2004 Cotton Outlook
Bob Goodman, Extension Economist, Alabama Cooperative Extension System
Presented at the Southeastern Regional Outlook Conference, September 24, 2003
In general, the 1990’s were not good years for cotton farmers in the Southeast, and the early
part of the 21st century has followed the trend of the previous decade. In the 90’s there were
hurricanes, drought, beet armyworms, pyrethroid-resistant tobacco budworms, the costs of boll
weevil eradication, the appearance of reniform nematodes, bronze wilt, the adoption of several
new farm bills, and many other challenges. Recently, cotton prices reached an historic, alltime low (in real dollars), declining below the equivalent of 8 cents from the early 1930’s – in
the early years of the Great Depression. In the face of, and perhaps because of these
challenges, we have seen a dramatic revolution in the way cotton is produced in the Southeast.
We have experienced about a 2 million acre increase in the size of the US crop - with much of
the increase occurring in the Southeast - and trend yield is up about 100 lbs per acre. US
cotton production peaked in 2001 with a 20 million-bale crop. Clearly, supply control was
needed to bring prices back in line with costs of production.
Supply control in the 2002 farm bill, however, was not dependant on set-asides, acreage
restrictions, allotments, or any other direct control. Supply control was designed to work
through market forces, by decoupling farm support payments from actual production. Farmers
would receive payments based on their historic acreage, but only a small portion of payments,
in times of depressed prices, would be paid on actual production. Because of this decoupling,
and because the adoption of modern production technology will impact different parts of the
cotton belt in different ways, some cotton production areas may become “marginalized.”
Marginal cotton production areas may not be able to produce as efficiently, and thus farmers in
those areas may choose not to produce cotton in times of low cotton prices, especially is an
attractive alternative is available.
It may be that much of the Southeast is such a marginal cotton production area. It can be
argued that in the past it has been. It must also be noted that alternative crops like corn and
peanuts and soybeans are a real possibility in most of the area, as are livestock operations. If
cotton prices are low, corn is an attractive alternative in many parts of Alabama, given the
average basis of about 30 cents on top of Chicago and given the newly re-discovered
recognition of the benefits of crop rotation.
The adoption of new cotton production technology may also mean that the Southeast is no
longer a “marginal production area”. The emergence of conservation tillage as predominant
over “conventional” in Alabama has been a tremendous change which has occurred in just the
past couple of years. Conservation tillage in conjunction with cover cropping has improved,
and will continue to improve, the resistance of many Alabama soils to the short summer
drouths that have plagued farmers for years. The old saying that “you’re never more than a
week away from a drought in Alabama” may someday no longer be true.
Other important production technologies include the adoption of Bt and Roundup-ready
cottons from Monsanto – soon to be joined by similar technologies from their competitors, and
the eradication of the boll weevil, which has revolutionized insect control in the area. Farmers
no longer meet to discuss whether the 5-day or 3-day spraying schedule is best. IPM and
scouting are taken for granted, and farmers perhaps are too reluctant to spray, according to
many entomologists. They refuse to “take out the beneficials” even when they probably
should.
Nevertheless, many serious production problems remain, and new ones will emerge. One
serious problem that must be addressed is the lack of financial and farm management expertise
among cotton producers. Farmers persist in managing their business as if their line of credit
for operating expenses were $30,000, not $300,000. They act as if their assets were a fraction
of their actual value. Even in making production decisions, farmers typically are too reactive,
rather than “pro-active.” How many cotton farmers do you know who could lay out, ahead of
time, the steps they would follow to successfully raise a crop of cotton? How many actually do
it?
In terms of market outlook and marketing, the US cotton industry is in the midst of a similar
transformation. The domestic spinning industry seems to by dying. There is no other word for
it. Another spinner closes it’s door every few months, and few are left. However, cotton is
still in demand on the world market. Production is trending upward, as is consumption. Trade
is also increasing, although at a slower rate. Since consumption is relatively steady, and
significant production variation occurs at the whim of nature, the amount of cotton left over at
the end of the marketing year may vary considerably. World ending stocks fluctuate
significantly from year to year and stocks may rise or fall for several years, with as much as a
10 million bale difference between the high and low. However, there is no corresponding
increase in trade in the years of high stocks. (Of course, over time consumption must equal
production.)
