Review of the Dairy Industry Restructuring (Raw Milk) Regulations: Options for addressing industry concerns April 2008
Appendix C: Overview of the Dairy Industry Restructuring Act (DIRA), Dairy Industry Restructuring (Raw Milk) Regulations, and policy objectives
Some of the submissions on the first discussion document indicated that the purpose of the DIRA and the principles that underpin it are not widely understood. It is therefore useful to clarify those objectives.
The purposes and objectives of the DIRA are, among other things, to:
- provide the efficient operation of dairy markets in New Zealand by regulating the activities of [Fonterra] to ensure New Zealand markets for dairy goods and services are contestable [section 4(f)]; and
- promote the principle that independent processors must be able to obtain raw milk, and other dairy goods and services necessary for them to compete in dairy markets [section 71(a)].
It is therefore relevant to note, that neither the purpose nor the objectives:
- make reference to equity objectives;
- distinguishes independent processors on the basis of size, domestic and/or international sales, and the presence – or otherwise – of own supply.
Competition policy levers
There are three competition policy levers, namely:
- “Open entry and exit” regime: The key competition policy lever in the DIRA is the open entry and exit regime, which is designed to put competitive pressure on Fonterra by facilitating farmers “switching” on a “no arguments”
basis.
- Under open entry and exit Fonterra is required to accept equity based milk from any supplier and issue/redeem co-operative shares at the same price. The requirement for price equivalence leads directly to a “fair value” (rather than nominal) share valuation process.
- The net result is a strong series of incentives on Fonterra to efficiently price raw milk12 that also avoided the need to impose a regulated milk price.
- Contractual terms and the 20% rule: The DIRA imposes constraints on the contractual terms Fonterra can specify in a regional area. Furthermore, under s108 of the DIRA Fonterra shareholder-suppliers are entitled to supply up to 20 percent of their weekly production to independent processors subject to an October supply rule; and
- The Raw Milk Regulations: The DIRA permits the Government to make Fonterra supply up to 5 percent of its milk [currently around 750 million litres] to independent processors at a regulated price. The Regulations were set at 400 million litres per annum from 2001/02 to 2006/07, but have been increased to 500 million litres for 2007/08 only and to 600 million litres for 2008/09 only pending the outcome of this Review.
When the Regulations were enacted in 2001, they aimed to:
- protect the position of companies that bought milk from either Kiwi or NZ Dairy Group from monopoly pricing;
- protect domestic consumers from monopoly pricing; and
- provide an entry path for new processors into the milk processing industry.
It is important to note that regulated milk was never intended to be “cheap” milk: either in the sense of creating a domestic “cheap food” policy or to subsidise entrance by new processors. Instead, the intent was to approximate, as close as possible, a “commodity milk price”.
The domestic competition provisions were largely satisfied by the requirement on Fonterra to divest New Zealand Dairy Foods Limited and the subsequent allocation of up to 250 million litres of regulated milk per season, as this ensured at least one significant domestic competitor to Fonterra in terms of fresh and liquid products for domestic consumption.
This allocation is now held by Goodman Fielder Limited.
The open entry and exit regime, the contracting terms and 20% rule, and the Regulations are only intended to remain in place until a sufficient level of fringe competition is re-created. This level of competition is measured by the North and South Island triggers.
While open entry and exit and the 20% rule are triggered on an island by island basis, the Regulations will not cease until the North and South Island triggers are both met. The triggers are as follows:
- South Island: independent processors collect at least 65 million kg of milk solids (approximately 780 million litres) in a season and one independent processor collects at least 25 million kg (approximately 300 million litres) of milk solids from dairy farmers outside the borders of the Westland Regional Council; and
- North Island: independent processors collect 12.5 percent or more of milk solids from dairy farmers in a season (or conversely, Fonterra’s market share falls to 87.5 percent).
In the South Island, the first part of the trigger either has, or will be met, this season. As yet, no independent processor has “tripped” the second part, though additional capacity is planned that implies this could be breeched in the near future.
MAF forecasts that in the 2008/09 season, independent processors in the North Island will collect around 6 percent of total milk solids. However, this situation will rapidly change given projected investments in new plant.
Given these developments the South and North Island triggers could be jointly triggered by 2013, and potentially earlier.
12 For example, if Fonterra set the milk price too low, it runs the risk of suppliers exiting and supplying (or establishing) independent processors. Conversely, if the milk price is too high, Fonterra runs the risk of receiving a flood of unprofitable milk. This avoids any need for regulated Fonterra’s milk price.
Contact for Enquiries
Principal Advisor
MAF Policy
Sector Performance Policy
Ph: 04 894 0128
Fax: 04 894 0745
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