The current downtrend in cotton prices began in 1996 (Figure 1). To be sure US cotton producers enjoyed several relatively good years in 1994, '95, and '96 but the downward spiral in prices has many producers in economic trouble.

The present quagmire of prices is largely due to a combination of failed US and foreign polices-- most notably the economic demise in Southeast Asia and the constant flux and uncertainty of China's policy on use and export of their available stocks. To a certain extent US farm policy that gave farmers "Freedom to Farm" has seen farmers sometimes unresponsive to low-price signals. This year is an example.

US cotton prices have also been negatively influenced by the loss of funds for the Step 2 marketing certificate provision. Funds available under the '96 farm bill were exhausted in December '98. Since that time, US prices have been driven below the A-Index and near the AWP.

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* Paper presented at the annual meeting of the American Agricultural Economics Association, Nashville, TN, August 9, 1999. Some revisions made to reflect USDA's August forecasts.
 
 
 

I believe the level of financial assistance to agriculture last year and again this year is probably unprecedented outside a farm bill year. It seems to be an admission that Freedom to Farm, coupled with inadequacy of crop insurance to provide a safety net, has failed to some degree.

The US and global cotton market is currently in a cycle that, in time, will correct itself. But it is more painful (because other commodity prices are low as well) and because it is more demand driven than supply driven.
 

High prices early in '95 attracted a large increase in acreage but yields were low keeping production down. With exception of '95, cotton acreage has not been much different than prior to the '96 farm bill when acreage was controlled by ARP to achieve a target US stocks/use ratio. We have, however, seen shifts in acreage with growth coming in the Southeast.
 

Crop Condition. The condition of this year's crop slowly improved during the season but has deteriorated in recent weeks. The crop is still, however, well above latst year's drought-stricken pace (Figure 3). Texas, typically plagued by dry or late cool conditions in the High Plains area crop, this year fought too much rainfall. Some acreage was lost and/or replanted to other crops but the condition of the crop has improved.

Problems in Texas that normally would move the market have not due to the large US acreage, weak demand, and potential large carry-out stocks.

More recently, concerns are mounting over hot, dry conditions in the Southeast. Continued concerns and a further cut in the crop in USDA's September report would be good reasons for a price rally. This year's market has quite a built-in buffer and it is doubtful anything short of disaster will move prices to trend upward for any sustainable period of time.
 

The US Balance Sheet. The 1999 US crop is forecast at 18.3 million bales-- 4.3 million bales above last year (Table 1 and Figure 4). Mill use is expected to inch upward very little and still well below the levels of 1996 and 1997. Exports are forecast to improve to 5.7 million bales compared to 4.2 million for 1998/99.

Ending stocks are forecast to increase to 5.7 million bales- up 2.1 million bales from last season. This would be the highest level of stocks and stocks/use ratio since the 1988/89 crop year.

US mill consumption (use of raw cotton) is often overlooked as a market factor. Generally, US cotton prices move on US and world production and US exports. Often, US mill consumption is a "gimme"-- and for good reason, for much of the 80's and 90's US mills have moved to higher and higher levels each year.

However, US mill use in 1998/99 was 8% below the previous year and at the lowest level since 1992. Mill consumption is being impacted by prices for MMF's (manmade fibers), a depressed denim market, and a flood of imported cotton, fabric, and finished goods (Table 2). The US mill share of all US cotton consumption has now fallen below 60% the past 2 years.

Mill use is currently forecast by USDA to improve only slightly to 10.5 million bales for 1999/2000. Use may and should prove better than this due to much lower raw cotton imports if Step 2 funding is renewed.
 

The Importance Of Exports. Perhaps the most critical influence on US cotton price is exports. Years of good prices tend to be associated with good exports. In 1994, the US exported over 9 million bales of cotton. Prices were high but foreign demand was good and the US was the only major exporter with available supplies.

Southeast Asia (particularly China, Japan, and Korea) are major US cotton markets (Figure 5). Southeast Asia accounts for 60-75% of all US exports. The economic crisis in Southeast Asia has cut US demand and weakened prices. Mexico has become a major market for US cotton since passage of NAFTA.

Exports for the 98/99 year are estimated at 4.2 million bales compared to 7.5 million bales for 97/98. Through the first 8 months of the 98/99 marketing year, exports were running 32 percent behind last year's pace (Figure 6).

1999 crop exports are forecast to improve to 5.7 million bales. Evidence suggest that the economic crisis in Southeast Asia is easing but exports may still be slow to recover due to the strong value of the US dollar. With improvement, low prices and renewed funding for Step 2 should encourage growth in foreign demand for US cotton. If this happens, 1999 could be the turning point and the beginning of a rebound in US cotton prices and income.

Cotton's current problems put down roots in 1995. For much of the early 90's, world consumption was fairly stable in the 85 million bale range. Price direction was largely a factor of production surplus or shortfall in key countries such as the US, China, or the former Soviet states. In a 3-year period, 1995-97, production outpaced consumption and world stocks grew. Then with the '98 crop, the Asian crisis hit and demand went into a tailspin. World stocks have grown from about 30 million bales in 94/95 to 41 million bales for 98/99. Stocks are projected to rise another 1.18 million bales by the end of the '99 crop marketing year.

