# EUR-Lex - 52012DC0741 - EN

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# 52012DC0741

**REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL Evolution of the market situation and the consequent conditions for smoothly phasing-out the milk quota system - second "soft landing" report /* COM/2012/0741 final */**

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TABLE OF CONTENTS

Mandate....................................................................................................................................... 3

Structure 3

1........... Evolution of the market
situation for milk and milk products............................................. 3

1.1........ Market developments to date.......................................................................................... 3

1.1.1..... Milk production.............................................................................................................. 3

1.1.2..... EU farm gate milk prices................................................................................................. 4

1.1.3..... Dairy product prices, stock levels
and exports................................................................. 4

1.1.4..... Estimated dairy farms' margins in
the EU......................................................................... 4

1.2........ Medium term market prospects....................................................................................... 5

2........... Smooth phasing out of the milk
quotas............................................................................. 6

2.1........ Milk production compared to quota
ceilings.................................................................... 6

2.2........ Milk quota price evolution............................................................................................... 7

3........... Concluding remarks........................................................................................................ 7

ANNEX I. MILK PRODUCTION
& PRICE DEVELOPMENTS.............................................. 9

ANNEX II. MEDIUM TERM
PROSPECTS IN THE DAIRY SECTOR.................................. 10

ANNEX III. MILK PRODUCTION VERSUS QUOTA........................................................... 13

ANNEX IV. EU MILK QUOTA PRICE
DEVELOPMENTS................................................... 14

REPORT FROM
THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL

Evolution of the market situation and the
consequent conditions for smoothly phasing-out the milk quota system - second
"soft landing" report

Mandate

Article 184(6) of Council Regulation (EC)
No 1234/2007 of 22 October 2007 establishing a common organisation of agricultural
markets and on specific provisions for certain agricultural products (Single
CMO Regulation) provides for the Commission to present a report before 31
December 2010 and 31 December 2012 to the European Parliament and Council
regarding the evolution of the market situation and the consequent conditions
for smoothly phasing out the milk quota system, accompanied if necessary by
appropriate proposals. The so called first soft landing report was published on
8 December 2010 under COM(2010) 727 final while the present one constitutes the
second report of the series.

Structure

This report is made up of three parts: the
first one describes the evolution of the market situation for cow milk from the
middle of 2010 (end date of the first soft landing report) and outlines medium
term prospects, the second section examines how the phasing-out of the milk
quota system has occurred while concluding remarks are presented in the third
chapter.

1.           Evolution
of the market situation for milk and milk products

1.1.        Market
developments to date

Volatility – although not to the extent
observed in 2007-2009 – persisted in the dairy market until the end of 2010. It
has somewhat receded in 2011 and in 2012 so far. Prices in 2010 and 2011
fluctuated at high levels, leading to increased production and a price
correction in the first half of 2012. Prices have started to move upwards again
in the third quarter of 2012.

1.1.1      Milk
production

Cow milk collection in the EU has
consistently increased over the past three years: + 1.4% in 2010, + 2% in 2011
and some 1.5% in the first seven months of 2012 compared to the same period in
2011.

Milk output also expanded in the main milk supplying
regions of the world: the combined production of USA, New Zealand, Australia
and Argentina increased by 5.3% during 2010-2011. The trend is continuing in
2012, although some slowdown is observed in the USA after this summer's heat
wave. As compared with the same period of 2011, milk production increased in
2012 by + 2.8% in the USA, +11.4% in New Zealand (until July only), +4.7% in
Australia and + 5.9% in Argentina in the first eight months of 2012 (see graph
1 in Annex I).

1.1.2.     EU
farm gate milk prices

Average EU farm gate milk prices constantly
increased from April till November 2010. They stayed around 33 c/kg until April
2011 and increased again to 35.1 c/kg in November 2011 as a weighted average
for the EU-27 (see graph 2 in Annex I). A seasonal correction appeared in
December 2011, January and February 2012, amounting to – 2%. As a matter of
comparison, the seasonal correction had been - 3% at the beginning of 2010 and
- 1% at the beginning of 2011.

