ICAC Tackles Volatility in Star-Studded Seminar
March 23, 2011 Whenever Gotham City was threatened, all Commissioner Gordon needed to do was fire up the Bat-Signal, point it at the clouds, and rest easy in the knowledge that Batman would arrive in the nick of time to save the day.
Fortunately for the cotton industry, no one needs to summon the International Cotton Advisory Committee (ICAC) when there’s a crisis – such as extraordinary volatility in the cotton market. The ICAC Standing Committee, including Patrick Packnett the Chairman, and Vinay Kwatra, delegate of India, saw the need to educate the cotton industry about this issue. Terry Townsend, executive director, was instructed to organize a comprehensive seminar on the topic, so he rounded up a handful of fellow cotton experts to help him pull it off.
Held at, and in cooperation with, the World Bank in Washington, DC on Feb. 8, the full-day seminar tackled three primary topics:
1. what is happening with cotton prices and why,
2. the impacts of price volatility, and
3. how to deal with price volatility.
All five presentations made during the seminar are available at www.ICAC.org.
FIRST SESSION
Presenters: Members of the ICAC Secretariat; John Baffes, economist, World Bank; Jordan Lea, president, American Cotton Shippers Association and chairman, Eastern Trading Co.
According to the Secretariat, the rise in prices during the current season is driven primarily by strong demand. The Secretariat indicated that the roots of the current rise in cotton prices were established during the recession in 2008 and 2009, when inventories throughout the cotton value chain were drawn lower. As consumer demand rebounded with unanticipated vigor in 2010, participants in the cotton value chain scrambled to fill pipeline stocks, resulting in upward pressure on prices.
The Secretariat presented a paper summarizing the history of government efforts to reduce volatility in cotton and other commodity prices. The conclusions of the paper were that international commodity agreements with economic provisions have been exhaustively considered, and it has been well documented that such efforts are not constructive in the long run.
Baffes reported that factors common to all commodities – economic growth, a weak U.S. dollar and fiscal expansion, among others – were all contributing to higher commodity prices. He noted that cotton prices had not risen as much as prices of other agricultural commodities, possibly because of increased production in India and China following the adoption of biotechnology, subsidies for cotton production, and the impacts of biofuel demand on grain prices.
Lea reported that cotton prices were rising because of strong demand for cotton and because of competition between cotton and other crops for planted area. He said that all segments of the cotton value chain were benefiting from strong demand and that the rise in cotton prices was encouraging increased efficiency in the industry.
MJ Nugent & Co.’s Herman Kohlmeyer concluded the session by observing that price volatility is an inherent part of commodity markets, and that the current situation is a function of scarcity that is driving prices to record levels, and imperfect information about available supplies is contributing to volatility.
ICAC INSIGHT: “I was particularly fascinated by a few things John Baffes had to say. He pointed out that during 2010, cotton’s price rose more than that of any other commodity, but that doesn’t necessarily show the bigger picture. When you look at the price of commodities over the last few decades, cotton’s increase lags behind many of the others. Dating back to 1948, energy has actually risen more than either metals or agriculture. From the 1960s through the 1990s, cotton’s price moved in tandem with other agricultural commodities. But in the last decade, agriculture as a whole went up 80%, while cotton was only up about 40% during the period between 2000 and 2010 (figures adjusted for inflation). The point is, cotton still has a ways to go to catch up to other agricultural commodities. Considering that cotton competes with many of those other crops for land area, it’s actually important that cotton maintain these price levels for at least as long as those other commodities do.”
SECOND SESSION
Presenters: Vinay Kwatra, Minister of Commerce, Embassy of India; Simon Smalley, Minister-Counselor (Agriculture), Embassy of Australia; Dr. John Robinson, associate professor, Texas A&M University; Cass Johnson, president, National Council of Textile Organizations.
Kwatra noted that rising prices are having cascading effects on downstream activities and that volatility in prices is essentially negative. He decried useless trade practices such as moving cotton to be exported into bonded warehouses, and the sale of export quotas. He noted that there are significant imbalances in world cotton stocks and that a policy response to cotton price volatility is needed. He said that an international agreement to manage world cotton stocks should be considered and efforts to improve transparency in the market should be strengthened, and that governments should agree on minimum stock levels.
Smalley said that prices are crucial signals to market participants that should be unfettered. He called on governments to push forward with completion of the Doha Round to secure trade reform at the global level. He said that protectionist measures distort production and undermine opportunities for development. Smalley endorsed mechanisms to facilitate hedging and income smoothing, and he concluded that increased production in response to high prices is the appropriate response to strong demand and tight stocks. He also called for increased transparency in cotton statistics.
Dr. Robinson noted that increased plantings in the U.S. are an indicator of enthusiastic producer responses to the rise in cotton prices. He noted that rising input prices and land rents will eventually erode profit margins, and he said that price volatility increases the costs of marketing as demonstrated by increases in options premiums.
