Industry shakeup - DIRA regulations

This year started with another discussion document out from the Ministry of Agriculture and Forestry (MAF) on the Dairy Industry Restructuring Act (the DIRA) and the associated Raw Milk Regulations.

MAF is opening up the DIRA to accommodate Trading Among Farmers (TAF), which is part of Fonterra's capital restructure. While it is open, MAF is considering a requirement for Fonterra to set its share price at the 'fair value' and to disclose how the milk price is set.

These proposed changes are significant and some will remain, even if Fonterra does not bring in TAF. Changes are to be expected in legislation which is over 10 years old.

Share price

This is the price farmers have to pay to enter the co-operative in order to supply milk. It is also the price paid for their shares if they leave.

The current legislation (section 77 of the DIRA) requires only that Fonterra sets the share price at the beginning of the season and allows for this to be amended. This light-handed legislation allows Fonterra to set its share price how it wishes.

MAF proposes Fonterra set its share price at the 'fair value'.

Federated Farmers, in its submission to MAF, was adamant Fonterra must continue to be allowed to set its own share price and asked for no change to be made. As only farmers and Fonterra can currently trade shares, the share price is set at a restricted level in recognition of the limited market.

We argued if Fonterra is required to set its shares at the 'fair value', all dairy co-operatives, such as Westland Milk Products and Tatua, must set their shares at 'fair value'.

Milk price disclosure

Federated Farmers believes the milk price is the key to the entire dairy industry. The milk price is the payment Fonterra farmers get for their milk. It sets the bench mark for the rest of New Zealand's dairy farmers, as other milk processors base the amount they pay their own farmers on this price.

The milk price is also instrumental in calculations setting the price of farmer shares, the cost of Regulated Raw Milk and will be used for TAF. It also affects the price consumers pay for milk.

Getting this right is important.

The Federation thinks having Fonterra's milk price manual, showing how the milk price is calculated, out in the open is good. Commerce Commission oversight, to check the calculations are based on reasonable assumptions is also welcome. The Commission will also test the milk price forecasts by looking back over the previous year's actual pricing contributions.

Fonterra should have nothing to hide and we, like the rest of the dairy industry, welcome this openness.

Trading Among Farmers

There are a number of new obligations in the DIRA covering off TAF. Federated Farmers is really concerned with these, as TAF is not finalised yet. We do not want to see Government legislation leading Fonterra's business strategy and asked MAF not to go ahead with any changes to the DIRA relating to TAF until Fonterra and its shareholders are ready to progress with it.

Raw Milk Regulations

The changes being made to the Raw Milk Regulations are timely, given the probability that demand for this milk, often known as 'DIRA milk', will exceed supply next season.

Federated Farmers thinks the changes proposed should go ahead, with a couple of tweaks. We told MAF the amount of milk taken by independent processors over the seasonal curve must be tied to that taken at the peak of the season.

We also said processors established before June 2008, with their own supply, should have their 50 million litre (ML) allocation ramped down, with zero entitlement by 2015/16.

We are disappointed MAF has not dealt with independent processors who do not source and collect their own milk.

We see this as an issue to watch for over the next few years. Nor has MAF dealt with the practice of firms who do not have processing units buying DIRA milk and asking another firm to process it. This is known as toll, or virtual, processing.

MAF is setting up a very attractive proposition for those countries wanting greater food supply security.

While this is laudable on the one hand, on the other it is setting New Zealand up to become the country of 50ML driers or ultra heat treated (UHT) milk processors, where participating countries are guaranteed a constant supply of high quality milk at a regulated price.

While Goodman Fielder has an annual allocation of 250ML, many of the independent processors currently take less than their permitted 50ML per year. However, only ten independent processors demanding their full allocation of regulated raw milk would cause an over-demand of DIRA milk.

This is a very low threshold. Rather than requiring Fonterra to supply more than the 750ML proposed in the Regulations, the number of independent processors allowed in this regime should be capped.

While there are pitfalls in trying to limit the number of independent processors based on who they are, what they do or some other sort of criteria, we think it will be easier for MAF to face this now than later.

Federated Farmers looks forward to seeing what MAF decides on both the Raw Milk Regulations and the DIRA. Whatever the outcome, we will continue to work with them to get a good result for the whole dairy industry.