CANADA'S SUPPLY MANAGEMENT SYSTEM FOR DAIRY

Introduction

On first impression, Canada's production and marketings system for dairy appears to be much like that of the United States even though Canada is under a system of supply management. Some of the common elements are: milk classes based on end-use, pooling of producer returns, protection from low-priced imports, and a government support system. However, on closer examination, many important differences between the U.S. and Canadian systems become apparent. The purpose of the paper is to describe the Canadian system with notes on how it differs from the U.S. system. Most of the material for this article is based on information gathered during the author's one-week trip to Canada in June 1997.

Prior to August 1, 1995, the Canadian dairy marketing system largely consisted of provincial prices and quotas for fresh milk and a largely federal system of prices and quotas for manufacturing or industrial milk. Milk classes were largely defined by the province. A 'cascading' system of prices was used to ensure that demand for higher classes of milk was met before lower classes were supplied. Actual distribution to bottlers and processors was determined by a provincial dairy board. At the farm, over-quota beverage milk production was applied against the industrial milk (nearly all non-beverage milk) quota while over-quota industrial milk production faced a heavy levy. Even in-quota deliveries of industrial milk were subject to a moderate levy. Funds from the two levies were used to subsidize exports and other programs.

The current dairy system, implemented in August 1995 and modified several times since, still consists of elements of provincial and federal control but is rapidly moving towards a single system. Milk classes, class prices, pools, quotas, and allocation systems are all moving towards harmonization between provinces.

Two other major forces in Canada's supply management system for milk, in addition to milk producers, processors, and provincial dairy boards are the Canadian Dairy Commission (CDC) and the Canadian Milk Supply Management Committee (CMSMC). The CMSMC, composed of representative of milk producers and the provincial governments and chaired by the CDC, is responsible for oversight of the operation of the national dairy plan. In addition, during it bi-monthly meetings the CMSMC reviews supply and demand conditions and determines if the quota for industrial milk should be adjusted. The CDC, a government crown corporation, is the key administrator of policies and programs for the dairy sector.

That administration includes, but is not limited to, setting the target price for industrial milk, estimating processor margins, and, as necessary, purchasing and re-selling butter and nonfat dry milk (NDM) at pre-set prices to support that target price.

Milk Classification and Pricing System

Currently, 5 basic classes of milk are defined based on the expected end use of the milk. Defining class based on expected end use is similar to what is done in the United States. However, in contrast to the U.S. system where there is no difference between domestic and export use, the Canadian system includes export categories.

Canadian Class 1 milk is for beverage use, while Classes 2 through 4 cover other products needed by the domestic market. Some of these classes are separated into subclasses with the result that, for pricing purposes, 10 separate classes are used in the domestic market. Class 5 milk, with 5 subclasses, includes dairy products for direct export and for further processing for both the domestic and export market.

Prices for the various classes and subclasses are based on multiple component pricing. Thus, with very few exceptions, the price the Canadian farmer receives and the price the processor pays is based on the fat content, the protein content, and the other solids content of the milk. As mentioned, Class 1 prices have traditionally been set by the province and parts of that system remain, though with interprovincial pools, the influence of individual provinces probably is on the wane here also. Technically, however, even when the pools are operational, the provinces will retain ultimate pricing authority.

Classes 2 though 4 are mainly for the domestic market with the support price for industrial milk playing a very large role in the setting of prices for individual components. Government support of the industrial milk price is provided by purchases of butter and NDM, largely similar to the US system.

Class 5, of particular interest to other dairy product exporting countries, is further divided into the following subclasses:

• 5A. Cheese for further processing for the domestic or export market. Prices are based the U.S. Basic Formula Price (BFP).
• 5B. Other dairy products for further processing. -- Prices are based the U.S. Basic Formula Price.
• 5C. Domestic and export activities of the confectionary sector. -- Prices are adjusted annually. During the past 2 years, 5C component prices have been below those of 5A and 5B.
• 5D. Specific negotiated exports including U.S. and EU quotas. This class covers all dairy products, not just cheese. Negotiated or contract prices prevail.
• 5E. Surplus disposal, usually CDC exports. Prices are based on international dairy product markets.

