Doubts over milk shake-up

In an attempt to placate public concern about soaring domestic milk prices, the Government appears to have alienated our biggest company and largest export earner and also unwittingly assisted its partly owned foreign-owned dairy processing competitors.

A discussion document on possible amendments to the Dairy Industry Restructuring Act (DIRA) released this week is designed to promote "a more transparent and efficient dairy market", and as such it understandably has the sector's biggest player Fonterra, which handles about 90% of New Zealand's milk production, at its epicentre.

There is little doubt the Government is motivated by public outcry at soaring domestic dairy product prices. Our farmers produce about 16 billion litres of milk a year, most of which is exported, but soaring international prices have turned what has been a healthy, staple food into a luxury for some. But, there is little evidence the changes proposed by the Government will achieve the desired result because there is no imperative for processors to divert product from the more lucrative export markets to the smaller domestic markets, short of Government regulating the price charged.

Fonterra, no doubt jolted by public opinion, last year froze milk prices for 2011 and has since announced a trial for free milk in schools, but other exporters have shown no inclination to target domestic consumers. Among the changes Primary Industries Minister David Carter is proposing to the DIRA are for Fonterra to make even more milk it collects from its shareholders available to its competitors, up to 770 million litres; for Fonterra to publicly disclose its milk price-setting system; impose greater milk price monitoring by the Commerce Commission; and to wipe a handling fee, of 10c a kg of milk solids, payable to Fonterra by the companies to which it supplies milk. There will also be a three year limit during which Fonterra has to supply milk to a competitor.

The Clark government created the DIRA when Fonterra was formed to ensure it did not become a monopoly. While it may have to an extent succeeded in achieving this, the focus of other companies has been on the more lucrative export market rather than the local one. The domestic fresh and manufactured dairy market absorbs about 400 million litres a year and consists of two national players: Fonterra Brands and Goodman Fielder, and five or six smaller independent regional players. Ironically, most of the milk they use is supplied by Fonterra under the DIRA regulations.

Export processors consist of farmer-owned co-operatives Fonterra, Westland Milk and Tatua Co-operative Dairy and a group of companies owned jointly by New Zealand and foreign investors, who focus solely on exporting. It has been estimated that less than half the 570 million litres of milk supplied by Fonterra to other processors in 2011-12 will end up on the domestic market.

Mr Carter is pinning much of the review on transparency of Fonterra's milk price - what is paid to farmers. As the dominant player, Fonterra sets the agenda for the New Zealand dairy scene, including what other companies pay their suppliers.

Fonterra calculates the milk price based on the revenue if all Fonterra's milk was processed into basic dairy commodities and sold overseas. It then deducts the cost of shipping raw milk to its factories, efficiently manufacturing those same commodities, freighting them to market and making a reasonable return on their investment. The balance between these two figures is known as the milk price. In addition, every two weeks Fonterra hosts a global internet auction of dairy products providing a market trend so consumers can see what is happening and relate that back to price trends on the domestic market.

Mr Carter says reviews by the ministries of agriculture and forestry, economic development, Treasury and other advisers have all found the milk price not to be excessive, but that it lacked transparency and it was difficult to assess whether or not it was consistent with a competitive market.

Increasing New Zealanders' access to dairy products is a laudable motive, but there are real doubts that these proposals will do little more than hamstring our largest export earner.