Required Report - public distribution

**Date:** 10/28/2004

**GAIN Report Number:** NZ4019

NZ4019

**New Zealand**

**Dairy and Products**

**Annual**

**2004**

**Approved by:**

![](media/image1.wmf)David Rosenbloom

U.S. Embassy

**Prepared by:**

Alastair Patterson

**Report Highlights:**

New Zealand's milk production in 2004/05 is forecast at 15.45 million
tons, an increase of 3 percent over the previous season. Whole milk
powder exports in 2004/05 are forecast to rise 3.3 percent to 711,000
tons, while skim milk powder, cheese and butter exports are expected to
remain at year earlier levels. New Zealand dairy farmers are now engaged
in a serious debate over the future capital structure of Fonterra.

Includes PSD Changes: Yes

Includes Trade Matrix: Yes

Annual Report

Wellington \[NZ1\]

\[NZ\]

# SECTION I. EXECUTIVE SUMMARY

New Zealand's milk production during the 2004/05 season (June-May) is
forecast at 15.45 million tons, an increase of 3 percent over a year
earlier. New Zealand's dairy herd, as of the beginning of the season,
increased 2 percent to 4 million cows and heifers in calf or milk.

Cold spring weather (August - September 2004) hurt grass growth and
resulted in reduced milk flows in much of New Zealand's key dairy
farming areas. Fonterra anticipates that peak milk flows, around early
November, will fall below a year earlier. However, increased production
later in the season is likely to boost total milk flows for the year as
a whole. Also negatively impacting this year's milk production is the
extensive flooding experienced in some areas of the North Island last
July that disrupted farming operations. Some farms in the lower North
Island are still recovering from the extensive flooding of February
2004.

Fonterra has now reached stable inventory levels for all dairy products
thanks to a specific program implemented in 2002 and 2003 to adjust
inventories downward to manageable levels. Exportable supplies of whole
milk powder will be noticeably larger this season and this commodity is
expected to show the largest growth in export volumes in 2004/05. In
contrast, skim milk powder, cheese and butter exports are forecast to
remain at similar levels to last year.

The New Zealand diary industry's market strategy continues to place an
emphasis on maintaining growth in its sales of milk protein concentrates
(MPCs). The U.S. market accounted for 55 percent of Fonterra's 167,000
tons of MPC exports in 2003. New Zealand is keenly aware that the United
States has few import barriers on MPCs. The New Zealand industry was
satisfied with a report conclusion issued in May 2004, by the United
States International Trade Commission, 'Conditions of Competition for
Milk Protein Products in the U.S. Market', that imports of milk protein
concentrates had done little damage to U.S. dairy farmers.

There is strong industry debate regarding Fonterra's cooperative
structure and the methodology utilized for share valuation. A lack of
transparency in the share value setting process has caused some industry
observers to suggest that Fonterra should alter its structure. Fonterra
maintains, however, that it will retain its cooperative structure, with
it evolving to suit the industry's changing needs. One option being
discussed is to separate Fonterra's value adding business, 'New Zealand
Milk', from its commodity business, 'Ingredients'. Fonterra's farmer
suppliers would retain ownership of Ingredients and outsiders would be
able to invest in New Zealand Milk. Fonterra insists that this division
will not occur and that it will remain a cooperative. It maintains that
its annual 3 percent growth in milk flows, providing an additional NZ\$
200 million funding per year is adequate to finance its business
expansion over the next three to five years. Many analysts, however,
believe that ultimately Fonterra may need access to additional capital
beyond that level which shareholders can provide.

SECTION II. STATISTICAL TABLES

## 

## PS&D TABLES

+------------------+-------+-------+-------+-------+-------+--------+
| #######          |       |       |       |       |       |        |
|  **New Zealand** |       |       |       |       |       |        |
|                  |       |       |       |       |       |        |
| ###### **Dair    |       |       |       |       |       |        |
| y, Milk, Fluid** |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| (1000 HEAD)(1000 |       |       |       |       |       |        |
| MT)              |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
|                  | 2003  | Re    | 2004  | Est   | 2005  | Fo     |
|                  |       | vised |       | imate |       | recast |
+------------------+-------+-------+-------+-------+-------+--------+
|                  | USDA  | Post  | USDA  | Post  | USDA  | Post   |
|                  | Off   | Est   | Off   | Est   | Off   | Es     |
|                  | icial | imate | icial | imate | icial | timate |
|                  | \[    | \[    | \[    | \[    | \[    | \      |
|                  | Old\] | New\] | Old\] | New\] | Old\] | [New\] |
+------------------+-------+-------+-------+-------+-------+--------+
| Market Year      |       | 06    |       | 06    |       | 0      |
| Begin            |       | /2002 |       | /2003 |       | 6/2004 |
+------------------+-------+-------+-------+-------+-------+--------+
| Cows In Milk     | 3842  | 3842  | 3920  | 3920  | 0     | 4000   |
+------------------+-------+-------+-------+-------+-------+--------+
| Cows Milk        | 14346 | 14346 | 14880 | 15000 | 0     | 15450  |
| Production       |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| Other Milk       | 0     | 0     | 0     | 0     | 0     | 0      |
| Production       |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Production | 14346 | 14346 | 14880 | 15000 | 0     | 15450  |
+------------------+-------+-------+-------+-------+-------+--------+
| Intra EC Imports | 0     | 0     | 0     | 0     | 0     | 0      |
+------------------+-------+-------+-------+-------+-------+--------+
| Total Imports    | 0     | 0     | 0     | 0     | 0     | 0      |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Imports    | 0     | 0     | 0     | 0     | 0     | 0      |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL SUPPLY     | 14346 | 14346 | 14880 | 15000 | 0     | 15450  |
+------------------+-------+-------+-------+-------+-------+--------+
| Intra EC Exports | 0     | 0     | 0     | 0     | 0     | 0      |
+------------------+-------+-------+-------+-------+-------+--------+
| Total Exports    | 47    | 47    | 45    | 50    | 0     | 50     |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Exports    | 47    | 47    | 45    | 50    | 0     | 50     |
+------------------+-------+-------+-------+-------+-------+--------+
| Fluid Use Dom.   | 360   | 360   | 360   | 360   | 0     | 360    |
| Consum.          |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| Factory Use      | 13895 | 13895 | 14430 | 14545 | 0     | 14995  |
| Consum.          |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| Feed Use Dom.    | 44    | 44    | 45    | 45    | 0     | 45     |
| Consum.          |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Dom.       | 14299 | 14299 | 14835 | 14950 | 0     | 15400  |
| Consumption      |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL            | 14346 | 14346 | 14880 | 15000 | 0     | 15450  |
| DISTRIBUTION     |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| Calendar Yr.     | 0     | 0     | 0     | 0     | 0     | 0      |
| Imp. from U.S.   |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| Calendar Yr.     | 0     | 0     | 0     | 0     | 0     | 0      |
| Exp. to U.S.     |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+