Johnson noted that the volatility in cotton prices this season is virtually unprecedented, and unpredicted. Accordingly, many textile mills were unprepared for the rise in raw material costs. He noted that U.S. cotton spinners are reliant on U.S. cotton production because of restrictions on imports, and therefore, the rise in U.S. prices was damaging to the interests of U.S. spinners. Johnson noted that a danger to the cotton industry is the loss of market share to competing fibers resulting from the rise in prices and the volatility of prices. He emphasized that restrictions on trade by exporting countries result in higher prices and greater volatility in prices for cotton.
During the ensuing discussion, Charlotte Hebebrand, president and CEO, International Food & Agriculture Trade Policy Council, noted that current World Trade Organization (WTO) disciplines on bans on exports are weak and that many countries have not notified the WTO of such actions. She observed that export restrictions on agricultural products are receiving increased attention in the WTO.
ICAC INSIGHT: “Part of the message delivered during the seminar is that cotton, as a commodity, is inherently unstable. As Joe O’Neil said, the cotton price situation ‘is what it is.’ True, cotton was the most volatile of all commodities in 2010, but there is a ‘most volatile commodity’ every year. Every year there is something that’s more volatile than everything else, and 2010 happened to be cotton’s year. The global financial recovery happened more quickly than anyone expected, and the demand emptied the cotton stockpiles. Now there is a concerted effort throughout the value chain, from retailers all the way to growers, to resupply the pipeline with cotton, cotton yarn, cotton fabric, finished fabric and finished products. But it will probably be the 2012/13 season before cotton prices and volatility come down.”ā©
THIRD SESSION
Presenters: Joe O’Neil, Chairman of the Cotton Committee, Intercontinental Exchange (ICE); Cass Johnson; Neal Gillen, author and commodity market regulation specialist.
O’Neil noted that “prices will go where they are going to go,” and that opportunities for future trading result in lower volatility through hedging mechanisms. He emphasized the need for more transparency in data on over-the-counter trading and better physical data to inform decision-making.
Johnson noted that uncertainty of contract fulfillment, exacerbated by changes in government policies in a major exporting country, contributed to price volatility this season. Even during the discussion, there were disagreements about the size of ending stocks and the location of stocks among countries represented at the seminar, and that improved reporting on production, consumption, trade, and stocks in standardized units would lead to improved understanding and thus lower volatility.
Participants noted that some countries maintain a national reserve of cotton or a state reserve, and that government purchases and sales for such reserves are inherently destabilizing.
O’Neil, Dr. Robinson and Gillen all agreed that market participants need to make greater use of hedging instruments. Gillen advocated government measures to facilitate hedging such as a fee-based insurance system that would not be subsidized. Participants did not endorse the use of subsidies to offset the costs of hedging. There was agreement that the facilitation of hedging, perhaps through greater education of producers and spinners on the use of hedging instruments, would be helpful. However, Marc Sadler, technical specialist with the Agricultural Risk Management Team at The World Bank, noted that there are not always stable relationships between futures prices and domestic prices in many countries, limiting the utility of hedging instruments in many cases.
Gillen emphasized that investment funds play a significant role in providing liquidity to commodity markets, particularly in contracts for distant months. He noted that the increased liquidity provided by investment funds allows producers better price discovery and the opportunity to hedge forward sales through put options. He also discussed the need to increase limits on futures positions to reflect the new price ranges and increased trading activity. He observed that existing position limits are outdated and have had no effect in limiting volatility.
Lea echoed a concern raised earlier by Johnson about the need for governments to support the principles of Good Trading Practices by supporting the enforcement of valid arbitral awards, and by ensuring that government policies are developed transparently and predictably to facilitate decision-making by market participants.
Participants agreed that improved transparency can be achieved through government efforts to collect and report timely and accurate estimates of cotton production, consumption, trade and stocks – especially improved reporting of data on stocks – and by ensuring that government policies affecting production, consumption and trade in cotton are transparent and predictable.
Sadler called for increased investment in agricultural research and extension to harness technical advances and make such advances available to small holders.
ICAC INSIGHT: “A majority of seminar participants agreed that no policy response to the current situation of high and volatile cotton prices is necessary, except that governments should be encouraged to improve the collection and reporting of statistics on cotton supply and use, especially stocks, and that governments should strive to maintain a stable policy environment. Participants were encouraged to hear that high prices will “cure” themselves by encouraging increased production. Participants also noted that the situation of scarcity can best be alleviated in the long term through government investments in agricultural productivity, particularly in developing countries with a large concentration of smallholder producers. That doesn’t mean that countries or shouldn’t act in their own self-interest. We only ask that policies affecting the cotton market be shaped transparently, with full public discussion and sufficient time to understand and prepare for any changes. Ideally, changes would be announced but not implemented until the following season so people have time to prepare.”
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