During this time, China has built stocks and currently accounts for about 16 million bales of the carryover. China's stocks are controlled through government policies that set the price at which this cotton can be purchased. This policy has been inconsistent. The uncertainty of Chinese policy has basically held the cotton market hostage. If market prices increase, China may sell stocks and prices would erode. A policy to allow this cotton on the market would continue to erode prices short term but would improve health of prices in the longer term.
 

A-Index and It's Impact. The A-Index is often referred to as the "world price" of cotton. It is the weekly average of the 5 best (cheapest) prices for Color 31/Staple 35 cotton delivered c.i.f. northern Europe. It is accurate reflection of supply and demand conditions and a valuable method of price discovery. The A-Index has dropped roughly 30 cents since the peak 94-96 period (Figure 8). Because the US is the world's largest cotton producer and exporter, US cotton futures prices tend to move in tandem with the A-Index and vice-versa. During the '90-98 crop years, US cotton futures have averaged 3 to 5 cents per pound above the A-Index.

The key to stronger US cotton prices and clearly the long term solution to the ails of the industry is an improvement in the A-Index.

The A-Index or "world price" is highly correlated to world supply and demand (Figure 9). As the stocks-to-use ratio falls (supply is tight relative to demand) prices increase. As the ratio increases (supplies are more comfortable relative to demand) prices decline.

In the late 70's, world supplies were tight, prices improved and encouraged production. As production increased, stocks built and prices fell. A price cycle is evident about every 3-5 years. The current cycle may run longer than most but eventually price will improve.

A world stocks-to-use ratio of 49% is forecast for the 1999/2000 crop year. Historically, this would equate with an A-Index of 50-60 cents. Currently the '99 crop A-Index is around 51 to 52 cents per pound.

The 1996 farm bill eliminated target price deficiency payments and replaced deficiency payments with Market Transition Payments (MTP's). MTP's are not linked to market forces and are scaled down over the life of the farm bill. Unlike in '91-'93, MTP's do not provide the same level of income protection. Further, slippage occurs in the MTP policy because much of the payments to the producer may be siphoned to the landowner in the form of increased rental rates. Clearly, producers do not have income safeguards as in the past.

For both the '98 and '99 crops, agricultural assistance legislation has aided farmers in this era of low prices and natural disaster (the '99 assistance package has passed the Senate but must go to conference and pass in the House).

The US average price received for cotton on the 1998 crop is estimated to be 61 cents per pound (Figure 10). The average price for the 1999 crop will very likely be less. When you compare this to the costs of production, we can see the plight of many cotton producers.

According to USDA, the average cost of production for the 3-year period 1995-97 was 68 cents per pound in the Southeast, 76 cents for the Delta (Mid-South), 98 cents for the Southern Plains (Southwest), and 83 cents for the West (Figure 11). Cost over the 5-yr period 1993-97 were lower. For each period and region, the Variable Cost of production is less than market prices but Total Economic Cost is not sustainable in the long term for some producers.
 

The '98 and '99 agricultural assistance packages will provide a cushion under producers as will renewal of Step 2 funding but producers know they cannot depend on these approaches. These are a "band-aid".

Production cost of 70-75 cents per pound plus basis means 73-80 cents on New York futures or a world situation that would support an A-Index in the low to mid-70's in order to breakeven on all costs.

I am doubtful that the answer to survival lies solely in improved technology, production practices, and higher yields. These will help but costs beyond the farm gate also need to be investigated. Some farmers are considering various means of vertical integration such as gin ownership.

Growers also need to become more aware of and use methods to improve marketing skills and manage risks.
 

At this writing there are mounting concerns over hot and dry conditions in the Southeast and Mid-South. Should this persist and with funding of Step 2, the market may yet find a reason to rally. I think any rally will run out of steam at 55-58 cents and certainly near 60 cents. The US and world supply and stocks situation is still fundamentally bearish. The only way to work off stocks is through low price and improved off -take.

USDA's September report will, in my opinion set the tone for price. To some extent, the August crop forecast of 18.3 million bales was surprisingly low enough to cause most market to give back 2-3 cents put the market appears not yet ready to commit fully.

Producers have a tough decision on marketing. With doubling of the LDP limit to $150,000, if it passes, fears over POP and loan decisions have been eased. If producers contract at levels above the loan rate, they will then be forced to forgo the loan and POP the cotton. Basically, the decision boils down to taking 2-3 extra cents above the loan rate, should it present itself by contracting vs. the harvest POP compared to the potential loan gain or equity. I think it prudent to have a floor under the cotton in the form of a contract or be willing to take the loan plus gain or equity as the worst case scenario.
 

The USDA September report, should it confirm a smaller crop, may well present the first real opportunity to lock in a price above the loan rate.

Producers may wish to think about contracting, particularly if above the loan rate, any cotton you know you can make and deliver then take the POP and buy a Call Option. This may be a relatively little risk way of holding cotton after harvest even if storing under loan would be free.
 

Table 1. World, Foreign, and U.S. Cotton Supply/Demand, million bales
 

Source: USDA. 1999/00 are August forecasts.
 

Table 2. US Cotton Mill Use, Imports, Exports, and Net Consumption
 

Source: USDA and Bureau of Census.

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