UK: Agricultural Bulletin, November 2006

Last Updated: 8 November 2006

With the recent failure of the Doha world trade talks still fresh in our minds, we focus on the effect of trade on the agricultural sector and where income, if any, is coming from – with particular attention to the UK dairy industry.

THE MILK SQUEEZE

UK dairy farmers are once again caught up in a dreaded cost/price squeeze. Milk prices have been tumbling whilst input costs have been escalating.

A long cold winter followed by a very wet spring and a summer drought will force many farmers to enter this winter with low forage supplies.

Tumbling Prices

The average weighted farm gate price for the 2005/06 milk year was 18.5 pence per litre (ppl), similar to the 2004/05 price of 18.4ppl. Unfortunately, this period of relative stability has been shattered by the substantial cuts (0.5-1.0ppl) made by purchasing dairies this summer.

These cuts are reflected in the monthly average prices, with June 2006 being down 0.5ppl on June 2005. The rolling 12-month average is likely to dip below 18ppl to 17.85ppl by March 2007, unless these cuts are restored across the board.

Escalating Costs

Farmers have to shoulder the burden of a falling market and, at the same time, incur cost increases in fuel, fertiliser and feed. A recent Milk Development Council report refuted the suggestion that milk production should decrease to only meet high-value processing and liquid consumption demand.

The report quite rightly pointed out that the effort and cost involved in decreasing production by 30%, and the number of producers by 40%, would not be worth it. Furthermore, UK producers are better placed than most EU farmers climatically, and in terms of herd size, to be more competitive in milk production.

Farmers need to work more closely with their milk buyers to determine levels of supply in terms of constituents, seasonality and quality, and they need to alter their production systems in order to improve cost efficiencies.

Poor Return On Capital

Net Farm Income (NFI) assumes that all farms are tenanted and that all tenant-type assets are owned by the farmer. It represents the return to the farmer and spouse for their manual and managerial labour and on tenant-type capital in livestock, crops, machinery, etc. The provisional UK average NFI for dairy farms in 2005/2006 was £26,000, a rise of some 9.7% over the previous year. Although an increase, it is still a relatively poor return on capital compared to other industries – in fact, if NFI is taken as a wage there is zero return to management or capital. Of course, averages must only be used as a guide to identify trends as performance varies significantly across dairy businesses.

The Squeeze On Profit

What is currently distressing the industry is the profitability ‘forecast’. Table 1 depicts figures for a fictitious farm,with a quota of 1.125m litres and above-average performance.

The budget shows an expected 0.8 ppl drop in the milk price, partially offset by better returns from cull cows and calves – the result of a strong beef market following the end of the Over Thirty Month Scheme and the lifting of the beef export ban. Output falls by 0.3ppl. Costs (including depreciation, rent, and interest and drawings) rise relentlessly over the period by 1.3ppl so that the deficit from production increases from -0.6 to -2.2ppl. It is only after bringing in the SP (and ELS) that the farm shows a profit in 2005/06 and 2006/07 of 1ppl and 0.6ppl respectively.

The business is budgeted to show a loss in 2007/08 if it makes no changes to its structure or performance. This is due to input costs increasing and output staying constant or decreasing, and the English SP peaking in 2006, but falling in subsequent years to 2012 on dairy farms.

Although an above-average performer, this business clearly needs to take action to improve cost efficiency if it is to remain a dairy business with no alternative income.

The Future: Alternative Forms Of Income

Indeed, many farms are looking to alternative ways of developing their future income streams. Taking steps into unknown ventures will involve new risks, but sometimes the potential long-term returns are either more rewarding or more reliable than producing highly perishable agricultural commodities with low margins.

The Department for Environment, Food and Rural Affairs (Defra) figures suggest that almost half of farm businesses have some kind of diversification enterprise alongside their agricultural production business. The bulk of these enterprises consist of the use of farm buildings in non-farming ways, but other farm resources are also being employed. The Total Income from Farming figures illustrate that, in real terms, the trading profitability from farming has been falling for 35 years. At the same time, the last decade has seen farming balance sheets strengthen on the back of rising land and property values. Many farmers are now seeing their future selves as ‘rural businessmen’ rather than food producers.

