June 23, 2011

New Zealand dairy giant Fonterra under probe

The dairy industry of New Zealand, and its flagship Fonterra, may end up being regulated by the Commerce Commission, after complaints from downstream milk processors and the public on their pricing methods.

Fonterra has come under further government scrutiny regarding how the dairy giant sets the milk price for New Zealand. If official investigations decide that the method is flawed, the Commerce Commission could end up regulating the NZD11 billion (US$9 billion) dairy industry in line with airports, electricity, and gas services.

In the absence of a competitive raw milk market in New Zealand, Fonterra, which collects 90% of the country's milk, sets the milk price using largely confidential methodology.

This price becomes the benchmark for New Zealand dairy markets, flowing into downstream industry processing and retail pricing.

Competition watchdog the Commerce Commission is also investigating whether a full price-control inquiry is warranted.

A starting point could be to require Fonterra to use "actual" costs in its methodology instead of "notional" costs.

According to the Ministry of Agriculture (MAF), Fonterra had discretion over how and where to allocate its returns, and the costs Fonterra uses in its calculations are "notional" based on a hypothetical efficient competitor in New Zealand dairy markets.

This means they are based on a theoretical set of efficiently designed and operated processing facilities, rather than Fonterra's actual processing costs.