+------------------+-------+-------+-------+-------+-------+--------+
| ######           |       |       |       |       |       |        |
|  **New Zealand** |       |       |       |       |       |        |
|                  |       |       |       |       |       |        |
| ######           |       |       |       |       |       |        |
| ## Dairy, Cheese |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| (1000 MT)        |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
|                  | 2003  | Re    | 2004  | Est   | 2005  | Fo     |
|                  |       | vised |       | imate |       | recast |
+------------------+-------+-------+-------+-------+-------+--------+
|                  | USDA  | Post  | USDA  | Post  | USDA  | Post   |
|                  | Off   | Est   | Off   | Est   | Off   | Es     |
|                  | icial | imate | icial | imate | icial | timate |
|                  | \[    | \[    | \[    | \[    | \[    | \      |
|                  | Old\] | New\] | Old\] | New\] | Old\] | [New\] |
+------------------+-------+-------+-------+-------+-------+--------+
| Market Year      |       | 06    |       | 06    |       | 0      |
| Begin            |       | /2002 |       | /2003 |       | 6/2004 |
+------------------+-------+-------+-------+-------+-------+--------+
| Beginning Stocks | 51    | 60    | 20    | 45    | 9     | 38     |
+------------------+-------+-------+-------+-------+-------+--------+
| Production       | 285   | 301   | 305   | 313   | 0     | 319    |
+------------------+-------+-------+-------+-------+-------+--------+
| Intra EC Imports | 0     | 0     | 0     | 0     | 0     | 0      |
+------------------+-------+-------+-------+-------+-------+--------+
| Total Imports    | 2     | 2     | 2     | 2     | 0     | 2      |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Imports    | 2     | 2     | 2     | 2     | 0     | 2      |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL SUPPLY     | 338   | 363   | 327   | 360   | 9     | 359    |
+------------------+-------+-------+-------+-------+-------+--------+
| Intra EC Exports | 0     | 0     | 0     | 0     | 0     | 0      |
+------------------+-------+-------+-------+-------+-------+--------+
| Total Exports    | 290   | 290   | 290   | 294   | 0     | 293    |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Exports    | 290   | 290   | 290   | 294   | 0     | 293    |
+------------------+-------+-------+-------+-------+-------+--------+
| Human Dom.       | 28    | 28    | 28    | 28    | 0     | 28     |
| Consumption      |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| Other Use,       | 0     | 0     | 0     | 0     | 0     | 0      |
| Losses           |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| Total Dom.       | 28    | 28    | 28    | 28    | 0     | 28     |
| Consumption      |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Use        | 318   | 318   | 318   | 322   | 0     | 321    |
+------------------+-------+-------+-------+-------+-------+--------+
| Ending Stocks    | 20    | 45    | 9     | 38    | 0     | 38     |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL            | 338   | 363   | 327   | 360   | 0     | 359    |
| DISTRIBUTION     |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| Calendar Yr.     | 0     | 0     | 0     | 0     | 0     | 0      |
| Imp. from U.S.   |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| Calendar Yr.     | 38    | 46    | 40    | 41    | 0     | 40     |
| Exp. to U.S.     |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+

Note that inventory levels for all commodities have been updated. Post
estimates inventories to be between 10 and 15 percent of exports for
each commodity at the start of the season. This is to cover the
production shortfall from June to August. Fonterra heavily reduced its
inventories during 2002 and 2003 and the numbers have also been updated
to reflect this.

+------------------+-------+-------+-------+-------+-------+--------+
| **New Zealand**  |       |       |       |       |       |        |
|                  |       |       |       |       |       |        |
| **Dairy,         |       |       |       |       |       |        |
| Butter**         |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| (1000 MT)        |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
|                  | 2003  | Re    | 2004  | Est   | 2005  | Fo     |
|                  |       | vised |       | imate |       | recast |
+------------------+-------+-------+-------+-------+-------+--------+
|                  | USDA  | Post  | USDA  | Post  | USDA  | Post   |
|                  | Off   | Est   | Off   | Est   | Off   | Es     |
|                  | icial | imate | icial | imate | icial | timate |
|                  | \[    | \[    | \[    | \[    | \[    | \      |
|                  | Old\] | New\] | Old\] | New\] | Old\] | [New\] |
+------------------+-------+-------+-------+-------+-------+--------+
| Market Year      |       | 06    |       | 06    |       | 0      |
| Begin            |       | /2002 |       | /2003 |       | 6/2004 |
+------------------+-------+-------+-------+-------+-------+--------+
| Beginning Stocks | 51    | 80    | 29    | 60    | 18    | 50     |
+------------------+-------+-------+-------+-------+-------+--------+
| Production       | 390   | 392   | 405   | 407   | 0     | 407    |
+------------------+-------+-------+-------+-------+-------+--------+
| Intra EC Imports | 0     | 0     | 0     | 0     | 0     | 0      |
+------------------+-------+-------+-------+-------+-------+--------+
| Total Imports    | 0     | 0     | 0     | 0     | 0     | 0      |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Imports    | 0     | 0     | 0     | 0     | 0     | 0      |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL SUPPLY     | 441   | 472   | 434   | 467   | 18    | 457    |
+------------------+-------+-------+-------+-------+-------+--------+
| Intra EC Exports | 0     | 0     | 0     | 0     | 0     | 0      |
+------------------+-------+-------+-------+-------+-------+--------+
| Total Exports    | 386   | 386   | 390   | 391   | 0     | 381    |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Exports    | 386   | 386   | 390   | 391   | 0     | 381    |
+------------------+-------+-------+-------+-------+-------+--------+
| Domestic         | 26    | 26    | 26    | 26    | 0     | 26     |
| Consumption      |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Use        | 412   | 412   | 416   | 417   | 0     | 407    |
+------------------+-------+-------+-------+-------+-------+--------+
| Ending Stocks    | 29    | 60    | 18    | 50    | 0     | 50     |
+------------------+-------+-------+-------+-------+-------+--------+
| TOTAL            | 441   | 472   | 434   | 467   | 0     | 457    |
| DISTRIBUTION     |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| Calendar Yr.     | 0     | 0     | 0     | 0     | 0     | 0      |
| Imp. from U.S.   |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+
| Calendar Yr.     | 22    | 21    | 18    | 29    | 0     | 30     |
| Exp. to U.S.     |       |       |       |       |       |        |
+------------------+-------+-------+-------+-------+-------+--------+