However, in 2012, the downward pattern
continued until the summer, exceeding the seasonal trend and responding to
pressure from increased milk supply in and outside the EU. The latest EU
average farm gate milk price is estimated at 31.3 c/kg for August 2012, which
is 9.5% below the average price of July 2011, but 1.2% above that of July 2010
and 27% above the lowest level reached in May 2009.

The latest available spot milk prices and
dairy product prices at the time of drafting the report were both pointing to a
recovery in the near future, which should be followed at a later stage by
higher farm gate milk prices.

1.1.3.     Dairy
product prices, stock levels and exports

Thanks to a significant recovery in prices
in 2010 and most of 2011 together with a series of favourable market
developments, there has been no buying-in into intervention in the period
2010-12 and public stocks are empty for both butter and skimmed milk powder.
The 76 000 t butter and 257 000 t skimmed milk powder bought into
public stocks during the 2009 crisis were released back onto the market, part
by open tender, part under the most deprived persons' scheme, without disturbing
the market.

The recovery in dairy commodity prices in
2010 was due to increased demand, notably from emerging economies, and limited
supplies from the Southern Hemisphere. The same situation prevailed in the
first half of 2011. But from the middle of 2011 dairy product prices came under
pressure following increased availability of dairy products from the main dairy
supplying regions of the world. Downward pressure continued in the first months
of 2012 until EU dairy product prices found a bottom level around 120% of the
(virtual) intervention price at the end of May. In June prices started to
increase and developments till the date of drafting the present report have
continued upwards, notably due to reduced milk availability from the US in the
wake of an unprecedented heat wave and to a simultaneous drop in milk
production in the EU as well, while the Southern Hemisphere was in its winter –
low production - season.

EU exports increased in 2010 and 2011 for
all major dairy products, with the exception of butter/butteroil and whole milk
powder. EU exports have been particularly dynamic for skimmed milk powder. Good
export performance has been confirmed in 2012 so far including a noticeable
recovery of butter exports which, on a cumulative basis, outpaced 2011 levels
in the first seven months of 2012. This has been achieved without export
refunds.

1.1.4.     Estimated
dairy farms' margins in the EU

Based on FADN data, during most of 2011,
increasing operating costs were compensated by increasing milk prices. In the
1st quarter of 2012, milk margins in the EU declined in the wake of decreasing
farm gate milk prices while still remaining above those of the first quarter of
2011.

According to first estimates for the second
quarter of 2012, purchased feed costs increased by 6% while total operating
costs slightly decreased (- 2%) due to a significant drop in energy costs (-
10%). The gross margin index fell by 17% due to an 8% decrease in the farm gate
milk price. The gross margin index is now 24% below that of the 2nd quarter of
2011, which was the second highest since 2007 (year of reference for the
EU-27).

The situation varies from Member State to
Member State and even within Member States, depending on the milk farming
system chosen and on the product mix used by the dairy sector.

1.2.        Medium
term market prospects

Medium-term market prospects for the EU
have been simulated with a modified version of the Aglink-Cosimo model and
assume no changes in the CAP following the Health Check decisions and no
changes in trade policies. This outlook is not intended to constitute a
forecast of future market developments, but rather to describe what would
happen under a specific set of assumptions and circumstances, which were judged
plausible at the time of projections. Moreover projection results presented in
this report are provisional and may differ from final values, which are to be
published by November 2012.

The world market and policy environment is
based on the OECD-FAO Agricultural Outlook 2012-2021, adapted to
more recent macro-economic projections as of September 2012. Some of the most
important drivers of the market projections are the EU GDP growth prospects (a
slight decline in 2012, followed by economic recovery thereafter), the assumed depreciation
of the Euro during the first three years of the projection period followed by
an appreciation in 2014 and 2015, and an update of OECD-FAO world market price
projections for dairy commodities that incorporates the impact of the 2012
drought in US and some European countries. If any of these
projections/assumptions do not materialise, this would affect the resulting
projections significantly. Furthermore, as in any other medium to long term
model, greater price volatility expectations are not incorporated into the
Aglink-Cosimo model.

