Changes in Fonterra and rise in the price of national dairy products: what is happening in the milk market?
Craig Hickman is an equity manager at a 1,000 cow dairy farm in central Canterbury.
OPINION: Proposed changes to Fonterra’s capital structure have ruffled feathers since the idea was first floated more than a year ago.
The latest cries of outrage come from New Zealand’s second-largest dairy processor, Open Country Dairy, which commissioned a report criticizing the proposal alleging, among other things, that the change could drive up the price of domestic dairy products.
Opposition processors are not alone in feeling dismayed, Fonterra shareholders could be forgiven for feeling the co-op has taken a cavalier attitude towards their substantial investment in the business, with the share price having halved since the announcement of the proposed changes.
He is also dismayed that the process has not been as polished or streamlined as other Fonterra successes, including securing unanimous support in Parliament for long-awaited changes to the Dairy Industry Restructuring Act. (DIRA) in 2019.
* The Cabinet agrees to support Fonterra’s capital restructuring
* Fonterra farmers vote in favor of capital structure changes
* A farmer asks himself the question: Why are dairy products so expensive here?
* Why Fonterra needs to change its capital structure
The idea of a change in Fonterra’s capital structure was met with vocal support by Agriculture Minister Damien O’Connor, only for him to withdraw government support in November ahead of a vote of shareholders on the issue. It was painfully clear that Fonterra and the Ministry of Primary Industries (MPI) were miles apart on what an acceptable structure looked like, but Fonterra went ahead with a farmer vote and won approval. 85% for the changes, essentially giving the government an ultimatum.
Fonterra wants the changes because everyone in the industry can agree on one thing, the pool of milk available for processing is declining. Fonterra currently requires all suppliers to hold a share for every kilogram of milk solids they supply, a situation that both acts as a barrier to new suppliers joining the cooperative and frequently leads farms to leave the cooperative to release capital.
A situation that suits Fonterra’s competitors very well, and that they exploit ruthlessly to persuade farmers to supply their factories instead.
Fonterra proposes that a supplier need only hold one share for every three kilograms of milk solids supplied, which would significantly reduce the barrier to joining the cooperative while simultaneously allowing existing shareholders to free up capital by reducing their involvement.
With a high cost of entry, independent processors can more easily source from Fonterra in the name of competition and market economies. With a lower cost of entry, Fonterra is more easily able to poach suppliers from poor independents who are just helpless orphans to the dairy giant, or so their reporting would have you believe.
Despite increased competition for milk from all processors due to reduced supply, Fonterra is still required by DIRA to subsidize new market entrants to compete for this supply.
The latest in a long line of factories to set up shop in New Zealand is Singaporean government-owned Olam, which is building a factory in Tokoroa to become Waikato’s 15th dairy factory.
Olam has sold its 15% stake in Open Country Dairy, itself starting life with subsidized milk from Fonterra, and using the money to build its own factory which in turn will be eligible for cost price milk from Fonterra for to start up. Much like Open Country, none of this milk will be sold domestically, all will be sent overseas to compete with the Fonterra product.
By rushing to help Fonterra with a sweeping change in the law, the government essentially saves Fonterra from the government. (First published June 2022)
The Open Country Dairy report suggesting milk prices could rise with the proposed changes is not new. For years, he accused Fonterra of overpaying dairy farmers, culminating in a 2019 judicial review of the Commerce Commission’s report into Fonterra’s commodity milk price calculations. The High Court dismissed the challenge, justifying both the process of calculating milk prices and the monitoring of this process by the Commerce Commission.
This time, the theory is that Fonterra will artificially inflate milk prices by shifting the stock dividend into the milk price, thereby attracting suppliers and raising the price of domestic dairy products in the process.
The independent processors’ fear that Fonterra could outsmart the system is not driven by concern for New Zealand consumers, but rather by concern for their bottom line. Independent processors are very vocal in comparing their price to Fonterra; a massive company heavily constrained by government regulations and a major player in the domestic market. They become very quiet when you point out that they have more in common with Tatua; a small, vibrant company with a minor national presence that specializes in high-value exports, and perhaps it should match Tatua’s payout rather than worry about Fonterra’s.
I have a solution for national dairy prices; any firm that received milk at cost under the DIRA should be required to supply the same volume to the domestic market. It is the height of hypocrisy to issue terrible warnings about the price of cheese when the internal market is a sandbox in which they have no intention of playing.
Fonterra is desperate to see the capital structure changes get government approval, and the government is annoyed to see an unsatisfactory proposal thrown into its lap. We can see this in the concessions that the MPI demanded and that Fonterra apparently readily accepted, such as having a second ministerial appointment to sit on the Milk Prices Panel and accepting that one of those appointments be chaired.
The whole process of changing the capital structure frustrated me. Fonterra spent vast amounts of political capital and agreed to almost anything the Department of Primary Industries asked of them to get him over the line. This is energy that could have been much better spent on removing DIRA altogether. When this series of tinkering around the edges is finally over, the DIRA will still be in place and decisions about the future of the cooperative will still be in the hands of the government. Fonterra will always be constrained by a playing field only slightly less inclined in favor of its competitors. A level playing field remains a distant dream.