+-------------------+-------+-------+-------+-------+-------+--------+
| **New Zealand**   |       |       |       |       |       |        |
|                   |       |       |       |       |       |        |
| **Dairy, Milk,    |       |       |       |       |       |        |
| Nonfat Dry**      |       |       |       |       |       |        |
+-------------------+-------+-------+-------+-------+-------+--------+
| (1000 MT)         |       |       |       |       |       |        |
+-------------------+-------+-------+-------+-------+-------+--------+
|                   | 2003  | Re    | 2004  | Est   | 2005  | Fo     |
|                   |       | vised |       | imate |       | recast |
+-------------------+-------+-------+-------+-------+-------+--------+
|                   | USDA  | Post  | USDA  | Post  | USDA  | Post   |
|                   | Off   | Est   | Off   | Est   | Off   | Es     |
|                   | icial | imate | icial | imate | icial | timate |
|                   | \[    | \[    | \[    | \[    | \[    | \      |
|                   | Old\] | New\] | Old\] | New\] | Old\] | [New\] |
+-------------------+-------+-------+-------+-------+-------+--------+
| Market Year Begin |       | 06    |       | 06    |       | 0      |
|                   |       | /2002 |       | /2003 |       | 6/2004 |
+-------------------+-------+-------+-------+-------+-------+--------+
| Beginning Stocks  | 100   | 80    | 80    | 50    | 60    | 35     |
+-------------------+-------+-------+-------+-------+-------+--------+
| Production        | 299   | 289   | 321   | 301   | 0     | 315    |
+-------------------+-------+-------+-------+-------+-------+--------+
| Intra EC Imports  | 0     | 0     | 0     | 0     | 0     | 0      |
+-------------------+-------+-------+-------+-------+-------+--------+
| Total Imports     | 0     | 0     | 0     | 1     | 0     | 1      |
+-------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Imports     | 0     | 0     | 0     | 1     | 0     | 1      |
+-------------------+-------+-------+-------+-------+-------+--------+
| TOTAL SUPPLY      | 399   | 369   | 401   | 352   | 60    | 351    |
+-------------------+-------+-------+-------+-------+-------+--------+
| Intra EC Exports  | 0     | 0     | 0     | 0     | 0     | 0      |
+-------------------+-------+-------+-------+-------+-------+--------+
| Total Exports     | 314   | 314   | 336   | 312   | 0     | 311    |
+-------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Exports     | 314   | 314   | 336   | 312   | 0     | 311    |
+-------------------+-------+-------+-------+-------+-------+--------+
| Human Dom.        | 5     | 5     | 5     | 5     | 0     | 5      |
| Consumption       |       |       |       |       |       |        |
+-------------------+-------+-------+-------+-------+-------+--------+
| Other Use, Losses | 0     | 0     | 0     | 0     | 0     | 0      |
+-------------------+-------+-------+-------+-------+-------+--------+
| Total Dom.        | 5     | 5     | 5     | 5     | 0     | 5      |
| Consumption       |       |       |       |       |       |        |
+-------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Use         | 319   | 319   | 341   | 317   | 0     | 316    |
+-------------------+-------+-------+-------+-------+-------+--------+
| Ending Stocks     | 80    | 50    | 60    | 35    | 0     | 35     |
+-------------------+-------+-------+-------+-------+-------+--------+
| TOTAL             | 399   | 369   | 401   | 352   | 0     | 351    |
| DISTRIBUTION      |       |       |       |       |       |        |
+-------------------+-------+-------+-------+-------+-------+--------+
| Calendar Yr. Imp. | 0     | 0     | 0     | 0     | 0     | 0      |
| from U.S.         |       |       |       |       |       |        |
+-------------------+-------+-------+-------+-------+-------+--------+
| Calendar Yr. Exp. | 1     | 1     | 1     | 1     | 0     | 1      |
| to U.S.           |       |       |       |       |       |        |
+-------------------+-------+-------+-------+-------+-------+--------+

+-------------------+-------+-------+-------+-------+-------+--------+
| **New Zealand**   |       |       |       |       |       |        |
|                   |       |       |       |       |       |        |
| #####             |       |       |       |       |       |        |
| # **Dairy, Dry Wh |       |       |       |       |       |        |
| ole Milk Powder** |       |       |       |       |       |        |
+-------------------+-------+-------+-------+-------+-------+--------+
| (1000 MT)         |       |       |       |       |       |        |
+-------------------+-------+-------+-------+-------+-------+--------+
|                   | 2003  | Re    | 2004  | Est   | 2005  | Fo     |
|                   |       | vised |       | imate |       | recast |
+-------------------+-------+-------+-------+-------+-------+--------+
|                   | USDA  | Post  | USDA  | Post  | USDA  | Post   |
|                   | Off   | Est   | Off   | Est   | Off   | Es     |
|                   | icial | imate | icial | imate | icial | timate |
|                   | \[    | \[    | \[    | \[    | \[    | \      |
|                   | Old\] | New\] | Old\] | New\] | Old\] | [New\] |
+-------------------+-------+-------+-------+-------+-------+--------+
| Market Year Begin |       | 06    |       | 06    |       | 0      |
|                   |       | /2002 |       | /2003 |       | 6/2004 |
+-------------------+-------+-------+-------+-------+-------+--------+
| Beginning Stocks  | 78    | 100   | 57    | 85    | 40    | 75     |
+-------------------+-------+-------+-------+-------+-------+--------+
| Production        | 615   | 619   | 625   | 677   | 0     | 710    |
+-------------------+-------+-------+-------+-------+-------+--------+
| Intra EC Imports  | 0     | 0     | 0     | 0     | 0     | 0      |
+-------------------+-------+-------+-------+-------+-------+--------+
| Total Imports     | 0     | 2     | 0     | 2     | 0     | 2      |
+-------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Imports     | 0     | 2     | 0     | 2     | 0     | 2      |
+-------------------+-------+-------+-------+-------+-------+--------+
| TOTAL SUPPLY      | 693   | 721   | 682   | 764   | 40    | 787    |
+-------------------+-------+-------+-------+-------+-------+--------+
| Intra EC Exports  | 0     | 0     | 0     | 0     | 0     | 0      |
+-------------------+-------+-------+-------+-------+-------+--------+
| Total Exports     | 635   | 635   | 641   | 688   | 0     | 711    |
+-------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Exports     | 635   | 635   | 641   | 688   | 0     | 711    |
+-------------------+-------+-------+-------+-------+-------+--------+
| Human Dom.        | 1     | 1     | 1     | 1     | 0     | 1      |
| Consumption       |       |       |       |       |       |        |
+-------------------+-------+-------+-------+-------+-------+--------+
| Other Use, Losses | 0     | 0     | 0     | 0     | 0     | 0      |
+-------------------+-------+-------+-------+-------+-------+--------+
| Total Dom.        | 1     | 1     | 1     | 1     | 0     | 1      |
| Consumption       |       |       |       |       |       |        |
+-------------------+-------+-------+-------+-------+-------+--------+
| TOTAL Use         | 636   | 636   | 642   | 689   | 0     | 712    |
+-------------------+-------+-------+-------+-------+-------+--------+
| Ending Stocks     | 57    | 85    | 40    | 75    | 0     | 75     |
+-------------------+-------+-------+-------+-------+-------+--------+
| TOTAL             | 693   | 721   | 682   | 764   | 0     | 787    |
| DISTRIBUTION      |       |       |       |       |       |        |
+-------------------+-------+-------+-------+-------+-------+--------+
| Calendar Yr. Imp. | 0     | 0     | 0     | 0     | 0     | 0      |
| from U.S.         |       |       |       |       |       |        |
+-------------------+-------+-------+-------+-------+-------+--------+
| Calendar Yr. Exp. | 3     | 3     | 3     | 4     | 0     | 4      |
| to U.S.           |       |       |       |       |       |        |
+-------------------+-------+-------+-------+-------+-------+--------+

