team has produced this briefing to discuss how might this impact the industry and what we already know about floor prices in Australian agriculture.  

Background

Milk is a global commodity and dairy farmers are price takers. Unlike many countries around the world, there is no legislative control in Australia over the price processing companies pay farmers for their milk. Australian dairy farmers have operated in a completely deregulated industry environment since 1 July 2000, when all states repealed legislation governing sourcing and pricing of drinking milk, and the state milk authorities, which administered these controls, were wound up2. Prior to 2000, the dairy industry was long one of the most highly assisted and regulated industries in Australia3. Immediately after deregulation, Woolworths announced standard national prices for its generic-labelled milk4 that effectively created a new floor price, as other major retailers (Coles, IGA and Franklins) soon followed suit.

At an average of around US42c per litre, Australian dairy farmers receive a low price by world standards. ABARES expects Australian farmgate milk prices to remain relatively unchanged in 2018–195, due to export price premiums for some commodities, competition among major processors for suppliers and an assumed fall in the Australian dollar.




Figure 1: Av. price/L Australian milk. Source: ABARES

International prices are the major factor in determining the price received by farmers for their milk. Most of Australia's dairy farmers are concentrated across the dairy regions of southern Australia, where most of their milk is processed and turned into cheese and milk powders for export. Around 40% of Australian milk production is exported - primarily as manufactured products - at international market prices, thus the global market is the biggest driver of the price.




Figure 2: AU milk price vs global (GDT) price. Source: Dairy Australia


The National Farmers’ Federation is keen to see the implementation of a Dairy Mandatory Code of Conduct, which was endorsed last year by industry and Government following the ACCC review, but has strongly cautioned against entertaining a return to floor pricing and regulation.

AFI commentary on dairy issues

In 2013, then-AFI Executive Director Mick Keogh wrote about the drought conditions in NZ affecting the global milk price, noting that if the Australian industry was functioning correctly it should follow the global market with increased farmgate prices flowing on to the consumer6. From 2013 to 2014 there was a rise in farmgate milk prices7, however the retail price of supermarket-branded milk remained unchanged over this period at $1/L. 

In the Autumn 2013 Farm Policy Journal Freshagenda Director Steve Spencer discussed the Horizon 2020 project investigation8 into the complex issues surrounding dairy market influences- including a decline in NSW/Qld milk production following deregulation, significant consolidation in processing ownership and capacity and changes in supply contracts - concluding that in effect the “actual impact of the lower retail pricing has not been as great as the industry feared”.

A 2016 blog post by the AFI10 discussed the sharing of risk along the supply chain which indicated the disproportionate level of jeopardy on farmers rather than processors and noted the need to modernise “outdated” marketing arrangements in sectors such as dairy.

Fundamental issues for Australia’s dairy industry were discussed by Dr Peter Stahle, Australian Dairy Products Federation Executive Director, and David Basham, Australian Dairy Farmers Acting President, in the November 2016 Farm Institute Insights Newsletter’s ‘In My View’ feature11. Both contributors noted the strong influence of the global market on domestic dairy prices and the need for improvement in contractual supply agreements.

ACCC inquiry findings

Due to the level of adversity the Australian dairy sector has faced over the past decade, the ACCC was commissioned to conduct an inquiry into the industry’s performance. The report12 (published in April 2018) covered supply chains, bargaining power and risk allocation, concluding that establishing a mandatory code of conduct is the best option to improve the position of farmers in the dairy supply chain.

The report also included recommendations on simplifying contracts, ensuring that contracts will not unreasonably restrict farmers from switching between processors, utilising mediation between farmers and processors. It did not recommend reconsidering regulation.

Of the 112 submissions received by the ACCC, only one representative group submitted that new legislation or reregulation should be considered to set prices and deal with alleged anti-competitive behaviour. The report noted that the industry has consolidated since deregulation, and that national milk production has decreased by 15% but has become increasingly stable over the past decade. Evidence obtained by the ACCC found no direct relationship between retail private label milk prices and farmgate prices, and that:

  • production volumes trended down in higher cost regions (Qld, WA) since price support was removed; the price of private label milk does not appear to have altered this trend
  • farm exit trends in the higher cost regions have not changed in response to the introduction of $1/L milk
  • total farm numbers, output and profitability trends have not changed since the introduction of $1/L milk

Effects of price floor on markets

Of course, farmers should get a fair return on what they produce but the question here is whether the price floor13 is the right avenue to correct the issues in the dairy sector.

Although now out of fashion with economists, the idea of a commodity price floor remains attractive to policy-makers. Price floors for agricultural commodities have been intensively used in global markets, such as the US and EU. However, this can have a negative impact on sustainable production and distort the correct functioning of markets by sending price signals that cause an unwanted accumulation of surplus product. 

