There was an impressive line-up of speakers: lots of senior bureaucrats and academics from Europe, and Sir Colin (Pine Tree) Meads (left) as after-dinner speaker. Col said his son had converted to organics a while back and while initially sceptical he’d been very impressed with the results.

Its true that locks are not usually selected for their brains, but neither are NZ sheep farmers noted for their gullibility or willingness to break ranks. So it is surely significant that Colin Meads fronted up to speak at an organic sector conference.

Other bits from the event:

• The organic market in the USA has been experiencing double digit growth (18% in 2008) but it looks like 2009 will break this trend and come in at around 7 – 9%. Still damn good in a market where “flat is the new growth“.
• Compared with conventional methods, organic agriculture sequesters much more carbon in the soil, but the science for measuring it is still deficient
• On average, Swiss farmers get 43,000 Euros/year from the state to provide public goods such as a nice landscape, soil conservation, animal welfare etc
• NZ’s organics industry organisation OANZ was lucky to score 3 years of government funding, which has now been cut.

Entry into adjacent markets is a major source of innovation.  So is there a case for dairy farmers also running chickens? Chicken manure is nitrogen rich and could substitute for urea, which is derived from fossil fuel. Instead of spreading urea, a flock of chooks could move in after the cows, spread out the cow shit, and add their own nitrogen rich contribution. There’d be a few logistics to sort out, but is it possible to get enough nitrogen this way?

Answer: perhaps, but you’d need a hell of a lot of chooks.

I reckon about its 15-20,000 per hectare to get the same dose of nitrogen in a day. Sounds ridiculous doesn’t it? And it probably is, but that stocking rate gives each chook 10 times its space in a battery, and they’d be able to move around, so it’d be heaps better for the chooks.

Here is the very rough calculation.

Farmers spread urea, which is 46% N,  at around 80kg/ha, so thats 37kg of N/ha.

Each ton of fresh chicken manure has 11.8kg of N, so we need 3.1 tonnes of chicken poo per hectare to replace the nitrogen, although there may be some other efficiencies, like having the cow shit spread around. So the estimates below could be at the top end of what is needed.

You get 145g of poo/chook/day, so that means 21,408 chooks would be needed to supply the 3.1tonnes to the hectare.

This is a stocking rate of 0.47 sqm per chook. In batteries, they get 0.047, so the difference is a factor of 10.

Lets start with the economics.

The co-op has too much debt. Previously acceptable gearing ratios are now considered excessive, and in a debt constrained world equity matters. Fonterra is asking farmers to approve issuing up to 20% extra shares, to be non-voting “dry” shares, and then to buy them. Based on current data these would pay a dividend of 11%, so there should be good uptake.

On the equity side, well there really isn’t any, at least not in the normal sense of that term. Fonterra stands ready to repurchase shares from any farmer at any time, but it would collapse if enough farmers tried to cash out at once. Under current arrangements, you must hold shares to cover all production. So if production falls eg because of drought, farmers have to sell back shares and the co-op has to buy them. $740m was paid out last year on share redemptions, some of which was initiated by farmers gaming the co-op.

So Fonterra argues that it needs to (a) get equity capital into the business and (b) protect the co-op against opportunistic gaming by its members.

I agree.

There are two ways to do this. One is to withhold revenue. Cut the payout, retain the cash and use it to pay down debt. That forces all farmers into the same structure. Issuing shares to those that want them allows greater flexibility and seems more efficient. It also helps to open the door to other sources of equity.

Brian Gaynor makes a defensive argument for getting some pure equity into the co-op, on the grounds that currently, as suppliers, farmers rank behind debt holders and ahead of equity holders. Its an OK argument, but the situation it applies to must (hopefully) be a very low probability event. The situation would need to be bad enough to involve capital loss, but not bad enough to ruin the whole co-op.

Now for a couple of sociological observations:

1. Well, um, Henry um Van der Hayden um didn’t um seem terrribly um sure of himself at times.

2. Why was I surprised that Blue Read has red hair? The obvious nickname really.

And what about the farmers?

