Ontario Dairy Council v Dairy Farmers of Ontario, 1997 ONAFRAAT 21

Agriculture, Food and Rural Affairs Appeal Tribunal 1 Stone Road West

Tribunal d’appel de l’agriculture, de l’alimentation et des affaires rurales 1 Stone Road West

Guelph, (Ontario) N1G 4Y2 Tel: (519) 826-3433, Fax: (519) 826-4232 Email: AFRAAT@ontario.ca

Guelph (Ontario) N1G 4Y2 Tél.: (519) 826-3433, Téléc.: (519) 826-4232 Email: AFRAAT@ontario.ca

Ontario Dairy Council v Dairy Farmers of Ontario

Ontario Dairy Council v DFO 1997 ONAFRAAT 21

Ministry of Agriculture, Food and Rural Affairs Act

May 21, 1997

DATE OF DECISION:

June 5, 1997

1997-21

1997 ONAFRAAT 21

Ontario Dairy Council v Dairy Farmers of Ontario

THE FARM PRODUCTS MARKETING ACT AND SECTION 16 OF THE MINISTRY OF AGRICULTURE AND FOOD ACT.

An Appeal to the Farm Products Appeal Tribunal by the Ontario Dairy Council from a decision of the Dairy Farmers of Ontario to deny its request, outstanding from the October 30/31, 1996 Board Meeting, to change the methodology used to determine the price of Class 4(a) and to then increase the Class 4(a) milk price to the -1 per cent level in the flexibility range, effective April 1, 1997.

Before:

Mr. James Rickard, Chair; Mrs. Nancy McGill, Alternate-Chair; Dr. Denis O’Connor, Vice-Chair; Mr. Gordon Hatch, Member.

Appearances:

Mr. Tom Kane, President of the Ontario Dairy Council, on behalf of the appellant, the Ontario Dairy Council.

Mr. John Core, Chair of the Board, on behalf of the respondent, the Dairy Farmers of Ontario.

This appeal was heard in Guelph, Ontario on May 21, 1997. The Ontario Dairy Council (the ODC) appealed to the Farm Products Appeal Tribunal (the Tribunal) from a decision of the Dairy Farmers of Ontario (the DFO) denying the ODC’s request to change the methodology used to determine the price of Class 4(a) milk and to then set the Class 4(a) milk price to the minus one per cent level in the flexibility range of the P6 Agreement, effective April 1, 1997.

The Background

The six eastern provinces - Prince Edward Island, Nova Scotia, New Brunswick, Quebec, Ontario and Manitoba - have entered into an agreement for marketing milk. This agreement is referred to as the P6 Agreement of the All Milk Pool.

The P6 Agreement provides for the pooling of revenues from all milk sales, including the federal subsidy dollars on industrial milk, the sharing of all future fluid and industrial market adjustments and the harmonization of all the provincial policies necessary to support them. The market sharing provisions of the agreement were implemented on August 1, 1995. The pooling provisions of the agreement came into effect on August 1, 1996, with the first pool being cleared for August milk in October.

The milk pricing provisions of the P6 Agreement call for each province to adopt the national harmonized class structure for pricing and for milk to be priced and sold to processors in accordance with the “end use” of the milk components used to manufacture or process the milk and milk products falling within each milk class. Component prices for butterfat, protein and other solids (lactose and minerals) are established for each class.

The butterfat component price is the same for all domestic milk classes and varies only for milk sold under special classes for export and further processing. The protein and other solids component prices vary from class to class.

Under Section 7 of the agreement on the All Milk Pool entitled "Harmonization", there are a number of subsections that reference the pricing system to be implemented in the pool. Those sections state:

"Beginning on August 1, 1995, provincial signatories,

c) shall adopt an harmonized milk classification system;

d) shall implement an harmonized end-use multiple component prices(MCP) system according to components for special classes and, for remaining classes, will endeavour to ensure its implementation as soon as possible;

e) shall calculate common target prices for classes one to four. These common target prices will be equal to the current weighted average of class prices in provinces participating in the pool plus one percent. Common target prices will be applied August 1, 1996. Common target prices will be adjusted by agreement of the signatories. A more explicit interpretative note appears in Annex D;"

Annex D states in part:

"Provincial prices as established within the province will be incorporated into the calculation of the final set of target prices in October 1995.

