Fran O'Sullivan: Key's silence leaves dairy farmers in peril

Fonterra's Andrew Ferrier is the latest corporate chief to bow to recession reality and announce a pay freeze for himself and his executive team.

But truth is it will take more than a top-level gesture to traverse the huge difficulties in front of the dairy industry without significant input from the New Zealand Government down.

Ferrier's move is just another PR gesture from New Zealand's largest exporter. His salary - based on figures in Fonterra's 2008 annual report - kicks in at between $3.97 million to $3.98 million. The dairy firm boss doesn't have an options deal as Fonterra is not publicly listed. It is simply a farmer co-operative.

Other members of his executive team are paid well over the $1 million mark.

Unlike other New Zealand companies facing huge financial pressures - such as Air New Zealand and Fisher & Paykel Appliances - Fonterra has not come down heavy (yet) by announcing across-the-board cuts for all employees paid over certain salary thresholds.

But given the buffeting Fonterra is taking through a mixture of persistently higher-than-forecast New Zealand exchange rates and falling auction prices for milk powder, it can only be a matter of time before the pressure comes on from the company's 10,500 farmer shareholders for the staffers to share more of the pain.

It is barely a fortnight since Fonterra chairman Sir Henry van der Heyden joined Ferrier to announce that the payout for dairy farmers for the 2009/10 season would be $4.55 a kg of milk solids - a 12 per cent drop on the $5.20 forecast for this season of $5.20 a kg.

But that forecast is predicated on two factors. First, an exchange rate of about US59c over the 2009/2010 period and, second, an expectation that milk powder prices had toughened.

Two weeks after the Fonterra announcement, the forecast assumptions are starting to look volatile at best. The New Zealand dollar nudged over the US65c mark because of a firming in the US dollar before dropping back yesterday to reach US$61.73.

With each 1c movement in the US cross rate equating to some 10c of dairy payout, farmers will be hoping the New Zealand rate will drop back again to Fonterra's forecast of US59c.

Their livelihoods depend on this.

Waikato University's Stuart Locke contends that a bulk commodity dairy model driven by continual cost reductions is not the best path.

Locke says Fonterra's 2009-2010 forecast payout of $4.55 will mean even farmers with 100 per cent equity in their dairy farms can expect only an annual surplus of $40,000 to $50,000.

This is a sobering figure, made even more sobering by Locke's other figures suggesting a farmer with a $6 million farm servicing $2 million of debt at 9 per cent will face debt-servicing costs of $180,000 a year with an overall loss of $130,000.

With farm prices dropping, the ability of farmers - and their banks - to withstand a lengthy period of losses is limited.

Unfortunately not only has the exchange rate been bumping up over Fonterra's US59c threshold, but dairy prices may still be on the downward slide with the average price of whole milk powder at Global Dairy's latest auction down another 12 per cent.

Toss in the concerning factor that the European Union is warning that its dairy export subsidies will not be eliminated before 2013 - and the expectation that the United States will soon signal its dairy subsidies will stay in place for a similar period - and there is the making of a full-blown crisis for New Zealand's dairy industry.

Neither the US nor the EU have broken World Trade Organisation rules. But the upshot is the pressure on world dairy prices will remain downwards.

This combination of factors is potentially deadly for the New Zealand dairy industry's supremacy in the global milk powder trade.

But so far, there has been diddly-squat from John Key's Government to suggest it even appreciates the economic danger this country's productive base faces.

It is no wonder that Federated Farmers president Don Nicolson took a direct swipe at United States President Barack Obama and US dairy subsidies in the Wall Street Journal this week.

Frankly, the message would have been tougher if Key had himself picked up the phone to "Call me Barack" and fronted the New Zealand response.

But his attention has been taken up by the Richard Worth affair.

So it was up to Nicolson to reprise the fact that Obama's stated desire is to improve America's image abroad and remind him how unfair the US dairy subsidy is to farmers in countries like New Zealand which had become the world's second-largest dairy exporter (after the EU and ahead of the US) without any farm subsidies.

The problem Nicolson faces is that there is no co-ordinated voice from the New Zealand Government to underscore the reality facing farmers.

Nicolson's article noted the American dairy lobby likes to complain of the squeeze put on American farmers by Fonterra and complain it is "flooding" the market with milk products at less-than-market prices, but New Zealand accounts for only 22 per cent of the global market to the 16 per cent share enjoyed by the US.

The problem is Federated Farmers distrusts the auction platform that Fonterra is using, arguing that it has driven prices down and is easily gamed.

Federated Farmers also argues that there should be an independent review of Global Dairy - but its concerns have been brushed away by the dairy co-op. Previous concerns raised by PGG Wrightson's Craig Norgate were dismissed as originating from "a competitor". But given that auction prices keep falling it must surely have reached the point where the Government should step in and order an independent review.

Nicolson's article was also bleak about dairy farmers' fortunes.

He noted that next season's forecast payout for many farmers is around US$2.88 for every 2.2 pounds of milk solids. The cost of producing those 2.2 pounds of milk solids is currently US$2.87. "Some farmers will inevitably fail, but that's all part of the risk and return of doing business."

Nicolson said that because New Zealand dairy farmers weren't subsidised they could not sell at a price that was less than the cost of production.

"Dumping is an illegal trade practice, and if we did that we'd go out of business.

"Problem is nobody is listening."