The U.S. cotton industry has experienced historically volatile and economically brutal trading in the past 18 months, and the roller coaster ride may not be over.
The highest cotton prices in history followed by equally squat low-valued lint forced a frightening near collapse of the cotton futures market. That could happen again, according to a seasoned cotton trader.
Acreage continues to fluctuate, merchants and others were told at the recent Western Cotton Shippers Association 89th annual convention in Monterey, Calif.
This unprecedented period of change plunged California cotton acreage to less than 200,000 in 2009. By comparison, California farmers planted 1.6 million acres of cotton in 1979 and for 25 consecutive years until 1997, acreage never dropped below 1 million acres, according to Earl Williams, president of the California Cotton Ginners and Growers Association.
Fortunately, says Williams, it rebounded to a little more than 300,000 acres in 2010 and went up another 150,000 acres last year to more than 450,000 acres. USDA says it will drop back to 400,000 this year. California cotton ginners say otherwise. This season it will be “something less than 350,000 acres” with a 60-40 split between Pima and Upland cottons, according to a survey Williams conducted of association gin members. Cotton prices compared to income from competing crops and a shortage of relatively inexpensive irrigation water this season are two key reasons for the drop.
“We thought last September that the 2012 acreage would not change much from 2011, but the ups and downs in the industry (since then) has taken its toll in a lot of ways,” Williams told WCSA members.
(For more, see: Bears back in control of global cotton market)
The acreage decline has also had a dramatic impact on the industry infrastructure with just 37 gins operating in the state last year. Fortunately, cottonseed prices have remained high, despite the economic malaise in the dairy industry, the primary market for cottonseed. Cottonseed sales, says Williams, have kept some gins open.
This anticipated drop to 350,000 acres or less this year brings the industry close to what Williams believes is the minimum needed to maintain industry viability, 300,000 acres.
Fortunately, advances in growing the crop have helped stabilize the industry. For example, 20 percent of the San Joaquin Valley’s cotton acreage is now drip irrigated, and the Roundup Ready technology has “worked well. We are also well positioned for exports,” Williams adds.
“There are some things about the cotton industry that should allow cotton to remain a viable rotation crop in California,” he says.
Cotton, like other crops in the state, is not without challenges. Fusarium Race 4 is one. The industry is aggressively pursuing solutions to the soil-borne disease that has no cure and can render a field useless for cotton production.
Looming groundwater regs
Looming on the horizon are the challenges of groundwater monitoring and extraction likely to lead to regulations and a regulatory process governing nitrogen use, adds Williams.
The recently released University of California, Davis study about groundwater contamination has raised the ire of many. However, Williams says it is flawed.
If 50 percent of the nitrogen used on crops goes into the groundwater as the study claims, Williams says that means crops are getting no benefit from nitrogen applied. That is not true, he proclaims.
The study, he adds, ignores the advancements made in nitrogen application using drip irrigation.
The marketing side of the industry has not escaped the turmoil of the past 18 months, but as WCSA president Matt Laughlin pointed out, the Western cotton industry has been spared much of the misery that descended on the rest of the U.S. industry.
Laughlin, general manager of the J.G. Boswell cotton marketing department, said a survey of American Cotton Shippers Association (ACSA) members revealed that “up to 3 million bales of U.S. cotton at an estimated value as high as $1 billion is either in default or at risk. That is a staggering number.”
Laughlin added that even though Far West merchants “haven’t been entirely immune to these problems… fortunately, such cases have been few and far between out here.”
Laughlin attributes this partly to the fact that the Far West cotton industry has long been primarily a cotton exporter with a long history of moving cotton in a streamlined warehousing and logistics system to nearby ports.
“Whatever the reason, we have not been subjected to the severity of these problems that have plagued much our industry for more than a year,” he says, “the consistently high quality cotton we produce in the Far West may have helped us avoid the level of overseas mill defaults that have hit shippers in other parts of the U.S.”
The WCSA president said the association must remain “proactive. Just as we expect our customers to perform on their contractual obligations, we have to hold ourselves and our grower-suppliers accountable, as well.” Laughlin said WCSA has hammered home “sanctity of contract” for years.
“That means we have to deliver on time what we promise to deliver,” he says. It also means to avoid business with mills on international default lists. “Once there is a contract in place, we all have responsibilities to meet; growers, ginners, shippers, warehouses and the transportation sector.”
Selling the cotton is just one step. Building relationships through the associations and marketing arms is part of the overall marketing process, said Laughlin.
The conference’s keynote represents a company that is involved in each step in the supply chain. The Esquel Group is a major importer of both Pima and Upland cotton in making more than 100 million cotton shirts annually, according to John Chen, vice chairman and CEO of Esquel, based in Hong Kong.
Esquel uses about 80,000 bales of Pima cotton and 220,000 bales of upland cotton annually.
“We want to partner with you because you are the most important Pima cotton growing region,” he says.
Esquel generated income of $1.2 billion last year and is projected to reach sales of $1.35 billion this year, according to Chen. It has been the No. 1 men’s woven shirt exporter for eight years.
These shirts are made mostly in China, which has long been an important U.S. cotton buyer to make export goods. However, China has rapidly advanced economically to become a major consumer of cotton products.
Chen acknowledges concerns about a slowdown in China’s economy that started after the 2008 Olympics. However, Chen said it lasted only two quarters. Right now, China is logging a solid 9 percent growth rate, notes Chen.
Consumer spending remains strong in China, he adds,
The Chinese economy is more stable. Chen describes it as “steady as she goes. This bodes well for our business.”
Collapse of 2008
Overall, it was an optimistic tone from all speakers, except one.
Cotton trader Gerald Marshall, owner of The Yiyang Company, which manages private trading accounts in cotton, told merchants and others at WCSA that the collapse in the cotton futures market of March 2008 can happen again.
Prior to forming his company in 2007, Marshall worked with Cargill Cotton, where he was global trading manager. He is past president of ACSA.
Wall Street’s investment in commodities is a “match made in hell. It has turned the price discovery futures into a haven for major investors seeking to more safely park assets.”
The problem with this is that “cotton futures contracts are designed to be self-liquidating, not to handle investment flows.”
The California Public Employees’ Retirement System (CALPERS) is now a bigger commodity trader than Cargill, according to Marshall. CALPERS has more than $40 billion in assets it manages for the more than 1.6 million California public employees, retirees, and their families.
This commodity as assets broke the Cotton Futures market in March 2008 and created a bloodbath among traditional cotton traders who could not meet margin calls created by the speculative institutional investors.
So far, government regulators have done nothing to prevent another market collapse. It would have, had the March 2008 debacle hit other commodities as hard as it did cotton.
Marshall said March 2008 will repeat itself if trading limits are not set and futures trading is made more expensive for these traders by raising margins.
“We have got to make commodities unattractive” to these large investors. “It is up to us to force a change in the system,” says Marshall.