…Common target prices for Class 1 to 4 will be calculated by October 1, 1995 as being the weighted average current prices in provinces participating in the pool plus one percent. This calculation will be done by class, on a comparable basis. It is understood that provincial prices must reflect gross dollars billed including any surcharges for each class of milk. After October 1, 1995, it is agreed that common target prices will be adjusted by agreement of the signatories. Actual provincial prices will be determined as a consequence of provincial pricing processes."

Ontario and each of the other provinces had to convert their existing prices using a new methodology that took into account new classifications and a new multiple component pricing system. This establishes that province’s "converted price". Once each province calculated its converted prices, it was weighted by that province’s volume to arrive at an average price for the All Milk Pool, to which one percent was added to determine the Common Target Price for that class in the pool. According to the P6 Agreement, Ontario would be allowed to set its class price within ±1% of the Common Target Price.

There are four key principles for the conversion process:

Revenue Neutrality at the Provincial Class and Industry Levels.
End-Use Component Pricing.
Common pricing methodology.
Target price for each class equals P6 Average +1%.

Milk in Class 4(a) of the harmonized classification system will be used for the manufacture of butter/powder and was Class 5 in the Ontario system.

In Ontario in 1993/94, 87% of the volume of Class 5 milk purchased by butter/powder plants was direct purchases of milk from the DFO. Thirteen percent of the volume of milk was surplus cream from the standardization of milk for fluid processing and cheese making which is declared in the butter/powder class by fluid milk and cheese plants. These plants were billed accordingly by the DFO. This surplus cream was purchased by the butter/powder plants. These are the industry averages and are not specific to a particular plant.

Under the Ontario system, Class 5 milk was billed on the basis of the volume used as verified by plant audits. Under the harmonized system, Class 4(a) is billed on the basis of the components as sourced. Under the Ontario pricing system, a litre of surplus cream was assumed to contain the same components as a litre of milk for billing purposes. In reality, it contains more butterfat and less solids not fat (SNF) - i.e. milk: 3.9598kg/hl butterfat, 3.3246kg/hl protein, 5.7789kg/hl other solids; surplus cream: 37.5kg/hl butterfat, 2.1031kg/hl protein, 3.6557kg/hl other solids.

The ODC is appealing the methodology used by the DFO to determine the converted price for Class 4(a) (butter/powder) in Ontario. The mathematics used to weight and average that price to get the Common Target Price is not being questioned.

The Issue

The issue before the Tribunal is whether the DFO followed the appropriate methodology in calculating the common target price for Class 4(a) milk to submit to the All Milk Pool?

The Evidence and the Findings

Mr. Tom Kane, president of the ODC, told the Tribunal that the ODC is the non-profit trade association that represents the interests of the dairy processing, marketing and distributing companies in Ontario. Collectively, the ODC's membership accounts for approximately 96% of all the milk produced in the province. The ODC is fully funded by the membership and receives no government financing for its operations.

Mr. Kane said that Ontario changed its pricing structure and its classification system to conform to the P6 Agreement. Mr. Kane said that in doing the conversion, it is the ODC’s opinion that revenue neutrality was not achieved for Class 4(a) industrial milk purchases. Mr. Kane claimed that the old price of protein and other solids for butter and powder was $3.2087/kg, and the new price is $3.3691/kg. The difference of $0.1604/kg represents a 5% price increase.