## TRADE MATRICES

+-------------+-------------+-------------+--------------+------------+
| ####        |             |             |              |            |
| #### Cheese |             |             |              |            |
+-------------+-------------+-------------+--------------+------------+
| Tons        |             |             |              |            |
+-------------+-------------+-------------+--------------+------------+
|             | January -   |             | January -    |            |
|             | December    |             | August       |            |
+-------------+-------------+-------------+--------------+------------+
| Country     | 2002        | 2003        | 2003         | 2004       |
+-------------+-------------+-------------+--------------+------------+
| Japan       | 44,459      | 45,698      | 27,336       | 34,739     |
+-------------+-------------+-------------+--------------+------------+
| United      | 47,742      | 37,842      | 28,001       | 27,226     |
| States      |             |             |              |            |
+-------------+-------------+-------------+--------------+------------+
| Australia   | 40,128      | 36,338      | 23,978       | 30,522     |
+-------------+-------------+-------------+--------------+------------+
| Belgium     | 19,169      | 29,274      | 19,511       | 12,945     |
+-------------+-------------+-------------+--------------+------------+
| United      | 17,016      | 19,258      | 11,166       | 9,488      |
| Kingdom     |             |             |              |            |
+-------------+-------------+-------------+--------------+------------+
| Mexico      | 13,462      | 14,674      | 8,822        | 7,314      |
+-------------+-------------+-------------+--------------+------------+
| Korea,      | 10,307      | 11,059      | 7,213        | 11,412     |
| South       |             |             |              |            |
+-------------+-------------+-------------+--------------+------------+
| Saudi       | 9,737       | 9,891       | 6,851        | 6,977      |
| Arabia      |             |             |              |            |
+-------------+-------------+-------------+--------------+------------+
| Taiwan      | 5,953       | 6,286       | 4,206        | 5,397      |
+-------------+-------------+-------------+--------------+------------+
| Other       | 70,916      | 71,615      | 40,573       | 50,782     |
+-------------+-------------+-------------+--------------+------------+
| Total       | 278,888     | 281,934     | 177,658      | 196,801    |
+-------------+-------------+-------------+--------------+------------+

+---------------+------------+------------+------------+------------+
| ####          |            |            |            |            |
| ## **Butter** |            |            |            |            |
+---------------+------------+------------+------------+------------+
| Tons          |            |            |            |            |
+---------------+------------+------------+------------+------------+
|               | January -  |            | January -  |            |
|               | December   |            | August     |            |
+---------------+------------+------------+------------+------------+
| Country       | 2002       | 2003       | 2003       | 2004       |
+---------------+------------+------------+------------+------------+
| Belgium       | 68,938     | 72,395     | 51,050     | 35,434     |
+---------------+------------+------------+------------+------------+
| Iran          | 33,623     | 37,477     | 17,180     | 9,539      |
+---------------+------------+------------+------------+------------+
| Russia        | 24,801     | 30,713     | 14,553     | 14,709     |
+---------------+------------+------------+------------+------------+
| Egypt         | 32,928     | 25,409     | 14,837     | 7,672      |
+---------------+------------+------------+------------+------------+
| United States | 21,049     | 22,871     | 15,271     | 24,783     |
+---------------+------------+------------+------------+------------+
| Denmark       | 4,808      | 20,816     | 7,092      | 23,008     |
+---------------+------------+------------+------------+------------+
| Mexico        | 23,415     | 19,080     | 10,262     | 8,132      |
+---------------+------------+------------+------------+------------+
| Canada        | 14,401     | 12,566     | 7,799      | 5,891      |
+---------------+------------+------------+------------+------------+
| Saudi Arabia  | 7,049      | 11,033     | 6,235      | 6,786      |
+---------------+------------+------------+------------+------------+
| Taiwan        | 10,829     | 10,596     | 6,910      | 7,102      |
+---------------+------------+------------+------------+------------+
| Philippines   | 5,452      | 9,604      | 6,343      | 5,916      |
+---------------+------------+------------+------------+------------+
| China         | 5,847      | 9,603      | 5,612      | 6,217      |
+---------------+------------+------------+------------+------------+
| Australia     | 6,337      | 8,482      | 4,581      | 6,938      |
+---------------+------------+------------+------------+------------+
| Thailand      | 7,487      | 7,938      | 4,200      | 3,888      |
+---------------+------------+------------+------------+------------+
| United Arab   | 4,826      | 6,270      | 3,187      | 5,116      |
| Emirates      |            |            |            |            |
+---------------+------------+------------+------------+------------+
| Indonesia     | 6,278      | 6,017      | 3,452      | 3,360      |
+---------------+------------+------------+------------+------------+
| Morocco       | 8,951      | 5,739      | 3,354      | 1,498      |
+---------------+------------+------------+------------+------------+
| Singapore     | 7,658      | 5,561      | 3,660      | 3,816      |
+---------------+------------+------------+------------+------------+
| Malaysia      | 4,541      | 5,280      | 3,092      | 3,706      |
+---------------+------------+------------+------------+------------+
| Other         | 101,713    | 49,015     | 24,238     | 29,454     |
+---------------+------------+------------+------------+------------+
| Total         | 400,930    | 376,464    | 212,907    | 212,963    |
+---------------+------------+------------+------------+------------+

