Dairy Exports: Shelter in the Face of Stormy Market Changes

By Ralph Dutrow

Amid a maelstrom of changing production patterns, new international trade agreements and aggressive competition, U.S. dairy exporters are employing new strategies that emphasize market flexibility, "designer" product lines, smart production strategies and shrewd use of market intelligence.

American agriculture's new focus on export markets is an oft-told success story. Yet one major sector of U.S. agriculture has been uncharacteristically restrained in the growth of its exports: dairy.

Despite having the largest, and by all measures one of the most efficient and progressive dairy production and processing industries in the world, U.S. dairy product exports have traditionally been small and shown little growth. On a milk-equivalent basis, exports have generally accounted for only 2 to 3 percent of U.S. dairy production---a figure roughly balanced out by imports.

What's more, only a relatively small proportion of those exports were sold on normal commercial terms. The majority of U.S. dairy product exports were either donations or sales at discounted prices by the U.S. Department of Agriculture of surplus dairy commodities under the Commodity Credit Corporation (CCC) price support program; or subsidized sales under the Dairy Export Incentive Program (DEIP).

But change is in the air; commercial, nonconcessional U.S. dairy product exports have risen steadily in recent years, so that in 1996 they finally surpassed the value of concessional exports. Furthermore, growing recognition is sweeping the U.S. dairy industry that the old ways have to change to meet new policy requirements and marketing opportunities, and that dairy, too, must take a more prominent place in the export picture.

Why hasn't dairy been more export oriented in the past? The high moisture content and perishability of many dairy products and the large U.S. domestic market explain part of it, but not all. By way of contrast, New Zealand, a country that's virtually cow heaven, has approximately one-third the number of milk cows yet only approximately 1.5 percent as many people as the United States. With this relatively small domestic market balanced against such hefty production, New Zealand thus exports 90 percent or more of its dairy output.

But many of the impediments to U.S. exports have been of an institutional rather than structural nature. In the United States and in many other nations, probably no other area of agricultural production and trade has been more influenced by government than dairy. However, three critical recent events point to a revolution in the dairy sectors not only of the United States, but of nations around the world.

Winds of Change, From Three Directions

The first change in the trade climate was the North American Free Trade Agreement (NAFTA). Over a 10-year period that began with implementation of the NAFTA on January 1, 1994, all tariff and non-tariff barriers to trade in dairy and other agricultural products are to be eliminated. (The single dairy exception to this is the Mexican duty on imports of nonfat dry milk from the United States, which will be phased out over a 15-year period. Mexico also established an initial zero-duty tariff rate quota of 40,000 tons for U.S. nonfat dry milk imports, which increases by 3 percent annually.)

In addition to giving U.S. exporters a break from the 10- to 20-percent tariffs Mexico applies to dairy imports from competitors, NAFTA eliminated import licenses that at times served as a serious non-tariff barrier to its dairy market.

NAFTA sets the stage for what will ultimately be open access for U.S. dairy exporters to Mexico, in most years one of the largest--if not the largest--dairy-importing countries in the world. Mexico is only about 70 percent self-sufficient in dairy production, implying a tremendous need for a wide variety of dairy product imports. Combined with U.S. proximity to Mexico, NAFTA has already proven to be a boon to the U.S. dairy industry.

Although U.S. dairy sales to Mexico dipped following the economic crisis that began in December 1994, with Mexico's improved economic conditions, the recovery of U.S. dairy product exports has resumed a rapid pace. In addition to significant shipments of fluid milk and cream from border areas, the United States exports a wide variety of processed and higher value dairy products to Mexico. With the recent financial difficulties in Asia, Mexico and Latin American countries are taking on even more importance to U.S. dairy product exporters.

The second new current to sweep through was the Uruguay Round Agreement. For the first time, multilateral trade negotiations under the General Agreement on Tariffs and Trade achieved reform in agricultural trade.

While establishing limits on internal supports for agriculture and setting minimum access commitments for imports, perhaps the Uruguay Round Agreement's most significant accomplishment affecting dairy was that it placed limits on subsidized exports--a market tactic that had been employed in one manner or another by virtually all dairy producing nations to dispose of surpluses.

No more. Over a six-year period to be completed in the year 2001, all Uruguay Round Agreement signatory nations must reduce their subsidized exports by 21 percent in volume and by 36 percent in budgetary expenditures. No longer will the world market be an unlimited dumping ground for surplus nonfat dry milk, butterfat, cheese and other dairy commodities that it has been in the past. By increasing import opportunities while curbing subsidized exports, the Uruguay Round Agreement is expected to contribute to a gradual, modest rise in world market prices for dairy products to levels more nearly approaching those prevailing in the United States, with our large and affluent consuming public.

The third current, perhaps as brisk as its predecessors, portended a greater international role for U.S. dairy-- the Federal Agriculture Improvement and Reform (FAIR) Act of 1996. With the Uruguay Round Agreement in place, Congress felt secure in charting a course for reduced involvement for government in agriculture generally, including dairy.

