By Adam Jourdan and Naomi Tajitsu
SHANGHAI/WELLINGTON (Reuters) - Milk powder buyers in China are starting to cut their reliance on New Zealand's Fonterra (FSF.NZ), opening the way for U.S. and European firms to break the dairy giant's grip on an infant milk formula market set to double to $25 billion by 2017.
Chinese drinks maker Want Want has said it plans to reduce imports to diversify its supply chain, and at least two multinational infant formula sellers have either cut supply from Fonterra or plan to diversify supply for the China market, people in the industry told Reuters.
A drought in New Zealand earlier this year curbed milk powder production, highlighting the risk of over-reliance on one supplier. Those concerns escalated in August when Fonterra said it had found a potentially fatal bacteria in one of its products, triggering recalls of infant milk formula and sports drinks in several markets, including China. Tests later found the initial finding was incorrect.
"They know they're reliant on 80 percent of their imported milk powder from one place - and 80 percent of that from one company. That's just not a healthy position to be in," said William Baker, a Beijing-based investment professional who focuses on the Chinese dairy industry.
China's appetite for foreign milk powder has soared in recent years, spurred by distrust in local products since a scandal in 2008 when milk laced with the industrial chemical melamine killed six infants and made thousands more ill. Tighter food safety rules and disease among Chinese cattle have also stymied domestic output this year, pushing import volumes up by almost a third in January-October.
Fonterra said it was normal that some fast growing customers would look around for other supply options.
"When you've got customers who are growing like mad, it's not so much that they're wanting to diversify, it's that they know that if they're growing faster than we are, they're going to have to see volumes of product coming out of Europe and the U.S. to fill what would be a supply gap," said Tim Deane, director of global sales at Fonterra."
"As growth in global trade outstrips New Zealand supply, increasingly more companies will have to (look at different suppliers). It's got nothing to do with their satisfaction or dissatisfaction with Fonterra."
Abbott Laboratories (ABT) and Mead Johnson Nutrition Co (MJN) of the United States, Danone SA (BN.PA) of France and Switzerland's Nestle SA (NESN.VX) are among the major sellers of infant milk formula in China.
They buy base milk powder from Fonterra to process into infant milk formula for sale in China's $12.4 billion market, the world's biggest. Earlier this year, Fonterra began selling its own infant milk formula brand in China on a pilot basis.
Supplying more than 60 percent of global whole milk powder exports, New Zealand has long dominated China's import market, accounting for an average 80-90 percent of total powder imports each month since 2009. But in June, even before Fonterra's food safety scare, imports from other countries surged, especially from Europe and the United States. By September, they made up more than half of all shipments, Chinese customs data showed.
While heavy demand lifted New Zealand powder imports in October, imports from elsewhere are rising fast, jumping 53 percent in the year to October, almost twice the pace as those from New Zealand.
"Any non-New Zealand supplier turning up in China is getting a warm welcome," said John Shaskey, New Zealand-based executive director of dairy broker Global Dairy Network.
One large U.S. infant formula firm plans to increase the proportion of supply it gets from Europe, especially Ireland, a person with direct knowledge of the plan said, adding he didn't want his or the firm's name to be used as the decision has not yet been finalized. He declined to name any specific suppliers.
Any new demand in the fast-growing market will likely be sourced from Europe, he said. The company currently gets around 60 percent of its milk powder used in China from New Zealand.
Mead Johnson, the largest infant formula seller in China by market share, according to Euromonitor, declined to comment. A spokesman for Abbott said he was unable to discuss supplier contracts.
Danone's Dumex milk powder unit has cut its supply from Fonterra for the Chinese market due mostly to lower production in China since the August health scare, said a person with knowledge of that situation.
Officials from Danone, which has said it is considering legal action against Fonterra over the impact of the food scare on its China sales, declined to comment. Nestle, which operates the Wyeth milk powder brand in China, did not respond to questions about its China business.
A spokeswoman for Hong Kong-listed Want Want, which uses Fonterra milk powder in some of its drinks, said it had a "diversified strategy" to manage supply chain risk. She declined to comment on individual suppliers.
U.S., EUROPE MAKING MOVES
Chinese firms, too, have been putting out feelers.
Over the past year, Inner Mongolia Yili Industrial Group Co Ltd has set up an alliance with Dairy Farmers of America Inc (DRFMA.UL), while China Mengniu Dairy Co Ltd (2319.HK) has announced tie-ups with Danish dairy group Arla Foods (ARLAF.UL).
Dairy Farmers of America is set to open a whole milk powder processing plant in the United States in the first half next year, with estimated annual output of 40,000 tonnes. It would be the first in the United States specializing in whole milk powder, an important step for targeting China, where whole milk powder consumption is seven times that of skimmed powder, according to the U.S. Department of Agriculture.
"The new plant is significant as it could establish the U.S. as a viable supply option to New Zealand," said Shaskey. He estimated around half the plant's output would go to China.
Dairy Farmers of America declined to comment.
Irish dairy firm Glanbia PLC (GL9.IR) is developing a 150 million euro ($206 million) milk powder plant in southeast Ireland to tap the export boom to markets such as China once the European Union scraps a 30-year-old limit on output in 2015. A Glanbia spokeswoman said China had become the firm's Asia hub, but she declined to comment on supply contracts.
Arla Foods has increased its range of offerings at global auctions as the cooperative looks to gain access to China. "We have primarily had our eyes on China as it's the fastest growing market for child nutrition products," said Finn Hansen, head of international operations.
Some Chinese buyers are also building their own facilities in New Zealand, which could help them bypass Fonterra.
But analysts said breaking Fonterra's dominance would not be easy, and it remained to be seen if Europe and the United States could significantly raise their export capacity.
New Zealand exports more than 90 percent of its output and controls a third of the global dairy trade. Most of those exports come from Fonterra, which is owned by its 10,500 farmer suppliers.
"There may be a shift to other suppliers," said David Mahon, managing director of Mahon China Investment Management. "But there's not enough capacity in Europe or even the USA for a shift away from Fonterra to be significant or long term."
($1 = 0.7271 euros)
(Additional reporting by Martinne Geller in LONDON, Dominique Patton in PARIS, Teis Jensen in COPENHAGEN, Silke Koltrowitz in ZURICH, Conor Humphries in DUBLIN, Sarah Young in BELVIEW, Ireland and SHANGHAI newsroom; Editing by Dean Yates and Ian Geoghegan)