The new world of Canadian dairy pricing

Nearly 30 per cent of the price farmers receive for milk is now tied to global prices

Dairy farmer Paul Vickers knew change was coming, but he was still a bit shocked when his June milk payments brought in less revenue than usual.

Like many dairy farmers across Canada, Vickers is adjusting to swings in revenue unlike anything seen since the advent of supply management almost 50 years ago. A greater percentage of the price farmers receive for their milk is now based on the world market and volatility there is more quickly reflected.

Why it matters: Canadian dairy farmers still have less price volatility than other sectors of agriculture, but having less predictability than they’ve been used to will require new skills and also affect suppliers and lenders.

Dairy farmers used to know what to expect in their milk cheques, with some minimal changes based on the type of milk product that was most needed in the market and their own variation in production of butterfat and protein. Prices to a large degree were influenced by prices set by the Canadian Dairy Commission (CDC).

The CDC pricing still determines most of the milk cheque, however, now about 29 per cent of what dairy farmers are paid is based on the world price. That compares to about 21 per cent before the introduction of Class 7, said Graham Lloyd, general manager and CEO of Dairy Farmers of Ontario.

How the system evolved

Led by a strong push from Ontario, the Canadian dairy sector responded in 2016 to rising imports of milk protein isolates, dried milk powders high in protein that could be imported free of tariffs, by creating Class 7, a special class of milk that was priced competitively with imported protein isolates.

The result has been hundreds of millions of dollars of investment in dairy processing across the country as processors here committed to replacing imported ingredients with Canadian-sourced milk.

It also meant a dramatic increase in milk quota as dairy farmers traded a bit of their price certainty for the ability to grow their businesses.

Growth in use of butterfat and in the use of Class 7 milk by processors boosted dairy quota more than 20 per cent over the past three years.

That growth has come to an abrupt halt. Slower-than-expected new processing construction ended extra fall production credits and prompted a clawback of 1.5 per cent of quota in Ontario and 3.5 per cent in other parts of the country.

Dairy farmers remain optimistic, however, and some welcome a chance to try to catch up to that increase in quota.

Vickers, for one, couldn’t keep up with that much growth. Just as he was planning to manage one growth period from a quota increase, another would arrive.

“We were getting ahead of ourselves. We are based on a market that produces for the demand. If we are over producing, then we wouldn’t be any different than Americans.”

He does question the hard stop to expansion and suggested growth and the later quota slowdown could have been foreseen.

Lloyd said the supply management system continues to provide significantly better stability than any other system, especially compared to the United States.

Farm Credit Canada issued a recent report amending its January predictions for Canadian dairy downwards, another sign of the increased volatility in the marketplace.

“Our January forecast for Canadian dairy failed to anticipate the challenges to profitability the sector faced in the first half of 2018,” stated the report. It said profits in the P5 milk pool (Ontario, Quebec, Nova Scotia, New Brunswick and Prince Edward Island) will be at breakeven or slightly profitable and dairy farmers in the western provinces will be slightly above profitability for the rest of the year.

“In supply management you have to balance that supply and demand. They maybe had over-estimated what that demand would be,” said Leigh Anderson, a senior agricultural economist with FCC.

New reality

Vickers, who milks about 60 cows, knew increased volatility was coming. He was chair of GayLea Foods, the dairy farmer owned co-operative, when it aggressively pushed for the adoption of Class 7.

“When I sat on the board of GayLea Foods, I understood that when we brought in Class 7 pricing that this would be happening. A certain amount of our milk is sold on the world price, so we have to get used to it,” he said.

The June milk cheques hammered home the new reality. The first milk cheque of the month is an interim payment, 90 per cent of the value of what was shipped in the first two weeks of the month, and so the second cheque is usually higher.

But in June the variations in the market meant Vickers’ second cheque was about the same as the first. “That was a little bit of a surprise,” he said.

Less stability in income has meant hiring less custom work, making older equipment last longer and paying more attention to global milk prices. “We’ve really cut out capital spending right now. Our farm is heavily indebted to start with. I know capital purchases are really put on hold.”

Vickers is not, however, cutting down on purchased feeds or protein in the barn.

“I might think it will save me money, but you still need that amount of milk going out the door,” he said.

They have also fixed the rate on some of their financing, as interest rates in Canada have risen over the past year. “I didn’t do it with all my debt, but with good chunk of it to give a bit of stability.”

Unlike previous downward cycles in world milk price, Canada’s dairy farmers are feeling more of the impact of the stubbornly low price, as they are more tied to the world market. Class 3 milk price in the United States had been improving until June, when it dropped throughout the month, and then tumbled further in July due to the tariffs placed on American milk in retribution for the U.S. steel tariffs and usual annual market influences. The drop was about 10 per cent. The U.S. price mirrors trends in the world price, to a large extent.

CDC still in control, with some external influences

The Canadian Dairy Commission, however, still has the largest single influence on price of milk in Canada and will continue to do so as long as the supply management system remains in effect.

And dairy farmers will see an increase in the butter support price as of Sept. 1, 2018. The price will be raised from $8.0062 per kg to $8.3901 per kg. That translates to about $2.60 per hectolitre increase for Ontario farmers, said Lloyd.

The CDC says that the cost of production of milk rose by 5.1 per cent in Canada in the last year, with fuel and feed leading the increase, along with some influence by interest rates.

With more volatility, dairy farmers will need to focus on what they can control, said Anderson.

Protecting on price risk?

Other livestock and crop farmers can protect against some of their price volatility by hedging and forward contracting.

Dairy farmers can’t do that with their price, even if 30 per cent of it is following unpredictable markets up and down, as the milk is all collectively sold through Dairy Farmers of Ontario.

There’s little doubt that Ontario dairy farmers are being paid less for their milk, based on the need to compete with imports. How much pressure will there continue to be if Class 7 milk continues to grow?

Lloyd doesn’t think there will be significantly more growth in the lower-priced Class 7 milk. Canadian producers have already won back much of the market for ice cream, cheese and yogurt being filled by imported protein isolates.

“I expect Class 7 will maintain its current utilization,” he said.

This article was originally published on Farmtario.

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