Cotton market mirrors 2001 situation

The 2004 cotton marketing year has many similarities to 2001, and that's not good news for producers.

“In many respects, the market shaping up for 2004 mirrors some of the same concerns we had in 2001,” says Don Shurley, University of Georgia Extension economist. “There's a lot of concern that we may be headed in that same direction this year, but I don't think that's necessarily true. There are differences between the situation this year and what we saw in 2001.”

For the 2001 crop marketing year, the U.S. average price received by farmers for cotton was 32 cents per pound — the lowest average price in almost 30 years, says Shurley. “This situation was brought about by large U.S. and foreign crops, a continued decline in the U.S. textile mill industry causing increased reliance on exports, a strong U.S. dollar which required that prices be driven even further down to trade-competitive levels, and near-record level stocks,” he says.

“As we consider the outlook for marketing the 2004 crop and look ahead to 2005, there are pending signs that this could be another year in which prices again struggle to reach levels that will be profitable for most cotton producers,” says Shurley. “Producers again will depend on LDP's or POP's, Marketing Loan Gains or Option to Purchase equity payments to provide any profit margin.”

While there are some supply and demand factors that appear to mirror 2001 and thus strike fear in growers, prices have not yet shown any tendency to drop to 2001 levels, he adds. “The large U.S. and world crops are not completely out of the field and in the warehouse yet. All eyes will certainly be focused on the Chinese crop and any internal issues that might affect supply and demand,” he says.

It also is worth noting, says Shurley, how quickly economic forces can change. “Prices for the 2003 crop are expected to average more than 60 cents per pound. While this is unlikely for the 2004 crop, looking ahead to 2005 reminds us that anything can happen. Prices for the 2005 crop very likely will be higher than this season,” contends the economist.

U.S. farmers planted 13.76 million acres of cotton in 2004 — up just 2 percent from 2003. The 2004 crop, however, is expected to be a record 21.5 million bales, says Shurley. This is due to a record yield of 782 pounds per acre and a low acreage abandonment rate of just 3.9 percent, which could be the lowest since 1997, he adds.

“In fact, high abandonment, especially in Texas, and/or disappointing yields kept the United States from making 20-plus million bale crops in many other recent years. U.S. farmers planted enough cotton acres to have produced a much larger crop than what actually was realized. Prices would have been even lower than they were if not for weather-induced supply management,” he says.

Without question, the major fundamental market shift within the U.S. cotton industry in recent years has been the decline of the textile mill industry, says Shurley. U.S. textile mills now account for only one-third of total purchases of U.S. cotton compared to 60 percent in 1997. The decline of the U.S. mill industry has been due to lower costs in foreign mills and the rapid influx of foreign manufactured cotton products into the United States, he says.

“While mill use has declined, total off-take (mill use plus exports) actually has been increasing and topped 20 million bales in 2003. For 2004, however, total off-take is forecast to decline by 1.85 million bales — the first drop in demand for U.S. cotton since 2000. For 2004, U.S. mill use is forecast at 6.1 million bales compared to 6.5 million bales last year and exports are expected to be 12.3 million bales compared to 13.8 last year.”

The major markets for U.S. cotton are China, Mexico, Turkey, Indonesia, Korea Republic, Thailand, Canada and Taiwan, says Shurley. These countries accounted for 80 percent of U.S. export sales of the 2003 crop.

China has become a major buyer of U.S. cotton as its mill industry has expanded tremendously, he continues. “When China experiences a short crop and needs imports, the United States typically has supplied 40 to 60 percent of its need. Mexico has become the No. 2 buyer of U.S. cotton since the passage of NAFTA.”

In an export-driven U.S. market, says Shurley, the price for cotton received by the U.S. producer will depend heavily on China's production and demand for imports, cotton production in countries that are our major trade competitors in the world market, currency exchange rates and trade policies.

“As U.S. exports have increased, its market share also has increased. From 1995 to 2000, U.S. exports averaged about 24 percent of total world exports. For the 2004 crop, market share is expected to decline from 42 percent to 39 percent — a relatively minor reduction, particularly in light of the expected large increase in foreign production and world stocks. This could signal that USDA's export projection is high or that low prices likely will be needed to move that much cotton.”

