Earlier this summer (well, it was winter down under) an Australian milk processor terminated the contracts of several dairy farmers because of an oversupply of milk. The processor cited the global supply of milk generally, and the increased production of milk in Europe specifically, as the basis for its decision.
Based on information reported by the Australian press, it appears these farms were direct suppliers to the milk processor, rather than members of a cooperative. That is significant because the rights of a dairy producer to market milk as an independent shipper versus a cooperative member are different.
Despite these differences, the unfortunate situation of these Australian dairy farmers provides an opportunity to compare their predicament with the situation of the American dairy producer in this time of global milk supply growth.
Without delving too deeply into the current supply and demand situation and the attendant impacts on milk prices, it is probably useful to point out that the most recent USDA data, which includes production figures through July of this year, reveals an increase of about 1.6 percent versus 2015.
The growth would be even greater but for the impacts of Winter Storm Goliath on the Southwest, which saw production decline year-over-year for each of the first seven months of the year. That trend might finally end in August. Meanwhile, production in Europe is up over 4 percent.
These increases in milk production are, predictably, responsible for a fair amount of the pressure on prices that have burdened the dairy industry for the past months. With an oversupply of raw product, it would be logical that milk buyers would be looking to control the amount of milk that must be purchased.
Nearly every contract between a milk producer and milk buyer can be categorized as an “outputs” contract. Simply stated, under these types of contracts, the buyer agrees to buy all the milk the producer can produce. So for the duration of the contract, the buyer is obligated to take all the milk coming off of the farm.
Now, in many instances, there are some upper limits on the amount of milk that can be produced. For example, a farm that historically milks 500 cows might be limited by contract in its ability to add cows to its herd.
Now that I have mentioned contracts, it should also be noted that the basis for all relationships between producer and their purchaser is governed by contract – hopefully a written one. It is the contract that determines the right of the handler or cooperative to terminate the contract. Each contract should have a term length, and the length of marketing agreements are far from uniform.
For an independent milk supplier, the contract to supply milk might have a term of one year, with a provision for renewal that might automatically extend the contract for successive years unless either side provides notice the contract will not renew. Where the relationship between the producer and the processor is strong, and market conditions are relatively stable, this automatic renewal might come and go without either party giving it much thought.
But where a processor is finding it is taking on too much milk relative to its ability to market finished product, the producer might find the handler has elected to non-renew the agreement. Without having a great deal of specific information about the contracts in the Australian example, it appears to me this could be the very situation there.
For the cooperative producer, the contractual situation is governed by any number of documents and agreements and is complicated by the matter of cooperative membership.
The rights and responsibilities of cooperatives and their members are defined by (a) the cooperative’s articles of organization; (b) applicable state and federal laws; (c) cooperative bylaws and policies; (d) the membership agreement between the cooperative and the member; and (e) the marketing agreement between the cooperative and the member.
In many instances, the membership agreement and marketing agreement are combined into a single agreement. For our purposes here, I am going to focus on the membership and marketing agreements.
Like the agreement between a processor and an independent producer, the membership and marketing agreements have a defined term. In the cooperative arena, I have seen agreements that grant the producer a right to terminate the agreement nearly at will (usually with some minimum notice – as short as 30 days), others that extend for multiple years and include strong renewal provisions and terms falling between those extremes.
Assuming the membership and marketing agreement obligates the producer to deliver all milk produced to the cooperative and the cooperative to market that milk, the cooperative producer faces little risk of losing their market during the term of the contract.
Cooperative membership provides the individual producer and the collective body of member producers significant protection against a lost market, versus independent milk producers.
At its most basic, a key purpose of the dairy cooperative is to improve the marketing position of the dairy producer by aggregating milk to expand the number of potential buyers and simultaneously insulating any individual producer from the loss of a market.
While cooperatives also serve important functions aimed at increasing the overall return for milk sales to its members, their initial purposes were more closely aligned with what I refer to as these “insurance” type functions of farmer protection.
Consider the following simplified illustration: A plant sees its sales projections falling, and it needs to reduce its production by 10 percent next year. It purchases its milk from 100 independent suppliers, and those contracts each renew annually. The logical business decision for the handler would be to select 10 percent of those contracts and opt not to renew them.
An identical plant purchases its milk from a cooperative supplier and faces the same economic pressures. Its agreement with the cooperative allows for purchase volumes to be established each year. In this instance, the plant reduces its purchases by 10 percent from the cooperative.
The cooperative now is burdened with finding a home for the 10 percent purchase reduction, which might be sent to balancing or marketed to a different customer (or perhaps the cooperative has mechanisms in place to reduce productions).
In any case, the producers in the cooperative model each share the lost market, rather than placing the entire burden on only 10 of them. In recent years, I have observed an increasing number of cooperatives implementing (or at least considering) volume management limitations to better align the cooperative’s total milk supply with the customer demands of the cooperative. For my money, this is a welcome trend.
Finally, while this article is not intended to be a discussion on a national supply management program, it would probably be incomplete without a mention. The last farm bill process illustrated just how difficult a political and practical task a federally administered supply management program would be to enact, let alone administer.
The Australian situation also introduces a concrete example of one particular shortcoming of supply management that does not get enough attention – international forces. Remember the increases in milk production in the U.S. and the EU? For comparison, production in New Zealand and Australia are flat to declining.
Yet Australian processors are terminating contracts. Despite whatever their domestic markets are experiencing, it is the world supplies that are driving prices and impacting production decisions. In my opinion, trying to manage domestic production on a macro level, rather than align individual supplies and demands between producers and customers, isn’t a model solution. 
-
Ryan Miltner
- Attorney
- The Miltner Law Firm LLC
- Email Ryan Miltner
