The base milk price is the average price Fonterra sets for raw milk supplied by farmers, which is currently forecast to be between NZ$7.10 and NZ$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.
“The key areas of focus for us in this year’s review were Fonterra’s administrative and overhead costs, as well as the range of commodity products manufactured and sold,” commission deputy chair Sue Begg said.
“Our review revealed no new areas of concern and we are satisfied Fonterra’s calculation is largely consistent with both the efficiency and contestability purposes.
“However, we have retained our 2017/18 view that the asset beta that Fonterra applies is unlikely to be practically feasible. We note that Fonterra has signaled that it will establish a new estimate of the asset beta for the 2020/21 season and we expect this will become a focus for next year’s review.”
The Commission invites submissions on its draft report by 12 noon, September 1, 2020.
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.
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.