Based on these projections, medium-term
prospects for dairy markets appear favourable. Continued expansion of world
demand, resulting from global population and economic growth, combined with
increasing preference for dairy products (also as a result of growing per
capita consumption) are expected to be the main drivers. Sustained import
demand, particularly from emerging countries, would have a positive impact on
dairy commodity prices, thus fuelling EU export potential. Nevertheless, EU
market shares are projected to slightly deteriorate for most dairy products, as
a result of a higher rate of increase in exports from other countries

EU milk production is projected to continue
increasing from 2012 onwards at a moderate growth rate but to remain below the
potential growth rate provided by the phasing-out of the milk quota regime (see
graph 3 and 4 in Annex II). EU milk production is projected to register a
cumulative increase of about 8% from 2009 to 2022, while milk delivered to
dairies would increase by around 10%. By the last quota year (2014-15), EU milk
deliveries are projected to be some 6% below quota. The expiry of the milk
quota regime is projected to have a limited impact on milk deliveries at the
aggregate EU level.

Projections for cheese and fresh dairy
products are quite positive (see graph 5 in Annex II). EU production of fresh
dairy products (including drinking milk, cream, yogurts, etc) is projected to
increase by almost 8% (from 2009 to 2022) and cheese by almost 10%. Demand
prospects on both the domestic and world markets look positive, and despite a
strengthening EUR towards the second part of the projection period, substantial
demand on the world market would allow for a progressive increase of EU
exports. However, due to more dynamic developments in the world market the EU
will gradually lose world market share, though it still account for around 31%
of global exports in 2022.

Whole milk powder production in the EU is
expected to stay relatively stable over the short term (see graph 6 in Annex
II). The medium term prospects for exports are supported by an increase in
world demand, led by China. The EU share in global exports is expected to
decline gradually to 14% by 2020 (from 25% in 2009).

EU skimmed milk powder production is
projected to increase by about 28% throughout the outlook (see graph 7 in Annex
II). A strong global import demand would contribute to a balanced market,
driving a favourable outlook for exports. The EU would see its world market
share reaching almost 31% of global exports in 2022.

The outlook indicates continued market
stability for butter, resulting from positive market conditions over the
projection period, with prices at relatively high levels and firm EU demand
(see graph 8 in Annex II).

2.           Smooth
phasing out of the milk quotas

2.1.        Milk
production compared to quota ceilings

Further to the decision to increase milk
quotas by 2% on 1 April 2008, the Health Check deal of November 2008 resulted
in an annual increase in milk quotas by 1% over five consecutive years, beginning
on 1 April 2009, plus an adjustment of the fat correction factor which resulted
in a further de facto 1% increase in quotas. There remains one 1% annual
increase (on 1 April 2013) until the expiry of the quota system on 1 April
2015[1].

Year on year, milk quotas are gradually
becoming less relevant, as actual milk output falls short of these ceilings in
a majority of Member States. In quota year 2010-11, only five Member States
exceeded their milk quota, while overall EU production was 6% below quota.
According to notifications received from Member States, the 2011-12 quota year
is estimated to have ended with EU milk deliveries approximately 4.7% under
quota and only six Member States exceeded their national quotas (see Annex III).
The number of Member States exceeding their quotas remains limited and the
concerned surplus production accounts for less than 0.2% of all milk delivered
or covered by direct sales.

After a slight contraction of milk
deliveries in 2009, favourable farm gate milk prices and good weather
conditions prompted increased production levels in both 2010 and 2011. When
increased production – not only in the EU but in all milk supplying regions
around the world – exerted downward pressure on farm gate milk prices, milk
production started to respond by slowing down in the subsequent months. Those
developments show that production response is gradually shaping according to
market signals but also that weather conditions are a true player in the dairy
market.

With milk quotas becoming less and less
relevant, EU milk supply can better respond to market opportunities, farmers'
response to price signals is less distorted and efficiency gains can be
achieved through restructuring.

