* Fonterra CEO says bacteria killed in processing
* NZ Prime Minister questions disclosure delay
* China restricts some imports; Vietnam in product recall
* Fonterra units down 3.7 pct, NZ$ drops to 1-year low
By Gyles Beckford and Megha Rajagopalan
WELLINGTON/BEIJING, Aug 5 (Reuters) - Fonterra, the world's leading exporter of dairy products, apologised on Monday for a milk powder contamination scare in China that risks tainting New Zealand's reputation for food safety.
The company said at the weekend it found bacteria that could cause food poisoning in some products. Contaminated whey protein concentrate had been sold to China, Malaysia, Vietnam, Thailand and Saudi Arabia and used in products including infant milk powder and sports drinks, it said.
Rushing to China, one of Fonterra's biggest markets, CEO Theo Spierings sought to reassure customers, telling local media that processing methods would kill off harmful bacteria.
"We really regret the distress and anxiety which this issue could have caused," he said. "We totally understand there is concern by parents and other consumers around the world. Parents have the right to know that infant nutrition and other dairy products are harmless and safe."
Spierings said Fonterra, a leader in New Zealand's $9 billion dairy export trade, was not facing a ban on its products in China, only restrictions on whey protein concentrate.
He said he expected the curbs would be lifted early this week, as soon as Fonterra provides Chinese regulators with a detailed explanation of what went wrong. The majority of the affected products have already been contained, he said, and the problem will be resolved within two days after all contaminated products have been recalled.
Units in Fonterra's Shareholders Fund, which offer outside investors exposure to the cooperative's farmer shareholder dividends, slumped as much as 8.7 percent to an 8-month low before closing down 3.7 percent at NZ$6.86. The New Zealand dollar fell nearly 2 U.S. cents to a 1-year low. Dairy produce accounts for about a quarter of New Zealand's NZ$46 billion ($36 billion) annual export earnings, and the currency is sensitive to Fonterra's fortunes.
Fonterra is a major supplier of bulk milk powder products used in infant formula in China, but doesn't sell in China under its own brandname after Chinese dairy company Sanlu, in which it held a large stake, was found to have added melamine - often used in plastics - to bulk up formulas in 2008. Six babies died then and thousands were taken ill.
Spierings said the latest problem originated in a pipe at a factory in New Zealand that was seldom used, so normal cleaning was not sufficient to sanitise it. Fonterra discovered in March that some whey protein concentrate, sold on to customers in May, was contaminated. It immediately began testing, but as most of the bacteria's strains are benign, the company only traced the harmful strain last month. Customers were informed on July 31.
"The supply chain for infant nutrition powder takes a long time, with many steps," Spierings said.
The affected plant was closed for cleaning after the possibility of a problem was discovered, Spierings said, adding the problem was isolated to that factory. He said he was confident all contaminated products had been found.
New Zealand Prime Minister John Key questioned why Fonterra took so long to disclose the contamination.
"When ... your whole business is about food safety and food quality, you'd think they'd take such a precautionary view to these things and say if it's testing for some reason in an odd way that (the product) would just be discarded till they're absolutely sure it's right," he said, noting Fonterra is New Zealand's flagship and the issue went right to the "heart of undermining consumer confidence".
In China, the official Xinhua news agency said Fonterra might have gained some credit had it moved quickly to recall the affected produce. "But when such a problem takes more than a year to come to light, it's elevated from an industry event to a national issue," it said in an English-language commentary.
Investigations found 38 metric tons of whey protein concentrate were contaminated, Spierings said, of which 18 tons were used in Fonterra factories in Australia and New Zealand to produce milk formula for two customers.
Dumex Baby Food Co Ltd, a subsidiary of France's Danone , told Fonterra that 12 batches could have been affected, Spierings said. Half had been recalled as a precaution and the rest was in factories. It was not clear which was the other affected company.
Spierings said products from Coca-Cola Co and Chinese food firm Wahaha were safe as any bacteria would be killed during processing. Protein drinks made by Auckland-based Vitaco Health Group Ltd, another Fonterra customer, were also unaffected, while products sold to China under the Karicare brand by Nutricia, another Danone subsidiary, do not contain the contaminated whey protein concentrate, he added. In Paris, Danone shares fell more than 1 percent. "None of the products tested by Dumex in China have reported problems," Spierings said. "There have been no customer complaints."
In China, parents - many of whom prefer foreign baby milk as it is seen as being of better quality than domestic products - were angry and confused.
"Domestic brands aren't very good. Now, neither are foreign brands," said Zheng Zhiqing, who was buying formula for his grandson in Shanghai. "I have no idea how I should choose."
Zizi Zhang, 36, said she feeds her 18-month-old child formula milk imported from the United States. "My impression of New Zealand formula was really good ... the cows and sheep are healthy, so you think the milk they produce is of a higher quality. I doubt people will switch to domestic milk powder. I'm even more nervous (now). All mothers will react this way. I just hope now that the U.S. won't have problems."
Nearly 90 percent of China's $1.9 billion in milk powder imports last year originated in New Zealand, with the lion's share coming from Fonterra, which manufactures milk powder for other companies to sell in China.
Vietnam ordered an immediate recall of a milk powder manufactured by Fonterra, while authorities in Thailand said they were waiting for more information from New Zealand officials before restricting Fonterra products.
In January, Fonterra said it found traces of dicyandiamde, a potentially toxic chemical, in some of its products.