The Commerce Commission has today released its draft report on Fonterra’s base milk price calculation for the 2018/19 dairy season.

The Commission is required to review Fonterra’s base milk price calculation at the end of each dairy season under the milk price monitoring regime in the Dairy Industry Restructuring Act (DIRA).

The base milk price is the average price that Fonterra pays farmers for raw milk, which was calculated at $6.35 per kilogram of milk solids for the 2018/19 dairy season. The report does not cover the forecast 2019/20 price of $6.25-$7.25 that Fonterra announced in May.

Commission Deputy Chair Sue Begg said this year’s review of the 2018/19 base milk price revealed no new major areas of concern.

“We’re satisfied that Fonterra’s calculation is largely consistent with both the efficiency and contestability purposes of DIRA, though we have been unable to reach a view on administration and overhead costs due to a lack of timely information from Fonterra. We have also retained our 2017/18 view that the asset beta that Fonterra applies is unlikely to be practically feasible,” Ms Begg said.

In March this year Fonterra provided the Commission with an independent expert report on the asset beta it applies.

“We asked economic consulting firm CEPA to review Fonterra’s report. We are of the view that Fonterra’s new report doesn’t raise any new arguments,” Ms Begg said.

The Commission invites comments on its draft report by 5pm, Wednesday 28 August 2019.

The draft report, expert reports on asset beta and related information can be found here.

Background

Asset Beta

The asset beta is used in calculating the estimated cost of capital 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. A higher asset beta would put downward pressure on the milk price Fonterra pays its farmers.

The Commission’s review

Each year the Commission reviews and publishes a report on 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 focus of the review is solely on the farm gate milk price and not any other milk price within the milk supply chain. In the review, the Commission is required to consider whether the base milk price calculation provides an incentive for Fonterra to operate efficiently and if it is consistent with contestability in the market for the purchasing of farmers’ milk.

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 efficient and contestable market outcomes. The regime exists because there is not yet a competitive domestic market for the purchase of farmers’ milk and the milk price is therefore set by Fonterra using an ‘administrative’ methodology. As Fonterra determines and applies that methodology itself, there is a risk that it might set a base milk price that is ‘inefficient’ – either too high or too low relative to what it would be in a competitive market. A price that is too high could act as a barrier to efficient entry by processors. The regime therefore also monitors whether the base milk price Fonterra sets might be too high relative to the price that would exist if the market for purchasing farmers’ milk was contestable.

DIRA review requirements

DIRA requires the Commission to conduct two separate reviews of Fonterra’s base milk price setting each dairy season. As well as the review of the base milk price calculation at the end of each season, the Commission is also required to review Fonterra’s Farmgate Milk Price Manual (Manual review) after the start of the season. Fonterra’s Manual sets out its methodology for calculating its base milk price for the season.

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