2.2.        Milk
quota price evolution

The milk quota price should be decreasing
with the shortening life of the quota regime and this is actually the case in a
majority of Member States where the quota price is very low or equal to zero
(see Annex IV).

In Member States whose milk deliveries are
well below quota ceilings, the quota price is already very low or equal to zero,
and no fundamental changes are expected before the expiry of the quotas regime.

However, in Member States whose milk
deliveries are close to the quota ceilings and in the limited number of Member
States whose milk deliveries exceed their ceilings, the quota price depends on the
expectation of a surplus levy. In the future, quota purchases are projected to
be further declining towards zero, with fluctuations due to occasional surplus
production under favourable weather conditions and remunerating milk prices.

3.           Concluding
remarks

Medium and long term prospects are favourable
for the dairy sector in line with population growth and appetite for western
diet in emerging economies. This does not however prevent short term market
fluctuations. Price developments since the publication of the first soft
landing report show a trend towards higher levels with some ups and downs along
the curve. Within the latter, the current difficulties endured by dairy farmers
in certain areas more severely hit by the hike in the price of feedstuffs
cannot hide the overall positive picture of the sector.

In the long run, the balance between supply
and demand depends on a large variety of factors, ranging from economic
parameters to policy decisions. In this respect, the so-called Milk Package[2] which has been fully applicable
from 3 October 2012 offers tools for operators in the dairy supply chain to attune
their supply to the market.

Both the evolution of milk production
versus milk quotas, and the downward trend in quota prices show that “soft
landing” is on track. In the vast majority of Member States, quotas are no
longer relevant to limiting production and the quota price has already reached
zero or is approaching it.

Against this analysis, the Commission is of
the view that no change is required in the existing framework, which has been providing
certainty to milk producers since 2008 and is proving its efficiency in
securing a smooth phasing-out towards a quota free environment.

Aside from the very concept of soft
landing, some concerns are voiced with regard to rural areas in which milk
production is playing a central role, in particular in the context of milk
quota expiry. In this respect, the inclusion of the milk sector in the
so-called "new challenges" under the second pillar of the CAP is
providing further support to dairy farmers in preparing for the end of quotas.

The CAP reform proposals contain
instruments that could mitigate potential impacts. Furthermore, the Commission
has issued an open call for tenders for an analysis by independent experts of
future developments in the milk sector from 2015 onwards, and will report to
the European Parliament and the Council by 30 June 2014 on the concrete
operation of the Milk Package provisions[3],
assessing, in particular, the effects on milk producers and milk production in
disadvantaged regions in connection with the general objective of maintaining
production in such regions, and covering potential incentives to encourage
farmers to enter into joint production agreements.

Annexes:          I.          Milk price
development

II.         Medium term prospects in the dairy
sector

III.        Milk production versus quota

IV.        EU milk quota price developments

ANNEX I.       MILK
PRODUCTION & PRICE DEVELOPMENTS

Graph.1           Milk collection
developments

Graph.2           Milk price
developments

ANNEX II.     MEDIUM TERM PROSPECTS IN THE DAIRY SECTOR

Graph.3           Cow's milk supply and dairy herd developments,
2000-2022

Graph.4           Milk deliveries and quota utilization for cow's milk

Graph.5           Cheese market
developments, 2000-2022

Graph.6           WMP market
developments, 2000-2022

Graph.7           SMP market
developments, 2000-2022

Graph.8           Butter market
developments, 2000-2022

ANNEX III.    MILK PRODUCTION
VERSUS QUOTA

ANNEX IV.    EU MILK QUOTA PRICE
DEVELOPMENTS

[1]               Except for Italy for which the cumulative 5% increase
was frontloaded on 1 April 2009.

[2]               Regulation (EU) No 261/2012
of the European Parliament and of the Council of 14 March 2012 amending
Council Regulation (EC) No 1234/2007 as regards contractual relations in
the milk and milk products sector

[3]               See point 9 of Article 184 of the single CMO
Regulation 1234/2007, as inserted by the so-called Milk Package Regulation
261/2012.