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Commission releases draft report on Fonterra’s 2016/17 Milk Price Manual

14 October 2016

The Commerce Commission today released its draft report on its annual statutory review of Fonterra’s Milk Price Manual for the 2016/17 dairy season. The Commission’s draft finding is that the 2016/17 Manual is largely consistent with the purpose of the milk price monitoring regime under the Dairy Industry Restructuring Act 2001 (the Act).

Deputy Chair Sue Begg noted that most of the Manual remains unchanged.

“The most significant amendment introduced this year is the inclusion of Fonterra’s sales outside the GlobalDairyTrade auction platform for whole milk powder, skim milk powder and butter milk powder. This shift could result in an increase in the milk price for the 2016/17 season of five cents per kilogram of milk solids,” Ms Begg said.

“We will be better able to assess the Manual’s consistency with the Act once we review how the amendment is applied in next year’s milk price calculation. Overall, we are pleased Fonterra is continuing to look at how it can improve the clarity of the rules in the Manual and its disclosures on their use to enable interested parties to better see how Fonterra would interpret and apply them.”

The draft report recommends Fonterra also considers some further issues, such as disclosing the milk price paid on standard terms to increase clarity on how winter milk premiums and other adjustments are treated in the calculation.

The Commission will review how Fonterra applies the Manual when it assesses the 2016/17 base milk price calculation at the end of the current dairy season.

The Commission welcomes submissions on the draft report by 15 November 2016. The final report will be published by 15 December 2016.

The draft report and related information can be found on our website.

Background

What does the Commission’s review of the Manual look at?

Each year the Commission reviews Fonterra’s Milk Price Manual for the dairy season that has just started. [1] The Manual sets out Fonterra’s methodology for calculating its base milk price (also known as the farm gate milk price) for the season.

The Manual does not cover any other milk price within the milk supply chain.

We are required to consider the ‘efficiency’ and ‘contestability’ dimensions of the methodology used in the base milk price calculation. Our review focuses on the extent to which the Manual provides:

  • an incentive for Fonterra to operate efficiently (the ‘efficiency dimension’)
  • for contestability in the market for the purchase of milk from farmers (the ‘contestability dimension’).

Efficiency

There are many factors which can, and do, provide efficiency incentives for Fonterra. Our review of the Manual against the efficiency dimension requires us to focus on only one of these possible factors (ie whether the Manual provides an incentive for Fonterra to operate efficiently).

Our view is that the Manual would be expected to provide an incentive for Fonterra to operate efficiently where the Manual uses independent benchmarks for the revenue and cost inputs in the base milk price calculation. This is consistent with the Dairy Industry Restructuring Act 2001, which envisages the use of notional values, and involves the assumption of a notional milk processing and collecting business (the ‘notional producer’).

Contestability

As explained by Section 150A of the Act, the ‘contestability dimension’ is a function of whether any notional costs, revenues, or other assumptions underpinning the base milk price calculation are ‘practically feasible’ for an efficient processor. Our review therefore considers whether the assumptions, inputs and processes adopted in the Manual are practically feasible for Fonterra or any efficient processor.

Policy objectives of the milk price monitoring regime

The milk price monitoring regime is intended to promote greater transparency of Fonterra’s base milk price setting processes, and greater confidence in the consistency of Fonterra’s base milk price with contestable market outcomes. The regime monitors whether the base milk price that Fonterra chooses to set provides incentives for Fonterra to operate efficiently but does not preclude efficient processors from potentially competing.

What does the overall monitoring regime consist of?

The Act requires us to do two separate reviews of Fonterra’s base milk price setting each dairy season.

The draft report concerns the first phase: the Manual review considers Fonterra’s methodology for calculating its base milk price at the beginning of each dairy season.

In the second phase, we are also required to review Fonterra’s base milk price calculation at the end of each dairy season.

We published our 2015/16 Review of the base milk price calculation in September 2016. In that report, we concluded that Fonterra’s 2015/16 base milk price calculation was largely consistent with the purpose of the milk price monitoring regime.

[1] The 2016/17 dairy season runs from 1 June 2016 to 31 May 2017.