Forward supply contracts for the WA sheep meat sector

Marketing arrangements in other commodities

Seven agriculture sub-sectors were examined and analysed to provide case study examples of forward supply arrangements and contracts, including discussions held with relevant case study sector representatives. The following sub-sectors were examined:

• United States red meat
• New Zealand sheep
• Australian beef cattle, pigs, dairy, grains (wheat), and horticulture (vegetables).

Findings illustrated the overarching impact of contracts common in the sectors was demonstrated as:

• price stability and certainty
• producers delivering production that the market and consumer demands
• guarantee for offtake and processing
• wholesale and middleman bypass
• the ability to generate finance and investment along the supply chain particularly when contracts are with strong credit rated counter parties.

A comparison of marketing arrangements commonly used for different commodities is presented in Table 2.

Notes: (a) Markets including Over the Counter (OTC) and Exchange

Source: various

Key case study summary and learnings

The key learnings and experiences of what has worked well as discovered through this examination essentially highlight the elements that will contribute to an effective and sustainable forward contracting system in agricultural commodities relevant and applicable to the WA sheep industry.

Supply chain integration

• Longer dated forward contracts of more than three months need to have retail, wholesale, and/ or importer pricing support otherwise processors and live exporters bear the greatest price risk and potential for loss.
• Direct producer to processor-market relationships underpinned by domestic retail customers are common and these facilitate longer term forward contracts with the end producer.
• Forward contracts in the Australian agricultural sector predominantly require domestic retail supermarket and/ or food service companies as end customers to underpin the forward contract. Export customers are much less likely to forward contract due to additional supply chain risks and complexities along the supply chain (i.e. currency fluctuations, international logistics, competition from other global products and geographic distance impeding close regular relationship maintenance).
• No agents or middlemen involved in direct forward contracts.

Production and quality requirements

• Producers must meet high quality specification standards.
• Producers are required to have strong farm quality assurance and food safety standards.

Formula pricing and payment

• Contracts that reward producer commitment and contain risk/ reward clauses so both parties are protected from spot market moves at time of physical supply are beneficial and typically based on formula pricing. However, the reference indicators for the formula need to be reliable, transparent and accurately reflect the class of livestock being sold in the physical transaction.
• The use of retrospective price step-down clauses as used in the Australian dairy industry example should be avoided.
• Consistent and unambiguous classification and description of product is critical for price transparency and formula based pricing. Inconsistent descriptions may result in comparing ‘apples with oranges’.
• Long term contracts beyond 12 months are possible with no operating local derivatives market based on minimum and formula based pricing mechanisms.
• The use of derivative products where available and practical to manage price risk and volatility should be considered.
• Adopt a conservative approach to forward prices through minimum and formula based pricing.
• Do not include retrospective price step-downs or price repayment clauses in forward contracts.
• Payment structures based on minimum and formula basis to provide the option to the producer for the highest possible price to be paid at time of physical supply.

Behaviour, resolution and information

• Strong peak industry leadership that supports and facilitates forward contracts is beneficial to all.
• Producers collaborating to partner with and supply to a major domestic retailer can create a forward contract system as price risk is more balanced towards the end of the supply chain that has the greatest capacity to manage and influence price.
• Industry Code of Practice for forward contractual arrangements can be beneficial for all parties.
• Independent and objective dispute resolution services for forward contracts can be beneficial for all parties.
• Focus on improving relationships and information exchange between farmers, processors and live exporters.
• Focus on domestic physical value chain alignment and high value export destinations for forward contracts.

Targeted requirements and outcomes

• Longer term forward price provides certainty for financial, production and supply management.
• Contracts need to be simple, transparent, fair and easily understood by both parties.
• Collective bargaining by producers can be positive, but success is not guaranteed.