Fonterra defends milk powder auctions

September 1, when Fonterra holds another online auction of whole milk powder, looms as an important economic event.

The last auction proved to be market moving, pushing up the New Zealand dollar by a whopping US1c.

Exporters were unhappy and farmers, despite seeing a 25 per cent rise in average per tonne price, carped again about the auction, which is suspected of driving down the value of dairy.

''Whatever we do, we can't win,'' says Nigel Kuzemko, Fonterra's director of trade and operations commercial strategy. But he is adamant  the internet-based sales platform is not a market-moving mechanism in of itself.

''The globalDairyTrade (GDT) did not move the market; it's a lens by which you look at the market.

Still, the event had an impact,'' he concedes, noting that ''some currency traders used that, apparently, to change their position [on the New Zealand dollar].''                                                                                                        

It was not as if the market did not have prior warning of an appreciation in milk prices. The prices of all commodities has stopped falling and some, such as sugar, have skyrocketed (see graph).

Fonterra chairman Henry van der Heyden had, prior to the August 5 event, talked of firming prices.

Fonterra has, Kuzemko notes, ''kickarse [statistical] software, to use the technical term'', to gauge global demand. Indicators for the auction were strong.

When you talk to Fonterra executives about the online auction, they mostly cite the benefit of having a real-time barometer of global demand. That is manifestly true. It is also, as Kuzemko says, a more transparent process for selling dairy products. There is a more practical reason with persisting with the auction, however. Using an independent, transparent price-setter such as GDT takes the sting out of client discussions.

As Rio Tinto can attest from its dealings with China, these discussions can be fraught and, in the case of the iron ore seller, result in serious conflict. The Chinese government has charged Rio Tinto executives with bribery and infringing trade secrets during negotiations for setting an iron ore price.

Kuzemko says it is human behaviour for price to dominate  negotiations even though negotiators don't talk dollars till the end of the discussion.

With GDT, ''they'll know they're getting the same price as their competitors, that the guy down the road isn't getting it cheaper''.

Auctions are an increasingly popular way of commodity price setting. Juice manufacturer Ocean Spray has introduced a similar system for cranberries.

GDT works like this: Fonterra puts up 20,000 tonnes with a starting price set at 15 per cent below the average price achieved at the last auction. Buyers will put in a bid based on volume. ''At that price, I'll buy 2000 tonnes,'' is how Kuzemko puts it.

If the volume exceeds the 20,000 tonne limit, bidding goes to round two at a higher price. That continues until the volume matches the limit and a price is  set. To date, prices have jumped around. In March, the average per tonne cost of whole milk powder rose 16 per cent before dropping  14 per cent the next month. It fell another 5 per cent the month after that,  then rose 4 per cent.

Next month the merry-go-round will begin again. The starting price, which it cannot go under, will be US$1956 per tonne.

Because of these rapid market changes, Fonterra has started offering financial products to customers to manage that risk. ''There's been a mixed uptake of them,'' Kuzemko reports. ''But the customers that have taken them are probably feeling quite good right now.''

This is where he sees the future of GDT: increased volumes sold online, including product supplied from Fonterra's competitors, but also a suite of financial products: hedges, futures and the like.

''I do see there will be global platforms where you can buy and sell dairy products on a physical basis and on a financial basis.'' Maybe, he surmises, the GDT will develop into something similar to the Chicago Mercantile Exchange  ''or it becomes part of the Chicago exchange  who knows.''

However it plays out, price volatility will be a constant, he predicts. His other prediction is  a financially secure dairy sector: ''It's a great product, there's growing demand around the world and there are fewer places you can do dairy well and effectively to match that demand.''

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