The price of milk is a big red herring

As the price of milk continues to hog headlines I found myself browsing submissions to the milk price inquiry ran by the Commerce Commission last year.

The inquiry was called after a flurry of publicity over the high price of liquid milk in supermarkets.

Two submissions stood out. One was the indignant foaming of former Federated Farmers president Don Nicolson.

The other was the sympathetic plea from the Families Commission for staple foods to be priced within reach of poor families.

On reflection, I found myself in the unfamiliar and uncomfortable position of leaning towards Nicolson's view.

This will take a bit of explaining.

Nicolson's submission is the more detailed and argues passionately that the inquiry is an irrational and wholly political reaction to the issue of consumer prices. In an argument that reads like it was written late into the night, he cites a lot of data before working himself up into a righteous fury.

"Hell, let's just put all of private enterprise to the sword and have collective of the people. That's been tried and it was called Soviet Union," he said.

Well, we can obviously ignore that sort of garbage, but there is some sense elsewhere in the piece, such as his observation that the price of other staples including bread, minced beef and rice, had increased much more than milk.

I've put together some numbers on the retail and farm gate milk price over the last few years, using Stats NZ and Fonterra data, which also suggest the current concern may be misplaced.

Between August 2005 and July 2011 - dates chosen to coincide with Fonterra's reporting season - the average retail price for 2 litres of standard milk varied from $2.60 to $3.68. The highest price was in 2011.

Over the same period, Fonterra's milk price for those 2 litres - the farm gate price - varied from 66c to $1.32. The highest price was in the year to July 2011.

Therefore a high Fonterra price equals a high retail price, right?

Wrong.

The numbers show Fonterra farmers received pretty much the same price per two litres back in 2007/08 - $1.30 - a period when prices averaged $3.13.

The following year they received some of their lowest returns while retail prices rose to an average of $3.29.

It looks like whatever is going on here, it's certainly not a simple story of farmers milking consumers.

Here's a summary of those figures:

While it is true that there is no effective competition for Fonterra domestically, the local farm gate milk price is strongly correlated with the global market price, where there is significant competition.

Fonterra's milk price manual does allow some price-setting wriggle room, which is of concern, but there is at least some transparency around where the numbers come from.

The same price, plus 10c/kg of milk solids, is used as the price Fonterra must supply other processors as required by the Dairy Industry Restructuring Act.

But where the farmers' milk price is linked to globally competitive markets, the same is not true beyond the farm gate.

There are effectively only two wholesalers supplying the retail market - Fonterra and Goodman Fielder - and only two supermarket groups supplying most consumers - Foodstuffs and Progressive.

In my view, a duopoly does not make for strong competition, so it's possible some excess margins could exist at these levels and the variation in the retail/farm-gate spread looks bigger than might be expected.

But if we suspect the two big supermarket players have too much market power, why restrict a price inquiry to milk?

Which brings me to the Families Commission submission.

"Although families recognise that milk is important for health, our research shows that the poorer families are limiting their consumption because of the cost," it said. "They often substitute cheaper soft drinks instead."

Troubling as that sounds, the numbers don't really stack up. In August 2005, the average retail price of milk was $3.15 for two litres. Six years later, when prices were triggering calls for an inquiry, the price was $3.68. That's a difference of 50c.

If a family with three teenagers consumed the recommended daily amount of 0.75 litres a day per child, they would go through 15.75 litres a week for the kids, plus some for the parents, so 20 litres a week, say.

At those levels of consumption (which look pretty high - my family of five would scarcely consume half that) the weekly milk bill would be $36.80, up from $31.50 six years earlier.

That's an increase of $5 or so, and of course every $5 matters if you're on a low income.

What if you drank 20 litres of soft drink instead? According to Stats NZ, the average price of 1.5 litres of soft drink in July 2011 was $2.55, so 20 litres would cost you $34, a saving of $2.80 a week.

Overall, it looks to me like genuine concerns over the rising cost of food in general have latched on the price of milk as a touchstone. If so, the inquiry, if it proceeds, will probably not do much to help.