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

14 December 2016

The Commerce Commission today released its final report on its annual statutory review of Fonterra’s Milk Price Manual for the 2016/17 dairy season.

The Commission’s finding is that the 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 said that while much of the Manual remains unchanged, the amendment to include sales for whole milk, skim milk and butter milk powders achieved outside the GlobalDairyTrade (GDT) auction platform will require additional analysis in the 2016/17 milk price calculation review.

“Although in principle we consider that including off-GDT prices is not inconsistent with the Act, we have concerns about the lack of detail as to how Fonterra will implement this change. We will take a closer look at this issue next year when we review Fonterra’s milk price calculation at the end of the current dairy season,” Ms Begg said.

The final report recommends that Fonterra revisits its current treatment of lactose costs in the Manual and considers including farmer support costs, though the Commission’s view is both of these components are immaterial to the milk price calculation and do not significantly affect its findings under this review.

The final report also recommends Fonterra discloses the milk price paid on standard terms to increase clarity on how winter milk premiums and other adjustments are treated in the calculation.

“There are a number of issues we will be following up in our review of the base milk price calculation next year, including a focus on the cost of capital calculation Fonterra uses to set the capital charge,” Ms Begg said.

Read the final report and related information.

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. 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’); and
  • 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 (i.e. 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.

This final 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.