+-------------------+-----------+-----------+-----------+-----------+
| ###### **N        |           |           |           |           |
| on-Fat Dry Milk** |           |           |           |           |
+-------------------+-----------+-----------+-----------+-----------+
| Tons              |           |           |           |           |
+-------------------+-----------+-----------+-----------+-----------+
|                   | January - |           | January - |           |
|                   | December  |           | August    |           |
+-------------------+-----------+-----------+-----------+-----------+
| Country           | 2002      | 2003      | 2003      | 2004      |
+-------------------+-----------+-----------+-----------+-----------+
| Philippines       | 25,223    | 50,631    | 36,534    | 25,727    |
+-------------------+-----------+-----------+-----------+-----------+
| Malaysia          | 20,895    | 25,264    | 14,136    | 21,424    |
+-------------------+-----------+-----------+-----------+-----------+
| China             | 20,084    | 21,125    | 11,858    | 18,569    |
+-------------------+-----------+-----------+-----------+-----------+
| Thailand          | 23,444    | 19,940    | 12,828    | 12,870    |
+-------------------+-----------+-----------+-----------+-----------+
| Belgium           | 12,047    | 19,331    | 48        | 205       |
+-------------------+-----------+-----------+-----------+-----------+
| Indonesia         | 24,200    | 16,013    | 9,844     | 9,842     |
+-------------------+-----------+-----------+-----------+-----------+
| Saudi Arabia      | 12,650    | 14,349    | 8,769     | 7,401     |
+-------------------+-----------+-----------+-----------+-----------+
| Japan             | 29,740    | 13,145    | 9,010     | 11,574    |
+-------------------+-----------+-----------+-----------+-----------+
| Singapore         | 8,206     | 12,082    | 9,287     | 8,470     |
+-------------------+-----------+-----------+-----------+-----------+
| Taiwan            | 14,250    | 11,409    | 8,451     | 6,763     |
+-------------------+-----------+-----------+-----------+-----------+
| Mexico            | 25,538    | 10,205    | 1,366     | 9,385     |
+-------------------+-----------+-----------+-----------+-----------+
| Vietnam           | 13,664    | 9,751     | 5,538     | 3,731     |
+-------------------+-----------+-----------+-----------+-----------+
| Cuba              | 6,346     | 9,158     | 5,312     | 128       |
+-------------------+-----------+-----------+-----------+-----------+
| Netherlands       | 8,905     | 8,875     | 0         | 185       |
+-------------------+-----------+-----------+-----------+-----------+
| Australia         | 1,483     | 4,562     | 4,018     | 3,313     |
+-------------------+-----------+-----------+-----------+-----------+
| United States     | 1,485     | 823       | 702       | 692       |
+-------------------+-----------+-----------+-----------+-----------+
| Other             | 75,611    | 48,197    | 25,139    | 27,861    |
+-------------------+-----------+-----------+-----------+-----------+
| Total             | 323,772   | 294,861   | 162,839   | 168,139   |
+-------------------+-----------+-----------+-----------+-----------+

+-------------------+-----------+-----------+-----------+-----------+
| ###### **Wh       |           |           |           |           |
| ole Milk Powder** |           |           |           |           |
+-------------------+-----------+-----------+-----------+-----------+
| Tons              |           |           |           |           |
+-------------------+-----------+-----------+-----------+-----------+
|                   | January - |           | January - |           |
|                   | December  |           | August    |           |
+-------------------+-----------+-----------+-----------+-----------+
| Country           | 2002      | 2003      | 2003      | 2004      |
+-------------------+-----------+-----------+-----------+-----------+
| China             | 55,874    | 78,774    | 51,685    | 66,529    |
+-------------------+-----------+-----------+-----------+-----------+
| Malaysia          | 47,955    | 53,290    | 33,071    | 28,261    |
+-------------------+-----------+-----------+-----------+-----------+
| Venezuela         | 21,738    | 44,030    | 16,920    | 17,088    |
+-------------------+-----------+-----------+-----------+-----------+
| Mexico            | 25,506    | 40,623    | 24,812    | 20,010    |
+-------------------+-----------+-----------+-----------+-----------+
| Sri Lanka         | 30,331    | 39,257    | 24,805    | 29,329    |
+-------------------+-----------+-----------+-----------+-----------+
| Philippines       | 32,331    | 39,103    | 28,269    | 18,620    |
+-------------------+-----------+-----------+-----------+-----------+
| Indonesia         | 39,841    | 38,468    | 30,323    | 12,612    |
+-------------------+-----------+-----------+-----------+-----------+
| Thailand          | 25,307    | 34,593    | 21,911    | 19,386    |
+-------------------+-----------+-----------+-----------+-----------+
| Vietnam           | 14,196    | 31,098    | 18,250    | 12,488    |
+-------------------+-----------+-----------+-----------+-----------+
| Saudi Arabia      | 26,227    | 30,617    | 17,268    | 28,499    |
+-------------------+-----------+-----------+-----------+-----------+
| Canada            | 20,666    | 21,289    | 15,387    | 14,502    |
+-------------------+-----------+-----------+-----------+-----------+
| Taiwan            | 21,658    | 19,730    | 13,064    | 13,885    |
+-------------------+-----------+-----------+-----------+-----------+
| Jordan            | 13,584    | 18,224    | 5,947     | 0         |
+-------------------+-----------+-----------+-----------+-----------+
| Algeria           | 15,903    | 17,162    | 10,136    | 16,654    |
+-------------------+-----------+-----------+-----------+-----------+
| Cuba              | 15,939    | 15,457    | 8,062     | 12,782    |
+-------------------+-----------+-----------+-----------+-----------+
| Oman              | 8,599     | 14,825    | 4,342     | 16,100    |
+-------------------+-----------+-----------+-----------+-----------+
| El Salvador       | 14,106    | 12,571    | 7,865     | 5,791     |
+-------------------+-----------+-----------+-----------+-----------+
| Singapore         | 15,560    | 12,495    | 9,679     | 10,237    |
+-------------------+-----------+-----------+-----------+-----------+
| United States     | 3,409     | 3,270     | 1,122     | 2,843     |
+-------------------+-----------+-----------+-----------+-----------+
| Other             | 99,541    | 92,851    | 56,257    | 72,716    |
+-------------------+-----------+-----------+-----------+-----------+
| Total             | 548,270   | 657,730   | 399,175   | 418,332   |
+-------------------+-----------+-----------+-----------+-----------+

