Fonterra's farmgate milk price out of step with efficiency

Fonterra CEO Theo Spierings
Fonterra Co-operative Group 12-month price history (NZX.com)

The Commerce Commission says Fonterra Cooperative Group's [NZX: FCG] decision to cut the last season's forecast payout to farmer shareholders by 55 cents per kilogram of milksolids below the result produced by its Farm Gate Milk Price calculation is not consistent with the milk price regime's intention to make Fonterra operate efficiently.

However, it says the decision - the first ever taken to vary the payout from the calculated level since the Farm Gate Milk Price regime came into force in 2009 - was consistent with ensuring competitive provision of milk to alternative suppliers, the commission concluded in its annual review of the regime.

Under the Dairy Industry Restructuring Act, which allowed a merger to create Fonterra despite creating a dominant local market player, the commission must monitor how Fonterra sets the price it pays farmers for milk as part of efforts to ensure it's possible for local dairy market competitors, such as Synlait or Westland Milk, to emerge.

Under the monitoring and reporting regime, the commission has no ability to force any change on Fonterra.

The cooperative announced earlier this year it would reduce the FGMP from a calculated record of $8.95 per kg/MS to $8.40 per kg/MS as it struggled with the impact of very high input prices and unprecedented volumes of milk production on earnings in non-commodity products like cheese. The problem is unlikely to re-emerge this year as global dairy commodity prices are close to half their levels at the beginning of the year and Fonterra's forecast payout for the 2014/15 season has been slashed to $6 per kg/MS.

"Our overall finding is that the way Fonterra is calculating and applying its adjustment to the base milk rice is not consistent with incentives for the company to operate efficiently," the commission's deputy chair, Sue Begg, said in a statement. "Fonterra is setting a lower price to cancel out the adverse effect of a number of unanticipated effects that would otherwise have had a negative impact on its profits."

Conversely, the commission found that if Fonterra hadn't cut the FGMP as it did, that would have been at odds with the sector competition requirements of the regime.

Fonterra will set a final price for the 2013/14 season next month.

(BusinessDesk)

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