Rethinking, Rebuilding the Merchant Model
June 4, 2009 As Executive Vice President of Domestic Sales and Southeast Buying, John Dunavant is part of the third generation to serve on the management team of Dunavant Enterprises ― one of the largest privately owned cotton merchandisers in the world, based in Memphis, Tennessee.
Dunavant currently serves as ACSA 1st Vice President and will be incoming President for the 85th ACSA Annual Convention in Chicago, May 27-29.
As U.S. cotton acreage and production dropped, so has everything else associated with cotton, almost without exception. “Membership (in ACSA) five years ago was roughly 250 people,” Dunavant says. “This year we’re down to approximately 160. That’s a drastic cut.
“And production has dropped from 24 million bales in 2005 to 13 million in 2009, so dues and fees have dropped considerably, too. We’ve had to tighten our belts throughout all cotton businesses, firms and shippers. That means so have associations. We have to rethink and rebuild the model, and that’s where our focus is right now.”
Consistently China
If there is a consistency in global cotton it’s China ― the world’s number one producer and consumer of cotton. China is also the U.S.’s number one cotton customer and its currency is pegged to the U.S. dollar and is a major factor in trade between the two countries. “When the dollar is weak, we’re not going to bring as much in; when it’s strong, we’re going to bring in more,” Dunavant explains.
But even though the two currencies are theoretically in tandem, he says Chinese products are extremely competitive for the U.S. consumer.
“In a lot of cases last year, boats were taking empty containers back to China so they would move quicker,” Dunavant says. “I know that is hard to believe, but China wanted the containers there to reload and send products back over here quicker.”
With those considerations in mind, is there a point where the value of the dollar and the competitiveness of Chinese products can find equilibrium
“It’s so hard to find a balance with the volatility in the markets,” Dunavant says. “If you want to sell cotton, the price cannot simply reflect the value of the dollar because there are so many variables.
“For example, India and China ― the two largest cotton producing countries ― are sitting on huge supplies of cotton. But while those countries’ supplies were available, they sat relatively intact while the U.S. had the second largest export sales for the month of February in history. Obviously we are extremely competitive.”
Two of the main reasons U.S. cotton is competitive, Dunavant says, are “competitive prices for de-certificated stock, and the large volume of level 1 bark available for export out of West Texas.”
The trade knows those stocks in India and China are there and at some point they have to move back into the market.
But China could have a considerable drop in cotton acreage this season due to increased food versus fiber concerns. Some projections have China decreasing cotton acreage by as much as 30%, although Dunavant says that much remains to be seen.
“We’ve heard that there could be some big percentage drops and we are researching to confirm that they are heading in that direction,” he explains. “Common sense tells you they have to plant more food crops, but the average farmer in China grows two to four acres of cotton … maybe up to five acres and they’re producing over 30 million bales (per year).
Still there is an upside for U.S. exports to both China and India, Dunavant says, “We’re going to continue to see improvement in the standard of living in both countries, and those consumers are going to want to buy cotton products. I have to be friendly to cotton over the next two to three years.”
Strained Relations
In late 2002, Brazil initiated a World Trade Organization (WTO) dispute against specific provisions of the U.S. cotton program. In 2004, a dispute settlement panel ruled against the United States on several key issues in the case, and the U.S. appealed.
Last March, U.S. and Brazilian government representatives appeared before a WTO Arbitration Panel in Geneva to contest the size of countermeasures sought by Brazil due to the alleged U.S. failure to comply with a previous WTO Dispute Settlement Panel. That Arbitration Panel should deliver its findings soon. Brazil is claiming damages of $1.3 billion.
But with only 2.7 million cotton acres in 2008 and 2.1 million in 2009, why would Brazil even bother to file a grievance?
“They were optimistic that cotton acreage was going to go through the roof,” Dunavant says. “Cotton is fairly new to a lot of areas of Brazil and the growers who had started planting cotton had had success with it. So they were extremely excited about cotton going forward.”
But after the complaint was filed, there was a major event that shook the cotton industry in both the U.S. and Brazil: Soybeans hit $13 per bushel.
“Based on where cotton, soybean and corn prices are now, I can see cotton acreage decreasing around 10% in Brazil next year,” Dunavant says. “But if cotton prices can make a significant move by October 2009 then cotton acreage should maintain current levels.”
However, the U.S. is not on the opposite side of the trading table in other parts south of its borders.
“Ninety percent of our textile products are shipped to Latin America, which I find fascinating,” says Dunavant. “We have a strong bond with those countries. What we’re doing is exporting the yarn down there to be cut and sewn. Those countries are close and we have very desirable tariffs ― or non-tariffs, really ― under either NAFTA or CAFTA.”
Improved Logistics
The explosion and crash in the cotton market a little over a year ago couldn’t have been missed by anyone in the cotton industry.
Nor could the similar circumstances with crude oil. What was a good logistics plan one day was unworkable the next.
“Obviously it was very difficult with crude going over $145 (per barrel) last year,” Dunavant says. “It had a ripple effect. Freight went straight up and we had sales on the books. We had calculations of what our landing costs were and then all of a sudden crude goes through the roof. Your landing costs go through the roof, too, but you could not pass that along.
“We went through a tremendous challenge with the freight carriers increasing their charges to shippers.”
The pressure from shipper to carrier reversed itself when crude oil dropped by $90 per barrel.
“The shipping lines understand that they have to be more competitive on their rates,” says Dunavant. “There’s just not as much being shipped to China or from China. There is not a container shortage like there was last year. With empty containers and the freight going down, the freight lines have less leverage and they clearly know that. They are a lot more open to negotiation on price.
“Cheaper freight rates help make U.S. cotton more competitive on the global market.”
Quality, Sanctity
Generally the U.S. is considered a supplier of high quality cotton and the most reliable shipper in the world.
“We have the least contamination and the fiber characteristics are on the upper end,” Dunavant says. “But since we are machine-picked versus hand-picked, there is a difference in short fiber content. That’s the one liability as far as quality, but the mills love the reliability of U.S. cotton being shipped to them.”
During the market gyrations of 2008, some mills found themselves in the precarious situation of having bought cotton at a high price then having to sell textiles into a depressed market. The result was some mills defaulting on contracts with merchants.
“Sanctity of contract means a lot,” says Dunavant. “There have been tremendous challenges from last year to this year with high price contracts. There have been numerous mills put on the ICA default list and that has sent up a red flag to our customers that if they don’t fulfill the terms of the contracts, they go on the default list and shippers who are members of ICA will not sell to them.”
The International Cotton Association (ICA) is an arbitrary association that attempts to settle disputes in the international cotton trade.
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