Mr. Kane used the following example to illustrate his point:

“In the submission to the Advisory Committee for Milk, all the calculations are based on the average composition of the milk supply in 1993/94 which were: 3.9598 kg/hl for butterfat; 3.3246 kg/hl for protein; and 5.7789 kg/hl for other solids. The component prices in effect at the time were: $5.4798/kg of butterfat; $7.6241/kg of protein; $0.6587/kg of other solids; and there was a volume differential of $0.07/hl. Therefore, the cost of one hectolitre of milk containing the provincial average milk composition would have been:

May 1996 Cost of Butter/Powder Using Old Methodology

Butterfat 3.9598 X $5.4798 = $21.6989

Protein 3.3246 X $7.6241 = $25.3471

Other Solids 5.7789 X $0.6587 = $03.8066

Differential = $00.0700

Total = $50.9226

May 1996 Cost of Butter/Powder Using New Methodology

Butterfat 3.9598 X $5.4922 = $21.7480

Protein 3.3246 X $3.3691 = $11.2009

Other Solids 5.7789 X $3.3691 = $19.4697

Total = $52.4186

Difference - $52.4186 - $50.9226 = $1.4960 or 2.9%

Regardless of the reason for the $0.1604/kg. adjustment made to the prices for protein and other solids, it is readily apparent that the cost of milk to manufacture butter and powder has increased, contrary to the overall objective of revenue neutrality for each class of milk.”

Mr. Kane said that the transportation surcharge would add $0.036/hl to the old price. This would raise the cost of butter/powder using the old methodology to $50.9586/hl.

Mr. Kane said that the ODC contends that the cost of milk used to manufacture butter and powder under the new system should have been no more than the $50.9586/hl that had been paid under the previous system. The costs of the individual components should have been determined by working backwards and using the overall objectives stated in the submission of the Advisory Committee for Milk. The following steps should have been taken:

The cost of one hectolitre of milk for butter/powder manufacturing at the provincial average composition (including the transportation surcharge) was $50.9586/hl.
All parties agreed that the price of butterfat should be constant throughout all the classes within a province and that price was set at $5.4922/kg.
The cost of butterfat in one hectolitre of milk would, therefore, be $5.4922 times the average composition of 3.9598 which equals a value of $21.7480.
The value of protein and other solids would, therefore, be the total value of milk of $50.9586 less the butterfat value of $21.7480 which equals $29.2106.
The total amount of SNF in the milk would be equal to 9.1035 kg/hl (3.3246 from protein and 5.7789 from other solids).
The cost of protein and other solids would be calculated by dividing the $29.2106 by the 9.1035 SNF which equals $3.2087/kg.

Mr. Kane said that this is the value that the DFO calculated. Then the DFO included an adjustment of $0.1604/kg to the protein and other solids prices to transfer to Class 4(a) the costs associated with the surplus cream that butter manufacturers purchase from fluid milk processors.

Mr. Kane explained that fluid milk processors buy milk at 4% and use 2% so they have extra butterfat they do not need. They sell that to butter or ice cream manufacturers or use it for fluid cream. Mr. Kane said that the DFO sells raw milk at average composition to processors, not surplus cream at average composition. He also said that the DFO has no jurisdiction over the pricing of surplus cream and the costs of the components found in surplus cream should not be included in the conversion methodology for the new system. This is the cause of the ODC’s concern and forms the basis of the appeal.

Mr. Kane told the Tribunal that if the appeal is granted, then Ontario will have to resubmit its Class 4(a) converted price to the All Milk Pool for weighting and averaging.

In response to questions, Mr. Kane explained that a change in the P6 Agreement must have the unanimous support of the parties. He said that the conversion process was developed by a technical committee which laid down a step by step approach to the calculations. This process is not included in the agreement other than the basic parameters contained in Annex D which says to take the gross billing and average it over the pool and add 1% and that becomes the common target price. He said if Ontario wants to submit a new calculation of its price for Class 4(a), it would have to go to the technical committee with its proposal, get agreement that this is the correct method of calculation and then submit the new price. Mr. Kane said he felt that his proposed calculation method would not result in much change for the other provinces in the P6 Agreement since they do not use much surplus cream in the manufacture of butter and powder.

Mr. Paul Van Weelie, from Ault Foods, told the Tribunal that Ault is likely the largest user of Class 4(a) milk in Ontario. He said that revenue neutrality is seen by the processors as the most important principle of harmonization. He said that, in his opinion and analysis of the data, the component prices submitted by the DFO do not meet the principle of revenue neutrality by Class. He said that by using the DFO’s methodology, the price of milk increases from $50.9586 to $52.4186/hl for butter/powder plants.

