Commission releases final report on its review of Fonterra’s 2015/16 base milk price calculation
15 September 2016
The Commerce Commission today released its final report on Fonterra’s base milk price calculation for the 2015/16 dairy season. The Commission’s view, after considering submissions on the draft report released last month, is that Fonterra’s calculation of the 2015/16 base milk price is largely consistent with both the efficiency and contestability purposes of Dairy Industry Restructuring Act (DIRA).
Deputy Chair Sue Begg said that the conclusion changed from the draft report because the Commission was not able to conclude on the practical feasibility of the asset beta, which is a key input to the weighted average cost of capital in the milk price calculation.
“Having considered the submissions made on the draft report, we decided we did not have enough evidence to conclude on the practical feasibility of the asset beta. However, we do feel that this is a matter that can be resolved and have set out in our report suggested next steps in this regard. ”
The Commission appreciates Fonterra’s continued efforts to provide more transparency of information about how it calculates the milk price and the ongoing efforts from interested parties to improve the milk price monitoring regime.
“We particularly acknowledge the efforts of Fonterra and its expert, and of other interested parties in engaging on the thorny asset beta issue,” Ms Begg said.
“We also want to thank those interested parties who have made submissions for the first time - the farmer suppliers. We look forward to continuing our engagement with a range of parties in undertaking our future reviews.”
The base milk price is the price Fonterra pays to farmers for raw milk and it is currently set by Fonterra at $3.90 per kilogram of milk solids for the 2015/16 season just ended. Our report does not cover the forecast 2016/17 price of $4.75 that Fonterra recently announced.
The Commission is required to review Fonterra’s calculation each year at the end of the dairy season under the milk price monitoring regime in DIRA. In the review, the Commission is required to consider the ‘efficiency’ and ‘contestability’ dimensions of the base milk price calculation.
What is the purpose of the milk price monitoring regime?
The milk price monitoring regime is intended to promote greater confidence in the consistency of Fonterra’s base milk price with contestable market outcomes and greater transparency of Fonterra’s base milk price setting processes.
The regime exists because, without a competitive market for the purchase of farmers’ milk, the price for that milk is set by Fonterra using an ‘administrative’ methodology. As Fonterra determines and applies that methodology itself, there is a risk that Fonterra might have the incentive and ability to set a base milk price that is ‘inefficient’.
The regime has the effect of monitoring whether the price that Fonterra chooses to set to buy milk might be ‘too high’ or ‘too low’ relative to the price that would exist if the market for purchasing farmers’ milk was workably competitive or contestable.
What does the Commission’s review look at?
Each year the Commission reviews the calculation of the base milk price for the dairy season that has just concluded. The base milk price is the average price Fonterra pays to farmers per kilogram of milk solids (kgMS). The Commission does not review how the forecasts of the price for the next season are calculated.
The focus of the review is solely on the farm gate milk price and not any other milk price within the milk supply chain. The term used in DIRA for the ‘farm gate’ milk price is ‘the base milk price set for that season’.
What does the overall monitoring regime consist of?
DIRA requires the Commission to conduct two separate reviews of Fonterra’s base milk price setting each dairy season.
As well as this review of the base milk price calculation, the Commission is also required to review Fonterra’s Farmgate Milk Price Manual (Manual review). Fonterra’s manual sets out its methodology for calculating its base milk price for the season.
In the report on the 2015/16 Manual review in December 2015, the Commission concluded that the Manual was largely consistent with the purpose of the milk price monitoring regime.
The Commission has commenced its review of the 2016/17 Manual. Read more about this work.