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New Zealand’s World Dairy Dominance Becomes Achilles Heel

New Zealand’s World Dairy Dominance Becomes Its Achilles’ Heel
Dairy cows rest in the sun at a farm which supplies milk to Fonterra Cooperative Group Ltd., in Otaki, New Zealand. The nation’s dairy industry employs about 45,000 people tending about 6.4 million cows. Photographer: Mark Coote/Bloomberg

New Zealand is finding that its greatest strength is also its Achilles heel.

A contamination scare at milk-producer Fonterra Cooperative Group Ltd. is jeopardizing export ties with China, which this year overtook Australia as its biggest trading partner. Dairy is the largest foreign exchange earner, accounting for 28 percent of overseas sales in an economy where exports make up about a third of output.

“The events of the past few days are a stark reminder of New Zealand’s increasing vulnerability to a single product and to a single export destination,” said Doug Steel, an economist at Bank of New Zealand Ltd. in Wellington. “Any lingering major concern about the quality of New Zealand’s food production could have far-reaching economic implications.”

The nation’s currency fell to a one-month low after Fonterra, the world’s largest dairy exporter, said Aug. 3 that a dirty pipe at a processing plant may have tainted whey protein used in baby formula with botulism-causing bacteria. China halted imports of some Fonterra products, and the official news agency Xinhua wrote in an editorial that New Zealand’s “100% Pure” tourism slogan is becoming a “festering sore,” saying buyers of Kiwi goods are losing faith in its clean, green image.

Product Recalls

New Zealand’s dollar fell more than 1 U.S. cent when markets opened on Aug. 5 and traders pared bets on higher interest rates this year on concern that the incident may weaken the $156 billion economy.

The news prompted product recalls in China, Vietnam, Thailand, Sri Lanka and New Zealand. Russia halted importation and distribution of Fonterra products and its veterinary agency has written to New Zealand’s Food Safety Authority asking it to suspend the company’s certification.

Whey protein is used in goods ranging from infant formula to sports drinks. Fonterra Chief Executive Officer Theo Spierings apologized in Beijing on Aug. 5 and expressed optimism that Chinese import restrictions will be lifted soon.

In 2008, Fonterra’s Chinese partner Sanlu Group collapsed after locally made melamine-contaminated milk powder killed and hospitalized babies, causing an industry-wide scandal. In January this year, Fonterra had to assure China that traces of an agricultural chemical found in some milk posed no health risks.

‘Quality Assurance’

“It’s been a continuation of failures of quality assurance,” said Stephen Julian, CEO of Peak New Zealand, whose baby formula is sold in China and doesn’t contain the contaminated ingredient. “It is going to damage New Zealand’s integrity for a long time to come unless the government steps up and gets involved.”

Prime Minister John Key has promised an inquiry into the incident amid questions about the time it took Fonterra to publicize the potentially tainted ingredient, which was initially identified in March.

Asked about a possible economic impact, Key said much will depend on how long it takes to get details and whether any health issues emerge.

“In the medium to longer term, I’m comfortable that New Zealand can regroup from this,” Key told a press conference in Wellington on Aug. 5. “But in the short term, there’s no question that it does damage New Zealand.”

‘White Gold’

China bought NZ$7.7 billion ($6 billion) of New Zealand’s goods in the year through June, NZ$3 billion of which was dairy.

“This cuts to our reputation as a clean, green, 100 percent pure provider,” said David Shearer, leader of the main opposition Labour Party. While “white gold” has “done an enormous amount for our economy,” New Zealand needs to diversify, he told state broadcaster TVNZ.

New Zealand’s dairy industry employs about 45,000 people tending about 6.4 million cows. Exports began in 1846, just six years after the Treaty of Waitangi between indigenous Maori and the British Crown was signed. Refrigerated shipments in 1882 opened new markets and laid the foundations for New Zealand’s dominance as a dairy exporter.

Fonterra, New Zealand’s biggest company, accounts for about a third of the world’s trade in dairy products and posted revenue of NZ$19.8 billion in the year through July 2012.

Virtual Monopoly

It was formed in 2001 from the merger of the nation’s two largest dairy companies. Government legislation protected its virtual monopoly after Fonterra argued it needed scale to compete with rivals such as Nestle SA in growth markets such as China.

It’s now the world’s largest milk processor, handling 22 billion liters a year. It sold 3.9 million metric tons of product in 2011-12. About 38 tons is affected by the possible contamination, Fonterra said.

There are signs New Zealand is getting on top of the scare and that the damage will be limited.

Spierings told a news conference in Auckland today that all affected product has been located and contained.

Finance Minister Bill English said in parliament yesterday that the products are worth NZ$125 million in sales to China a year, and only a fraction of that is subject to restrictions. “There is no indication that the issue has escalated to the point where it could have a significant impact” on economic growth, English said.

Whole milk powder prices fell 1.6 percent in a GlobalDairyTrade auction overnight, the first since the scare. That suggests Fonterra’s problems “shouldn’t weigh too heavily” on farmers, ANZ Bank New Zealand Ltd. economist Con Williams said. ANZ retained its 2013-14 milk payout forecast at NZ$7.40 per kilogram.

Kiwi Recovers

The New Zealand dollar has recovered all of its lost ground and traded at 78.97 U.S. cents at 5:15 p.m. in Wellington today compared with 78.38 cents at last week’s close.

At the same time, investors reduced bets on central bank Governor Graeme Wheeler raising the official cash rate from a record-low 2.5 percent this year. The odds fell to 17 percent late yesterday from 53 percent on Aug. 2, according to interest-rate swaps data compiled by Bloomberg.

Concerns about New Zealand’s ability to safely process its dairy produce will persist, said Julian of Peak New Zealand, who sees Holland and Germany as poised to take advantage.

“What we’re finding is a lot of chains that are buying New Zealand product are now looking towards those markets, they see them as much more secure,” he said. “New Zealand as an ingredient is fantastic, it’s what we do with that ingredient that’s of concern.”

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