Mr. Van Weelie said there are two reasons why the methodology used by the DFO did not achieve revenue neutrality by provincial class and industry level. The first reason is that the DFO failed to differentiate between the multiple component pricing system and the billing system. The DFO reduced the component price of the SNF in Class 1 by $0.12/kg in order to reconcile the new fluid milk revenue to the old billing system. Then the DFO added $0.16/kg to the SNF for Class 4(a) to offset the reduction in Class 1. The second reason is that there are three industrial levels - fluid, frozen and industrial. Each component of the industry should be charged the same amount after conversion as before and it is not. He said he already has shown that the total collected in Class 1 and Class 4(a) have both changed.

Mr. Van Weelie said that while surplus cream is excess to the needs of the fluid plants, it is a valuable commodity that is sold to the butter/powder plants for whatever amount the fluid plants can achieve. He said that as long as the butter/powder plants can buy the surplus cream for an amount that allows them to make a contribution towards the fixed costs of the plant, they will buy it. He said that in the controlled market for milk, the plant either buys or goes out of business. He said the fluid plant gets a 5 cent/kg break in cost, but if the plant management has a customer that is willing to pay, then they will not pass that cost savings on. He said that the DFO should not rely on a reduction in the price of surplus cream to mitigate the fact that the price of Class 1 milk has decreased and the price of Class 4(a) has increased.

Mr. Bob Sinclair of Gay Lea Foods spoke to the Tribunal. Mr. Sinclair told the Tribunal that Gay Lea Foods is a producer owned cooperative operating butter/powder plants and has about $200 million in annual sales. Mr. Sinclair told the Tribunal that he had compared the new price of milk to the old price and found that the new price resulted in an increase in the cost of raw product that equaled 120% of Gay Lea Foods’ gross profits before tax. He said that a cost increase of this magnitude puts Gay Lea Foods in an uncompetitive position. Mr. Sinclair said that the reduction in the cost of raw product to the fluid plants is not well understood and he believes there has to be another way of dealing with the situation other than expecting the fluid plants to reduce the cost of excess cream to the butter/powder plants.

Mr. John Core, dairy farmer and Chair of the board of the DFO, told the Tribunal that the ODC’s contention is that if the DFO had done the calculations differently, the P6 Target Price would have ended up at a lower level permitting a lower Class 4(a) price within the context of the All Milk Pooling Agreement. The said that the ODC is suggesting to the Tribunal that the P6 Target Price of $3.5572/kg for Class 4(a) should have been $3.5053/kg, thereby permitting the DFO to establish a price of $3.4702/kg at -1.0% flexibility. The DFO concedes that this would be correct if all the components declared in Class 4(a) came from milk. He said the reality is that only 87% of the components relate to milk and 13% relate to skim-off cream.

Mr. Core said that following the presentation of the ODC at the DFO hearing on this matter, but before making its decision, the DFO had further discussion of the issue at the P6 Technical Level. The discussions at the P6 Technical Level resulted in no change, as other provinces were not prepared to change methodologies at such a late date. Therefore, the DFO denied the ODC’s request. Mr. Core said that Quebec has a large part of the Class 4(a) milk production and Quebec has not implemented the harmonized classification and pricing system. The target date for implementation is now August 1, 1997. It is the DFO’s intention to adjust the Ontario Class 4(a) price, to match the Quebec price, on the date on which Quebec implements the harmonized system. He said that all provinces in the P6 are committed to bring their prices within the minimum flexibility limits of the All Milk Pool Agreement, by the Quebec implementation date. He told the Tribunal that the flexibility limits are not imposed on Manitoba to enable it to align itself with milk prices in the other three western provinces under the Western Milk Pool.

Mr. Core said that the DFO’s position is that the conversion and the resulting Ontario Class 4(a) price submitted to the P6 averaging process was fully consistent with and precisely followed the P6 conversion procedures and principles. He said the DFO had no choice in this regard as it was essential that the same procedures and principles be applied in all the P6 provinces. To do otherwise would have jeopardized the objective of leveling the playing field on price between processors producing the same products in different provinces.

