Divestment means Fonterra can focus on its strengths
OPINION: Fonterra's board has certainly presented us, as shareholders, with a major issue to consider.
This is based on growing health awareness in response to "excessive use of pesticides, fertilisers, ionising radiation and sewer sludge", as well as animal hormones and antibiotics. At the same time, however, the report warns that, "the high pricing of organic dairy products is expected to deter growth during the reporting period".
Fonterra has responded to apparent demand by paying a premium for organic milksolids in order to attract more suppliers. In March 2015, it lifted the premium from $1.05 to $1.50. In August, it increased the premium by 25c/kgMS, to a total of $1.75 on top of the basic price. At the time that was forecast to be $3.85, indicating a 45.5% benefit to organic milk production.
To Fonterra, however, the value of the organic whole milk powder was reported to be $14,600/tonne versus about $2800/t for conventional whole milk powder (520% premium).
The question must be whether Fonterra's premium to farmers covers the costs.
The challenge in comparing farm management systems is that so many variables change; identifying the drivers for positive and negative results is difficult. In addition, climate variability, and the time for the new biological cycle to reach equilibrium, obscures effects.
Massey University has attempted to isolate some effects through paired farm research. It reported a reduction in operating profit per hectare of 13.6% over the first five years after organic certification, with a reduction in milk of 18.2%. Costs of production were generally higher on the organic farm, particularly in years of drought, leading to increased risks in economic viability.
Often not considered in the cost of production is that the value of stock in an organic system can be eroded. Homeopathic remedies have not been shown to be effective in treatment of mastitis and though incidence of mastitis is reported to be lower on organic farms, research has shown that farmers do not use the same criteria to detect it.
Of further concern is the soil nutrient status. Associate professor Dave Horne, Massey University, has warned that an organic system tends to focus on micronutrients while eroding the macronutrients (particularly phosphorus) and ultimately creating deterioration in soil fertility and pasture quality. Both take considerable time to re-establish. And though nitrogen loss through leaching might be reduced (depending on management system).
In 2009, following the global financial crisis, premium products took a hit globally and organic farmers suffered. Fonterra contracted 127 farmers to supply organic milk and then cancelled the contracts of 53. Processing of organic milk dropped from 10 million kgMS/year to 6 million.
A mere six years later, Fonterra was reported to be "desperate for high value organic milk".
Fonterra's latest announcement is that from June 2016 organic milk payments will reflect the performance of the organics business. Farmers will be able to choose to take the 'link' or stick with a fixed price. At $4.15 milk price, the premium of $1.75 appears to cover the opportunity cost. The real cost of change to organics is also unknown, and the risk in operating in a changing climate has been identified.
'Organic' dairy production has been identified as an opportunity, but the reason the demand is growing is based on perception of high use of chemicals. New Zealand dairy production systems do not involve excessive use of pesticides, fertilisers, ionising radiation, and sewer sludge, nor animal hormones and antibiotics. Marketing that, rather than taking a punt on 'organic' might be more valuable and less risky for everybody.
- Jacqueline Rowarth is professor of agribusiness, The University of Waikato.
