The Canadian dairy industry has a window of opportunities to reinvent itself. Will it be missed?

This morning, David R. Henderson published a post on the Fraser Institute blog calling for the dismantlement of the dairy cartel enforced by the public policy of government-mandated supply-management. Although I can see from where his opposition to this policy comes from, I doubt ending supply-management will change the dairy industry structure in any way. The most likely path would be accelerated consolidation throughout the industry and accelerated decline if transition was to be inadequately planned for.

In the meantime, the current debate about what to do with diafiltered milk is also symptomatic of the prevailing shortsightedness hindering the discussion about how the dairy industry should be regulated. Although the present inconsistency of definition of diafiltered milk between CFIA and CBSA calls for harmonization, the direction that will be taken to resolve it may have unintended consequences that dairy farmers should consider. The truth is that this issue cannot be actually resolved without addressing the whole dairy ingredients’ strategy which in turn leads to question many, if not all aspects, of the current policy framework.

More generally, the fact is that publicly available knowledge about the actual economics of supply management is not sufficient to draw any conclusion about what would be best for the different stakeholders. Raw data exists, but the analytics is either not publicly available or simply not done. Because we are talking about a government policy affecting all consumers of dairy products, more transparency is needed.

Just an example focusing on dairy farms, my area of expertise. One of the main arguments for keeping the status quo is that supply-management shields Canadian dairy farms from the competition of US milk produced under much more favourable conditions, either natural or socio-economic. But do we actually know to what extent it is true? Do we know how much milk is produced in Canada at a cost which could be competitive with the US price after transportation, and foreign exchange is accounted for? Is it 30%, 50% or maybe 70%? The answer would change our view about the competitiveness of Canadian dairy farms, especially if we were to test the impact of policy change. For instance, I have estimated that on average the direct cost of supply management for a farmer is in the 6-to-10 dollars/hectoliter range (capital cost of quota purchase + marketing cost). The raw data of the Cost-of-Production survey of the Canadian Dairy Commission might provide some answer. I have asked to access these data through an Access-to-Information request a few months ago. I am still waiting for an answer.

Regardless of the current supply management policy, dairy production may be heading towards a major debt-fueled crisis set to occur within the next 10 to 15 years. The trigger would be an interest-rate increase coupled with a price drop because of either a demand crisis (food safety) or a supply crisis (disease, deep market imbalances). Then, a lot of dairy farms would not be able to adapt to such a new economic and financial environment, especially in Quebec.

Other questions: How competitive are Canadian dairy products on the domestic markets compared to other sources of proteins or fat, to other drinks or desserts? What are the determinants of this competitiveness? How does the policy of supply-management affect the latter? How does the policy of supply-management interfere in the allocation of capital for investment within multinational dairy processors operating in Canada? What might be the consequences for Canadian farmers and consumers?

Consequently, before making any judgement about the merits of supply-management as a policy tool to regulate the dairy industry in Canada, we should focus on establishing a comprehensive set of evidence of its benefits and its costs.

Considering the economic weight of the dairy industry, the importance of the issues at stake, the time on hands now that TPP negotiations are behind us, I think a Parliament-appointed commission should conduct i) an in-depth review of this policy, its impact in the dairy industry, in rural economies and in consumption, and ii) a foresight exercise to anticipate and imagine possible paths forward.

Over the next two years, the federal government will design its climate-change policy, which will most certainly change some aspects of the farming economy. Growing Forward 3 will also result in a new economic framework for the Canadian agriculture.

The Canadian dairy industry has a unique window of opportunities to find a form of regulation and build an economic framework that brings benefits to all stakeholders. Will that window be missed?

First, it is urgent to fill the knowledge gap to clear the horizon. Then, and once possible paths forward are identified, I am sure the leadership for change will emerge.

I have some ideas about how to address some of these issues, either in a supply-management framework or not. I also know from interesting Twitter’s conversation that farmers and other stakeholders have also very good ideas about what could be done to make a sustainable dairy industry prosper in Canada, beyond the current framework.

CREDIT, will it remain available and affordable for Canadian farming businesses?

Between 2005 and 2014, farm debt has increased by 43% to reach almost 85 billion dollars (constant 2014) in Canada. The gross value-added (in constant dollars) of the Canadian agriculture increased by 23% over the same period in a context of historically very high agricultural prices.

If the last decade was to repeat itself over the next one, farm debt would reach more than 120 billion dollars in 2014 terms. Canadian farming businesses may need tens of billion dollars of additional credit over the next decade in order to remain competitive and to make farm assets transfer possible.

Credit availability and affordability has not been a critical issue so far, but it will be unwise to assume it won’t be in the future.

In a previous post, I questioned the financial capacity of the Canadian agriculture as a whole to increase significantly its indebtedness over the next 10 years. In this post, I want to open a discussion about the availability and affordability of agricultural credit from financial institutions over the long run.

