Ireland's £2 billion dairy industry is poised for its biggest challenge yet with EU farm policy facing another major shake-up. Plans unveiled last year by the European Commission will, if adopted, leave dairy farmers relying more than ever on direct payments from Brussels and hit co-ops' profit margins.

The Commission's "Agenda 2000" proposals, which are to be spelt out in detail before the end of March, would have most impact on the beef and cereals sectors where subsidy cuts of 30 per cent and 20 per cent respectively are mooted.

But the 10 per cent cut in support prices proposed for the dairy industry, and the as yet unspecified details of how it will be implemented, have major implications for the sector's future direction.

The Santer package, as Agenda 2000 is also known, proposes that the dairy industry cuts take place over the period 2000 to 2005. A dairy cow premium would be paid to farmers as compensation.

The aim of the overall package is to prepare the EU for talks on a new world trade agreement, which begins in 1999, and the next wave of EU enlargement. No-one doubts that further reform of the CAP is necessary. In the dairy sector, high EU prices have brought a rapid decline in the Union's share of an expanding world market. From a one-time share of 50 per cent-plus, the EU now has around 40 per cent of the world market and that figure is set to decline to 33 per cent in the foreseeable future.

But industry and farm leaders here have expressed deep concern that the proposed reforms could have a disproportionate effect on Ireland for a variety of reasons.

One of these is the proposal to relate the new cow premium to average milk yields; instead of getting a uniform payment per animal, Irish farmers - whose extensive, grass-based system results in lower milk yields than are produced by more intensive systems elsewhere - could get less per cow than their EU counterparts.

Ireland's heavy percentage of exports - some £1.3 billion of our total £2 billion in sales - also makes us more vulnerable to cuts in export refunds which will inevitably be part of any reform.

"It is clear the Commission and most member-states accept the thrust of the Agenda 2000 proposals," says Mr John Tyrrell, director-general of the co-ops' umbrella body, ICOS. "We have to ensure that those parts which adversely affect Ireland are modified."

The dilemma for the European Commission is how to balance the high prices paid to EU farmers with the need to make EU milk products more competitive on world markets.

The quota system which has restricted production but underpinned prices since its introduction in 1984, is set to remain until at least 2006. The system has served Ireland well but calls for a more flexible approach are growing.

An option gaining support, particularly in France and Denmark is the introduction of a "B" quota, which would allow farmers to produce a small amount over-quota and sell it without the usual market supports.

EU exporters' desire to participate in the growing world market has led to a great deal of interest in this idea, says Mr Pat Ivory of the Irish Dairy Industries Association.

"The advantage would be that a certain amount of trade would take place without subsidies and therefore free from GATT/WTO (world trade agreement) restrictions," he says.

The need for some flexibility of the quota regime is accepted by the EU Agriculture Commissioner, Mr Franz Fischler, but the "A" and "B" quotas idea is ruled out in the Agenda 2000 proposals.

Instead the Commission seems set to further pursue the course adopted with the MacSharry reform of the CAP in 1992, which saw price supports replaced by direct payments to farmers from Brussels.

But plans to expand such payments may fall foul of other trading blocs, who may argue that they are a distortion of the market, when new world trade talks begin.

Commissioner Fischler believes the EU's negotiating position will be strengthened if reforms are already in place before those talks get underway. In the meantime the Irish dairy industry is not prepared to wait around for things to happen.

Mr Tyrrell said processors are already taking steps to prepare for the changes being signalled, and further rationalisation within the industry is on the cards.

The recent Avonmore/Waterford merger is unlikely to be the last in the sector, and similar moves elsewhere would be welcome, says the ICOS boss. "We are encouraging people to look at the value and benefits of scale and what steps they can take in the best interests of their members."

Whatever challenges lie ahead, the dairy industry's track record in recent years suggests it is unlikely to shirk them.