The Commerce Commission today released its draft report on its annual review of Fonterra’s Milk Price Manual for the 2018/19 dairy season.

Commission Deputy Chair Sue Begg said Fonterra’s 2018/19 Manual remains largely consistent with the purpose of the milk price monitoring regime under the Dairy Industry Restructuring Act.

The Commission has no concerns with Fonterra’s amendments to the Manual this year. However, the treatment of farmer support and the capacity of standard plants remain aspects of the manual that would benefit from revisions to improve consistency with the purpose of the regime and clarity, respectively.

“The draft report builds on our previous reviews of Fonterra’s Farmgate Milk Price Manual. This year we have taken a closer look at the rules and assumptions around the risk of asset stranding in the event of static or declining milk volumes. Our draft view is that the treatment of asset stranding risks in the manual is consistent with the purpose of the regime,” Ms Begg said.

The Commission will review how Fonterra applies the Manual when it assesses the 2018/19 base milk price calculation at the end of the current dairy season.

The Commission welcomes submissions on its draft report on the Manual by 16 November 2018.

The final report will be published by 14 December 2018. The draft report and related information can be found here.

Background

The Commission’s review

Each year the Commerce 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 using a notional processor construct. It does not cover any other milk price within the milk supply chain.

We are required to review Fonterra’s Farmgate Milk Price Manual (Manual review) at the beginning of each dairy season under the milk price monitoring regime in the Dairy Industry Restructuring Act (DIRA). We 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’)
• for contestability in the market for the purchase of milk from farmers (the ‘contestability dimension’).

Purpose 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 exists because, without a competitive market for the purchase of farmers’ milk, the milk price 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 also monitors whether the price Fonterra sets might be ‘too high’ or ‘too low’ 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.

Fonterra’s Manual sets out its methodology for calculating its base milk price for the season using a notional processor construct. As well as the review of Fonterra’s Farmgate Milk Price Manual (Manual review), the Commission is also required to review the base milk price calculation (calculation review).

We published our report on the 2017/18 Review of the base milk price calculation in September 2018.