Review of Fonterra’s base milk price calculation

Final report on review of Fonterra’s 2017/18 base milk price calculation

The Commerce Commission has released its final report on Fonterra’s base milk price calculation for the 2017/18 dairy season.

The base milk price is the average price that Fonterra pays farmers for raw milk, which was set at $6.69 per kilogram of milk solids for the 2017/18 dairy season. The report does not cover Fonterra’s forecast price of $6.75 for the 2018/19 dairy season.

Deputy Chair Sue Begg said no issues had been raised in submissions to the Commission’s draft reportthat warranted a change in the conclusions.

“We remain satisfied that Fonterra’s calculation of the 2017/18 base milk price is largely consistent with both the efficiency and contestability purposes of the Act. We further remain of the view that the asset beta that Fonterra applies is unlikely to be practically feasible,” Ms Begg said.

The final report and related information can be found here.

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

Asset beta
The asset beta is used in calculating the estimated cost of capital of financing milk processing operations, and in turn affects the milk price Fonterra pays its farmers. It reflects the extent to which the assets associated with processing milk are more or less risky than the stock market as a whole. A higher asset beta would put downward pressure on the milk price Fonterra pays its farmers.

The Commission’s review
Each year the Commission reviews and publishes a report on 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 focus of the review is solely on the farm gate milk price and not any other milk price within the milk supply chain. In the review, the Commission is required to consider whether the base milk price calculation provides an incentive for Fonterra to operate efficiently and if it is consistent with contestability in the market for purchasing farmers’ milk.

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 there is not yet a competitive domestic market for the purchase of farmers’ milk and the milk price is therefore set by Fonterra using an ‘administrative’ methodology. As Fonterra determines and applies that methodology itself, there is a risk that it might set a base milk price that is ‘inefficient’ - either too high or too low relative to what it would be in a competitive market. A price that is too high could act as a barrier to efficient entry by processors. The regime therefore also monitors whether the base milk price Fonterra sets might be too high 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. As well as the review of the base milk price calculation at the end of each season, the Commission is also required to review Fonterra’s Farmgate Milk Price Manual (Manual review) after the start of the season. Fonterra’s Manual sets out its methodology for calculating its base milk price for the season.

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