Comment: The signals are clear, the EU's dairy 'safety net' is malfunctioning
Despite historically high prices for butter and normal prices for milk, intervention in the skimmed milk powder (SMP) segment continues, providing a clear example that the EU’s dairy ‘safety net’ mechanism is not functioning as it should.
Dairy farmers in the bloc are clearly being overcompensated and this is not only costly for the EU budget but also sows the seed for market destabilisation further down the line, writes Dr Roel Jongeneel of Wageningen Economic Research (Editor's note: The views and opinions in this article are those of the author and not IEG Policy).
With the debate around reform of the CAP beginning in earnest, a workable solution to this particular issue should be near the top of the agenda.
CAP market tools
The mandate of the CAP states that safety net mechanisms should contribute to two main policy objectives.
Firstly, it should support farm income in case of extreme market conditions (such as downside milk price fluctuations). Secondly, it should contribute to market and price stabilisation.
In regard to the latter of these objectives, the safety net provision is the only instrument in the CAP to achieve this objective.
What is important to stress, however, is that the aim of the provision is to protect dairy farm incomes and not necessarily specific processed dairy products such as milk powder.
Alongside public intervention measures, another CAP market tool is the granting of support (aid) for the private storage of butter, SMP and specific cheeses – effectively taking products off the market temporarily.
It differs from public intervention, as the goods remain under the ownership of private operators who are responsible for selling them once the contractual storage period has elapsed.
No need for SMP intervention purchases
Currently, the milk price that EU dairy farmers receive is in the normal range and butter prices are hitting new highs.
So why is the EU’s dairy safety net provision active if there is no urgent threat to farmers’ incomes?
Put simply, it is because the price for milk powder is currently very low. So low, in fact, that it is below the level that triggers the intervention mechanism.
Therefore, significant intervention purchases of milk powder are taking place, even though there is no need for this if you take into account the prices farmers are receiving for other products.
Intervention in the powder market actually contributes to supporting the milk price at a level beyond its safety net level. As such it is as if the old days of milk price support are coming back.
Depressing price impact
This needless intervention has led to significant public stocks that have reached 350,000 tonnes at an EU level. This is not only costly to the EU taxpayer, but will also contribute to future marketing problems.
Stocks that are generated once will have to be sold and brought back into the market again. When these stocks represent a substantial amount, as is currently the case (already more than 20% of the EU’s total annual skimmed milk powder production), they are likely to create a depressing impact on future milk powder prices.
This will potentially drive farmers’ dairy prices below their safety level at a time when butter prices will also likely come down.
While the market orientation in the dairy sector in general has been improved in the recent reforms of the CAP, the EU dairy policy still contains a safety net provision that lacks a proper market orientation.
So what should be done?
A minimum milk price should be supported, not dairy product prices
The safety net provision in dairy should have a clear focus that aims to protect farmers against extreme downside price risk.
For that reason, a minimum milk price should be supported - not minimum dairy product prices.
The system to link the support to dairy product prices worked fine in the past, but not necessarily so today. When the butter price is extremely high and the skimmed milk price very low, as is currently the case, still an acceptable milk price that is far above its minimum intervention trigger level can result.
In such cases, no intervention whatsoever in the dairy product market should take place.
Markets take on board different signals and as such prices of dairy products can diverge, even though in the longer run one would expect price developments in different dairy product markets to behave in a correlated way (due to the economic principles of the hedonic or milk ingredient pricing and market arbitrage).
The intervention mechanism should be such that it can cope with fluctuating dairy product prices.
It is part of the EU’s market orientation to accept price movements, since they have an important function to clear markets, taking into account different shocks to the system.
This implies that the EU safety net provision, which aims to support the farmer milk price, should allow for substitution in the dairy product mix, and only starts to operate when the total return from dairy product sales is too poor to support the safety net-minimum milk price to farmers.
Moreover, it needs to be considered whether the possibilities for private storage support should not be extended.
Private storage support has an advantage in that the responsibility for the stocked products stays in the private sector, which could not only contribute to reducing risk for the European Commission, but also to a more business-driven management of market stabilisation operations.
In conclusion, it is time to complete the EU’s market orientation of the CAP by also reforming the safety net provision in dairy.
This would prevent the ongoing waste of public money and help avoid the build-up of market-destabilising stocks of dairy products in the future.
Dr Roel Jongeneel is Market & Policy Analyst for the Agricultural and International Policy Group at Wageningen Economic Research. For further information, visit the Wageningen Economic blog page: weblog.wur.eu