Late last month, trade authorities of the U.S., Mexico and Canada have finally agreed to an updated trade deal dubbed the U.S.-Mexico-Canada Act. In Part 1 of a two-part episode, we enlist the help of dairy industry expert Mike McCully as we analyze what’s new and what’s not under the USMCA.

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Anna: Welcome to The Milk Check, a podcast from T.C. Jacoby and Co., where we share market insights and analysis with dairy farmers in mind. Today is October 1, and with us we have industry expert Mike McCully to talk about two timely topics. They will be coming to you in two separate episodes. Up first will be the new agreement between the U.S., Canada and Mexico that will replace NAFTA. The second topic, which will come to you in about a week, will be the new California federal milk marketing order due to start on November 1.

Ted: Are you updated, up to speed, on what the changes are, Mike? Can you give us a little bit of a preview as to how this is gonna effect our UF and blend sales?

Mike: I think on just the initial…well, the initial reaction is I think positive overall that they’re gonna eliminate the Class 7 pricing. The actual impact is gonna take a little while to come into effect. What they’ve said is it’s gonna be six months after the new agreement goes into force, and when they’re gonna change that. So, you know, if you figure it’s not gonna get officially done here until later this year, you’re really looking out into middle of 2019 before being able to eliminate that, and we can get back to maybe where it was before.

I think then the next question is, you know, they’ve increased milk production in Canada a fair bit since then, and whether they’re gonna really have that much of a need for U.S. milk out of the U.S. at that time, I think it’s directionally positive that there could be some imports starting second half of next year. But I think it’s partly still a little too soon to tell whether that’s gonna happen or not.

Ted: So how’s Canada gonna handle it internally? Now, if they don’t have the Class 7, so what are they gonna do? Take a hit on selling powder in the world market?

Mike: That I think that’s probably gonna be the early impact of it, and what…they’re going to implement to minimum price for the solids nonfat in Canada that will correspond to the U.S. nonfat dry milk price, minus the margin for what they called the Canadian margin. So they have been pegging that class seven price at what they call the world price, which was essentially, you know, I think arguable not compliant with WTO. But this is one of the concessions they made, is they would change the peg to the U.S. NFDM price, which is, you know, to kind of get it back on more of an even footing than what the U.S. price is.

T3: That Canadian margin, Mike, is that kind of like our make allowance? Or what is that, exactly?

Mike: I think that’s what they’re referring to. There wasn’t a lot of elaboration on the notes that I got, but I’m gonna assume that’s what it is.

Ted: Okay. Let me see if I got this straight. They’re gonna adjust the Class 7, by whatever name, to conform to international indices for milk powder and butter?

T3: No, that’s the way it is now. They’re going to make it conform to U.S. pricing.

Mike: Yeah. Instead of pegging the class seven SNF price to this, quote, “global” price or world price, they’re going to now take it to U.S. nonfat dry milk price.

T3: The reason that it wasn’t working before, from the U.S.’s point of view, was because, basically, by dumping powder onto the world market, Canada was actually driving down the world price, and then using that price they were driving down to lower their own milk price.

Ted: Right.

T3: Now they’re gonna use the U.S. price, which is, you know, given the breadth of nonfat production that we have…and skim milk, powder production we have in the U.S., it’s gonna be a little bit harder to move that dial.

Mike: Right.

Ted: So they’ll still be able to maintain their quota system, but the losses that they take on moving the surplus will come out of the quota, or will come out of the Class 1 portion indirectly.

Mike: Yeah.

Ted: Indirectly.

T3: I’m not sure I agree with that. What do you mean by that?

Ted: Well, I assume they have a pool of some sort. If they take a hit on moving powder, which is based on a higher indices, who picks up the tab? It probably is picked up in whatever pool they have up there, and I assume they have a regulatory pool similar to what we have. Is that—

Mike: I think a couple things could happen. One is, to your point, if it can roll back down to the farmer and it gets to be  lower net price because of it…

Ted: Right.

Mike: …that would be one potential outcome. A second potential outcome is, since the government does control that quota, if they see that there’s a surplus on milk, they could then dial that back, because they increased it last year to try and get more fat. They were short of  butter, short of cream. They increased the quota by 5%. So you have the, you know, a pretty quick reaction, where milk production jumped up to fill the need for the fat. But then what are they gonna do with the skim, which this Class 7 pricing helped them move that stuff out. As they lose that Class 7, then it’s gonna kick it back over to the decision of, do they just basically sell that skim milk powder at a loss, or do they dial back production, which then has an impact on the fat market if they become more of an importer of fat products again.

T3: The other thing…which leads me to the other part of the agreement, which, it sounded like they also were opening up slightly, I would say. Further access for U.S. dairy products to go into Canada.

Mike: Yes.

T3: From, what, 3.25 to about 3.8?Was that about right?

Mike: So they’re going to grant market access to 3.59% across a broad range of products. There’s gonna be a six year phase-in period for those volumes. Then, after that…so the volumes will go up 1% thereafter.

T3: Oh, really?

Mike: So for fluid milk, I mean, it goes from fluid milk down to different products. So the…after 10 years, tariffs on whey powder will be eliminated.

Ted: So it sounds like, 10 years from now, we’ll have an integrated market.

T3: Well…

Mike: Only whey powder. Not—

T3: …but, still, they’re using tariff rate quotas. So there’s still a limit in terms of how much can come in to Canada.

