Independent report on how Fonterra estimates risk in setting milk price
Published11 Apr 2018
The Commerce Commission has released an independent report into whether Fonterra’s approach to estimating risk in calculating the cost of financing milk processing operations is consistent with competitive market outcomes.
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.
The report has been written by CEPA, in collaboration with Freshagenda, who bring specialist knowledge of the international dairy industry. It looks into whether Fonterra’s approach to estimating the asset beta used in calculating the financing costs in its milk price model is consistent with the DIRA. The asset beta reflects the extent to which the assets associated with processing milk are more or less risky than the stock market as a whole. CEPA and Freshagenda conclude that the evidence from comparable companies suggests that a higher asset beta should be used.
“While our recent reviews have found the way Fonterra sets its milk prices is largely consistent with the DIRA, we continue to be concerned that Fonterra has not provided sufficient evidence to support using an asset beta lower than that of comparable processors,” Commission Deputy Chair Sue Begg said.
We invite submissions on the report to regulation@comcom.govt.nz by 5pm on Wednesday 9 May 2018. We will confirm next steps for this year’s milk price calculation review once we have considered the submissions received.
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.
