E.U. fines can't cap milk output as prices surge worldwide

LONDON – Irish dairyman Pat McCormack figures it makes more sense to pay a 20,000-euro ($27,300) fine for producing too much milk than to pass up surging prices and an early start to a jump in European output.

The 36-year-old farmer expanded his herd to 80 cows from 60 two years ago and estimates that his milk production will exceed his European Union quota by 20 percent at 450,000 liters (119,000 U.S. gallons) this year. While output limits imposed in 1984 won't end until April 2015, E.U. prices are 17 percent higher on average than a year earlier. Even with the fine, McCormack says he will be profitable and his herd will be ready with more supply when quotas are lifted.

"People have been gearing up since 2010," McCormack said by telephone from his farm in Greenane in County Tipperary, 115 miles southwest of Dublin. "Without a doubt, farmers have been increasing their herd sizes. There has been significant investment, both on-farm and processor investment."

Global dairy prices tracked by the United Nations more than doubled since early 2009 as demand surged in China and droughts limited supply from New Zealand and the United States. The end of quotas in the 28-nation E.U., the world's top producer, will spark an output gain after 2015 of 6.6 percent to 162.3 million metric tons, Rabobank International said. Before 2013, production grew 2 percent since 2005, industry data show. Processors including Royal FrieslandCampina, Europe's biggest dairy cooperative by revenue, are expanding to handle the increase.

Farmers in the E.U. got 39.89 euro cents per 100 kilograms on average in December, up from 34.24 cents a year earlier, after reaching a record 40.55 cents in November, the Dutch Federation of Agriculture & Horticulture said. That's boosting costs for buyers including Danone, the world's biggest yogurt maker, and Nestlé, the largest food company. More-expensive milk and cheese contributed to a 0.8 percent gain in eurozone consumer prices in January.

Class III milk, used to make cheese, reached an all-time high of $23.43 for 100 pounds on the Chicago Mercantile Exchange on Jan. 31 and is up 20 percent since the end of 2013. The gain is more than 23 of the 24 commodities tracked by the Standard & Poor's GSCI Spot Index, which rose 2.4 percent this year.

Milk prices have surged after wet weather in the last two years cut supply from northwest Europe, while New Zealand, world's the top exporter, saw its first drop in milk-solid output in five years because of a drought in early 2013. California, the top U.S. producing state, is contending with extreme drought, according to the U.S. Drought Monitor, scorching pastures and reducing this year's dairy supply. At the same time, demand is rising in China, where imports of whole-milk powder jumped 14-fold since 2008, U.S. Department of Agriculture data show.

Eight countries are at risk of exceeding their output caps this year, including Germany, the Netherlands and Denmark, said Bart Van Belleghem, managing director of the Brussels-based European Association of Dairy Trade, known as Eucolait. Germany is the bloc's largest producer and top exporter of cheese, while the Netherlands and Denmark are the biggest shippers of whole-milk powder, the International Dairy Federation said.

Ireland will top its quota by 1.5 percent, with farmers who overproduce facing "super-levy fines" of about 28 euro cents per 100 kilograms, the country's Agriculture Ministry said on Feb. 17. Ireland last exceeded its quota in the 12 months ended in March 2012, with farmers incurring 16 million euros in fines.

"Farmers in many countries in the E.U. that risk producing more than their quota are not slowing down their production, and they're doing so in full knowledge they will pay a super-levy fine," Van Belleghem said. "That could have an impact on the global supply and potentially on the development of prices."

Rabobank expects prices to decline later this year, before quotas are lifted, with Class III milk dropping to $17.88 by the fourth quarter. That's 23 percent less than futures for delivery this month in Chicago that closed Thursday at $23.19. The contract for delivery in February 2015 traded at $17.50.

There will be no production shocks when quotas end next year as the E.U. boosts exports of milk, cheese and other dairy products, Herman Versteijlen, the acting deputy director general for agricultural markets, direct payments and economic analysis at the European Commission, said at a conference in Brussels Sept. 24. The bloc will be exporting 11.1 percent of its output by 2022, up from 10.1 percent last year, he said.

China, the top consumer of whole-milk powder often used in baby formula, will import a record 650,000 tons in 2014, 21 percent more than last year, according to the USDA. Chinese imports surged since 2008, when six infants died after some domestic companies were found to have sold formula tainted with the chemical melamine.