The Commerce Commission today released its draft report on its annual review of Fonterra’s Farmgate Milk Price Manual for the 2020/21 dairy season.

This year’s review focused on the changes Fonterra has made to the Manual. These include amending the requirement for an independent reviewer to assess certain aspects of the milk price calculation, and the introduction of the ability to apply the outcome of a ‘Within-Period Review’ to the year in which the review is undertaken.

We consider the ‘Within-Period Review’ is inconsistent with the efficiency dimension of the purpose of the base milk price monitoring regime under the Act. The introduction of the ‘Within-Period Review’ rule could give rise to the replacement of benchmark inputs with current actual inputs. This may remove an incentive for Fonterra to beat a benchmark in the year of review. 

Non disclosure in the Manual of the capacity for both primary and secondary plants also remains an outstanding matter from previous reviews. However, we do not consider that either matter is sufficiently material to render this season’s Manual inconsistent with the Act as a whole. Therefore, we are satisfied Fonterra’s manual is largely consistent with both the efficiency and contestability dimensions of the purpose of the base milk price monitoring regime. 

We will review how Fonterra applies the Manual when we assess the 2020/21 base milk price calculation at the end of the current dairy season.

We welcome submissions on our draft report by 16 November 2020. The draft report and related information can be found here. 

The final report will be published by 15 December 2020.

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 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 at the beginning of each dairy season under the milk price monitoring regime in the Dairy Industry Restructuring Act 2001 (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’).

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.

We published our base milk price calculation 2019/20 final report in September 2020.