Farmers across eastern Australia fear payments for second tier milk production which exceeds their main quota will be slashed in half, with Lion already understood to be paying some of its suppliers just 15 cents a litre.

With its Pura and Dairy Farmers milk brands savaged by competition from discounted supermarket house brands and its cheese production scaled back in Victoria and South Australia, Lion can't absorb the milk volumes it was asking suppliers to produce just 18 months ago.

Last year it cut tier one milk requirements from its major supplier group the Dairy Farmers Milk Co-operative by 19 per cent.

Now Lion, Australia's biggest fresh milk processor, says it will cut tier one volumes by another 9pc for 2012-13.

For the second year running an independent arbitrator has been called in to settle this financial year's farm gate milk price negotiations with Lion's big contract supplier the Dairy Farmers Milk Co-operative which represents 1200 producers on 600 farms from South Australia to North Queensland.

Price talks are meant to be finalised by June but many farmers now believe Lion is using the impasse to avoid committing to previous price arrangements during July or August.

"We've pushed our cows and feed programs all winter to keep production up but the rumours suggest Lion wants to introduce lower prices retrospectively, maybe removing August from the winter payment schedule altogether," said NSW South Coast farmer, Stephen Downes at Jamberoo.

"I think Lion's aim is to rid itself of as many smaller producers as possible by cutting tier one requirements back so much that it's just impossible for us to survive."

DFMC chairman Ian Zandstra said the farm gate milk market had gone "seriously downhill" in the past two years, catching out many younger farmers who had deliberately expanded herds or maintained strong production volumes at the processors' request.

Current pricing arrangements and production pressures were the exact opposite to an environment that encouraged profitable growth.

While Parmalat has picked up some former Lion suppliers to help fill its NSW Woolworths house brand contracts, farm gate prices have remained distressed with farmers saying much of its extra volume needs siphoned from the discounted Victorian pool or its over-supplied Queensland factories.

Australian Dairy Farmers vice president Adrian Drury said all processors were "talking prices down", using this year's depressed global values as a convenient benchmark, and drawing from the export pool if they needed cheap fresh milk supplies.

"We're seeing fresh milk prices getting closer and closer to export values, with processors and retailers ignoring the extra costs involved in producing milk 365 days a year," he said.

Mr Drury said with global prices now showing modest signs of lifting again processors and supermarkets should stop abusing their relations with farmers and acknowledge that producers required long term price incentives and security to guarantee year-round supplies.

An independent expert is expected to arbitrate on the Lion-DFMC contract price next week.

Last season's DFMC contract price from Lion averaged 51c for tier one payments in NSW, with a blended average of about 47 cents for tiers one and two.