Classes 2--4 and 5A--5D are used to calculate the market sharing quota, (MSQ). The MSQ, including regulation governing its calculation and use, is probably the most important element of Canada's supply management system. Prices for milk produced within the MSQ are supported by direct government subsidy, mandated selling prices for the individual components of milk and an offer to purchase program based on minimum prices for butter and nonfat dry milk. A schematic of the support system follows this article.

Quotas and Pooling

Quotas on milk production are an important feature of Canada's supply management system for the dairy sector. As mentioned earlier, Canada is rapidly moving towards a harmonized system of milk classification and pooling, however, elements of both the federal and provincial systems are still in play. For fluid milk, (Class 1) provincial bodies are largely responsible for determining provincial demand and setting the provincial quota accordingly. The quota for industrial milk, Classes 2-5D is set by the CMSMC, based on its view of national demand, and the national marketing sharing quota (MSQ) is set accordingly. Once the national MSQ is set, it is subdivided among the various provinces according to historical production patterns. At the provincial level, the fresh milk quota and the MSQ are combined and are allocated to individual farms. The provinces of Alberta and British Columbia still have different quota systems for fresh milk and MSQ, however, even these provinces are moving toward a single system.

The quota system is run by officially established provincial boards, which are usually made up of dairy farmers or their representatives. These same boards are also

responsible for allocating the milk to the various processing plants. In addition to the provincial pools, during the 1996/97 dairy year, agreements were reached on interprovincial pooling. The P6 pool, consisting of the six eastern provinces was set up on October 1, 1996, while the P4 consisting of the four western provinces was agreed to in March 1997. At the moment, Manitoba is in both pools. Movement of milk between provinces is generally not allowed. Thus for the immediate future, the major function of the inter-provincial pools is expected to be work on harmonization of classes and standards of milk, common prices, and revenue sharing.

At the individual farm level, it is necessary to possess a minium amount of quota in order to sell milk. Though payment is made on a multiple component basis, the quota itself is calculated and applied on only a butterfat basis. The minimum quota that a farm must have varies between provinces. In Ontario, the minimum quota currently is 1825 kilograms of butterfat per year. (With milk averaging 3.9 percent fat, the minimum quota is approximately equivalent to 470 hectoliters of milk or the annual production of approximately 8 cows.) Provinces also require that quota be used, rather than held for speculation. Again, the rules vary between provinces, but typically provinces require that at least 90 percent of the quota be used in any 6 month period.

Over or under-quota production has been measured on a monthly basis with only small adjustments for seasonality. However, most of the pools allow for an annual balancing at the end of the dairy year. That is, over-quota production early in the year can be offset by under-quota output late in the year. In addition, there is a system for rebates so that refunds can be sent to individual farms that were penalized for being over quota but the province ended the year within its quota.

As part of the harmonization effort, provinces are moving towards a daily quota system with under and over quota measured in days. Thus for example, a farmer would be able to be 10 days over quota or 20 days under the quota before action was taken. The actual over-quota and under-quota limits, expressed in days, are still under negotiation. It was suggested that once the daily system is in place, it would be used to push for more production in the fall months when supply tends to lag demand.

For the individual producer, over-quota production is initially paid at the estimated 'world market price', a figure set by the provincial board with guidance from the CDC. Canadian authorities at various levels claimed that some producers are willing to produce for the figure. In fact, they say there are a few dairy farms, large, modern units, who have only the minimum quota and sell most of their milk at the over-quota price. However, in general the low over-quota price is not considered profitable. Thus most producers who want to expand, purchase additional quota. In recent months, the over-quota price for Canadian producers has approximated $C22.00 per hectoliter.

Provinces provide a market structure to facilitate the exchange of quotas to enable producers who want to expand to buy quota and producers who want to scale back to sell their quota. In addition there are some provisions for moving quota from one province to another. The cost of quotas represent a significant expense for someone who wants to expand his dairy operation and an important asset for someone ready to sell.