Mr. Core told the Tribunal a fundamental point which needs to be recognized is that revenue neutrality at the provincial class and industry level does not necessarily imply or guarantee revenue neutrality at the individual plant or processor level. Mr. Core said that this was the first time he had heard anyone talk about three industries. It has always been his understanding that industry meant the industry as an entirety.

Mr. Core said that in making its arguments, the ODC is ignoring end-use component pricing. He said that under the harmonized pricing system, processors are being billed on the basis of the actual components used to manufacture the products falling in Class 4(a). This compares to the former classification system in Ontario where processors were billed on a volume-related basis for the milk (87%) and surplus cream (13%) used in Class 5 (now Class 4(a)) with components being billed at the average composition of the total milk purchased by the plant.

Mr. Core also said that under the P6 Agreement, each province has its own method of settling within-province disputes but if a settlement at the provincial level has an impact on the other provinces, it has to be submitted to the P6 governing body and then a decision made by that body on what action should occur in the P6 Agreement. There is or will be a dispute settling mechanism for P6.

In response to questions, Mr. Core told the Tribunal that if Ontario proposed new numbers to the parties of the P6 Agreement they could:

Accept the new method of calculating and recalculate their numbers, or
Say no, or
Take Ontario to the dispute settling body of the governing body of P6.

Mr. Core did not dispute the accuracy of the calculations made by the ODC and the plant spokesmen. He said that their calculations did not conform to the agreed upon methodology. He also pointed out that since Ontario is committed to matching the Quebec price for Class 4(a) milk, the only difference that winning the appeal will make for the Ontario processors is that the price of Class 4(a) milk in the pool will be lower for all processors who buy from the pool. This will not change the competitive position of Ontario-based processors compared to Quebec-based processors once the multiple component pricing by end-use system is fully implemented.

The Tribunal examined the evidence and came to the following conclusions:

There is no dispute that multiple component pricing by end use, as calculated by the DFO using the P6 agreed upon methodology, results in a lower cost per hectolitre for fluid milk plants after implementation in Ontario than the price was under the previous billing system. Likewise, there is an increase in the price for butter/powder plants.
The Tribunal finds that the DFO followed the P6 agreed upon methodology when it calculated the new component prices to submit to the governing body of the P6.
The Tribunal finds that the result of the component pricing for Class 4(a) is an increase in cost to those plants that buy Class 4(a) milk and therefore, does not conform to the principle of revenue neutrality by Class.
Since the DFO is committed to matching the price set by Quebec for Class 4(a) milk, the end result of any decision of this Tribunal would be establishing the initial value of Class 4(a) milk in the pool. The ODC’s argument, if accepted, would result in a slightly lower initial price than currently resulting from the DFO’s calculations. The competitiveness of Ontario-based processors compared to Quebec-based processors for Class 4(a) milk would not change as a result of a decision on this dispute. There is insufficient information for the Tribunal to decide the effect of this pricing decision on the competitiveness of products made from P6 milk compared to milk purchased from the Western provinces or imported products.
In the opinion of the Tribunal, it would be reasonable to expect that the reduction in the cost of surplus cream billed to fluid plants would be passed on in the form of lower costs to the butter/powder plants except that this part of the market is not controlled by the DFO and operates on a free market system.
The parties agreed that a change in the calculations by Ontario cannot be made unilaterally but must be submitted to the governing body for the P6 for consideration. There are three possible outcomes to this submission - acceptance, rejection and an appeal to the dispute settling mechanism.

The Tribunal concluded that since the DFO has followed the P6 agreed-upon methodology and that resulted in an increase in the cost of Class 4(a) milk after conversion over the pre-conversion price, the proper solution to the problem is for the governing body of P6 to review the methodology in light of the facts and decide on a course of action. The fact that Ontario cannot unilaterally act to solve this issue is a necessary consequence of entering into an agreement with the other provinces.

Decision and Reasons

After careful consideration of the evidence presented and submissions made, the Tribunal declined to make a decision in this dispute. The reason for this decision is that, in the opinion of the Tribunal, both parties are correct in their position but the proper forum for resolving the issue is with the governing body of the P6 Agreement. Ontario cannot act independently on this matter.

Dated at Guelph, Ontario this 5th day of June, 1997.