Mike: There’s definitely have a limit. I mean, this is gonna be a small crack. So there’s gonna be a little more, but…and the but is a pretty big but. So my understanding is that most of that quota, if not all of it, is held by dairy companies. Dairy companies may or may not be very interested in buying products from the U.S. to compete against what they’re doing in, you know, their own product in Canada.

So I saw a comment last week from an EU exporter who said, “Oh, yeah, we got, you know, additional access with the EU getting a trade deal a year or so ago,” but in reality, so far, they’ve only seen about half of the volume that they were expecting because the Canadian companies are not buying the stuff. So you can grant access, but if somebody on the other side doesn’t buy it, you’re still at the same point as where you were before, which is not much. So I think the market access one is interesting. I think there’s a lot of detail in terms of how to actually…to implement it.

The six-year phase-in is something…so now we’re gonna be talking about this for a long time, and the actual impact may or may not be very material, depending on the actions of the companies in Canada that are actually gonna do the buying of it.

Ted: That is interesting. It sort of follows the original NAFTA agreement with Mexico, where we phase it in over a five-year period.

T3: Right, but in Mexico they didn’t have the tariff rate quotas.

Ted: No.

T3: So the access was unlimited. I kind of think of those tariff rate quotas as a similar kind of impediment as the cheese import licenses that we have here in the U.S. You actually have to have someone how has the license who’s willing to…

Ted: Yeah.

T3: …to import the product.

Ted: All right. Well, it looks like a step in the right direction then, huh?

T3: A step in the right direction is probably the right way to put it.

Ted: Yeah.

T3: We’ll see where it goes from here.

Mike: Yeah, directionally positive. I think the initial impact should be a plus for, you know, the global SMP market or the nonfat market just if you assume over, you know, the next year or so, they’re gonna be exporting less and less of the skim milk powder into that Class 7.

Ted: All right.

Toby [producer & engineer]: I have a question. We’ve got these aluminum and steel tariffs, meanwhile, on Mexico and on Canada. It was my understanding that the retaliatory tariffs that Mexico put on our cheese will go away only if there’s a trilateral deal, which has been agreed to, which now we have. Do we still need the United States to cancel those tariffs on steel and aluminum before any of these good things that are supposed to happen with the dairy, happen with the dairy?

T3: I’ll give you my speculation on how that’s gonna play out, and Mike, you can tell me whether—

Ted: Lumber, and lumber too.

T3: Yeah, lumber. There’s a lot of it. Well, the lumber with Canada is particularly touchy, because the previous NAFTA had an issue there.

Ted: Yeah.

T3: But I think the steel tariffs and the dairy and other agricultural tariffs that the retaliatory tariffs that were put in place, my belief is that those are all gonna come down together at some point. But right now they’re gonna stay in place until—it’s not NAFTA anymore, it’s USMCA, I believe what it is—when the USMCA is ratified by the respective governments. At that point, I think all the trade negotiators will be able to get together and drop those tariffs. My guess is they will all come down on the same day.

Mike: Yeah. That’s my understanding. Most relevant for the discussion around dairy is the cheese import tariffs in Mexico, and what I’ve seen and heard is that if even after the U.S. and Mexico agree to a deal, those are gonna stay in place until they actually got the pens out and sign the document, sign, know, the deal. So I don’t see those being lifted until the actual deals are, you know, ratified and signed by all the parties.

T3: Which will probably happen sometime late November, if I’m not mistaken.

Mike: Yeah. Mexico, they want to get that done with the current administration before the next president comes in, which is December 1st.

T3: Though it does sound like AMLO, Obrador, over in Mexico, has been not overly antagonistic to getting in the way. So there’s hope there.

Mike: Yeah, and he made that point even in the run up to the election, was that if this deal gets done and it’s passed before I get into office, I’m okay with it. But if it’s not, and I’m coming in December 1st, I’m gonna want to get involved. So that’s been another one of those kind of hard deadlines of this whole negotiation, is, you know, you better get this done with Mexico before December 1st, and done to go, signed, before December 1st, because you might enter a new wildcard with him getting involved with it, and getting his leanings on some things might not be all that productive in terms of getting something resolved very soon.

So that’s been…you know, between the U.S. administration and bringing something to congress by September 30th, and the December 1st changeover with the new administration of Mexico, those have been two of the hard dates that finally got negotiators to get something done.

T3: The other big issue wasn’t a diary issue, but the other big issue for the Trump administration was the chapter 19 clause about dispute resolution, and that has stayed in place. Basically what happened was, Canada did end up throwing their dairy industry slightly under the bus, but they also held onto the dispute resolution, which has been an issue for the U.S. and, for all intents and purposes, been an issue for the dairy industry. The milk going into Mexico…chapter 19 plays a role in why we haven’t been able to get that in—

Ted: There was no dispute resolution, as it turned out.

T3: Well, technically there is. But it’s set up in a way that makes it very difficult.

Ted: They just ignore it.

T3: Exactly.

Ted: Yeah. So that sounds like it’s probably gonna continue to be a problem.

T3: Yes.

Ted: I don’t know whether Canada recognizes that or not.

T3: Oh, Canada does, because they want it to be a problem.

Ted: Yeah. Mexico, I think, does too a little bit. So we’ll see.

T3: Okay. Well, we’ll see.

Ted: That’s good.

Anna: We welcome your participation in The Milk Check. If you have comments to share or questions you want answered, send an email to podcast@jacoby.com. Our theme music is composed and performed by Phil Keaggy. The Milk Check is a production of T.C. Jacoby and Co.

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