Commission concerned Fonterra's risk estimate is too low when calculating milk price
Published14 Jun 2018
The Commerce Commission has released an emerging view that Fonterra’s estimate of risk in calculating the cost of financing milk processing operations is too low. The impact of this is that Fonterra calculates a higher milk price than would be the case if it used a more feasible allowance for risk in the cost of finance, consistent with other processors.
The cost of financing (also known as the cost of capital) feeds into the calculation of the milk price Fonterra pays its farmers. The Commission administers a milk price monitoring regime under the Dairy Industry Restructuring Act (DIRA) as Fonterra has market power over the purchase of farmers’ milk.
“For several years now Fonterra has been unable to provide sufficient evidence to convince us that using a lower asset beta than comparable processers is justified,” Commission Deputy Chair Sue Begg said.
The asset beta is used to calculate the cost of financing milk processing operations, and in turn affects the milk price Fonterra pays its farmers. It reflects the extent to which the assets associated with processing milk are more or less risky than the stock market as a whole.
“We acknowledge that estimating the asset beta with reliability and confidence is difficult. However, after considering all available information, including submissions on the independent report we released in April on the subject, our emerging view is that Fonterra’ asset beta of 0.38 is not practically feasible.”
“We acknowledge there are differences between the risks borne by Fonterra and other comparable producers. However, based on the evidence we have, we do not consider the differences in the risks are sufficiently material or relevant to justify using an asset beta of 0.38."
The purpose of the milk price monitoring regime is to incentivise Fonterra to operate efficiently while providing for contestability in the market for the purchase of farmers’ milk. The regime exists because there is not a competitive market for the purchase of farmers’ milk.
The regime also provides transparency of information about how Fonterra sets the farm gate milk price and gives independent processors greater confidence that the price reflects market prices for commodities and efficient costs of collecting and processing milk. Under the regime, the Commission must review Fonterra’s Milk Price Manual and the base milk price calculation each dairy season.
