KEY POINTS:
From Australia to Ireland, foreign dairy farmers (and a few locals) want to return to the halcyon days when Fonterra managed world dairy prices.
The expressed concern is that Fonterra has handed market power to its customers on a web-based trading platter - globalDairyTrade.
This raises two questions.
Could Fonterra exert market power to manage world dairy commodity prices if it chose to? And, if Fonterra could manage prices and isn't, why are Fonterra's competitors more concerned than Fonterra is?
Fonterra is a large player in dairy trade between nations. According to US Department of Agriculture (USDA) estimates, New Zealand accounts for a third of the 4.5 million tonnes of global dairy exports (see graphic).
However, while New Zealand's 1.5 million tonnes of USDA-tracked dairy exports appears significant, it is only 5 per cent of total world dairy production estimated on a comparable basis.
That New Zealand is a small player in the world dairy market is not surprising. Most dairy products are consumed within the market in which they are produced, since major dairy markets historically fenced themselves in behind trade barriers.
Historically, that enabled Fonterra and its predecessors to play in the smaller internationally-traded pond, making ripples or sometimes a small splash. But if the much-vaunted Kiwi power to influence dairy prices ever existed, it's gone.
Higher prices in recent years have cleared out inventories and stimulated additional supply by major producers like the US and Europe. These factors, along with weakening global demand, have led to dramatic falls in dairy prices over the last eight months. Other agricultural commodities have been affected similarly.
In short, Fonterra's production represents in aggregate only a small part of a broader and increasingly interdependent world dairy market.
If Fonterra is capable of managing world dairy prices in the face of these stark and relentless changes, then economists should find out how and rewrite the textbooks.
Even if Fonterra accounted for a huge share of world dairy production, we would have to consider buyer power before concluding that Fonterra could manage world dairy prices.
Specifically, note that food processors have experienced considerable consolidation over recent decades.
If large dairy suppliers and large food processors both seek to set prices, it is far from clear that the resulting brinkmanship will result in above-market dairy commodity prices.
Add increased commodity market volatility and consequent price uncertainty, and bilateral negotiation between large customers and their large suppliers becomes a volatile mix. GlobalDairyTrade provides a simple, efficient way of discovering the market-clearing price.
There is no basis on which to assert that Fonterra could manage world dairy prices.
Yes, Fonterra is big, but so are many of its customers; they have options, and substitutes, that must be taken into account in assessing Fonterra's market power.
Now, let's consider the size of its globalDairyTrade initiative. Through globalDairyTrade, Fonterra has so far sold approximately 100,000 tonnes of whole milk powder (WMP). But, the world WMP market is huge, with over two million tonnes traded annually across international borders.
And, substantial WMP production historically consumed within trade barriers could be diverted to international trade depending on market conditions. Also, WMP is one form of dairy commodity among substitutes. So, trade that might be affected by WMP-related supply and demand is dramatically greater than that indicated by just WMP trade.
In short, globalDairyTrade is currently small, and not capable of having moved WMP prices.
Demand for almost every traded dairy product has fallen over the last eight months during which globalDairyTrade has operated, reflecting softening end-consumer demand for the things food processors make.
Meanwhile, record-high agricultural commodity prices over recent years have prompted significant and lagged supply increases. The resulting price decreases, magnified by an appreciating US dollar, take a farmer's breath away.
While the world's dairy farmers might like Fonterra to stand confidently in the market against the crashing wave of supply and the receding tide of demand, it can't, for two reasons. First, the market positions Fonterra would be required to take on are well beyond its financial or physical storage capacities.
Second, even if it could, what mandate does Fonterra have from New Zealand dairy farmers to take such a risk? Foreign dairy farmers would reap the dubious upside of such a gamble, and New Zealand dairy farmers would shoulder the downside alone.
So why are Fonterra's competitors complaining?
In past circumstances of substantial over-supply, Fonterra would attempt to support weak global dairy markets by selling at above-market prices.
Not surprisingly, this would often work poorly, resulting in Fonterra building up large inventory positions. Fonterra would then conjure huge quantities of dairy commodities out of existence by quietly selling volume at substantially lower (or "real") prices to segments of the market believed to be disconnected from the rest of the world's dairy markets. This strategy, if ever successful, helped foreign dairy producers at New Zealand's expense.
While this conjuring trick was hidden from view, large, sophisticated dairy purchasers that make up a large proportion of Fonterra's customer base generally demanded similar accommodation from Fonterra.
So, New Zealand dairy farmers bore the cost of transacting at "real" market prices, while other dairy producers may have benefitted by transacting at prices indexed off the "unreal" prices that drowned Fonterra in inventory.
Those days are over, thanks to Fonterra's forward-looking grasp on current realities, and its globalDairyTrade innovation.
As recently as last week, bidders competed competitively and efficiently on globalDairyTrade, with thousands of tonnes sold at competitive prices despite some of the most difficult dairy market conditions encountered in recent times.
Now that the WMP price and (by inference) the milk price is apparent, dairy companies worldwide can get on with succeeding by adding value for shareholders - not calling on New Zealand farmers to "manage" dairy prices for the world.
* Alister Hunt is a financial economist, advising on the restructuring of industries, companies and markets, including the New Zealand dairy industry before Fonterra's formation, and advising Fonterra from the outset of global DairyTrade development.
