Fixed price contracts not the answer

When farmers want certainty of income and livestock prices aren’t very good, thoughts often turn to fixed price contracts. But they have never really taken off because I suspect neither farmers nor meat exporters are very keen on them, although Silver Fern Farms continues to offer its Backbone contracts with reasonable uptake.

 

For farmers they provide certainty, but often it’s only the certainty they could have done better by selling on the spot market which they only find out when it’s too late to change. Equally the meat company has to take a punt on what the market price will be when the livestock is available or able to be matched to contracts it must fill. There are also times when the farmer commits to supplying to specifications which seasonal conditions make it difficult to achieve.

 

The big challenge for the company is to be able to calculate several months in advance the value of all parts of the carcase which will inevitably be sold into many different markets. The easiest time to do the calculation is when there is a specific supply contract for a defined and limited period, like the UK Christmas lamb market. Nevertheless their supply contract is only for certain high value cuts and as a result the processor has to estimate what the rest of the animal will be worth.

 

However early spring is the hardest time for the farmer to get the lambs up to the required weight range in time to meet the shipping schedules which normally finish around the first week of November. The pre Christmas contracts always offer the best prices, so provided the season is normal, farmers who know the productive capability of their flock and farming country shouldn’t have too much problem complying with the terms of the contract.

 

There are also winter supply contracts available which require a change in farming practices and involve additional costs. But there is not really any call for a contract through the peak of the season when supply is plentiful and it’s often when a meat company aims to make some money.

 

Therefore amid all the mud slinging and hand wringing about the state of the red meat sector, it is not easy to see a solution that will work either every year or even for a whole season. Volatility is inevitable in a soft commodity market, especially when 90% of the product is sold overseas to a range of different markets.

 

The exchange rate, whatever some politicians would like to claim, cannot be influenced by action by the Reserve Bank Governor. New Zealand is so small that our dollar is like a kayak in a hurricane on the ocean. It is viewed as a safe haven because our economy is performing better than many of our trading partners in spite of relatively high debt levels and a trade deficit. That could always change.

 

Red meat prices would be a lot better in NZ dollar terms if the world didn’t rate our economy and our currency was worth what it has been historically. But the price of a lower exchange rate would be correspondingly higher prices of imported goods, including oil, electronics, cars and a whole range of capital items.

 

The big differences between meat and dairy are world demand for dairy products which appeal to the mass market, increasingly so in Asia, and the comparatively simple range of dairy products. In contrast red meat has an enormously complex product range which must be disaggregated in the processing plant before they can be sold onto one or other of the global markets available for a particular product type.

 

I am not trying to suggest that the meat industry can’t do better for farmers, but it’s not easy to provide an answer to farmer expectations at all times, especially without certainty of supply. I am still certain that the best sort of relationship between farmer and meat company is one built on mutual trust.

 

This requires commitment from both parties: the farmer commits to supply a proportion of the livestock to one company to a delivery schedule and specification in return for some guarantees; the company promises to offer a price, whether contract or spot, which is at least as good as any other price offered to any other supplier for stock of similar specification and delivery timing. In case of capacity constraints, as in a drought year, the farmer who has committed to a supply programme gets precedence over any other category of suppliers.

 

The Meat Industry Excellence Group should focus on getting buy-in to just two of the items on its wishlist: a change in farmer supply culture from current model of chasing the extra money and transparent and equal treatment by the meat companies. Fixing those two would do wonders for increasing the level of trust between the parties, infinitely more than forming a company with 80% of industry throughput or trying to achieve farmer ownership of the whole industry.

 

I believe MIE can make some real progress if it acts as a mediator between processors and exporters on the one hand and farmers on the other. If it tries to achieve the impossible, the parties will retreat into their respective corners and a good opportunity will have been lost, possibly for good.

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2 Responses to “Fixed price contracts not the answer”

  1. Horace the Grump Says:

    Hmmmm… THe development of futures markets based around farmers and buyers wants to have better price certainty… given the toubles of the red meat sector in NZ why hasn’t a futures market developed or been encouraged to develop in NZ to help each side manage their risks and smooth price cycles?

  2. Hilda Says:

    Could I find more information somewhere?

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