Dairy Industry Restructuring Amendment Bill introduced

Yesterday, the Government introduced the Dairy Industry Restructuring Amendment Bill (“DIRA Amendment Bill”).

The Bill makes changes to the Dairy Industry Restructuring Act 2001 (“DIRA”), which provides some of the cornerstone regulatory architecture affecting New Zealand’s dairy industry.

When Fonterra was formed in 2001 and became, from the date of its foundation, the dominant market player, a number of the key features of DIRA were implemented in to ensure an efficient and innovative dairy industry to promote the long-term interests of farmers and consumers.

A report from the Commerce Commission last year found that competition is not yet sufficient to warrant de-regulation at this point.  It is expected that, once there is sufficient competition in place, competitive pressure, rather than the DIRA regulatory provisions, should drive the efficiency of New Zealand dairy markets.

The DIRA Amendment Bill has been introduced after a period of consultation on the Government’s proposals to amend DIRA.  Primary Industries Minister, Nathan Guy, said yesterday that these were split between those who wanted further deregulation of Fonterra and those who said Fonterra was still in a dominant position.

The DIRA Amendment Bill will introduce a number of changes to the DIRA regulatory regime.  The primary changes are:

 

• Retain the DIRA regime for the time being, by preventing it from expiring;
• Require a review of the need for the DIRA legislation during 2020/21;
• Allow Fonterra discretion to accept applications to become shareholders from new dairy conversions from 2018/19; and
• Make other technical changes unrelated to the review of the state of competition.

Supply of DIRA milk

The need for the DIRA regulatory provisions on Fonterra in subparts 5 and 5A of Part 2 is contingent on sufficient competition developing in New Zealand dairy markets.  If or when sufficient competition develops, competitive pressure will drive the efficiency of New Zealand dairy markets, removing the need for the DIRA regulatory provisions to do the same.

An automatic expiry of key provisions in subpart 5 and all of subpart 5A in the South Island was triggered in 2015.  A statutorily required report on the state of competition, undertaken by the Commerce Commission, found that competition is not yet sufficient and that subparts 5 and 5A should remain in place for the time being.  The report also recommended that any transition pathway to deregulation should take a staged approach and initially involve removing elements of the regulatory regime that contribute least to efficiency and contestability.

In the interim, as a result of Cabinet decisions announced in October 2016, whilst the DIRA regulatory regime is being retained for the time being, some changes are to be made to the regime to smooth the pathway towards future deregulation.

Specifically, the changes:

 

• prevent parts of the DIRA from expiring in the South Island, and require that the next review of the state of competition in the New Zealand dairy industry begin during the 2020/21 dairy season
• alter who is eligible for regulated milk from Fonterra, and the terms that it is available on – in particular:
  • Fonterra will no longer be required to sell regulated milk to large, export-focused processors from the start of the 2019/20 season.
  • All processors purchasing regulated milk will have reduced flexibility in forecasting the volume of regulated milk they intend to purchase from Fonterra from the start of the 2018/19 season.

The requirement for Fonterra to supply regulated milk to processors other than large, export-focused processors is not being changed at this time, although these processors will be subject to the changes in forecasting flexibility.

Allowing Fonterra discretion to accept supply from new dairy conversions

The DIRA Amendment Bill requires entering farmers, who are not already Fonterra suppliers, to provide evidence that their farm is not a new dairy conversion.

DIRA requires Fonterra to accept all applications to become a shareholding farmer (with limited exceptions that relate to minimum volume to be supplied and transport costs).  This is the “open entry” provision.  The “open exit” provisions of the DIRA require that Fonterra must allow shareholding farmers to withdraw without unreasonable restrictions or penalties.

The open entry and exit provisions reduce farmers’ switching costs and risks by enabling them to freely enter and exit Fonterra.  This lowers the barriers to entry for independent processors by enabling farmers to leave Fonterra and supply someone else, with the confidence of being able to return to Fonterra in the future.  In turn, this ensures contestability of the market for farmers’ milk and simulates the competitive pressures that Fonterra would face in a competitive market.

The DIRA Amendment Bill establishes an exception to open entry, which allows Fonterra discretion to accept applications that relate to new dairy conversions.  This exception applies only where an application relates to a new collection point that has not been used to supply milk in the 5 years immediately prior to the application being made to Fonterra.  (In some situations, a new collection point may be established on existing dairy land – which is not captured by the new exception).

The effect of the exception is that Fonterra has discretion to accept an application to become a shareholding farmer that relates to a new collection point if less than 50% of the land used to supply milk to that point has been used as dairy land in the previous 5 years.  The exception allows for existing dairy farms to expand and the references to 5 years allow for land use to change over time to the most efficient use.

Concluding comments

Minister Guy noted that the consultation process provided new information about risks of some of the originally proposed changes to regulated milk – particularly for downstream markets and consumers.  As a result, he said that the Government is deferring the consideration of those potential changes to regulated milk for Goodman Fielder and small or domestically focused processors – pending further work by MPI officials to understand the complexities in this area and any outcomes will inform the next review.

The next review will commence in the 2020/21 season – 20 years since DIRA was created.  The scope of this review will be wider than just competition policy to take into account any impacts from the work on downstream milk markets.

The changes affecting Fonterra’s obligation to accept supply from new dairy conversions probably manage the risk of Fonterra having to build more capacity for dairy conversions in (seemingly) more-and-more marginal areas.

However, the changes affecting the ability of “large, export-focused processors” to source DIRA milk from Fonterra from the start of the 2019/20 season – are likely to lead to further concerns about the risk of stifling competition in the added-value sector.  Will this stifle the prospect of another Lewis Road being developed?

Next steps

As noted above, MPI has already undertaken consultation – but this may not stop the Select Committee process being interesting.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.