Today, the Commerce Commission invited submissions on the draft report on its annual review of Fonterra’s Base Milk Price Manual for the 2021/22 dairy season. The Manual describes the methodology used by Fonterra to calculate its base milk price – the amount farmers receive from Fonterra for each kilogram of milk solids in a dairy season.

Our preliminary conclusion is that the Manual is consistent with both the efficiency and contestability dimensions of the purpose of the base milk price monitoring regime with the exception of the rule for the asset beta. We now consider that a number of issues from previous years have been resolved and there is more transparency overall as a result of changes by Fonterra.

Recent amendments to the Dairy Industry Restructuring Act (DIRA), which came into force on 1 June 2021, mean Fonterra’s discretion in estimating the asset beta has been reduced. The asset beta is a component of the estimated cost of capital of financing the operations of a ‘notional’ milk processor and reflects the extent to which these operations are more or less risky than the stock market as a whole. A higher asset beta would put downward pressure on the base milk price Fonterra pays its farmers. Our preliminary view is that the Manual rule for the asset beta is inconsistent with the new requirements in DIRA because it potentially allows for an approach different from the approach prescribed in the Act.

In our previous Manual reviews and the review of the 2020/21 base milk price calculation, we also identified a number of potential issues with how the Manual gives effect to the DIRA definition of “commodity”. Based on the information available to us at this time, we do not consider that these matters render this season’s Manual as a whole inconsistent with the DIRA purposes, but we intend to examine more closely how the Manual gives effect to the DIRA definition of “commodity” in a future Manual review.

We will review how Fonterra applies the Manual when we assess the 2021/22 base milk price calculation at the end of the current dairy season.

We welcome submissions on our draft report by 15 November 2021. The draft report and related information can be found here.

The final report will be published by 15 December 2021.

Background

The Commission’s review

Each year the Commerce Commission reviews Fonterra’s Base Milk Price Manual for the dairy season that has just started. 

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’).

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

Under DIRA, the Commission is required to review Fonterra’s Manual, which sets out Fonterra’s methodology for calculating its base milk price at the start of each dairy season.

The legislation also requires the Commission to review the base milk price calculation at the end of each season. We published our base milk price calculation 2020/21 final report in September 2021.