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Potter's View: "In this crisis, having a buyer who will collect and pay you for all of your milk is worth a lot"

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This month, Ian Potter gives his opinion as at whether Iceland has managed to negotiate itself a highly favorable deal, and looks at the dilemma facing some Arla-AMCO producers.

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Firstly, tentatively, happy New Year. I say tentatively because the prospect of further significant cuts in ex-farmgate milk prices this year is real and inevitable.

 

The devaluation of milk by Iceland, Lidl and Aldi to 89p for four pints is devastating and likely to come under fierce attack in January from our big four retailers, led by Asda or Tesco, who will either price match or top trump the 89p price. I don’t for one minute believe milk will be singled out to be devalued, but it will be a key basket item in what will be an aggressive post Christmas price war.

 

The quota market is certainly sparking – against all the odds I have to say, and not because of something I have said. Buyers are plentiful and focused on two possibilities. One is the European milk price will plunge further into crisis in spring, which will force the Commission to do a last minute U-turn and extend quotas beyond April 1. However, I do believe that is bordering on the impossible.

 

The second possibility, which has quickly risen to the top of the pile, is that the Commission’s interest in A and B production is serious, and it may attempt to influence its introduction across the EU. The thinking is if the Commission wades in it will not base a scheme on actual production, but on quota held at March 31. However, if milk purchasers introduce A and B prices/“quotas” they will surely base their calculations on actual production and not on quota held. I think A and B limits will be introduced by milk buyers based on production, but I can understand why a large number of producers are buying quota just in case.

 

The Iceland deal brokered by FFA, whereby Iceland will ensure a minimum of 70% of its cheddar is made from British milk with packs carrying the Red Tractor logo, is a very positive move on which FFA is to be congratulated. The food industry simply has to improve on provenance labeling. I wonder, for instance, how many consumers realise Philadelphia cheese is made in Germany, with German milk?

 

The other liquid milk pricing deal FFA negotiated with Iceland looks fantastic but as always the devil is in the detail. The deal is if the Muller/Arla non-aligned farmgate price drops by 1ppl, Iceland will automatically pay 1ppl less, and won’t exert further downward pressure on milk processors. If it goes up 1ppl it pays 1ppl more.

 

However I bet it won’t, because it looks to me like a win-win situation for Iceland. Every time the farmgate price drops Iceland pockets the money. Look at it this way, if for example, the farmgate price is cut by 3ppl due to a fall in cream values or the cost of balancing, under this deal Iceland pockets 3ppl. Having deducted 3ppl from Iceland’s invoice its milk processors (principally Muller, which supplies

 

Iceland with the most milk) will then surely have to cut the price further to compensate for the Iceland deduction until they fully cover both the 3ppl cream value drop plus the money Iceland are demanding under the deal. Theoretically the opposite will happen when prices go up, but will it?

 

Most processors push to maintain clear water with no linkage between farmgate prices and their commercial relationship with retailers. To do otherwise gives retailers more power, and all that happens is they lock onto the farmgate costs of milk and squeeze the processor.

 

As soon as this market turns processors will be desperate to immediately reflect all improvements in the farmgate price. By locking into a farmgate price Iceland has scored a goal because we all know there is a time lag between the global market improving and it filtering down to farmgate level.

 

A rough calculation leads to the conclusion that in excess of 200 milk producers will be looking for a new milk buyer by April 1, and one analyst calculates it could be as many as 350. That’s why I emphasise in this crisis, having a buyer who will collect and pay you for all of your milk, is worth a lot.

 

While those farmers battle to find a milk buyer, around 200 Arla–AMCO Tesco producers have some serious number crunching to do. This month the gap between their price and the Arla Tesco direct price has widened to 7ppl. These Arla members could leave the co-op after only three months notice to become Tesco direct suppliers again, subject to paying a relative modest penalty of 2% of the value of last year’s milk as well as paying off their loan account. In the run up to January 1, I received a number of emails and calls from those involved, one of which was jaw dropping. He had employed a consultant to advise him whether to make the switch for April 1.

 

The consultant was focusing on whether Tesco could scrap its aligned milk purchasing scheme and avoid serving its contractual 24-month notice. My response was this was a Mickey Mouse way of looking at it, and the real question to focus on was whether Tesco has the ability to vary the terms of the cost tracker at short notice, as well as whether the producer who leaves would be allowed to rejoin as an

 

Arla member at a later date. I believe Tesco can change the formula and cost tracker giving only one month’s notice, and given the fact its current milk purchasing policy appears to bring minimal benefit to Tesco it is likely to come under severe scrutiny.

 

As to whether a resigning farmer could rejoin Arla, if I were the co-op I would make this a nigh on impossibility. Thus the decision to stay or leave is a tough call, but now may not be the time to jump out of the fire into (potentially) the frying pan unless there are sound alternative milk buyers to switch to. For the financially stretched they may have no choice but to make the switch. However, while the gap may be 7ppl today it certainly won’t be 7ppl over a 12-month period, and one day there will be no gap.

 

A recovery will come but it will be late 2015 at the earliest. The problem is not so much how low the milk price drops but more of how long it stays low!

Ian Potter

Ian is a specialist milk quota and entitlement broker. Comments please to ianpotter@ipaquotas.co.uk

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