+--------------------+------------+------------+----------+----------+
| ####               |            |            |          |          |
| ## **Casein, Casei |            |            |          |          |
| nates, and Other** |            |            |          |          |
+--------------------+------------+------------+----------+----------+
| Tons               |            |            |          |          |
+--------------------+------------+------------+----------+----------+
|                    | January -  |            | J        |          |
|                    | December   |            | anuary - |          |
|                    |            |            | August   |          |
+--------------------+------------+------------+----------+----------+
| Country            | 2002       | 2003       | 2003     | 2004     |
+--------------------+------------+------------+----------+----------+
| United States      | 54,836     | 63,249     | 42,009   | 35,394   |
+--------------------+------------+------------+----------+----------+
| Germany            | 21,247     | 18,349     | 13,341   | 9,011    |
+--------------------+------------+------------+----------+----------+
| Japan              | 8,819      | 10,209     | 6,685    | 7,559    |
+--------------------+------------+------------+----------+----------+
| Mexico             | 13,477     | 9,188      | 5,404    | 5,686    |
+--------------------+------------+------------+----------+----------+
| Canada             | 4,733      | 4,864      | 3,588    | 1,644    |
+--------------------+------------+------------+----------+----------+
| Italy              | 2,899      | 2,860      | 1,853    | 2,123    |
+--------------------+------------+------------+----------+----------+
| Korea, South       | 3,064      | 2,445      | 1,519    | 1,959    |
+--------------------+------------+------------+----------+----------+
| Australia          | 1,552      | 2,260      | 1,570    | 1,383    |
+--------------------+------------+------------+----------+----------+
| Other              | 15,965     | 14,001     | 8,912    | 10,099   |
+--------------------+------------+------------+----------+----------+
| Total              | 126,592    | 127,425    | 84,881   | 74,858   |
+--------------------+------------+------------+----------+----------+

#  SECTION III. SUPPLY, DEMAND POLICY AND MARKETING

## 

## PRODUCTION

New Zealand's milk production during the 2004/05 season (June-May) is
forecast by Post at 15.45 million tons, an increase of 3 percent on the
previous season. This follows last years 5 percent increase in milk
production on a similar increase in cow numbers. New Zealand's dairy
herd at the beginning of the season is estimated to have increased 2
percent to 4 million cows and heifers in calf or milk.

Cold spring weather (August - September 2004) hurt grass growth and
resulted in reduced milk flows in much of New Zealand's key dairy
farming areas. Supplemental feeding will offset this negative impact to
some extent, although farmers will balance the benefits versus cost to
determine the level of supplemental feeding. Fonterra anticipates that
peak milk flows, around the start of November, will fall below a year
earlier. However, a continuing trend towards higher production levels
later in the season is forecast to boost total milk flows for the
season. This is due to the increase of South Island dairy farms, whose
season finishes later than their North Island counterparts.

Also negatively impacting this year's milk production is the extensive
flooding experienced in some areas of the North Island last July that
disrupted farming operations. This prompted affected farmers to move
cows to unaffected areas. Most of the stock has returned for the start
of the season and grass is beginning to grow in these areas. The stock
is returning in variable condition, reflecting the shortage of grass and
other feed in the central and southern North Island. Many of the lower
North Island farms damaged in heavy flooding in February are also still
recovering (see NZ4008).

It is difficult to predict the long-term impact that changing weather
patterns such as El Nino will have on New Zealand's dairy industry. New
Zealand's low cost agricultural production relies on its ability to grow
grass, which is determined by temperature and rainfall. Farmers will
need to adapt to climatic changes, with different areas of New Zealand
becoming hotter or colder, dryer or wetter than historically. New
Zealand's dairy industry appears unconcerned, with a strong focus on
improving cow production and efficiency through genetic and management
improvements.

### Fonterra's Production Capacity

Fonterra owns the three largest dairy factories in the world, all based
in New Zealand. Fonterra continues to upgrade its manufacturing base in
New Zealand, stating that it will invest an additional NZ\$ 200 million
into its Clandeboye plant building a forth milk drier within the next
five years, making it the largest in the world. The biggest is currently
Fonterra's Whareroa plant at Hawera, followed by its Edendale plant.

## TRADE

Fonterra has reached stable inventory levels, following their controlled
reduction during 2002 and 2003. The PS&D tables have been updated to
account for this. These inventory clearances are reflected in low
international prices of commodity milk products during this period. This
was part of Fonterra's strategy to reduce supply chain costs. Export
supply will tighten for the 2004/05 season now that inventories are at
stable levels.

### Cheese

New Zealand's cheese production is forecast to increase 2 percent to
319,000 tons for the 2004/05 season. Exports are estimated to remain
unchanged from last season at 293,000 tons as a result of Fonterra
having tighter exportable supplies for the 2004/05 season.

### Butter

New Zealand's butter production for the 2004/05 season is forecast to
remain the same at 407,000 tons. Lower inventory levels will restrict
butter exports, which are forecast to decrease 2.6 percent to 381,000
tons.

### Skim Milk Powder

Skim milk powder (SMP) production in New Zealand for the 2004/05 season
is forecast to increase 4.7 percent to 315,000 tons. Exports are
forecast to remain the same at 311,000 tons, due to tighter exportable
supply.

### Whole Milk Powder

New Zealand's whole milk powder (WMP) production is forecast by Post to
increase 4.9 percent to 710,000 tons. Exports are forecast to increase
only 3.3 percent to 711,000 tons as a result of tighter exportable
supply.

New Zealand's dairy industry represents over 20 percent of New Zealand's
total exports by value, with 95 percent of dairy production exported.
Fonterra accounts for 95 percent of New Zealand's dairy exports.
Although New Zealand only produces 2 percent of the world's milk, it
accounts for one-third of world dairy trade. Through its international
acquisitions and joint ventures Fonterra manages 40 percent of world
dairy trade. The United States is New Zealand's largest export market by
value, taking 11 percent of its dairy exports in 2003. Two thirds of New
Zealand's exports by value to the U.S. in 2003 were casein products.

Due to the dairy industry's large share of New Zealand's total exports,
New Zealand's objectives for multilateral trade negotiations in relation
to dairy are very similar to those for New Zealand's general
agricultural negotiations. New Zealand's stance is heavily influenced by
its membership of the Cairns Group, in which it plays a constructive
role in the negotiations and is fully supportive of the Group's
proposals. New Zealand's main focus is on the elimination of export
subsidies and increased market access.

## MARKETING

### Fonterra's Market Strategy

Since its formation in 2001, Fonterra has repeatedly stated its goal to
continue the work of its predecessors towards global dairy industry
leadership. Fonterra has stated that its goals are for long-term
competitiveness and cost leadership; to remain a farmer-owned
cooperative; and the continued expansion of its value-add activities.
Due to the significant trade barriers facing New Zealand dairy products
in overseas markets, future growth will largely come from international
acquisitions, mergers, and joint ventures and not from New Zealand-based
dairy export increases. Fonterra further benefits from this strategy
through ready access to dairy products produced offshore via both
established relationships and the spot market, allowing it to guarantee
a consistent supply of product to its international customers. Although
Fonterra is forecasting consistent growth in New Zealand's milk
production of 3 percent per year, the cooperative is increasingly
sourcing milk product from outside New Zealand and Australia to meet
increasing customer demand.

