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If Canada's tightly regulated dairy regime is about to come crashing down, someone forgot to tell Gay Lea Foods.

The Mississauga-based dairy processor, owned by 1,300 Ontario dairy farmers, is spending $250-million over four years to modernize and expand its operations across Canada.

Last week, the company acquired a cheese maker in Calgary – Alberta Cheese Co. This Wednesday, it will open a large new butter and dairy ingredients plant in Winnipeg, part of a joint venture with Vitalus Nutrition Inc. of Abbotsford, B.C.

Martha Hall Findlay: On supply management, the Americans should be careful what they wish for

Read more: U.S. demands end to Canada's supply management as part of NAFTA negotiations

They are risky bets, given the troubled state of talks to overhaul the North American free-trade agreement. U.S. negotiators are demanding Canada immediately open up as much as 17 per cent of its heavily protected dairy and poultry markets, and within a decade entirely dismantle the supply management system that controls the sectors.

Gay Lea's aggressive growth strategy appears to hinge on a different scenario – namely, that Canada's dairy industry remains largely sheltered from foreign competition. Ottawa will continue to restrict most imports through quotas and a steep tariff wall, and prices and production levels will remain strictly regulated.

If the United States gets its way, all that would end, including Canada's 270-per-cent tariff on milk.

Gay Lea knows it must become more competitive if it's going to survive as the United States and other countries chip away at Canada's protected market in various trade negotiations. But it's not clear that it and other Canadian processors are ready for wide-open free trade after decades of underinvestment. Two of Gay Lea's competitors, Agropur and Saputo, have chosen to spend heavily outside Canada. Both companies now process more milk in the United States than in Canada.

Gay Lea, on the other hand, has focused on the domestic market. Its expansion plans are based on being able to buy milk from Canadian farmers at the lower wholesale prices that prevail in the United States and elsewhere, rather than generally higher domestic prices. Canadian farmers pushed for the creation this year of a new price class specifically for milk destined for the production of dairy ingredients, such as protein concentrates. The new milk pricing scheme has stemmed the flow of cheaper imported dairy ingredients from the United States – a source of tension with the Trump administration.

Lower prices have given Gay Lea and other processors the confidence to invest in new production. As with Gay Lea, Parmalat Canada is boosting its capacity to produce dairy ingredients by adding a new production line at its dairy in Winchester, Ont. – one of its 16 Canadian plants.

A whole lot more investment and consolidation will be needed if the border opens wide. Structured as it is now, the Canadian dairy industry would face problems of scale. And Canadian processors are generally not positioned to export to the United States or anywhere else.

A single U.S. company – Dean Foods of Dallas – processes as much milk as the entire Canadian industry. Dean Foods makes everything from milk and protein ingredients to yogurt and ice cream at 66 plants across the United States, including many clustered near the Canada-U.S. border.

For farmers, the economies of scale look even more challenging. The average Canadian dairy farm has 85 cows. In the United States, it's closer to 200, and the largest farms have thousands of animals. Nothing in Canada matches Fair Oaks Farms, in Fair Oaks, Ind. The operation has 32,000 cows and produces enough milk to supply the city of Chicago.

The long-held fear is that an open border would decimate the Canadian industry – that Canada would not be able to compete with large industrial farms and more efficient processing plants in the United States.

The outcome of the NAFTA negotiations is highly uncertain. Ottawa has insisted it won't buckle to the U.S. demands on dairy. The United States is threatening to walk away from NAFTA, but it's unlikely to relent in demanding a more open border on U.S. dairy exports to Canada.

The dairy industry is facing the same challenges the rest of the economy did, circa 1988, on the eve of the original Canada-U.S. free-trade agreement. The companies that invested heavily and positioned themselves for a larger market thrived.

The rest faded away.

Gay Lea and other Canadian dairy players will have to figure out a way to be competitive beyond the sheltered domestic market. And that will mean getting into the export market.

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