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Thursday, July 30, 2015

Supply drives lamb prices…but where are they off to?

By Angus Brown  |  Source: ABS, MLA, NLRS

Key points

  • MLA has released its latest sheep and lamb projections update, with a large increase in expected 2015 supply, and relatively small declines in 2016-17.
  • The close supply and price relationship for lamb allows us to project prices based on current demand, with values expected to remain relatively strong over the medium term.
  • Normal price seasonality will continue. However, even with a poor season, lamb price downside should be limited to 450¢/kg cwt, and upside to 620¢ assuming steady demand.

2015-07-30 Lamb Market Outlook FIG 1

2015-07-30 Lamb Market Outlook FIG 2

2015-07-30 Lamb Market Outlook FIG 3

Meat and Livestock Australia (MLA) released its sheepmeat projections update this week. Given that sheep and lamb markets are generally driven by supply, its projections, and our analysis of these projections, are largely focussed on how changes in supply will impact markets over the coming years.

The good, and possibly bad, thing about sheep and lamb markets, relative to cattle and grain markets, is that Australian supply generally has little competition in export markets.  Obviously, New Zealand produces about as much lamb as we do, and exports more. However, a large domestic market in Australia helps to underpin prices, while premiums are driven by export markets.

The lack of export competition and a large domestic market, means that supply and price have a very strong relationship in lamb and sheep markets. This means that supply forecasts can be directly linked to price forecasts without having too much interference from things like exchange rates and world supply.

In its latest projections update released on 27 July, MLA lifted 2015 lamb slaughter to levels similar to last year. Supply in 2016 and 2017 was forecast to decline because of the expected flock rebuild, before rising again.  Long-time Mecardo readers will know that lamb supply is not easy to forecast. Figure 1 shows the three 2015 slaughter forecasts for January, March and July, with MLA’s January forecast now a 2.5 million head or an 11% underestimate compared to the latest forecast.

The increase in forecast slaughter in July compared to the January forecast is a result of higher lambing percentages than expected, and possibly more ewes being joined. 

We can use MLA’s long term lamb supply forecasts and apply Mecardo’s existing demand curve analysis to see where the average Eastern States Trade Lamb Indicator (ESTLI) will sit at different supply levels (figure 2).  In 2016 and 2017, lower supply should mean higher price, with the ESTLI averaging 545-565¢/kg cwt. On the other hand, increasing supplies in 2019 would be likely to see the average ESTLI fall to 496¢/kg cwt. 

These forecasts assume that demand remains steady. There are obvious risks to this assumption, with the major one being the Australian dollar and world (mostly Chinese) economic growth.

The normal seasonal variation around the ESTLI average is 10-12%, so a forecast ESTLI of 543¢/kg cwt for 2015-16 implies a low of 478¢/kg cwt in the spring and a high of 608¢ in the winter (figure 3).

What does this mean?

The downside risk to this supply outlook is more lambs than expected coming through the market.  Given the declining flock, it is hard to imagine that lambing percentages could increase sufficiently to drive an extra 1-2 million lambs to the market. This is unlikely, even in the event of a dry spring driven by El Nino.  More likely is a supply shift lower caused by a good spring and retention of more females for breeding and Merino wethers for wool production.

There is little doubt that supply projections will be proven incorrect over the longer term. However, it appears that we are in for reasonable lamb prices over the medium to long term thanks to improving demand, which is matching the increased supply.

Mecardo information is provided to assist in your marketing decisions. It contains a range of data and views on the current market. It is not intended to constitute advice for a specific purpose. Before taking any action in relation to information contained within this report, you should seek advice from a qualified professional. The information is obtained from a variety of sources and neither Mecardo nor Ag Concepts Advisory will be held liable for any loss or damage whatsoever that may arise from the use of information or for any error or mis-statement contained in this report. 


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