The following quote from Rabobank’s Capital Adequacy and Risk Management Report 2013 reminds us some of the basics of credit portfolio management, which apply to any credit portfolio, including agricultural credit :

Rabobank wants to continue its prudent credit policy and controlled growth in the credit portfolio which is in line with Rabobank’s strategic framework and image. In order to accomplish this:

  • the credit portfolio must retain a low risk profile;
  • the credit portfolio cannot grow without bounds;
  • capital and funding will need to be used selectively


Understanding how a credit portfolio is managed is critical for any business or sector, which will need to access credit to fund its development. It is all the more so when credit is overwhelmingly the primary source of capital such as in the case of the Canadian agriculture.

Bertrand Montel, ©2016

Is the Canadian agriculture falling into a debt trap?

With agricultural commodities prices falling and the prospect of rising interest rates getting closer, I thought it could be interesting to see where the Canadian agriculture stands debt-wise. In this post, I will look at the indebtedness in two ways.

Firstly, farm indebtedness will be assessed relative to the output of the Canadian agriculture. We start by deflating the farm debt value by the CPI. The output is derived from the value of the production (farm sales and change in inventories) by deflating it by the farm products price index. By building an index, we are able to obtain the change in our ratio [Farm debt / Output].

We do the same with the Gross value added (GVA) of the Canadian agriculture and the total value of farm assets (real estate and quota).

The first graph below presents the evolution of our three ratios. What really stands out is:

  • the significant decrease of the economic efficiency (GVA/Output) of the Canadian agriculture over the period considered here (1981-2014) though it has bounced back a bit over the last 10 years thanks to high prices.
  • from 1995, the divergence of dynamics between, on one hand indebtedness and farm assets value, and on the other economic efficiency.

debt trap CDN_AG

That could be explained mainly by two factors :

  • lower interest rates which are now close to the lowest level they could reasonably be at;
  • the increasing share of off-farm income in the farm households which is not captured by the GVA account, and that provides liquidity to repay debt obligations

Secondly, we will look at the indebtedness in the Canadian agriculture through the ratio (Farm debt outstanding)/(Maximum farm debt).

Maximum farm debt is defined as the long-term debt allowed by the aggregate debt servicing capacity, assuming terms and conditions complying with current best agricultural lending practices:

  • Debt service coverage ratio of 1.1, calculated as Earnings before Interest, taxes, Depreciation and Amortization (EBITDA) divided by Principal plus Interest payment. Using Statistics Canada data, EBITDA is approximated by Net cash income plus interest. Because of the intrinsic volatility of farm income, we will use a 3-year average of net cash income before interest in place of the current value to calculate our debt repayment capacity.
  • Repayment period based on useful life of assets. Usually, it is based on the weighted average of the useful life of the different asset classes. However, in order to assess the maximum level of debt, we could use a 20-year repayment period providing the ratio Maximum debt to total Land value remains below 75%. If that ratio was to be above 75%, we would have to revert to the weighted average, with 15 years a good benchmark.
  • Prudent interest rate: the 5-year conventional mortgage rate which is commonly used to stress-test credit risk of agricultural loans. Comparing it to the apparent average interest rate paid by farms, we could note that from the mid-90’s, the spread between the two interest rates is relatively stable.

The graph below shows that indebtedness capacity became more and more saturated until 2005-2007. Then, lower interest rates, increasing farm products and farmland prices, all contributed to raising the maximum farm debt.

max debt + scen

We note that two provinces stand out : Saskatchewan and British Columbia (BC). The former has experienced a remarkable drop in indebtedness saturation because all the recent trends mentioned previously were amplified here. The latter, a contrario, has experienced a very significant jump with a current indebtedness saturation of more than 100%. How is that possible? Short answer: off-farm income, low interest rate, non-standard lending term and conditions, farmland prices driven by non-agricultural factors.

Now, we will assume that the interest rate gradually reverses to its 20-year mean over 10 years while debt repayment capacity, farm debt and land value remain constant. That sole change would lead to increasing saturation of the indebtedness capacity. However, we could construct realistic scenarios which would lead to a much faster saturation.

As far as I am concerned, the debt problem of the Canadian agriculture is not a problem of solvency. The Canadian agriculture is solvent. I do not foresee any collapse of crisis-scale within the next decade. It is a problem of restricting the ability of the Canadian agriculture to sustain, over the long term, a level of investment consistent with the competitive pressure, the pace of innovation and of demographic change.

Then, questions come to mind: Why debt? Are there other sources of capital available? 

This is a first-level analysis at a very aggregated level. To assess the risk identified here adequately, we need to dig deeper and go to disaggregated levels. Preliminary results show differences along industry and farm-size lines.