Foreign cotton production currently is forecast by USDA at 88.12 million bales — up 11.9 million bales or 15.6 percent from 2003. The total world crop stands at an estimated 109.67 million bales. If realized, this too would be a record crop.

“Most of the increase in foreign production is accounted for by one country — China. China increased acreage by 1.46 million acres in 2004 and is expecting a crop of 29.5 million bales — 7.2 million bales above 2003. This represents 70 percent of the increase in foreign production for 2004. Larger crops also are expected in Pakistan, India, Central Asia and Australia.”

On the demand side, world consumption of cotton is expected to top 101 million bales for the 2004 crop season, notes Shurley. World demand is expected to be 101.4 million bales or 2.5 percent above 2003. This would be a record level of use. Cotton demand has increased each year since 1998.

“While the U.S. textile industry has declined, world consumption of cotton actually has increased,” he says. “Since 1997, U.S. mill consumption of cotton has declined by more than 5 million bales while foreign mill consumption has increased by 19 million bales. What this means is that roughly 5 million bales of what once was U.S. mill business has been lost to overseas mills plus another 14 million bales in demand growth.”

While the demand side has been trending upward and is expected to reach a record-level in 2004-05, price will be determined by supply, says Shurley. The 2004 world crop will be the first crop since 2001 and only the second crop since 1997 to exceed demand. Thus, stocks are expected to rise by 8.5 million bales and to the highest level since 2001. “However, stocks still will be less than in 2001, and the stocks-to-use ratio will be 41 percent compared to 50 percent in 2001. So, while this likely will keep a lid on prices for the 2004 crop, there is hope that prices will not reach the very low levels experienced with the 2001 crop.”

Prices for the 2004 crop are currently about 45 cents per pound, he says. This places farmer cash prices at about 42 cents plus or minus quality premiums and discounts. “Hurricanes Frances, Ivan and Jeanne trimmed the Southeastern cotton crop. Barring any reduction in size of the U.S. crop or other problems, prices may not be able to hold at this level. The burden of large U.S. and world crops may be too much.”

On the downside, says Shurley, prices could test the 40-cent level on futures, which could translate into cash prices in the mid to upper 30s for farmers. “On the upside, if the U.S. crop comes in shorter than expected or problems develop in foreign crops, futures prices easily could challenge the 50-cent area or higher.”

Based on what is known of supply and demand at the present time, he says, the likely range of pricing opportunities for marketing the 2004 crop appears to be 40 to 50 cents on futures. This would translate into mostly 37 to 47 cents per pound cash price plus or minus fiber quality premiums and discounts, he adds.

“From a risk management standpoint, perhaps the best approach for a producer to take on the 2004 crop would be to a) take the LDP, sell cash cotton, and be done or b) place the cotton in government loan. Holding cotton unprotected after harvest is risky. At this point, using Options (either Puts or Calls) also appears risky because the likely future direction of the market is unknown. The “path of least resistance” appears stable to down given what we know right now. Storing the cotton in loan or using Options would still be less risky than holding cotton unprotected.

For any cotton already contracted and priced for delivery, total money received on that cotton will increase as prices decline prior to harvest, delivery and application for the LDP because the LDP will increase.”

Holding cotton in storage has become increasingly risky and often unprofitable, says Shurley. In the past four crop marketing seasons, prices have declined during the storage period in two of four years and have risen enough to reward storage only one year out of the four.

“Based on world stocks, supply/demand, previous price history, and recent price behavior, low prices — 40 to 44 cents on futures — this fall should be sufficient to generate buying interest and pull prices back up. How low prices will go, and the prospects for trending up, will depend on the level and pace of U.S. exports.”

Looking ahead to 2005, he says, it would seem unlikely that the United States and world could repeat with record crops. This year's lower prices could discourage acreage both U.S. and foreign. “This, combined with more average yields, would reduce production. Large carry-in stocks from 2004, however, would keep prices in check somewhat but 2005 crop prices should improve above 2004 crop levels.”

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