FORWARD price contracts for prime lambs are based on guesswork, which is accompnaied by a great deal of risk.
On today's high values for sheepmeat is can be very costly when it all goes wrong.
Effectively, that is what has happened after meat processors last year misread supply-and-demand dynamics and offered record forward prices of up to 640c/kg for export-weight lambs delivered in the late autumn and winter.
History now tells us that the supply of lambs was more plentiful than anticipated, and saleyard prices often tracked 150c/kg below this rate.
For farmers who locked into the contracts, it meant a big win.
For processors it meant substantial costs - the forward contract deals would have cost the big processors tens of millions of dollars in extra payments for lambs (over what they could have bought them for in the auction system).
Feel sorry for the processors?
No. I said as much when Paul Leonard, livestock manager for T&R Pastoral, said this week how the contract deals had hurt the company.
There have been plenty of times in the past when the shoe was on the other foot, and farmers have locked into contract deals that cost them big money compared to what the lambs would have made in saleyards.
In a nutshell, though, that is the point that Mr Leonard was making about lamb forward contracts - there always appears to be a winner and a loser, which effectively makes the system a failure as a risk-management tool for industry.
While it would be easy to dismiss T&R's move away from forward contracts as a knee-jerk reaction to last year's result, The Weekly Times' discussion with the company didn't come across that way.
Mr Leonard made some considered comments about the issue.
The first being that the sheep and lamb industry lacks much-needed data about the true nature of the flock and where it is heading.
Mr Leonard said when trying to set forward contract prices, they were basing their decisions on information that often seemed to be wrong, which was a problem when lamb values are averaging well over $100 a head.
"What the forward contract deals proved last year is that processors don't know, and no one really knows, what is happening out there in regards to supply," he said.
"When the information you are basing decisions on is not close (to accurate), and you get it wrong, as a business, that is a problem."
The other key issue Mr Leonard raised was the different way that the market segments interrupted forward contacts.
He said for processors, the main benefit from forward contracts was securing supply and filling kill space, even though the common view was that processors were trying to outsmart the market and save money.
For farmers, forward contract deals usually have to be priced well ahead of current saleyard rates for them to be appealing and even then, the prices tend to be viewed as a guarantee that processors expect auction rates to climb.
For example, Mr Leonard said lamb prices over the past six months had been relatively stable at 480-500c/kg, but if processors offered 500c/kg for February and beyond it would be shunned by most farmers who would expect forward deals to be priced higher.
"There is no black and white rule that said forward contract deals had to be higher.
When you look at the current situation all the information suggested there has been a bigger carry-over of lambs for next year and prices could ease, but there is no way you would get farmers to lock into contacts that only matched current rates," he said.
Mr Leonard said forward contracts could also act as a self-fulfilling prophecy. He questioned if processors had played a part in the record rates of recent times by putting out contracts that buoy farmer confidence and forced values of store lambs higher, effectively driving the price of kill lambs higher.
It brings into question the claim that farmers need forward contracts as a risk-management tool for buying and finishing lambs.
In simple terms, if there are contracts out there at 640c/kg farmers feel comfortable paying $130 for store lambs. Whereas if the contracts were at 500c/kg, farmers would be more likely to cap their purchases at $100.
The argument being that farmers aren't gaining any more trading margin because of the high forward prices, as the value of store lambs rises to take up the difference.
Mr Leonard said you could argue processors have been irresponsible by putting out forward price contracts at the top of the market, which creates an extreme market.
T&R's proposal of a risk-sharing arrangement, whereby a forward price deal was linked to the physical market through a mechanism such as the Eastern States export lamb indicator has merit.
Because the current system is not working.
