Fonterra looks likely to win the right to refuse to take milk from dairy farmers who fail to meet environmental, animal welfare and other standards important to the cooperative's reputation under proposals released today.

However, the discussion document on options for reforming the Dairy Industry Restructuring Act stops well short of Fonterra's desire to be freed from the 'open entry and exit' provisions it says prevent it from pursuing value-added strategies.

Instead, the preliminary conclusions outlined in the document released by Agriculture Minister Damien O'Connor says there is nothing stopping Fonterra from dropping its milk price for farmer-shareholders if it wants to reduce supply.

The DIRA was enacted in 2001 to preserve competition in the New Zealand dairy market in exchange for allowing the country's two largest dairy cooperatives at the time to merge, giving them scale and greater efficiency in export markets.


The release of today's discussion document, on a high-performing Fonterra supplier's dairy farm on the Taieri Plains near Dunedin, is a crucial step along the way to likely legislative reform, most likely by the end of next year.

MPI is seeking submissions on the proposals by February 8 ahead of policy decisions next year.

Suggestions the cooperative should be broken up are not addressed, as proposed by Economic Development Minister and NZ First MP Shane Jones, although O'Connor acknowledged that if Fonterra's commercial performance did not improve "in the future, that could be one of the options".

The discussion document does not make recommendations but gives strong hints as to where official advice is landing.

For example, preliminary findings favour tightening up how Fonterra calculates its base milk price. While the Commerce Commission reviews that annually, Fonterra has considerable leeway in the definition of what constitute "practically feasible" assumptions, inputs and processes for a notional "efficient processor".

"It is therefore timely to consider whether a similar level of guidance/prescription (to other parts of the base milk price calculation process) could usefully be provided for the 'practically feasible' part of the … calculation to further improve confidence," the discussion document says.

However, it acknowledges the legal principles required to enact such an approach "is difficult".

It finds also that there is no evidence that requirements that Fonterra supply international investors entering the New Zealand dairy industry is encouraging inefficient entrants.


However, it does propose moving to a system where dairy processors requiring more than 30 million litres of milk annually should not be subject to guaranteed Fonterra supply arrangements.

It also suggests that the current 'entrance pathway', allowing access to 50 million litres of milk for new processors, is no longer fit for purpose.

"It seems timely to consider whether the original rationale for providing access to regulated milk to large dairy processors during their establishment stage still stands."

Fostering competition for dairy products in the New Zealand market emerges as one of the most thorny issues in the DIRA review, with tension around current arrangements that guarantee Goodman Fielder 250 million litres of raw milk annually from Fonterra for competitive domestic supply.

The review findings note that while Goodman Fielder has done less to find its own raw milk supplies than had been anticipated when DIRA was enacted, new international players had shown little interest in entering the domestic market.

As a result, Goodman Fielder remains Fonterra's only large-scale domestic competitor.

Proposals include a sinking lid on Goodman Fielder's annual entitlements as a way to ensure the company does not become overly reliant on regulated milk supply. The report notes "there is a relatively high risk that this option may simply deprive Goodman Fielder of a reliable raw milk supply, with consequent detriment to consumers".

Likewise, a proposal to force Fonterra to sell raw milk to competing processors at the same price as it sells milk internally to its Fonterra Brands arm might preserve domestic competition "but could also increase undue regulatory dependency over time".