Fonterra offers premium, rolling contracts to organic dairy producers

Fonterra Cooperative Group [NZX: FCG] is paying its organic dairy producers a 45c a kilogram of milk solids premium to boost supply amid growing demand.

It's also moving to rolling rather than fixed contracts to give suppliers greater certainty over Fonterra's commitment to the organic strategy, which still accounts for less than 1% of total milk supply.

Fonterra's move is something of a U-turn to the shake-up of its previously unprofitable organics business in the past four years. In 2011 it scaled back its operations as public appetite for organic dairy products waned in the wake of the global financial crisis.

Then in 2013 it refocused supply to the central and lower North Island, leaving many Northland organic farmers out in the cold. At the time Federated Farmers said Fonterra's "we want you; now we don't want; now we do" attitude to organics was confusing for farmers and made it difficult for them to plan and de-risk their businesses.

Fonterra says its new strategy is about giving its 73 organic dairy producers, who are all New Zealand-based, greater certainty than they've had in the past because it recognises "it has been a difficult journey". It wants to add an extra 600,000 kg/ms of supply this year, rather than a set number of producers.

"This is about controlled growth and follows us consulting widely with our organic farmers and customers about what they want," says Craig Deadman, Fonterra's global business manager for organics.

Contracts for nearly half of its existing suppliers are coming up for renewal this year. The new rolling contracts include farmers having to give 16 months' notice if they want to quit supply, while Fonterra must give 28 months' notice.

Suppliers not yet producing organic milk will get the new 45c a kg/ms payment while they undergo the rigorous three-year conversion process and after that, the extra payment will be added to the existing $1.05 premium for organic milk to help towards the costs of maintaining certification.

It comes at a time when the overall forecast payout for dairy farmers this season has dropped to $4.70 a kg/ms and dairy prices reversed their recent upward trend to fall by 8.8% in this morning's GlobalDairyTrade auction. It was the first sale held since last week's 1080 infant formula contamination threat, although the drop is thought primarily to reflect soft international market conditions.

At today's auction whole milk powder, the most important product for New Zealand producers, fell by 9.6% to an average of $US2928 a tonne.

Federated Farmers dairy industry group chairman Andrew Hoggard says he doubts the additional payment to organic farmers will mean other dairy farmers switching over, given it's usually a philosophical choice rather than a business decision.

But he ays the extra support will be welcomed by existing organic dairy producers who face significant costs in getting organically certified and have had mixed messages from Fonterra over the years.

He says the payment could make a difference to whether some daicry producers continue organic farming, citing the example of a Tararua organic dairy producer who has been planning to convert his farm back to normal dairying because he can't afford to continue under new environmental regulations that, ironically, made it unsustainable to stay organic.

Deadman said the cooperative has refreshed its growth strategy for organic to allow it to grow the business profitably and sustainably. While the organic business had been cash-flow positive for some years, it has been repaying the significant investment the cooperative made to get the business started.

"The organic business relied on the cooperative for that initial investment but  it is now on a solid footing," he says.

While organic remains a niche specialty product, Fonterra is committed to developing the business over the long term to meet escalating demand, particularly out of southeast Asia, China and the US. Asian consumers also favour organic milk powders, especially infant formula and fortified milk powders.

Fonterra wouldn't reveal the value or volume of its organic business for commercial reasons, though Federated Farmers indicated two years ago that Fonterra saw a 28% increase in demand over 2012 and 2013 and a 30% increase in prices for organic products.

Organic Dairy and Pastoral Group chairman Brian Clearwater says that with organic whole milk powder worth two and-a-half times the value of non-organic and demand for pure dairy products increasing rapidly, it is common sense to put more effort in supporting farmers to convert to organic production.

(BusinessDesk)