Freer trade in dairy products was partially left behind when NAFTA began in 1994. It was mostly excluded in the U.S.-Canada relationship and provided with a 10-year transition for U.S.-Mexico and Canada-Mexico trade in most products and a 15-year transition in the highest volume product, nonfat dried milk. Nonfat dried milk trade becomes duty free on January 1, 2008 at a time of high prices for nonfat dried milk and changes in international trade.

Mexico wanted access to nonfat dried milk imports under NAFTA because exports were highly subsidized by most major milk producing and exporting countries. Given Mexico’s close proximity to the U.S., it became the largest importer of nonfat dried milk under the U.S. Dairy Export Incentive Program. Subsidized exports were limited under the Uruguay Round WTO agreement, but have not impacted exports in recent years as rising international prices made the U.S. competitive. In 2005 Mexico imported 154,715 metric tons (MT) of nonfat dried milk, with 84 percent from the U.S. Imports slowed to 111,033 MT in 2006 because of high prices, with 76 percent from the U.S.

Under NAFTA the U.S. was provided increasing tariff rate quotas (TRQ) with lower over-quota tariff rates. For 2007, the TRQ is 58,741 MT with an over quota tariff equal to the greater of 11.8 percent or $98 per MT. In the first six months of 2007 imports were 55,542 MT, with 37,711 MT, 68 percent, from the U.S.

A company controlled by the Mexican government known as LICONSA charged with distributing milk to poor families accounts for about 40 percent of nonfat dried milk imports from the U.S. LICONSA is trying to increase the amount of fluid milk it purchases from small and medium sized domestic producers, but has run into pricing problems because the government controls the selling price to consumers and holds the purchase price for farmers below the currently high international price for milk.

Mexico has 6.8 million dairy cows, unchanged in recent years, with 2.2 million used exclusively for milk and the other 4.6 million being dual-purpose milk-beef cows. According to analysis by the U.S. Agricultural Attaché in Mexico, the dairy production industry has three principal systems. The northern states of Mexico have confinement systems similar to those in the U.S. with mostly Holstein cows fed 20-22 pounds of grain per day. Semi-confined systems are used in the central states with some grazing and grain fed at 11-13 pounds per day. Dual purpose cows are used mostly in the sub-tropical south with native grasses and cultivated pastures as feed. This third system has two-thirds of Mexico’s dairy cows, but produces only 30 percent of the nation’s milk output.

Of the 10.1 MMT of milk produced in Mexico in 2007, 4.3 MMT is expected to be consumed as fluid milk, with the remaining 5.8 MMT processed into products. The country’s five major dairy processors compete aggressively to supply quality milk products to the growing middle class. In low income areas fluid milk consumption continues to be limited by sanitation, transportation and processing conditions. In those areas LICONSA reconstitutes nonfat dried milk and sells it at subsidized prices. LICONSA uses about 60 percent of Mexico’s nonfat dried milk (domestically produced and imported), and 35 percent is used by private processors to reconstitute for fluid sales and in production of cheese and other products.

USDA expects Mexico’s fluid milk production to increase by only 1 percent in 2008. Nonfat dried milk production is expected to increase by 5 percent to 200,000 MT. Use of nonfat dried milk is likely to increase by 8 percent in 2008 to 335,000 MT, and imports will increase by 13 percent from 120,000 MT in 2007 to 135,000 MT in 2008. This increase partially offsets a 28 percent decline in imports that occur in 2006 when nonfat dried milk prices first began to escalate.

As with the January 1, 2008 removal of TRQs and over-quota tariffs on corn and dry beans, the ending of import restrictions on nonfat dried milk under NAFTA has come at an opportune time with high prices in global markets. One benefit of the ending of restrictions will be that importers and exporters can better time shipments of nonfat dried milk. In the past the government of Mexico sometimes delayed import license commitments until late in the calendar year rather than releasing them on a regular basis. For 2007 the government has established additional amounts of TRQs under NAFTA and the WTO because of strong market demand. Trade has also benefited from the lack of sanitary/phyto-sanitary issues that could stifle movements.

Imports also play an important role for dairy products that have had unrestricted trade since 2003. Mexican cheese production in 2007, including cheese made from imported nonfat dried milk, is estimated at 147,000 MT. Imports will supply another 88,000 MT of cheese. Consumption is expected to grow by 2 percent in 2008 as the middle class continues to demand more cheese products. A preference for non-Mexican cheeses will result in imports increasing by 2.2 percent. Butter imports of 50,000 MT per year supply 30 percent of the market and are expected to be unchanged in 2008.

Mexico should continue to be a major market for U.S. dairy products as increased demand exceeds domestic production. Because of efforts by the Mexican government in recent years to expand access for U.S. products beyond the minimum requirements of NAFTA, Mexican milk producers in the northern two-thirds of the country have been competing with U.S. producers in an open market. Concerns about the ability of small-scale milk producers in the center and southern portions of the country to compete in the NAFTA market will be an ongoing political issue. The real test will come when dairy markets are more amply supplied and prices descend from their recent highs.