Use on sheep to get wool, use wool on spinning wheel to get ball of wool. Required in the infamous "Sheep shearer" quest.
Notes:
The sheep you are shearing may get away while you try to get its wool, resulting in not obtaining its wool. Only sheep with a big, fluffy coat of wool can be sheared, once a sheep is sheared it will lose its fluffiness until it grows back minutes later. Use on on spinning wheel to get ball of wool for stringing amulets.