International expansion plans have been well below initial expectations
during Fonterra's first three years of operation. Its new CEO Andrew
Ferrier, however, has indicated his desire to expand Fonterra's
international operations in the near future. At formation, Fonterra
generated 80-90 percent of its earnings from New Zealand production,
although its alliance with Nestlé will have altered this percentage in
favor of earnings from overseas operations. Fonterra believes that only
a third of its future overseas sales growth will be achieved by
increasing its exports of New Zealand-produced dairy products, while
expanding its overseas operations will generate the lion's share. The
principal markets targeted for expansion and promotional activity by
Fonterra include Australia, Asia, the United States, Mexico and South
America.

### Fonterra's International Expansion

Negotiations between Fonterra, the Chinese government and the Chinese
dairy company Shijiazhuang Sanlu Group Co. (Sanlu) to purchase a stake
in Sanlu continue. It is likely that Fonterra will become the second
largest shareholder in the company with a 39 per cent stake. China is a
key market for Fonterra, who supplied 70 percent of China's dairy
imports (excluding whey) in 2002. This is Fonterra's fourth largest
market. Chinese urbanization and rapidly rising per capita incomes are
increasing demand for western-style food, making China an increasingly
important export destination for New Zealand dairy products. Chinese
companies outside China's dairy belt face serious difficulties in
ensuring a regular milk supply, creating opportunities for Fonterra to
supply imported milk products. Fonterra states that this deal will
provide Fonterra with a Chinese distribution network, while Fonterra
will provide its branding experience in the fast-moving consumer goods
category. Fonterra's sales of milk powder may be negatively affected,
however, if the Dairy Association of China introduces a fresh milk
identification system in major Chinese cities. This may create a
consumer perception that fresh is better, which is not necessarily true
in China. The system will also penalize China's own dairy companies
situated in the North of the country, some distance from the affluent
coastal cities, including Sanlu.

In North America, Fonterra's joint venture with Dairy Farmers of
America, DairiConcepts, is attempting to gain advantage over competitors
by becoming the first to gain regulatory approval for a U.S. plant to
supply milk protein products for use in products such as yogurt, ice
cream and frozen desserts. This plant, located at Portales, New Mexico,
is the only plant in the United States using the ultra filtration
process, allowing it to produce a higher grade product than other plants
in the U.S. Through its venture with U.S. cooperative Dairy America,
Fonterra is the largest exporter of U.S.-produced non-fat dry milk
powder. Acquisitions in Mexico have allowed Fonterra to gain a large
share of the Mexican cheese and spreads market.

Fonterra is also moving ahead with production and marketing strategies
in South America through a strategic business alliance Dairy Partners
Americas with Nestlé. Currently operating in Argentina, Brazil and
Venezuela, in April 2004 the two partners announced their second phase
of development, expanding into Ecuador, Colombia and Trinidad and
Tobago. Fonterra is investing U.S.\$ 35 million in this expansion. The
third phase involves Fonterra merging Chilean dairy company Soprole into
its Dairy Partners Americas venture with Nestlé, who is currently
Soprole's major competitor in the Chilean market. Fonterra has a 51
percent shareholding in Soprole, which is one of Chile's four largest
dairy organizations. Unfortunately, the other major shareholder of
Soprole is against this idea. Fonterra is assessing buying out its
current business partner, however it faces uncertainty as to Chilean
competition authorities allowing the merger of Fonterra's business with
Nestlé's, due to the dominant market share the resulting joint venture
would command of Chile's dairy industry.

In Australia, Fonterra is bringing together its existing production and
marketing assets, allowing it to manage its business activities more
effectively. This reflects Fonterra's strategic view that Australia is
part of its domestic market and should be included in its consolidation
to ensure its future success. Some industry commentators, however, argue
that Fonterra has not adequately articulated a strategy for the
Australian market, with some of its investments failing to create the
impression of a cohesive strategy. Fonterra's 50 percent ownership of
Bonlac Foods and 17 percent share of National Foods, along with
shareholdings in other dairy companies in Australia, may allow it to
take advantage of trade benefits provided to the Australian dairy
industry by the U.S.-Australian FTA that was negotiated in February
2004.

In Europe Fonterra brought its Anchor brand into a new marketing
arrangement with the Lurpark brand of ARLA, a European dairy
cooperative. This will ensure that Fonterra obtains maximum marketing
value from its Anchor brand in the European Union, with a focus on the
U.K. Fonterra also has a joint venture with Britannia in India.

### U.S. Imports of New Zealand Milk Protein Concentrate

The New Zealand diary industry's market strategy continues to place an
emphasis on maintaining growth in its sales of milk protein concentrates
(MPCs). The U.S. market accounted for 55 percent of Fonterra's 167,000
tons of MPC exports in 2003. New Zealand is keenly aware that the U.S.
has few import barriers on MPCs, due to imports increasing after new
world trade rules were set in 1994. The New Zealand industry was
satisfied that a report issued in May 2004, by the United States
International Trade Commission, 'Conditions of Competition for Milk
Protein Products in the U.S. Market', found that regardless of these low
barriers, imports of milk protein concentrates had done little damage to
U.S. dairy farmers. Through a joint venture between Dairy Farmers of
America, Fonterra is producing MPCs at its Portales plant in New Mexico.
The factory is the only one in the United States producing high-protein
MPCs using an ultrafiltration process.

## POLICY

### Fonterra's Share Value and Capital Structure

There is strong debate regarding the Fonterra's cooperative structure
and the method used to value its shares. Fonterra has begun extensive
consultations with its shareholders and undertook a tour of Australia
and the United States involving farmer representatives in August 2004 to
study other cooperative structures. Fonterra maintains that it will
retain its cooperative structure, evolving it to suit the industry's
needs. For a change in Fonterra's capital structure to occur its
shareholders need to vote 75 percent in its favor.

