Wednesday, 11 April 2018

Regional Dairy Regulation

The original 2001 version of the Dairy Industry Restructuring Act (DIRA) allowed Fonterra to form, subject to regulatory constraints including free entry & exit provisions. Anticipating that independent processors (IPs) would enter and attack the mega-co-op's share of farm-gate milk supply, DIRA included sunset provisions that would effectively dissolve the regulatory constraints once IPs captured 20% of milk supply in each island.

Last year, two reports cited Fonterra's market share of farm-gate milk at 84% nation-wide and it seems the 80% trigger has actually been breached in Te Wai Pounamu. In response, Minister Damien O'Connor has bought time by getting Parliament to repeal the sunset provisions, and launched an inquiry with potentially quite broad terms.

Regionally different rules should be an important consideration for the inquiry. In regions with plenty of competition the case for regulation is much weaker than in regions where Fonterra remains a monoposonist. This is true for farmers and processors.

  • Farmers in competitive regions have alternative supply options so it is fair to question whether they need still regulatory protection.
  • There may also be a case for using regulation to lean against the further addition of capacity in regions where excessive capacity is a looming threat, in favour of monopsony regions.

The two-island structure of the existing rules seems inadequate for today's market structures. For example, farm-gate milk collection remains a Fonterra monopsony in the top-of-the-south (Nelson-Marlborough) where we are located, even though Fonterra has lost more than 20% share in Te Wai Pounamu as a whole. I'm not sure how a proper geographic market definition analysis would pan out, but I am sure that one is needed. 

If there are regional markets, dairy regulation might need to change quite a bit in response. Here are some obvious questions to get us started.
  • Is there any need for the milk price manual in competitive regions? It was needed when Fonterra was so dominant that "market" pricing would have exposed farmers to hold-up risk, but competition pushes the milk price up so once Fonterra loses enough market share, maybe there should be no constraints on the farm-gate price.
  • How should the farm-gate milk price be set in other regions? Suppose Fonterra starts paying above the manual price to retain market share in competitive regions. Do we still need a milk price manual for other locations, or could those prices be pegged to the market-determined prices in competitive regions?
Obviously there are lots of other interesting questions facing the review, but since one of the objectives is to promote competition/contestability the geographic boundaries of markets are probably about to become important.

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