Stephen Harmer Pens Winning Essay for ACSA International Cotton Institute
July 16, 2015 For many years, Meister Media Worldwide’s Cotton Group has conducted an essay contest for students attending the ACSA International Cotton Institute, held annually in Memphis, TN. The contest is open to all members of the Institute class who choose to prepare and submit an entry focusing on a key topic of interest to the international cotton industry.
Stephen Harmer of Jess Smith & Sons submitted the winning essay for the 2015 class.
We congratulate him on this honor and are pleased to share his essay with the global cotton community.
Strategic Actions Needed for 2015/16 in Light of Higher Than Expected Yields
By Stephen Harmer
In May 2015, the United States Department of Agriculture estimated a substantial reduction in world cotton stocks during the coming marketing year. With world production falling around 4.0 million bales less the estimated consumption, the USDA reported its first decline in world ending stocks since 2009.
In June, the following report was released, revealing virtually no change to the estimates (typical until the current crop has begun to reveal itself around July or August).
However, the unexpected weather-related reductions in acreage and production in the U.S., India and China, in conjunction with strong export sales and shipments of high quality cotton, have stimulated the possibility for a further reduction in world carryover stocks. Initial estimates of a 4.0 million bale reduction increased by 10 to 15 million bales, resulting in ending stocks of 90 to 95 million bales of low quality cotton.
These predictions, without a doubt, are the most refreshing headlines to hit the cotton world this year.
Between 2004 and 2010, normal ending stocks were hovering in the 60 million bale range. In terms of totals, 90 to 95 million bales remains a large figure. Despite the fact, if the scenario holds true, what would this reduction mean for world cotton prices and how should the trading community prepare to help move existing stocks while waiting for the late arrival of high grades?
From here on out, we are in a weather-related market, simple as that. Excessive and untimely rains across Texas, combined with worries of El Niño generating dry conditions during the crucial Indian monsoon season and the existence of widespread rainfall and damaging hail storms across China’s major producing region Xinjiang, all led to speculation of significant losses in acreage and production on the global scale.
As June came to a close, Mother Nature has left us scratching our heads once again. While acreage may be down in Texas (U.S. Total Planted Acreage is down 18.5 percent from 2014/15 season), if the remainder of the season is blessed with adequate weather, the increased availability of soil moisture will likely lead to two things. One, reduce abandonment – which was 15 percent last year – close to zero. Two, increase average yields by as much as 50 percent or more, creating a bumper crop in the U.S.’ largest cotton producing state.
In India, the southwest monsoon has progressed ahead of schedule, resisting the threat of El Niño’s dry conditions and providing nourishing rains across India throughout the month of June. In China, weather and crop developments in general are already ahead of last year. If sufficient weather conditions prevail throughout the remainder of the growing season in these regions (predominantly the major exporters, U.S. and India), it will likely keep adverse pressure on prices in the coming season and surpass harvested yield expectations.
For the sake of the discussion, weather speculation aside, if world ending stocks are in fact reduced by 10 to 15 million bales after the coming season, how then do we tame the 95 million bale gorilla?
First, let’s focus on China. Recently, the China National Reserve release of a total volume of 1.0 million tons composed of 2011 and 2012 domestic crop, as well as 2012 imports, was approved to be auctioned off. The bigger issues are a) how much reserve will they release now, before new crop arrives, and b) when will they release cotton during the 2015/16 season? The Reserve also announced there will be no additional import quota allocation.
As we’ve seen in the past, China can change its policy at a moment’s notice. Until the auctions commence, we likely will not know the details of how they will approach their stated plan of strategic reduction.
Keep in mind, China does not want their state reserves to drop below 4.0 or 5.0 million tons. Why? Due to the growing population and desire for more food than fiber, it would be extremely dangerous if stocks fell below these levels. Currently, China holds roughly 14 million tons – far too much – and needs to lower their reserves to a more sustainable figure. They will likely do so by establishing a rotation mechanism – in with the good, out with the bad.
The game to be played by China is, to first, estimate the coming production to consumption deficit. Once they are comfortable with some certain figure, they will choose to match it, or some portion of it, by rotating their stocks. A “first in, first out” method.
Let’s say the deficit is 10 million bales, and China decides to make up 75 percent of the deficit. The government would purchase 10 million fresh bales, while simultaneously selling 17.5 million stale, dated bales from the reserve. The net result would be 7.5 million bales, which were previously unavailable, brought into the global supply chain and making up 75 percent of the 10 million bale deficit. If executed carefully, this would not disrupt the global pricing model.
But will the mechanism be effective in reducing overall stocks, or is it a total shell game? Sell a little reserve, buy a little domestic, allow a little import – and do it all very, very carefully. In other words, China’s production, plus imports, is currently greater than their consumption. Any of the reserve released simply moves to ending stocks, which then turns into beginning stocks the following year, reducing very little to none of the carryover.
It appears that will be the case for at least a few years. Effectively (quickly) reducing stocks without hurting the global market is not a true possibility.
As for the rest of the trading community, an even bigger question remains – what will be the relationship between production and consumption outside of China? In recent years, the trade has grown accustomed to China’s dominant levels of consumption. “China” translated means “Center of the World,” and that is exactly who they’ve become in the cotton industry. The U.S. used to sell 50 percent of its crop to China. Now, with China’s consumption nearly cut in half from the 2013/14 season to 2014/15, the rest of the world (ROW) must adapt and tighten its production to consumption ratio.
China cannot export the reserve due to WTO regulations. Therefore, the reserve cotton will be spun in China, further decreasing their consumption of imports and increasing the availability of high grades in other parts of the world. Depending on the relationship between production and consumption less China, this may or may not put pricing pressure on better quality cotton. If ROW increases medium to high grade consumption, prices will likely stabilize and truly reflect its lack of availability in the world.
Mills in China are very frustrated due to their lack of import quota. The reserve is predominantly low quality, and many of the Chinese buyers spin higher qualities. In efforts to bypass quota limitations, taxes, and capitalize on a surplus of affordable cotton, mill owners from various countries – not limited to China – have responded by building mills in new parts of the world, particularly in countries that have seen substantial development in recent years such as Vietnam, Bangladesh, Indonesia and other free trade zones, for example.
Increased consumption outside of China will play a key role in the stabilization of prices.
In the coming year, weather-related reductions in acreage and production will not have as substantial an effect on harvest yields as speculated in May and early June. The key to normality, in terms of a sustainable relationship between world production and consumption, will spawn from an effective rotation mechanism by China and healthy consumption from developing markets.
At end of the day, China’s slow release of reserve cotton will likely cap prices for the next three to four years. As always, the downside will be supported by mill buying. If mills foresee China auctioning off substantial amounts of cotton, buying will decline. But, if the perception is that any fiber being released by China is undesirable while they can purchase high grades to rotate their stocks, then prices for better qualities should remain stable.
Cotton prices can still find support. The U.S. carryover will be far less than originally anticipated. And with the 2015/16 crop being as late as it is, mills will surely have to start consuming older stocks while waiting for new crop. As previously stated, the absolute level of stocks outside of China is important in determining prices. But perhaps more important may be the availability of the high grades.
Overall, to really move general prices for the coming year, it may take some fear. And even at 90 million bales, no one has any fear.
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