The cooperative currently uses a 'fair value' share system for
determining its share value. The value is based on an estimated value
range calculated by Standard & Poor's. Fonterra has set its fair value
share price at NZ\$ 4.69 for the 2004/05 season, a 7 percent increase
over the previous season. Fonterra's current fair value share value is
56 percent greater than its initial value of NZ\$ 3 set during
Fonterra's creation in 2001. Fonterra maintains that the price trend
indicates that Fonterra is creating value as the share price takes into
account the long-term benefits to the cooperative's shareholders.
Suppliers are unaware of what portion of their payout is the result of
commodity prices versus value-add activities. Although the share value
increases have increased the asset value of farmers with shares, the
higher share value places a larger burden on farmers wishing to start
new dairy operations or expand existing ones. Fonterra has admitted that
this may make it difficult to generate adequate milk flows in the
future.

The lack of transparency of the value setting process and Fonterra's
potential future need for additional external capital has caused some
industry observers to suggest that Fonterra alter its structure. One
option is to separate its value adding business, 'New Zealand Milk',
from its commodity business, 'Ingredients'. Fonterra's suppliers would
retain ownership of Ingredients and outsiders would have the ability to
invest in New Zealand milk. This has created industry wide debate.
Fonterra maintains that this separation will not occur and that it will
remain a cooperative, never incorporating external ownership into any of
its core businesses. Fonterra states that its annual 3 percent growth in
milk flows is providing an additional NZ\$ 200 million funding per year,
adequate for the next three to five years. Many analysts, however,
believe that in the future Fonterra may need access to additional
capital beyond what shareholders can provide in order to continue
investing in its commodity and value adding businesses.

New Zealand Milk's poor performance since the cooperative's creation has
supported some analysts' arguments that the value-added business is a
poor fit inside a producer oriented cooperative structure. Fonterra has
reassured its suppliers that the disappointing returns are due to strong
milk commodity prices, which reduces New Zealand Milk's margins while
increasing revenues for Fonterra's commodities business, Ingredients.
The cooperative argues that this situation is beneficial to farmers as
the value-add businesses provide a natural hedge during times of low
commodity prices. To date Fonterra's business has been driven by
continually increasing supply, which is typically sold as commodities.
In the future Fonterra may need to decide whether to focus on its
commodity business or value added business. If it focuses on its value
added business the currently fair value scheme could distort signals to
farmers. This may motivate farmers to purchase more shares and supply
more milk, which may make it more challenging for Fonterra to create
more value per liter of milk.

Another contentious issue that Fonterra's shareholders are currently
debating is its Peak Notes scheme. This scheme is designed to ensure
that farmers with a strong peak of production during the season hold
more capital in Fonterra. This is due to the extra processing capacity
that Fonterra has to invest in to meet the demands of peak milk flow for
a short period of the season. The current system is complicated to use
and many farmers are against the recognition of different production
curves. Fonterra, however, argues that a system is needed as producers
with flat production curves can be 'picked' by other processors to suit
a particular purpose, leaving Fonterra with a large proportion of
producers with 'peaky' production curves, increasing its costs.

### Farmer Payouts

Fonterra's final payout to its farmer shareholders for the 2003/04
season is NZ\$ 4.25 per kilogram of milk solids. Fonterra states that
the large gain over its NZ\$ 3.85 forecast at the beginning of the
season was the result of higher commodity prices, increased supply chain
efficiencies and merger benefits. Fonterra announced in October 2004 its
forecast payout for the 2004/05 season as NZ\$ 4.05 per kilogram of milk
solids. The main cause of this 5 percent drop is due to the continuing
strength of New Zealand's currency and Fonterra's inability to hedge the
weaker U.S. dollar at as favorable a rate as in the past. The average
conversion rate for 2004/05 will increase to U.S. 60-62 cents, from an
average of U.S. 52 cents the previous season. Fonterra forecasts milk
product commodity prices to remain strong during the 2004/05 season.

### Live Dairy Cattle Exports to China

New Zealand live dairy cattle exports increased significantly in 2003
and 2004 due to strong Chinese demand for New Zealand bred Friesian
dairy cows with specific attributes. New Zealand has the current
advantage over other potential export countries of being free of major
bovine diseases such as BSE. The value of these particular animals is
substantially higher when exported to China rather than sold
domestically. Exports to China in 2003 totaled 8,860 animals. Exports
between January and August of 2004 have totaled 34,000 animals. This is
a contentious issue, with some industry participants warning that New
Zealand is effectively 'giving away' years of genetic research and
development. Others argue that if New Zealand doesn't take advantage of
the situation then others will. They also argue that China only controls
a limited percentage of the worlds arable area and that the Chinese
market will continue to expand so rapidly that it will always need
outside sources of milk.

### Potential Benefits of Future New Zealand Trade Deals

The New Zealand government is currently working towards trade deals with
China, Thailand and Chile that could be beneficial to New Zealand's
dairy industry. Trade and economic framework discussions for a Free
Trade Agreement (FTA) with China were initiated in January 2004. New
Zealand and China are currently undertaking a joint feasibility study
with the results to be released in November 2004. New Zealand hopes that
this will lead to negotiations on a trade deal, which are expected to
commence in early 2005. Both countries have expressed a desire to
conclude a FTA in 2005. New Zealand's efforts to reach a trade accord
with China were enhanced by its willingness to meet China's demand to be
recognized as a market economy. This provides China with relief from the
anti-dumping provisions it accepted when it joined the WTO.

New Zealand and Thailand are likely to agree on a free trade agreement
by the end of 2004. Fonterra currently accounts for more than half of
New Zealand's exports to Thailand (approximately NZ\$ 200 million per
year), which could be expanded if current quota and tariff barriers were
reduced. Thai dairy farmers, however, have asked that their government
exclude dairy products from free trade negotiations with New Zealand.

New Zealand's dairy industry could also benefit from a trade deal with
Chile, which is currently in negotiations with the New Zealand
government. Benefits may be limited, however, due to the influence of
Chile's dairy industry, which in the past opposed a FTA between the two
countries. Fonterra currently holds a 51 percent stake in Soprole, one
of Chile's four largest dairy organizations. Soprole currently exports
more than it imports from New Zealand. Fonterra maintains that its focus
is on continued expansion of Chilean export production rather than
importing New Zealand milk products.

### Additional Resources

[www.fonterra.com](http://www.fonterra.com/) (New Zealand's main dairy
cooperative, 95 percent of exports)

[www.westland.co.nz](http://www.westland.co.nz/) (small dairy
cooperative)

[www.tatua.com](http://www.tatua.com/) (small dairy cooperative)

[www.maf.govt.nz](http://www.maf.govt.nz/) (various reports on New
Zealand's dairy industry)

[www.lic.co.nz](http://www.lic.co.nz/) (herd improvement cooperative)

[www.dexcel.co.nz](http://www.dexcel.co.nz/) (New Zealand's dairy
industry research organization)

<http://www.fedfarm.org.nz/fonterra.htm> (represents farmer interests,
discusses capital structure and peak notes)