In one of its most high-impact features, the FAIR Act began phasing out the price support program that has for decades set the floor under U.S. dairy product prices. Already in 1998, the support price for milk, $10.05 per hundredweight (100 pounds), is the lowest since early 1979. On Jan. 1, 2000, the CCC will no longer be the buyer of last resort for surplus dairy production; prices will be free to find their market-clearing level. The international market will replace the CCC as the "ultimate safety net" for the U.S. dairy industry.

However, even with the added uncertainty stemming from milk market order reform and changes to classified pricing, the U.S. dairy industry at all levels is expected to continue to chalk up productivity and efficiency gains. The domestic market will continue to be of overwhelming importance in setting demand and price parameters.

Even the most optimistic forecasts for growth in U.S. dairy product exports don't make it to double-digit percentage levels. With supply and demand in approximate balance, however, farm milk and dairy product prices could be marked by even greater volatility than has been experienced in recent years. The international market may actually have to set the price floor for bulk dairy commodities during times of surplus U.S. production.

But in perhaps its greatest adjustment, the U.S. dairy industry will have to focus less on production and orient itself more to the market, especially to the requirements of the export market, than it ever has in the past.

A Peek at Production Peaks

Fluid milk consumption in the United States has remained flat for a number of years-- population growth has barely kept ahead of reductions in per capita consumption. Milkfat supply and demand have been in such delicate balance that butter prices have been marked by dizzying fluctuations in seasonal, and at times even week-to-week levels.

Cheese, of course, has been the major growth item in the dairy product constellation. With a seemingly insatiable appetite for pizza, U.S. consumption of Mozzarella and other Italian-type cheeses has led the way. More recently, cream cheese consumption has shown a marked increase, driven by the American taste for bagels for breakfast.

The major dairy product of greatest concern is nonfat dry milk. To understand why requires an understanding of production patterns: Milk production in the United States in recent years has remained essentially steady in such traditional dairy farming regions as New England, the Great Lakes region and the Upper Midwest.

Not so in the West. Taking advantage of attractive climates, room for expansion and economies of scale, the dairy industry there has grown by leaps and bounds. California is now America's leading dairy state, and other states from Idaho to New Mexico have also dramatically cranked up milk production. With relatively stable local demand for fresh milk, most of the increased milk supply in the West is being used for manufactured dairy products--including nonfat dry milk by the ton.

Finding outlets for it may be the greatest marketing challenge ever for Western dairy processors. In recent years, nonfat dry milk has been the only surplus dairy commodity purchased in significant quantities under the CCC price support program. For decades, nonfat dry milk in the United States has been processed largely to meet CCC product specifications, and marketing very often meant little more than delivery to CCC.

But in less than two years, this option will be gone. The potential for burdensome supplies of Western nonfat dry milk hanging over dairy product markets throughout the United States is of great concern to the entire U.S. dairy industry.

On a positive note, the DEIP will still continue to provide help to U.S. exporters of nonfat dry milk in combating subsidized exports and other unfair trade practices of competing exporters, primarily those of the European Union (EU). During the period July 1997 to June 1998, 92,217 tons of nonfat dry milk, the maximum volume permitted to the United States under the Uruguay Round Agreement, could be exported under the DEIP. This tonnage allowance is expected to be fully reached by U.S. exporters.

But this volume will decline to 68,201 tons during the 2000/01 year. Clearly, the DEIP, while offering important assistance to the U.S. dairy industry where appropriate, is not a solution to the potential oversupply problem of nonfat dry milk on the U.S. market.

Expanded non-DEIP exports and greater product differentiation may provide more of the answer. With Mexico right next door and with all of Asia waiting, the West Coast is in an excellent position to increase exports of nonfat dry milk and many other kinds of dairy products. Rising international dairy product prices may close the gap with those of the United States and make commercial, non-subsidized sales feasible at least during portions of the year. Perhaps even greater opportunity lies in fine-tuning the manufacture of nonfat dry milk and other milk powders to meet the specific requirements of food processors and other end users around the world.

Product Trends Perk Dairy Sector

A greater commitment to meeting the exacting needs of international buyers, improved packaging, more flexible delivery terms and other product and marketing improvements should give U.S. exporters an edge in the international marketplace of the future.

Greatly increased U.S. exports of whey products, lactose and other milk powder components in recent years may serve as a model for what can be done to boost exports of nonfat dry milk. Never buoyed by government price support programs, many of these products were until recently seen as little more than waste to be disposed of as cheaply as possible. Now they are valuable ingredients for myriad food processing and industrial purposes. Exports have increased from essentially zero not too long ago to over $177 million in 1997. (For further information on whey product exports, see "The Best Whey to Expand Exports.")

Cheese exports promise to ripen even more in the future. As American cuisine has spread around the world, U.S. exports of Mozzarella, processed American and cream cheese have increased significantly. There is every reason to believe that these exports will continue to increase in the future.

The global reduction in subsidized cheese exports, thanks to the Uruguay Round Agreement, also opens tremendous opportunities for expanding U.S. cheese exports. The EU has traditionally been the leading subsidizing exporter of cheese and most other types of dairy products.

However, in what will perhaps be the Uruguay Round's single most important dairy trade reform, the EU must sharply reduce its subsidized cheese exports, from approximately 450,000 tons in the early 1990s to 321,300 tons by the year 2001.

