Sunday, October 16, 2016

More on TPP - Good or Bad for the Dairy Industry?

The Trans-Pacific Partnership agreement (TPP) has been previously mentioned in this blog.  On September 18 free trade agreements in general were discussed and the October 2 post discussed the maximum Somatic Cell Count allowed for the U.S. vs. international standards.  Additionally, there is more information available in two of my recent articles published in Progressive Dairyman - Free Trade Agreements and SCC.

In this post I will review some of the published analysis material available on the TPP as it applies to the dairy industry.  The TPP, if approved, will impact the dairy industry.  To date the TPP has not been approved by congress.  If the TPP is not passed, other forms of free trade agreements will no doubt be developed and approved.  In general, by increasing competition, trade agreements typically reduce consumer costs, but they also create an environment that causes an industry to adjust.  When adjustment occurs, some businesses gain and some businesses lose.

There has been a lot of study on the impact to various industries, and the information discussed here is generally available.  The two most comprehensive documents are by the U.S. Agricultural Sector/American Farm Bureau Federation and the U.S. International Trade commission.  They both depict a favorable impact from passage of the TPP.  Exports would increase, domestic producer prices would increase, and there would be very little impact on imports.

The published data show an expectation of increased exports of $1.85 billion annually and increased imports of $427 million annually.  The increase in exports will come primarily from Canada (60% of the increase) where the closed market will be opened to some dairy products.  This would be a dramatic change for Canada, which has kept its dairy industry very closed to imports.  The increase in imports would come primarily from New Zealand (60% of the increase) and would consist of mostly high-protein powders.  The data does suggest that current limits on butterfat imports will be significantly increased, thereby increasing imports and reducing the price of butter.  The other major assumption behind the data is that U.S. produced dairy products are generally lower priced than the international market, so few additional imports will occur.  The studies were based on pricing data from the 2014 period when prices were very different than they are in 2016.  In 2016, U.S. dairy prices are above international prices and imports have swelled.

Dairy product imports to the U.S. are kept at a minimum by the established two-tiered system where a limited amount can be imported at tariffs in the range of 10% to 25%.  Above the first tier quotas, the tariffs increase dramatically to essentially eliminate further imports.  By the terms currently in the TPP, the tariffs on the first tier quotas would be eliminated totally and immediately.  The volumes allowed would be increased dramatically in many cases.  For instance, New Zealand would be allowed to ship significantly larger volumes of cheese duty free to the U.S.   The volumes allowed would continue to increase incrementally over 9 years, and would then be unlimited.  In all, first tier tariffs are being eliminated for ten countries.

The changes are very different for U.S. dairy exports.  Only Canada, Japan, and Malaysia are creating new TRQ's for imports of U.S. produced dairy products.  In the case of Canada, quantities are very limited and phased in over 14 or 19 years and then fixed at those amounts.  Similarly, exports to Japan are also very small amounts and are phased in over 12 years and then fixed.

In essence, the statistics are based on an expectation that U.S. produced dairy prices will be lower than international prices and imports will be restricted only by a lower U.S. price.  In 2016, with the strong USD, the opposite is currently true.  The only protection from massive imports has been the TRQ's

What is not covered in any analysis is the subject of volatility.  The analysis described above was done at a time when U.S. imports were minimal and exports were growing nicely and prices were high.  The year 2016 is not that kind of year.  The year 2016 is an example of the volatility brought on by the huge swings in export/import volumes and and international prices.

In 2008 to 2010, exports were impacted by swings in the exchange rates between the USD and the NZD.  Producer prices went form $20/cwt. to $10/cwt.  In 2015 and 2016, import/export volumes and prices were impacted by a very strong USD, a Russian embargo, a lifting of quotas in Europe and lower dairy imports in China.  What is on the horizon next?  Free trade agreements as defined in the TPP will certainly increase the volatility caused by international events.

The trade agreements are complex and involve many products.  Any sector can be adversely impacted in exchange for other sectors, so it's very difficult to say if this trade agreement in total is "fair." The impact on the U.S. dairy industry, as analyzed by the U.S. International Trade Commission, appears to be slightly positive by the calculations provided, but there is a potential down side from international events and there will certainly be increased volatility. Dairy is a "different" business compared to many other industries.  Producers are probably the most impacted.  It's difficult to tell a cow "you're fired."  Dairy production is capital intensive and individual countries like to be self-sustaining.

The key for producers seems to be maintaining a very low cost/high margin structure while learning to manage price volatility through financial tools such as hedging. Dairy processors use hedging extensively to manage volatility, but few dairy producers use hedging.  Producers also need to manage not just to reduce costs, but also to manage to high margins.  The industry is filled with examples of reduced costs, especially in feed, with the result that milk components are compromised resulting in net margin decline. Successful production management is much more complicated with the increasing free trade agreements and globalization.   Those who survive must become sophisticated managers with good analytical analysis of their business and proper actions based on these analytics.  The analytics must include national and international events as well as local herd events.