Whether the U.S. pursues a resolution to the current dairy trade dispute with Canada by seeking judgment through the World Trade Organization (WTO) or through renegotiation of the North American Free Trade Agreement (NAFTA), the issue is likely to be contentious for years.
While the outcome of either or both paths is uncertain, a recent report from Rabobank explores three possible directions for NAFTA:
1) NAFTA remains unchanged.
2) NAFTA is renegotiated.
3) No agreement is reached and NAFTA is broken apart.
In the report, RaboResearch Food & Agribusiness dairy analysts look primarily at how possible NAFTA disbandment or renegotiation could impact U.S. dairy producers. They conclude dissolution of NAFTA would be the worst-case scenario, while renegotiation is far more likely. President Donald Trump moved in that direction in May, informing Congress of its intent to renegotiate the 24-year-old agreement between the U.S., Canada and Mexico.
With the domestic U.S. market maturing, the U.S. will increasingly count on exports to absorb milk production, and NAFTA already plays a big role. The U.S. exports about 15 percent of its milk production, and about 45 percent of that goes to Mexico and Canada.
Dissolution costly
Even the threat of the loss of NAFTA is a wake-up call, Rabobank’s analysts warned. If the U.S. were to lose access to Canada and Mexico markets, roughly $3.7 billion in annual U.S. dairy exports would be at risk in the short term.
It would not be as simple as redirecting products into other markets. The U.S. has free trade agreements with 18 other countries, with other negotiations underway. As such, the U.S. has access to a growing pool of demand.
However, compared to its NAFTA partners, U.S. exports into individual non-NAFTA markets are relatively small, and these markets have different tastes and preferences, meaning products need to be tailored to buyer requirements. The U.S. would need to invest in plants, staff, research and development and regulatory approval to get products into new markets. There is also more competition from other exporters, and longer distances mean high transportation costs to contend with. Exporting costs could rise 2-5 percent, resulting in lower returns to the U.S. dairy market overall.
While the dispute with Canada has garnered most of the political attention, U.S. dairy leaders have routinely raised the importance of Mexico in the NAFTA relationship. Last year, Mexico was the largest recipient of U.S. dairy exports, accounting for 32 percent of the U.S. total, with room for more growth.
“As the standard of living and wealth of Mexican citizens improves so does their purchasing power,” said Tom Bailey, senior dairy analyst. “As a result the growing Mexican middle class is buying more dairy products, and requiring more imports to fill the growing demand unfilled by domestic supply.”
Mexico has several potential dairy product suppliers knocking on their door. Talks with the European Union (EU) to update an existing free trade agreement and include dairy have already begun, and Mexico is said to be in the process of seeking bilateral agreements with New Zealand and Australia. Although it might take years, Mexico could easily fill its skim milk powder (SMP) and cheese import demands from the EU and New Zealand, which currently account for about two-thirds of all globally traded SMP and cheese.
Along with dairy trade, strained U.S.-Mexico relations due to immigration policies will have a negative impact on labor. Dairy farm labor costs have risen 16 percent since 2010, and some areas of the U.S. are struggling to find labor altogether. Given that over 50 percent of U.S. dairy labor is from Mexico, stricter enforcement of immigration would limit the labor pool, forcing the cost up considerably and pushing more farmers to invest in robotic milkers.
According to Rabobank, farmgate margins would shrink for U.S. producers if NAFTA was dissolved, with cost of production rising 5-7 percent.
No change
Under the ”no change” scenario, U.S. exports to Mexico would increase to accommodate the U.S. surplus, while filling demand from Mexico’s growing middle class. If economic growth in Mexico continues, the product mix will likely include more cheese and higher-value dairy products.
Most of the current NAFTA dairy trade tension is along the U.S.-Canadian border, Rabobank researchers note. A “no change” scenario does nothing to reduce that tension.
Concerns over NAFTA were heightened after Canada adjusted its Class 6 and 7 milk pricing system, rendering prices of both U.S. ultra-filtered (UF) and dried milk protein concentrate (MPC) uncompetitive in Canada. U.S. exporters in Wisconsin, Minnesota and New York saw exports of UF/MPC plummet to 30 percent in the first quarter of 2017, according to the Rabobank report.
With Canada’s milk quota allowance dictated by national demand for milk fat, its milk protein surplus will build. Rabobank projects Canadian milk fat demand will increase at a rate of 2-3 percent over the next two years, while protein demand will rise 1 percent, ultimately increasing Canadian SMP exports and negatively affecting other global protein suppliers.
Renegotiation
The analysts expect a renegotiated deal could be a win-win for the U.S., Mexican and Canadian economies, avoiding the prospects of retaliatory tariffs and trade disruptions.
Even under renegotiation, Mexico will likely remain a net dairy importer for years to come, and its dairy situation is likely to remain status quo. There’s more upside than downside for the U.S. in NAFTA renegotiations, but more risks for the Canadian industry due to increased, albeit small, U.S. access to the Canadian market. Even if concessions are minimal, Canadian producers likely face the biggest challenges, particularly if European cheese begins to flow to Canada under terms negotiated under a Comprehensive Economic and Trade Agreement (CETA).
Canadian farmers say they are open to limited NAFTA renegotiation.
"Dairy Farmers of Canada will continue to support dairy trade between Canada and the United States through the NAFTA renegotiation process," said Wally Smith, president of Dairy Farmers of Canada. "We will be supportive as long as they maintain a focus on trade and not on our domestic supply management system."
In announcing its intentions to begin NAFTA talks, the office of the United States Trade Representative (USTR) solicited public comments to identify negotiating priorities. The National Milk Producers Federation (NMPF) and U.S. Dairy Export Council (USDEC) jointly filed comments.
Read: Dairy groups pledge to work with Trump administration on NAFTA modernization
At its June meeting, the NMPF board passed a resolution further outlining its NAFTA goals. These include confronting Canada’s pricing schemes, while protecting the export market in Mexico. It also calls for special attention to preserving and enhancing the protection of foods using common names, and strengthening rules related to sanitary and phytosanitary commitments with Canada and Mexico.
“NMPF’s membership recognizes NAFTA’s essential role in expanding access to the Mexican market, where we export more than $1 billion annually in dairy products,” said Jim Mulhern, president and CEO of NMPF. ”We need to build on that market, and at the same time use the modernization effort to obtain more access to the Canadian market for our products, and roll back anti-competitive trade schemes used by Canada’s dairy sector.”
Rabobank’s report also cautions the renegotiation process could take several years.
“History tells us that it will take at least 2-4 years to renegotiate the deal, and all that assumes all three nations will be able to agree,” said Rabobank dairy analyst Aga Dobrowolska Perry.
Read also:
US Ag Secretary discusses UF milk with Canadian leaders
UF milk fighting FDA label, Canadian border barriers
Policy Watch: The NAFTA story features a contrast in characters
NAFTA renegotiation adds uncertainty to U.S.-Mexico dairy relationship 
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Dave Natzke
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