Key Points:

Dairy consumption could drop in China - a market worth $401 million to Fonterra in the year ended July 31 - with the country in the grip of a contamination crisis in which at least four babies have died and tens of thousands have been ill.

A Bloomberg report quoting UBS says milk consumption increased 9.3 per cent last year in China but could fall next year because of concerns about chemical contamination.

"Following the pattern of consumer behaviour after other food safety cases in China and elsewhere in Asia, we believe liquid milk consumption may recover in 2010," UBS says.

Fonterra's 43 per cent-owned Chinese dairy company San Lu is one of 22 firms caught up in the scandal, with products testing positive for the chemical melamine.

Dairy production in China doubled between 2000 and 2005 to 28.7 million tonnes.

UBS lead analyst Lei Chen said the estimated 8.3 per cent growth in milk consumption for this year would not be reached, with the thirst for milk destroyed for the rest of this year.

UBS says parents may choose foreign-produced milk powder as a replacement for domestic products in China's large cities.

A survey by Sinogie Consulting of 300 shoppers in Beijing, Shanghai and Guangzhou shows 77.2 per cent had cut back on dairy produce purchases since the scandal.

Henry Chung, senior lecturer in marketing at Massey University, suspected consumers would use more of the traditional soybean milk in the short-term but could later return to dairy milk.

The Sinogie survey also shows 56.2 per cent of people had increased the amount of foreign branded dairy produce they bought.

Imports account for about 80 per cent of Fonterra's business in China.

"Fonterra had such a high reputation before this incident I still believe they could come back with a quite strong position if they handle the situation well," Chung says.

New Zealand China Trade Association chairman Stuart Ferguson says Chinese milk consumption has been rising and consolidating for at least a decade.

"Anything like this has an impact on consumption. It would here."

San Lu was being targeted by the Chinese Government, Ferguson says.

"You don't see Fonterra mentioned by the Chinese central government, do you, you see San Lu, San Lu, San Lu.

"I think that's significant in itself. It's like understanding old-style Chinese and Russian politics. It's not what's said, it's what's not said."


Meat industry reform has stalled again with a $220 million deal by PGG Wrightson to buy half of meat processor co-operative Silver Fern Farms falling foul of global financial turmoil.

A payment of $145 million was planned for last Tuesday, followed by $75 million by March.

PGG Wrightson chairman Craig Norgate says banks that committed to finance the deal had been unable to complete credit approvals in time for the part-settlement.

PGG Wrightson had aimed to raise about $100 million towards the cost from a new share placement but in the end raised $78.1 million.

As well, a retail share offer was underwritten to $32 million. Both the share placement and retail offer have been deferred.

"We needed some approvals to change the detail of the term sheet around that equity underwrite," Norgate says. "While in principle nobody had any problem with that, it gave the opportunity to review the whole thing."

And so the deal, at least for now, has stalled. At the time of writing the Herald understood that discussions were likely to continue this week.

Many people have been calling for meat industry reform, with sheep farmers having three years of low returns, sheep numbers dropping and people migrating to the dairy sector.

However, farmers at rival co-operative Alliance Group last month voted against resolutions to support the creation of a single co-operative, a Meat & Wool New Zealand taskforce was shut down in June lacking consent, an Alliance proposed mega-merger collapsed in April and last year Alliance turned down an offer to merge with Silver Fern Farms.

Ever get the feeling someone's trying to tell you something?

But Norgate has a track record of getting deals done.

He has nearly 50 mergers and acquisitions under his belt, and he was one of the brains behind the restructuring of the dairy industry and consolidation of the rural services sector.

He won't want to lose this one, but he's also a realist.

The global financial situation could be the toughest time in a century to do a deal and Norgate says you can neither take forever nor too many risks in this market environment.


International dairy prices are dropping quite far and quite fast - down about 25 per cent from a peak last year.

As the drop translates to cheaper cheese in supermarkets the nation will breathe a sigh of relief. We can nibble nervously on a lump of colby as the world teeters on the brink of recession, with all that could entail - shrinking economies, unemployment, repossession, social unrest, no pay rises, no holidays, old cars and cookers.

But at least cheese will be cheap again.

The price of cheese has been a big story and many shoppers expect it to be plentiful and cheap, what with New Zealand being a dairy country and white gold hoofing about in the paddocks.

But domestic prices soared with global dairy prices on the back of world economic growth, demand from emerging markets, reduced supply, drought in Australia and biofuel production.

The cost of butter increased 86.6 per cent in the year to June, cheddar cheese ripened by 61.9 per cent and milk rose 22 per cent. Shoppers were not happy and some vowed to stop buying cheese altogether.

Understandably, no one wants to pay more but we can't force retailers to set a price or commercial companies to sell products for less than they are worth.

Considering the importance of dairy to the economy - 27 per cent of national export revenue in the year to May - high prices are something to celebrate, while farming can be a cyclical business with a need to maximise returns during good years.

But there is hope on the horizon for shoppers.

The ANZ Commodity Price Index for dairy products fell 7.9 per cent last month and is down about 25 per cent from its peak, having risen for 15 consecutive months from 127.6 in August 2006 to hit 291.9 last November.

Historical trends suggest it could drop by another 25 per cent.

Fonterra Brands sells about half the dairy products in New Zealand and managing director Peter McClure expects shoppers will start seeing lower prices before Christmas.


"We can't yet put a figure on the size of the price drops because we don't know when the commodity prices will level off and there are other important factors such as the US dollar exchange rate," McClure says. Boo.

Fonterra Brands continues to subsidise the New Zealand dairy market, McClure says.

"We never passed on the full amount of the commodity price rises to our customers over the last 18 months, and we continue to feel the pinch in our margins."

I don't expect shoppers will have too much sympathy for Fonterra on that front.

It is in the interest of manufacturers and retailers to suck up some of the pain for customers because if people did stop buying cheese altogether they might find they didn't really need it.

A world without cheese. I feel dizzy.