Fonterra publishes Farmgate Milk Price Manual

Information published today by Fonterra shows that changes in the price Fonterra pays farmers for their milk each season are driven by the impact of global commodity prices.

Fonterra has published its Farmgate Milk Price Manual, which sets out the way it calculates the amount paid to farmers for milk supplied in New Zealand. It has also published a Farmgate Milk Price Statement for the Season ending 31 May 2011, which details how the 2011 Farmgate Milk Price has been determined.

The Statement shows that the 2011 Farmgate Milk Price of $7.60 per kilogram of milksolids (kgMS) was based on revenue[1] of $9.51 per kgMS, less cash and capital costs totaling $1.91 per kgMS.

The 2011 Farmgate Milk Price is $1.50 higher than the previous 2010 Season’s $6.10 per kgMS. This is driven by an increase of $1.56 in net revenue, offset slightly by an increase of 6 cents in costs.

“These figures demonstrate what Fonterra has been saying all along – that the price New Zealand farmers are paid for milk, which in turn flows into retail dairy prices, reflects global prices for dairy commodities,” said Fonterra’s chief financial officer Jonathan Mason.

The 2011 milksolids payment to farmers of $7.60 per kgMS equates to approximately 66 cents per litre of liquid milk.

Over the past two Seasons, net revenues have increased $2.96, or 45%, but in the same period costs have increased by 8 cents or 4% - roughly in line with inflation.

The Farmgate Milk Price Statement outlines key elements of the Farmgate Milk Price calculation and also contains a report by Fonterra’s external Auditors that the Farmgate Milk Price complies with the Farmgate Milk Price Manual and the Milk Price Principles.

The basis for the Farmgate Milk Price is as follows:

• Revenue is calculated by determining the revenue Fonterra would earn if all of its milk was converted into commodity whole milk powder (WMP), skim milk powder (SMP) and their by-products[2]. These products are referred to in the Manual as ‘Reference Commodity Products’. Prices reflect US dollar prices achieved by Fonterra on the twice-monthly GlobalDairyTrade (GDT) trading events[3], converted to New Zealand dollars at Fonterra’s actual average monthly foreign-exchange conversion rate.

• Costs include the cost of transporting raw milk to Fonterra’s factories, and the cost of efficiently manufacturing the Reference Commodity Products and then transporting them to the point of export from New Zealand. They also include depreciation of fixed assets and an appropriate return on investment, including investment in working capital. Where feasible, and where doing so is consistent with the Milk Price Principles, costs are derived from Fonterra’s actual costs associated with these activities.

Mr Mason said the Reference Commodity Products comprise around 70 percent of Fonterra’s total production. The Farmgate Milk Price does not include any returns earned by the Co-operative from value-add products (such as infant formula and specialised protein products) and branded consumer dairy products. These types of products earn premiums over and above the returns from standard commodity ingredients, and have resulted from significant investment over a number of years by farmer shareholders. It is therefore appropriate that these premiums are taken into account in Fonterra’s earnings rather than in the Farmgate Milk Price.

Almost all additional milk collected in New Zealand by Fonterra and its competitors over the last decade has been used to make milk powders. It therefore makes sense to base Farmgate Milk Price revenue on the sale of milk powders and their by-products, as they best represent the product mix likely in a competitive market, Mr Mason commented.

He said both operating and plant-related capital costs are based on ‘standard’ plants with capacities equal to Fonterra’s actual average daily capacities for each type of plant, and which reflect current technology of the type typically employed across the industry.

“The Farmgate Milk Price Manual ensures that the Farmgate Milk Price in any Season is calculated in a consistent manner using a robust methodology that is independently verified and audited,” Mr Mason said. “Publication of the Manual and the annual Statement is part of our commitment to adopt increased disclosure and transparency, for the benefit of our farmer shareholders and other stakeholders.”

Farmgate Milk Price Governance
The Fonterra Board is accountable for setting the Farmgate Milk Price each Season. However, the Board has put in place a governance structure to ensure robustness and to provide assurance around the application of the Farmgate Milk Price Manual.

A critical part of the governance structure is the Milk Price Panel, which is charged with recommending to the Board the minimum aggregate Farmgate Milk Price in accordance with the Farmgate Milk Price Manual. The Panel oversees the governance of the Farmgate Milk Price and the Manual, including changes to the Manual and verification by independent external experts of key parameters.

The Panel is made up of three Fonterra Directors (two Appointed Directors and one Farmer Director) and two appropriately-qualified nominees of the Fonterra Shareholders’ Council (at least one of who must not be a farmer shareholder). Current members of the Panel are: John Waller (Chair), David Jackson, John Wilson, Paddy Boyle and Richard Punter.

The Panel takes advice from a number of internal and external parties to ensure the process to determine the Farmgate Milk Price is robust and appropriate. The most important is the Milk Price Group, which administers the Manual day to day. The head of this Group is appointed by the Board, must be independent of Fonterra, and reports directly to the Panel. The Group is largely resourced by Ernst & Young.

The Farmgate Milk Price Manual and the Farmgate Milk Price Statement 2011 are available for download at www.fonterra.com. The Statement will also be mailed to all farmer shareholders. 

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[1] Revenue relates to the sale of Reference Commodity Products if Fonterra had converted all of the milk collected into these products. Revenue is net of lactose costs used to standardise milk powders. These costs fluctuate similar to dairy commodity prices.

[2] By-products are buttermilk powder, butter and anhydrous milkfat.

[3] See www.globaldairytrade.info