Year-end cotton stocks are generally held by the country that produced them, of course.
Further, there is a significant difference between the cotton market and the market for other
agricultural commodities like grains. In the case of corn, for example, if an oversupply occurs
farmers may expand livestock operations to take advantage of the supply of cheap feed. In the
cotton market, there does not seem to be as immediate a response in consumption to
overproduction. Stocks tend to accumulate and weigh on the market for years. We have been
worried that the low prices of the past two years would persist for many years to come. It
seems those worries were unfounded.
As previously mentioned, US cotton production has trended upward in the last 40 years or so.
We have produced nearly 20 million bales a couple of times in the past, and have always relied
on exporting what cotton could not be marketed in the US. However, since the loss of many
domestic spinners, there has been increased reliance on exports in the US market. Before
1999, about 10 million bales were used in the domestic market, and 6 were exported. Since
1998, US exports have more than doubled. During the same period, there has been a decrease
in domestic consumption of over 3 million bales.
Whether spun or exported, cotton must be moved to avoid the accumulation of stocks. The
inverse relationship between stocks and price holds for the US as well as world market.
Although, in the new “world” market it is conceivable that US stocks could fall while world
stocks rose, in turn causing US price to fall, such is not the usual case, at least in part due to the
general desirability of US growths. Between 2000 and 2002, US stocks nearly doubled from
an already large 4 million bales to nearly 8. Further, at that time production was feared large,
and the prospect of an 8+ million-bale carryover was a major factor in a decline in farm prices
from near 60 cents to near 30 cents. In 2000 and 2001 the stocks-to-use ratio was near 40%,
and a further decline to 50% was feared in the market. Luckily this decline did not occur.
The 2003 crop will be the second year in a row where ending stocks, world and US, have
declined. In the past two years, world demand has exceeded production by about 12 million
bales. World ending stocks for the 03/04 crop are forecast to be in the very reasonable 34
million bale range. US Production has not fallen, discounting the exceptional 2001 crop,
demand has improved. While production has averaged 18 million bales over the past 3 years
(including the 19.6 million bale 2001 upland crop), consumption – including domestic use and
exports – has averaged 18.5. This represents about 3 million bales more consumption than in
previous years. It would not have happened without the shift from a domestic-driven market to
an export-driven market. If we had not found a way to sell cotton overseas, the US would be
out of the cotton business. The survivors in the cotton industry are to be congratulated for
successfully completing this historic shift in the market. A few years ago we didn’t even think
it was physically possible to ship 10 million bales of cotton overseas, and now we will have to
ship 12 every year.
A regression of farm price on the forecast 20% stocks to use ratio suggests a farm price for
2003-04 of 62 cents. I believe this is realistic. Outlook for the 2004/05 crop at this price must
include a marginal increase in world production, but US production may not significantly
increase. A further recovering world economy coupled with a relatively weak US dollar could
make domestic supplies a little tighter, and push domestic prices a little higher. Look for an 18
million-bale crop, with domestic use at 7 million and exports at 12.5.
Finally, as prices rise and outlook improves, farmers are interested in “hedging” the countercyclical payment. A look at the price chart shows that the market is rapidly approaching the
magic point where the CCP will be reduced. Is it possible to hedge the CCP? Well, anyone
can buy a call, but the question is how much good will it do you, and when do you place your
hedge and when do you lift it? A graph of farm price and spot price show pretty good
agreement, naturally. However, the CCP is calculated on season-average farm price. A chart
of season average price and spot price show much less agreement. In years where a significant
move upward in price is experienced (1993, 1994, 1999) a call option for the following
December contract, purchased at the start of the market year, may return significant value.
However, in most years much of the premium for a call on such a distant contract may be time
value, which as it erodes would erase most of the hedge. As an example, a farmer might
purchase a December 2004 call option at 72 cents for about 1.5 cent premium. If cotton is
trading at 75 cents next fall and the CCP is lost, the value of that option may approach 3 cents.
Options closer to the money may retain more value, but will also cost much more up front.
This farmer will have hedged 1.5 cents worth of CCP, not counting interest paid. On the other
hand, shorter duration hedges may be more efficient, and rollover strategies might also work.
In general, nobody is going to want to buy a call when futures are well below 65 cents, and
when they reach 65 cents it may be too late to place an effective hedge using options.