2007 Cotton Market Outlook

He said they were big shoes to fill. He said it was a tough act to follow. Then he went right out and didn’t waste his efforts even trying to fill or follow.

Obviously taking the place of the iconic Billy Dunavant and his heretofore traditional presentation at the Mid-South Farm and Gin Show — held in early March in Memphis — would be difficult. Dunavant was conspicuous in his absence and the duties of presenting the Outlook for U.S. and World Cotton fell to Joe Nicosia, CEO of Memphis-based Allenberg Cotton Co.

Dunavant was always off-the-cuff. Nicosia used detailed Powerpoint slides. No fill, no follow.

Nicosia promised to make it a journey, and started with the obvious: “As we look forward, I think we can sum up it up in the main headlines — the new challenges from grains and soybeans. Right now cotton is not very dynamic, and it is putting stress on the system. You live it every day and you know what is happening. You are having to make decisions based on demand and profitability for your operation.

“About a month ago,” Nicosia continued, “I was talking to one of the larger fund traders — a person I respect greatly — and I stole this line from him: ‘It doesn’t matter what you are trading today, you are trading corn.’”

Unlike U.S. cotton, of which in excess of 70% is exported, 80% of corn demand is domestic. Ethanol production demand has increased by 600 million bushels this year and Nicosia’s trade sources say that could increase to one billion bushels in 2008. To meet the demand, 10 million more acres of corn will be required.

And that increase is coming, Nicosia said. “Price response will do that. Corn futures are over $4 per bushel and soybean prices have risen to $8 per bushel. That (will put acreage into corn and soybeans) to meet the demand. Profitability shifts toward corn and beans,” he explained. “The job of the market in the United States is going to be to curtail cotton acreage to grow more oil seeds and corn.”

In the U.S., the Mid-South and Southeast can make a fairly seamless transition. Texas’ alternatives to cotton are somewhat limited. Worldwide, Nicosia said Brazil comes closest to the U.S. in terms of making a reasonably easy transition. “But in India and Pakistan, it gets up to 120 degrees and there are not a lot of alternatives to cotton,” added. “Corn and soybeans are not going to do very well in that heat.” Additionally, China has backed away from ethanol production because of demand from its own people for food. Said Nicosia: “They are concerned about converting food into energy because the last thing they can afford to do is run short on food.”

So at the bottom of the ethanol bucket and at the top of cotton basket is this: The world in general is not reacting to high American corn prices for one reason or another and we will not see a substantial decline in world cotton acreage. Coupled with a huge American crop in 2006 of 21.7 million bales — despite severe drought on the High Plains and parts of the Southeast and Mid-South — and the increase in the world’s yields as a whole, cotton stocks draw down will not be enough to rally prices in the short term.

“On the usage side, we are struggling with exports. We lost Step 2,” Nicosia said. “Our most important customer was China, and in 2004/05, we had 50% of the (Chinese) market share. The next year — 2005/06 — we had 47%. Going into August of 2006 at the end of Step 2, we took 69% of the market share.” But by the end of December of 2006, that had dropped to 16%.

Nicosia pointed to a USDA and a Congressional Budget Office (CBO) projection that said the loss of exports would be minimal after Step 2 expired — “200,000 to 250,000 bales,” he said — and would even save money in the long run. The American Cotton Shippers Association (ASCA), in defending the Step 2 program, said the U.S. would lose 1.7 million bales of export at a cost of $800 million. Said Nicosia, “Today we know that our exports will go down by 4 million bales.” Based on a 21.7 million-bale domestic crop, 5 million bales of domestic consumption and exports of 14.5 million bales, carryover will jump from 4.7 million bales to 8.3 million bushels by the end of this marketing year. That’s what USDA says. Allenberg projects the carryover to be more like 9.4 million bales.

2007 Cotton Acreage Projection

In January, Cotton Grower’s survey projected 13.5 million acres of cotton for this season. At the National Cotton Council (NCC) Annual Meeting in February, NCC pegged acreage at 13.21. By March, Allenberg’s estimate was 12.5 million acres. That would be a drop of 2.8 million acres, or down 18%.

Charting the course of the future of American cotton requires a first look at yields. In 1995, average yield for the U.S. was less than 550 pounds per acre. That spiked to over 850 pounds in 2004, then dropped back slightly to around 825 pounds this past season.

So where will 12.5 million acres planted this year get us using the current average yield? Nicosia answered with still more questions: “Is 12.5 million acres enough? Too much? Or too little? If you take beginning stocks of 9.4 million bales, usage of 21.7 for next year — 4.7 million for domestic consumption and hopefully 17 million for export — and a normal yield of 19 million bales, where does that take us? If you look at the supply/demand balance sheet for the 2007/08 crop, this will take ending stocks down from 9.4 million bales to 6.7 million.”

Global Cotton Situation

China, India, Brazil and the U.S. all had very good crops. “We see that continuing,” Nicosia said. “But with demand continuing to increase, there will be a small draw down in world stocks.” Based on beginning stocks of 54.2 million bales, 118.6 million bales of production, 120 million bales of consumption, and allowing for “unaccounted for” bales, ending stocks for the end of the next marketing year will drop about 500,000 bales.

So if there is a silver lining and some hope for improvement in cotton prices, where is it? Despite record increases in production, demand is outstripping it, meaning that as we progress, the gap between production and demand has begun to widen.

“What you are looking at, despite everything, is a growth (in demand) chart that is going straight up, extremely quickly,” Nicosia said. “The projections are that the world is going be massively deficit in cotton.”

That could lead cotton prices to “explode” said Nicosia. “There is no way in the world we can take production … and chase this (demand) unless we can find millions of acres around the world.”

The world production spike of 119 million bales in 2003/04 has now been trumped by a projected demand of 124 million bales as we begin a new marketing year. “At first, people thought the spike in production was a quirk, but they were wrong. Production has been stable,” Nicosia said. “Demand is pulling away from production and the question is whether yields can keep up. If not, the production and demand lines will separate even more and world stocks will continue to decrease.”

The projections are that the world is going be massively deficit in cotton.

Ultimately, world cotton demand is your savior.

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