Most analysts suggested that the typical dairy farmer would need 5 years to recover the cost of new quota. One analyst estimated that for someone who wanted to start dairying, buying quota would represent approximately one-third of his capital costs. (In recent months, quotas have sold for approximately $C40 per kilogram of butterfat, i.e. approximately 8 times the current price of butterfat). It should be noted though they represent a significant expense, quota costs are not part of the cost of production calculations that go into fixing the target price for MSQ milk.

As mentioned, pooling of returns is generally done at the provincial level with the Provincial Dairy Board managing the pool. Provincial Dairy Boards generally manage both the pickup of milk for individual dairy farms and its allocation to processing plants. Processors are required to document and pay for milk according to the expected end-use of each of the 3 components that make up the price of milk. For example, a plant bottling 2-percent drinking milk (Class 1) will have surplus butterfat and it is likely that butterfat will be used outside of Class 1, perhaps for ice cream production. The Provincial Dairy Boards have the right to audit processing plant records to ensure compliance with that requirement.

Class 5 milk is pooled at the national level with the pool operated by the CDC. The pool of returns for Class 5 milk consists of the sale of all class 5 components, plus a share of the returns from other sales.

That is, under current rules, the CDC uses the province with the highest percentage of milk in Class 5 as the standard and pools that percentage for the whole country. Thus, if Province A sells 20 percent of its MSQ milk into Class 5 while the other Provinces are in the 4 to 5 percent range, then 20 percent of all MSQ milk will be in the national pool for Class 5 milk. For Class 5 milk, returns and disbursements are controlled by the CDC.

Recent Prices:

In recent months, published component prices have indicated class 1 milk was valued in excess of $C62 per hectoliter ($US19.65/cwt), however, prices received by farmers are a pool price and average somewhat lower. April 1997, data for Ontario, the second largest producer, indicated gross producer returns at $C54.46 per hectoliter ($US17.26/cwt). That level of returns was based on component prices of $C5.25/kg for butterfat ($US1.72/lb), $C8.19/kg ($US2.68/lb) for protein, and $C1.17/kg ($US0.38/lb) for other solids.

The actual return to Ontario producers was further reduced by a $C2.15 per hectoliter charge for transportation and $C1.49/ hectoliter for miscellaneous administrative charges. This means a net return for milk of $C50.82/ hectoliter ($US16.10/cwt).

The direct government subsidy than boosted that return to $C53.20/ hectoliter of milk ($US16.86/cwt) or $C13.85/kg of butterfat quota held. (Exchange rate of $CA1.00=$US0.724 was used for conversions).

For the same month, over-quota milk was priced at $C22.12 /hectoliter ($US7.01) based on world market component prices of $C1.48/kg ($US0.48/lb) of butterfat, $C3.99/kg ($US1.30/lb) of protein, and $C0.54/kg ($US0.18/lb) of other solids. That is, the penalty for over-quota production was $C32.34/ hectoliter or over 60 percent of the gross returns. Over-quota production is also not eligible for the direct federal subsidy.

Also, as mentioned component prices for classes 5A&B are based on U.S. prices but with a delay of almost 2 months, i.e. the April BFP, announced on May 5 in the United States was used to set Canadian component prices for June. In cases where manufactures have a choice between using U.S. or Canadian dairy products that delay means that during periods of rising U.S. prices, like spring and summer 1996, Canadian products have a significant price advantage while during periods of declining U.S. prices, like spring of 1997, U.S. products should have a competitive edge.

CANADA'S INDUSTRIAL MILK SUPPORT PRICE SYSTEM
(August 1, 1996 Prices)

1/ Using 3.6 kg of butterfat per hectoliter of milk.
2/ Actual level of producer returns not guaranteed can vary.
3/ Processor margin inferred only from target support level and offer-to-p
4/ Adjustment made to compensate for producer income losses resulting from reduction in the direct payment on to solids non-fat (SNF) only.
Source: Canadian Dairy Commission.

Last modified: Thursday, April 06, 2000