With reduced subsidies, EU cheese exporters have learned to tighten profit margins and continue to export significant quantities of cheese. Nevertheless, U.S. cheese manufacturers are already gaining new market opportunities in countries where the EU is no longer competitive.

Anticipating Tomorrow's Competition

Who will U.S. dairy producers have to compete with in the international marketplace of the future?

Clearly, the EU will continue to be a major force, and Eastern Europe may become a more significant competitor after the year 2000.

Some in the dairy sector look to a more important role for Argentina, pointing to its vast grasslands and abundance of feedstuffs. Already, Argentina is exporting significant quantities of dairy products to Brazil and other South American countries. Argentine dairy producers, however, will have to compete against export buyers for locally produced feed grains and protein meals, and with Argentina's recent status as "free of" foot-and-mouth disease, its grain-grabbing beef sector should be reinvigorated.

With its pasture-based farms, New Zealand is probably the world's lowest cost producer of dairy products, making it a leader in international markets. New Zealand's strategy is to place increasing reliance on exporting higher value products, such as cheese and whole milk powder, and relatively less on bulk commodities such as nonfat dry milk. Boosted by strong export revenue growth, milk production in New Zealand increased by one-third between 1993 and 1997.

However, New Zealand's ability to expand low-cost milk production may be approaching full capacity. Most of its best pastureland is already being used for dairy, so further growth may require higher milk output per cow--based on increased, and increasingly expensive, grain feeding. Expanded dairy processing capacity also requires major capital investments, which dairy farmers are increasingly reluctant to make.

Australia gives pause for thought. It's in an excellent position to expand its already thriving dairy industry, either through a pasture-based or confinement production system using locally grown feedstuffs. Already, there are reports of New Zealand dairy producers moving to Australia in search of expansion opportunities. With easy access to Asia's huge markets for dairy products, Australia would appear to be poised as an increasingly important player in international dairy markets.

Take Exporting by the Horns

Where does this leave the United States? Without doubt, moving to a more market-based environment will require a substantial adjustment for the U.S. dairy industry. Most industry observers, however, feel that the U.S. dairy sector will make this transition successfully, with exports inevitably playing a much greater role than ever before.

Above all, it will require a serious industry commitment to meet the exacting needs of overseas buyers, and to be a reliable supplier at competitive prices throughout the year. Significant investments will be necessary, both in processing equipment and, perhaps more importantly, in foreign market development to allow the U.S. dairy industry to fully exploit emerging export opportunities.

_____________________________________
The author is group leader for Dairy and Poultry in FAS' Dairy, Livestock and Poultry Division. Tel.: (202) 720-7400; Fax: (202) 720-0617; E-mail: dutrow@fas.usda.gov

The DEIP - An Important Market Development Tool

By Paul Kiendl

The Dairy Export Incentive Program (DEIP) has undergone a number of changes since its inception in 1985. In the early days, the emphasis was on battling European subsidized exports and getting rid of surplus stocks of U.S. butter and nonfat dry milk.

But with the signing of the Uruguay Round Agreement and the implementation of the Federal Agriculture Improvement and Reform Act of 1996, there has been a growing recognition in the U.S. dairy industry that the role of government in international and domestic markets is set to decline.

Now the industry is entering a period of uncertainty as it moves towards a more market-oriented environment where the traditional government support net will be much lower.

In this setting, the ability to sell products such as nonfat dry milk (NFDM) and butterfat to overseas customers will become more important. For this reason, the role of the DEIP has evolved to focus primarily on the development of new foreign markets and thus promote the added sale of U.S. dairy products. This transformation has been aided by the greater involvement of dairy exporters and processors in targeting potential markets and helping to make the program more user-friendly.

For example, while traditionally the bulk of NFDM was exported to Mexico and North Africa, the program has now been expanded to cover a number of Asian countries that continue to offer long-term market potential, despite recent economic setbacks. It is expected that once economic growth resumes in this region the United States will have an opportunity to become a significant supplier of dairy products. Thus, the DEIP has become in essence a "calling card," enabling exporters not only to break into a market for bulk products but also to introduce a broad range of other value-added dairy products.

The DEIP has also been modified in recent years to allow exporters greater accessibility and flexibility. Registration qualifications have been changed to allow broader participation in use of the program. In addition, program requirements have been reformed, giving exporters unprecedented flexibility and thus more incentive to successfully complete transactions in the complex international environment. For example, allocations are no longer country-specific but regional, so that resources are more likely to be directed to the most attractive markets.

In future years there will undoubtedly be further modifications in the program to adapt to the needs of the industry and the evolving domestic market structure. But the DEIP's role as simply a market-clearing device is rapidly diminishing; sales will increasingly be to markets where the U.S. dairy industry ultimately holds a competitive edge in the absence of subsidies.

______________________________
The author is an agricultural economist in FAS' Dairy, Livestock and Poultry Divison. Tel.: (202) 720-8870; Fax: (202) 720-0617; E-Mail: kiendl@fas.usda.gov

Last modified: Thursday, October 14, 2004 PM