If this offers greater returns to their business, this is certainly the avenue to pursue, and one for dairy producers feeling the squeeze to consider.

‘RESTING’ TALKS EQUALS CHAOS?

When it comes to trade negotiations, what is preferable: failure or compromise? In the eyes of the negotiators of the major economic players, no deal is better than an aborted one.

The Doha world trade talks finally collapsed on 24 July after five years of discussions and minimal progress. In the end, it simply proved impossible to bridge the differences between the parties: the emerging and poorer countries pressing for dramatic cuts in agricultural tariffs without willingness to address their own; the US keen to cut the highest tariffs; thus putting the onus on the European Union (EU) with the higher tariffs, and the EU unprepared to move unilaterally by more than it had offered – clearly an insufficient offer in the eyes of the other countries.

The last round of the trade talks that was scheduled to take four years was completed in eight, and it was only concluded as the result of a compromise. Now, with more World Trade Organisation (WTO) member countries than ever before, and a more sophisticated set of players (the developing countries have had far greater input this time round).

Officially, the talks are not dead, merely ‘resting’. The WTO’s director general Pascal Lamy suspended further negotiations indefinitely, with no timetable planned for the talks to restart. It could be years rather than months before the political will is mustered to try again. In fact, it looks unlikely that anything will happen until after the next US president takes office in January 2009 and tries to secure a new Trade Promotion Authority from Congress (the present deal expires in June 2007).

The future remains unclear. Global trade is at its post-war peak, so does it really matter that the negotiations failed? The number of bilateral agreements between two countries/ trading regions has been steadily increasing and this could accelerate that trend further. However, weaker-negotiating countries will lose out from this trend, and stronger ones will benefit in certain aspects of trade.

With the talks suspended, the EU retains the bulk of its agricultural subsidy and blankets itself from international trade. Moreover, the opportunities for global trade are somewhat diminished and the net effect will be less choice for the consumer, higher prices, and potentially less productivity in the sector through a lack of competition. Although the US has already instigated discussion on how to rekindle the talks, any decisions are most probably many years away.

Furthermore, global trade is presently powered by the enormous spending capacity, and inclination, that the US consumer has had in recent years, coupled with the massive growth in production capacity of developing countries (particularly China) over the same time span. However, signs of weakness are starting to show on both sides of this double act, indicating that it lacks longterm sustainability and that one of these countries will sooner or later fall off the economic balance, sending the other tumbling too.

The implications of this will be widespread and, at that point, we might all decide that a trade agreement compromise would have been better than a failure.

FARM DRAWINGS EXCEED INCOME

Those working in the agricultural sector know that a lot of income coming into farming businesses does not actually come from farming.

Diversification, off-farm employment and investment income have all grown in recent years to offset the widespread fall in agricultural profits.

Defra is working on producing figures that more accurately reflect this situation and has recently published a report on farm household incomes in England for the 2004/2005 year (http://statistics.defra.gov.uk/esg/statnot/householdincome.pdf).

The analysis is based on information gathered from 60,800 farm businesses of a minimum size of half of the standard labour requirement. These businesses actually sustain 79,000 households, because a single business might support two families, for example, a father and son. On average, farm households each drew £29,700 from their farm businesses in 2004/05. However, those same farm businesses only made a profit of £28,200 for the same period. Therefore, in aggregate, farmers are taking more out of their businesses in drawings than they are earning in profits.

In fact, because 61,000 farm businesses are supporting 79,000 households, the situation is worse than these figures suggest as the call on drawings for each farm business is higher than reflected. Based on this, the average drawing from a farm business is £35,300 – resulting in a shortfall of £7,100. On many farms this shortfall is being ‘covered’ through capital transfers funded by increased borrowing or asset sales.

At first glance, one could believe that this is just a one-off phenomenon and that 2004/05 was a particularly bad year for profitability; however, Defra figures show that private drawings have exceeded farm business income for seven out of the last ten years.

SINGLE PAYMENT SCHEME ROUND-UP

Voluntary Modulation

EU farm ministers have recently been discussing the issue of voluntary modulation. Whilst the 2005 pre-Christmas budget deal set out that Member States would be able to levy rates of up to 20% if they wished, no detail about the scheme was included.

