The Commerce Commission today released its draft report on its annual review of Fonterra’s Farmgate Milk Price Manual for the 2019/20 dairy season (Manual). The draft report builds on our previous reviews of the Manual.

Commission Deputy Chair Sue Begg said Fonterra’s 2019/20 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, we continue to conclude that the exclusion of farmer support costs remains an aspect of the Manual that is inconsistent with the contestability dimension of the purpose of the regime, although those costs are not significant to the base milk price.

“This year we have taken a look at the amendments to the Manual made by Fonterra and matters carried forward from our previous reviews. In addition to our findings on farmer support costs, we continue to recommend that Fonterra increase disclosure in the Manual about actual foreign exchange rates assumed, capacity of standard plants and the materiality threshold for making changes to the Manual,” Ms Begg said.

The Commission will review how Fonterra applies the Manual when it assesses the 2019/20 base milk price calculation at the end of the current dairy season.

The Commission welcomes submissions on its draft report on the Manual by 15 November 2019.

The final report will be published by 13 December 2019 The draft report and related information can be found here.

Background

The Commission’s review

Each year the Commerce Commission reviews Fonterra’s 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). Consistent with the purpose of the milk price monitoring regime, 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’).

This season the Commission has looked at the amendments to the Manual made by Fonterra and matters carried forward from our previous reviews. Matters carried forward include farmer support costs, actual foreign exchange rates, capacity of standard plants, materiality and qualifying outlier sales.

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.

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 Manual, the Commission is also required to review the base milk price calculation (calculation review).

We published our report on the 2018/19 Review of the base milk price calculation in September 2019.

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