Commission releases final report on Fonterra’s milk price 15 September

The Commerce Commission has today released its final report on Fonterra’s base milk price calculation for the 2019/20 dairy season.

The base milk price is the average price Fonterra sets for raw milk supplied by farmers, which is currently forecast to be $7.10 – $7.20 per kilogram of milk solids for the 2019/20 dairy season.

The Commission is required to review the calculation at the end of each dairy season under the milk price monitoring regime in the Dairy Industry Restructuring Act (DIRA). The regime is designed to provide Fonterra with incentives to set the base milk price consistent with efficient and contestable market outcomes.

“We are satisfied Fonterra’s calculation is largely consistent with both the efficiency and contestability purposes of the Act,” Commission Deputy Chair Sue Begg said.

“Our review this year focused on Fonterra’s administrative and overhead costs, as well as the range of commodity products manufactured and sold, and revealed no new areas of concern.”

The Commission remains of the view that Fonterra’s current estimate of “asset beta” – the extent to which the assets associated with processing milk are more or less risky than the stock market as a whole – is unlikely to be practically feasible for an efficient processor. Fonterra is scheduled to review its estimate for the asset beta for the 2020/21 season, which will likely be a focus for next year’s report.

The final report and related information can be found here.

Background

The milk price regime is designed to provide Fonterra with incentives to set the base milk price consistent with efficient and 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 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.

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

Today’s decision is consistent with the draft decision the Commission consulted on in August 2020.

Asset beta

The asset beta is used in calculating the estimated cost of capital of financing milk processing operations and 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 DIRA has recently been amended by Parliament, with a change reducing Fonterra’s discretion in setting the asset beta. This change does not affect this year’s review.

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