However, the EU Commission is not in favour of the scheme, and appears to be trying to thwart it by imposing strict rules. They are planning on applying the same model as used for compulsory modulation: a €5,000 franchise, minimum spending on certain ‘axes’ and implementation at Member State level. Furthermore, an element of co-funding might still be required, and rates would have to be set for the entire 2007- 13 period. Obviously, all this makes the concept of voluntary modulation much less attractive.

The UK, as the only country currently using the provision, is arguing against these measures. It wants the present system to be rolled over almost unchanged: no franchise, maximum flexibility on spending and devolved regions able to set their own rates. One change that will be sought from the current system is a weakening of the co-financing provisions. The UK has support from other Member States, but it may not get all that it wants. Farm Commissioner Mariann Fischer Boel has indicated that whatever rules are agreed to now would still be up for review in the 2007/08 Health-Check, along with the rate of compulsory EU modulation.

SPS Appeals

Until now the Rural Payments Agency (RPA) has not had an Single Payment Scheme (SPS) appeals procedure, as there have not been any appeals to process. However, appeals are starting to occur now that some farmers have had penalties applied to their Single Payment for breaches identified in their cross-compliance inspections. The RPA has thus set up a formal appeals procedure consisting of three stages; we have provided guidance on the process below.

Prior To The Formal Stages

If there is an error with your entitlement allocation or payment, you should write to the RPA setting out your reasons for contesting the decision. If the RPA rejects your written petition it will notify you in writing of your right to appeal and enclose the Stage 1 form (SP6) and Guidance Booklet. The booklet is also available from the RPA website, click on ‘Customer Focus’ and then ‘Appeals Procedures’.

Stage 1

You must respond within 60 days of receiving the RPA letter by completing the SP6 form and sending it to the Customer Relations Unit (CRU). The CRU ‘aims’ to respond, in writing, within 90 days of receiving the SP6; if it rejects your appeal it will send you a SP7 form attached to a case summary.

Stage 2

Complete the SP7 form and return it to the CRU within 60 days with a cheque for £100 payable to the RPA. You can opt to put your case forward, in person, to the Appeal Panel (three independent members) who will consider your case. If your appeal is successful the £100 will be refunded. The panel makes a recommendation to a minister who will then make the final decision.

Final Stages

If the minister rejects your appeal you can challenge the decision through the Courts or, if there has been maladministration, you can get your MP involved with the Ombudsman. There are no definite time limits on the Stage 2 procedures, so the whole process could be lengthy and it is all at the appellant’s cost, even if the appeal is successful.

Top And Bottom Limits On Payments?

The proposal to impose an upper limit on payments (capping) may get a boost at the Health-Check with the inclusion of the disclosure of payments made under the CAP. Until now, Member States have had the right to keep payments made under the CAP confidential, but as part of its European Transparency Initiative 1 the Commission wants to make it compulsory for Member States to publish a list of all beneficiaries (the UK already does this). Commissioner Fischer Boel argues this point by stating that EU citizens have a right to know what their money is being spent on.

There may not just be limits at the top end either. Commissioner Fischer Boel has questioned the efficiency of thousands of very small payments to farmers, as the administration costs are higher than the amounts actually paid out, suggesting that a minimum cap may also be necessary.

Don’t Forget To Complete Your SPR

Farmers in England should by now have completed their Soil Protection Reviews (SPR), having passed the 1 September deadline. The SPR forms part of the cross-compliance rules, and those farmers who have not yet completed it stand to lose part of their Single Payment.

All SPS claimants in England should have been sent a SPR booklet that needs to be filled out (mainly tick-boxes and some text), kept on farm, and updated on a regular basis. It is not designed to be an arduous procedure, but rather a means for the farmer to identify areas requiring attention in order to minimise the chances of soil erosion. Anyone inspecting under crosscompliance is likely to ask to see it.

The SPR is available online at www.rpa.gov.uk/rpa/index.nsf/0/CF30405DCA75A610 802571CE004502B5. Warning: it can take a long time to download.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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