The Australian Wool Reserve Price Scheme provides a good example. The Australian government set a price floor for wool in the mid-1980s to protect the sector. However, the price floor simply set the price at artificial and unsustainably higher levels. By interfering with demand and supply forces, the eventual demise of the price floor scheme led to one of Australian agriculture's greatest financial disasters in 1991. With the collapse of the system, the price of wool fell overnight from 700 to 430 cents per kilogram, leaving the Australian industry with a stockpile of 4.6 million bales of wool (almost a year’s production) and a debt of A$2.7 billion (Bardsley, 1994)14. The collapse of the Wool Reserve Price Scheme demonstrates the inherent risk of price floors; ie. if regulation sets a price floor above the market price, this causes an artificial supply and demand cycle resulting in an oversupply.

If the price floor is higher than the market clearing price, consumers reduce their purchases, while on the other hand suppliers increase production as they are now getting paid more for the product than before, naturally creating a surplus of unsold product in the market. If this surplus is allowed to be in the market, it will create a downward pressure on the price. To keep the price from dropping, the government has to either: (1) buy up the entire surplus; (2) strictly enforce the price floor and let the surplus go to waste; or (3) control how much is produced. 


Figure 3: Effect of price floor on markets 


According to the ACCC report local milk demand is stagnant, meaning increases in prices would not incentivise processors to buy more milk and influence farmgate prices. In regions where milk is mainly produced for export, farmgate prices and profit reflect the global dairy commodity price changes.

Questions to consider

  • What impact would a regulated price have on the dairy export market? 
  • Would a floor price lead to a supply management system such as that employed in Canada?15
  • Has the attention on the $1/L price war distracted from the fundamental problems within the industry (e.g. disproportionate risk allocation between farmers and processors)?
  • With Australian dairy producers being amongst the world’s most efficient, what impact might a floor price have on production efficiency?




  1. Press release: Labor will investigate a floor price for dairy farmers
  2. Dairy Australia: deregulation 
  3. Edwards, 2003
  4. Australian Competition & Consumer Commission, 2001 
  5. ABARES agricultural commodities: Sept 2018
  6. An interesting test ahead for the Australian milk market, (Keogh, March 2013)
  7. http://www.agriculture.gov.au/milkpriceindex/Documents/understanding-the-cmpi.pdf 
  8. Freshagenda: Horizon 2020
  9. Spencer (2013), Dairy's challenging horizon, Farm Policy Journal, Vol. 10, No. 1, pp. 13-29
  10. Is it time agricultural risk was shared along the supply chain? (Keogh, July 2016)
  11. November 2016: In My View - Fundamental issues for Australia’s dairy industry
  12. ACCC Dairy inquiry report (April 2018)
  13. A price floor is the minimum legal price set by the government, often used in agriculture to protect farmers’ incomes or to guarantee food supply.
  14. Bardsley, P. (1994). The Collapse of the Australian Wool Reserve Price Scheme, The Economic Journal, 104(426), 1087
  15. Time to get regulation back into Australian dairy? (Muirhead, 2016)

 
Comments
Andrew Weinert commented on 09-Mar-2019 10:16 AM
Thanks for this work. I have several points that I would like considered by the writers. No mention of 115,000 tonnes of cheese imported (note USA only imports 80,000 tonnes). Equivalent to 1.15 BILLION Litres of milk. @ average price of $0.46 per litre = $526 million not going to Aus farmers. The prices paid for milk at farm gate change from state to state and time to time. Some have a base price that rises through the year, some have monthly prices, some are paid on components (going to storable products) and some are paid by the litre for drinking milk and some a combination. The calculation above is based on 10 litres per kg cheese and $0.46 per litre. Change the calc if you like. Prices across Australia can be found at Dairy Australias web site. No mention of 37,000 tonnes of butter imported. That is 30,340 tonnes of fat. If we use $5.46 / kg milk solids (since we gave up using the sensible specific price for fat and protein). That gives a value of $165,656,000 NOT GOING TO AUS FARMERS. Actually the price of fat was higher last year. No mention of the higher costs of a flat production curve (so called high cost states) vs seasonal production. These apply to states where the residual effects of the quota system exist (yes, 20 years later). No mention that Australia had AT LEAST 2 payment systems!! In reality 7 - one for each region. Basically: Pooling - which stimulates supply AND supported large scale factories eg Koroit, Cobram, Wynyard, Leongatha etc etc.; and Quota (carrot and stick). Set volumes based on market milk requirements with no care for growing cheese consumption and that new fangled sour milk stuff (Yoghurt). We need to look at the needs of the future and what is required for current consumption. The have not calculated how much milk is required to make the dairy products consumed by Australians - why would you do that. Population 2019 - 25 million growing at 1.8% per year. That is 450,000 per year. 102 L Drinking milk 135 L for cheese. 13.5 kg per person - consumption rising slowly. Also produces about 6.5 kg whey powder per person for export (some factories - not all). 96 L for butter 4.8 kg - consumption rising. Also produces about 9 kg of skim milk and Buttermilk powder per person for export. 17 L for Infant formulas. (Based on imports). 10 L for Icecream. 10 litres for Yoghurt. 371 litres (ball park) needed per person. 9.25 billion litres. Needed to produce all the dairy products consumed in Australia. Note: there will be some cross usage of products. These are rule of thumb calculations.

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