Fonterra’s transport charges are not reasonable

29 April 2005

Commerce Commission considers Fonterra’s transport charges are not reasonable

The Commerce Commission has reached a preliminary view that the amount that Fonterra Co-operative Group Limited (Fonterra) has been charging Open Country Cheese Company Limited (Open Country) for the transport of raw milk is not reasonable. Fonterra has used a charge based on its national average transport cost.

The Commission published its draft determination today relating to Waharoa-based Open Country’s dispute with Fonterra as to the cost of the transport component of the default price for raw milk that Open Country purchases from Fonterra. This determination is made under the Dairy Industry Restructuring (Raw Milk) Regulations 2001. Under those Regulations, Fonterra is currently required to supply Open Country with raw milk at the default milk price. Regulation 8(5) provides that the default milk price is the wholesale milk price for the season plus the ‘reasonable cost of transporting the raw milk to the independent processor’.

Fonterra currently charges Open Country 22.1 cents per kilogram of milk solids (kgMS) for transport, which is based on its average national transport cost. In its draft determination, the Commission has set out its preliminary view as to a method of calculating the transport cost to Open Country, which would reduce the amount paid by Open Country by approximately seven cents to 14.76 cents per kgMS.

Fonterra argues that the reasonable transport costs should reflect the fact that it optimises its national milk collection network and therefore, a charge based on the national average is appropriate. Open Country alleges that the national average-based cost that Fonterra proposes to charge Open Country does not account for Open Country’s particular circumstances.

The Commission considers that the reasonable transport costs should be based on Fonterra’s actual costs. However, these need to be adjusted to exclude some costs included by Fonterra that the Commission considers are not transport costs. A further adjustment is required because Fonterra’s transport costs are relatively high. Fonterra operates large, efficient, centralised processing plants, which can necessitate transporting milk over long distances. In contrast, raw milk is supplied to Open Country over relatively short distances. Overall, the Commission considers the reasonable transport cost should reflect the particular characteristics of the supply to Open Country.

The Commission’s preliminary view is that it is appropriate to use costs that a hypothetical Fonterra stand-alone, Waikato region, raw milk transport division would bear, and scale them to reflect the portion that Open Country should bear. The Commission’s approach is based on a formula that reflects its preliminary view that the primary drivers of Fonterra’s delivery costs to Open Country are region, volume of milk delivered, and delivery distance travelled.

The Commission invites submissions from interested parties on its draft determination. Submissions close on 10 June 2005. After considering these submissions, the Commission may invite interested parties to present at a conference. The Commission will consider these submissions before it releases its final determination.

The Commission’s draft determination is available on www.comcom.govt.nz (select Public Registers/Dairy).
Background
Section 126 of the Dairy Industry Restructuring Act 2001 requires specific matters to be in the Commission’s Determination.
(1) A determination by the Commission must -
(a) state the Commission’s decision on the matters in dispute; and
(b) state clearly whether a breach of {Subpart 5 of Part 2} or any regulations has occurred; and
(c) include the reasons for the determination; and
(d) include the terms and conditions on which the determination is made; and
(e) specify the actions that a party to the determination must do or refrain from doing, which may include (without limitation) payment of compensation by one party to the other.
(2) The Commission may specify an expiry date for the determination.

ENDS

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