Fonterra is New Zealand's biggest business, collecting just under 80 per cent of the country's raw milk. Photo / Michael Craig
Agriculture Minister Damien O’Connor has defended approving a Fonterra-promoted appointee as chair of New Zealand’s farmgate milk price-setting panel - despite new Government legislation calling for the chair to be “fully independent” of Fonterra.
Fonterra, New Zealand’s biggest business, collects around 78 per cent of the country’s milk production. As the big cheese of the $22 billion dairy industry, its dominance means the market doesn’t get to set a price for raw milk. Instead a milk price panel, which was until recently chaired by a Fonterra director, produces a base farmgate milk price which becomes the industry norm each season.
The panel’s Bible is the Fonterra-authored Milk Price Manual, which requires calculations to be based on an imaginary domestic market competitor similar to Fonterra. The convoluted process is subject to Commerce Commission scrutiny.
An amendment to the Dairy Industry Restructuring Act (DIRA), shepherded in by O’Connor and passed by Parliament late last year, included changes to the milk price panel. The legislation change, opposed by some of Fonterra’s much smaller processor rivals for milk, was to support a Fonterra capital restructure.
One of the changes was that the panel must have a chairperson “fully independent of Fonterra, and appointed only with the approval of the minister”.
That job was taken on last month by experienced company director and former Fonterra and Dairy Board senior executive David Pilkington. A 30-year veteran of the dairy industry, he told the Herald he was approached by Fonterra chairman Peter McBride.
Asked why he had approved a chair nomination engineered by Fonterra, O’Connor said DIRA “requires Fonterra to appoint an independent chair to the Milk Price Panel, which the Minister of Agriculture must approve”.
“After carefully considering his experience, credentials for the role and that there were no conflicts of interest, I approved Fonterra’s appointment of David Pilkington as the independent chair.”
It’s been nearly 20 years since Pilkington, chair of Rangatira Investments and Douglas Pharmaceuticals, former chair of Port of Tauranga and a former director of Zespri, Restaurant Brands and Ballance Agri-Nutrients, last worked for Fonterra.
But Westland Milk Products chief executive Richard Wyeth said while Pilkington had a quality pedigree, a principle was at stake.
“[He] has good knowledge of the industry, [he] has a track record of independent thought and action when necessary,” Wyeth said.
“But the whole point is that the chair be independent of Fonterra. But he has been selected by Fonterra, which undermines perceived and actual independence.”
Wyeth said while Fonterra and its farmer-shareholder council had chosen to appoint only three members, when entitled to four, making the panel equally weighted between Fonterra interests and independent members, in reality, Fonterra interests would still dominate the panel.
This was because the chair did not have a casting vote. In a deadlock, or if any two members disagreed with a majority decision, the panel’s terms of reference required the issue to be elevated to the chairs of Fonterra, the farmer council and the panel.
“Fonterra interests are once again in the majority. The panel remains largely subservient to Fonterra’s interests,” Wyeth said.
He noted the panel could only make decisions based on information supplied to it by Fonterra, a farmer-owned co-operative created 22 years ago from an industry mega-merger under the special, enabling DIRA law.
“Other dairy processors have no opportunity or standing to provide information to the panel.”
Westland wants the milk price to be calculated completely independently of Fonterra.
“If that’s not possible, the panel should be equally represented by Fonterra interests and the interests of the wider processing industry, with an independent chair holding a casting vote,” said Wyeth.
The country’s second-biggest dairy processor and exporter, Open Country Dairy, was not available for comment.
Open Country has previously claimed the Milk Price Manual allows Fonterra to “game” the milk price.
Wyeth said: “That’s not the word I would use.”
“Rather, the DIRA is an example of light regulation which Fonterra maximises to their advantage.”
Pilkington dismissed the gaming claim. He said the process was subject to extensive oversight.
“It has huge scrutiny down to the smallest thing. For a start, we have [assurance, accounting and auditing firm] EY overseeing the milk price calculations, then you’ve got KPMG auditing those calculations,” he said.
“You’ve got the Commerce Commission ready to investigate claims by independents [processors]. It has the power to drill into claims.
“It’s as close as one could probably arrive at a milk price if we had a market. I think it’s very robust and it’s hugely technical and time-consuming, but it’s the price Fonterra has to pay for being dominant in the milk market.”
Pilkington said there was “always noise” from independent processors.
“They want to pay as little as possible at the farmgate” while directors of Fonterra were probably under pressure from farmer-shareholders to pay as high a milk price as possible, he said.
But Pilkington admitted that in the distant past, the milk price model may have been interfered with.
“It’s fair to say, going way back, there may have been incidences, changes made to the way the model operated and they were made in a way that suited Fonterra at the time. I’d say we are long past that. In recent years I know of no changes.”
With 95 per cent of New Zealand dairy production exported, the retail price Kiwis pay is predicated on global market returns. Fonterra’s domestic market manufacturing arm, for example, has to pay the same for milk as offshore prices. While the farmgate base milk price has an indirect impact on household dairy prices, farmers suggest any premium is collected by retailers, not them.
While it’s been some time since Pilkington worked at the industry coalface, he’s a master at explaining a subject that’s as dry as dust.
“Almost every other country has multiple purchasers of milk at the farm gate and the market sets the price. In New Zealand, there isn’t a market, given the dominance of Fonterra as a purchaser of milk - so the modelling of the Milk Price Panel sets out to try to establish what that price should be if you had an independent body requiring a volume of milk to enable it to become an effective, efficient processor,” he said.
“Where it gets technical is [in] the assessment of the minimum amount of milk required, what plant would you put that milk into, what would your overheads be, what would your variable input costs be, what would be the costs of getting the product shipside... It has to identify appropriate technology, what sort of plant, how would it operate, what its collection costs would be... what the yields would be of particular products.
“What you’re [also] trying to do is derive, out of Fonterra’s total sales, where are the pure commodity products, what price did Fonterra sell those at, given the international currency is US dollars, what is a sensible foreign exchange hedging strategy an independent processor would have, what would be the New Zealand dollar return someone could expect for producing those products and selling on the international market?”
Pilkington said this was just a sketch of the work involved.
“Within that, there are all sorts of interrogations.”
Isn’t there risk in the panel making a lot of assumptions because it’s working with an imaginary model?
“I would say it’s complex because it is trying to create something that doesn’t exist. It is extremely detailed. When you say ‘a lot of assumptions’, there are, but a lot are based on actual data,” Pilkington said.
And if the model isn’t “Fonterra-centric”, as critics call it, why did the company challenge O’Connor’s wish last year, while tweaking regulations, to introduce more independents to the panel?
Pilkington thinks it was an understandable reaction to the implied Government message that the panel was not independent enough from Fonterra at the time.
Asked if the debut of Singapore’s Olam food group to Waikato’s already-lively dairy processing scene suggested confidence in New Zealand’s base farmgate price-setting system, Pilkington said it was a good observation.
“It is the ultimate test for the setting of the price. If it was artificially high, why would someone invest external capital?”
Andrea Fox joined the Herald as a senior business journalist in 2018 and specialises in writing about the dairy industry, agribusiness, exporting and the logistics sector and supply chains.
Retaining a premium price in the future could be a problem, Zespri warns.