The Commerce Commission says it is concerned that the 'asset beta' Fonterra Cooperative Group uses to determine the farmgate milk price is too low, meaning it ends up paying its farmers a higher price for their milk than would be warranted under the company's enabling law.
"The impact of this is that Fonterra calculates a higher milk price than would be the case if it used a more feasible allowance for risk in the cost of finance, consistent with other processors," the commission said in a statement accompanying an 'emerging views' paper.
Under the Dairy Industry Restructuring Act 2001 (Dira), the commission conducts an annual review of the milk price 'manual' that Fonterra uses to calculate its base milk price each season. The regime was put in place when Fonterra was created because there wasn't a competitive market for the purchase of farmers’ milk. In the past two years, the regulator has concluded that the manual is largely consistent with its statutory purpose under the act but has been unable to reach a conclusion on whether the asset beta is consistent with the act.
The beta is a measure of the volatility, or systemic risk, of a security or a portfolio in comparison to the market as a whole, according to Investopedia. A beta of less than 1 suggests the security is theoretically less volatile than the market. Utility stocks typically have a beta of less than 1, which is important for Fonterra because the beta it advocates, of 0.38, is based on a sample of electricity lines businesses.
“We acknowledge that estimating the asset beta with reliability and confidence is difficult," the regulator said today. "However, after considering all available information, including submissions on the independent report we released in April on the subject, our emerging view is that Fonterra’ asset beta of 0.38 is not practically feasible.”
The commission hired Cambridge Economic Policy Associates (CEPA) and Freshagenda to establish whether Fonterra’s proposed approach to estimating the asset beta for a "notional processor" as set out in Dira is appropriate. The act sets out an approach to calculating the farmgate milk price paid by Fonterra, to ensure New Zealand's dairy markets are efficient and contestable in the face of Fonterra's market dominance.
A lower asset beta allows a higher milk price to be calculated. Last month Fonterra raised its forecast farmgate milk price for 2018 by 20 cents to $6.75 per kilogram of milk solids and gave an opening price forecast for 2019 of $7/kgMSand 2019 seasons while cutting its projected dividends for 2018, saying rising global dairy prices were squeezing margins.
The commission has sought feedback on its paper by 5pm on July 4.
The government has put on hold an amendment to Dira that had been prepared by the previous National-led administration and in February, Primary Industries Minister Damien O'Connor said the move would allow a broader review of New Zealand's dairy sector and whether it is adding enough value to the nation's biggest export commodity. The legislative amendment followed a Commerce Commission review triggered by Fonterra's share of South Island milk falling below a Dira threshold which concluded Fonterra's market dominance still warranted regulation.
Units in the Fonterra Shareholders' Fund, which are entitled to dividends from Fonterra's ordinary shares, last traded at $5.10 and have fallen 20 percent this year.