Commission releases draft report on Fonterra’s 2015/16 base milk price calculati…

The Commerce Commission today released its draft report on Fonterra’s base milk price calculation for the 2015/16 dairy season. The base milk price is the price Fonterra pays to farmers for raw milk and it is currently set by Fonterra at $3.90 per kilogram of milk solids for the 2015/16 season just ended. The report does not cover the forecast 2016/17 price of $4.25 that Fonterra recently announced.

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

Deputy Chair Sue Begg said Fonterra’s calculation of the 2015/16 base milk price is consistent with both the efficiency and contestability purposes of DIRA.

“We have worked closely with Fonterra over the past few years to provide clearer information about how it calculates the milk price.  We’re pleased to see further improvements that will assist the broader dairy industry to understand Fonterra’s approach,” Ms Begg said.

“This year Fonterra has provided information that has enabled us to compare the performance of a real world Fonterra production operation with the notional values used in the base milk price calculation. This comparison has helped us to conclude that the calculation is practically feasible as a whole. We have also concluded that the cost of capital component of the calculation is consistent with the purposes of DIRA. This was an area of the calculation that we have previously been unable to reach a conclusion on.”

The Commission welcomes comments on its draft report by 1 September 2015. The final report will be published on 15 September 2015.

Read the draft report and related information.

Background

What does the Commission’s review look at?

Each year the Commission reviews 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 Commission does not review how the forecasts of the price for the next season are calculated.

The focus of the review is solely on the farm gate milk price and not any other milk price within the milk supply chain. The term used in DIRA for the ‘farm gate’ milk price is ‘the base milk price set for that season’.

In the review, the Commission is required to consider the ‘efficiency’ and ‘contestability’ dimensions of the base milk price calculation.

What is the purpose of the milk price monitoring regime?

The milk price monitoring regime is intended to provide incentives for Fonterra to operate efficiently, while providing for contestability in the market for the purchase of milk from farmers. It also promotes greater transparency of Fonterra’s base milk price setting processes.

The regime exists because, without a competitive market for the purchase of farmers’ milk, the price for that milk 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 has the effect of monitoring whether the price that Fonterra chooses to set to buy milk might be ‘too high’ or ‘too low’ relative to the price that would exist if the market for purchasing farmers’ milk was workably competitive or contestable.

What does the overall monitoring regime consist of?

DIRA requires the Commission to conduct two separate reviews of Fonterra’s base milk price setting each dairy season.

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

In the report on the 2015/16 Manual review in December 2015, the Commission concluded that the Manual was largely consistent with the purpose of the milk price monitoring regime.

The Commission will shortly be commencing its review of the 2016/17 Manual.