I’d imagine there’ll be some grumbles about share prices. Henry said that shares are currently valued on the assumption that anyone could buy them. And that since the board clearly ruled out an IPO, the pool of potential buyers is smaller, so the shares must trade at a discount (reflecting that constraint), so they are worth less than we all thought. Hmmm. So all of the periodic share valuations since Fonterra formed in 2001 have formed been on a basis that was incompatible with the apparent belief of farmers that non farmers could not buy in? Well yes, admitted Henry, but that was in the context of something to do with “two proud co-operatives”. Not a good look.

More generally, I just hope they back the concept and don’t get too hung up on the fact that external capital will eventually be needed.

And to be fair the link is a bit tenuous, but bear with me.

There are two arguments for wanting to get more capital into the co-op: to manage “redemption risk”; and to fund growth.

Redemption risk is the risk that farmers will give up on Fonterra for some reason and cash in their shares. In that case, the co-op stands ready to buy them out. While there are some cyclical ups and downs, the main risk is of a “run on the bank”, where selling up could look rational simply to avoid being one of those left behind paying all the redemption bills. The only real way of managing that risk is by performing well as a business, so farmers will want to stay. If a decent fraction of them become disillusioned and quit, those that remain will be much worse off. This is true irrespective of whether the co-op does has cash lying around to make the payouts, or needs to borrow it. So at this point I’m pretty sceptical of redemption risk as an argument for more capital.

Funding for growth makes sense though. Growth could involve commodity processing in foreign countries or advanced product development of the sort that has made Tatua rich. Either way there is risky investment capital required. We all have different appetites for risk and my guess (based on casual observation) is that many dairy farmers are fairly risk averse. So an obvious solution is for the co-op to form joint ventures with other investors to pursue growth, along the lines suggested by Harry Bayliss and Michael Joyce last time around.

The co-op would take a cornerstone stake in each JV, and would recruit entrepreneurial capital from others. Ideally individual farmers could also subscribe for a slice of the action on specific projects.

There will be more to say on these subjects after the announcements, but in the meantime, the change of thinking apparent in the decision not to float, and all this redemption risk chatter, got me thinking of these lines from Bob Marley’s classic Redemption Song:

Emancipate yourselves from mental slavery

None but ourselves can free our minds

We can but hope for more of that!

I am puzzled about why we should worry about methane emissions, given that they result from a circular process whereby carbon in grass is converted into methane by cows, but then carbon is reabsorbed from the atmosphere to re-grow the grass.

BK Drinkwater, I think correctly, pointed to fertiliser extracted from the ground and used to grow grass which (once eaten by cows) generates extra methane emissions; this is not part of a closed carbon cycle. But Seamus then observed that

my memory from high-school science and geography is an important source of New Zealand’s advantage in agrigculture is that we don’t have need for nitrogen fertilisers (something to do with clover), just for superphosphate. And a quick Wikipedia search confirmed that while Carbon is present in urea (a typical nitrogen fertiliser), it is not present in super phosphate.

It is true that clover is a nitrogen fixer, so we can & do get nitrogen from including it in the pasture mix (the salad bar). Also cow piss is unbelievably high in nitrogen, so we also get lots like that (too much actually, but that’s another story). However the key point is that, notwithstanding these facts, it still makes economic sense to apply urea because doing so accelerates grass growth and at current prices the value of the resulting milk is worth the cost of the urea.

So (in my current state of ignorance) it seems that the policy implication may be to tax urea.

Commodity auctions are pretty straight-forward. They are not like a spectrum auction, where the value I attach to one chunk can depend on what other chunks I own. You’d have to be pretty incompetent to screw up the design of a commodity auction.

It looks to me as though the Feds mainly don’t like the fact that dairy prices have been falling since the auction started (apart from the last round when the price went up). They are not alone; the Europeans have a similar complaint.

There must be a fair chance that the market is working properly and demand is just weak (GFC anyone?). While it would be excellent economist-geek fun to get an inside look at the dairy auction process, I would not be holding my breath when looking for poor design.