When Dr. Jody Campiche stood before delegates to the National Cotton Council’s 2020 annual meeting in mid-February to share her economic analysis, her outlook leaned just a bit to the bearish side. That’s not too surprising.
At that time, Campiche, the NCC’s Executive Vice President of Economics and Policy Analysis, projected U.S. planted cotton intentions for 2020 at 13 million acres – down 5.5% from 2019 primarily due to slightly weaker cotton prices relative to corn and soybeans. She provided cautious optimism about an improvement in U.S. cotton economics from the Phase 1 trade agreement with China. She noted the potential for strong U.S. export sales to continue, with increased opportunities to China and other markets – even in the face of increasing export competition from Brazil.
Yet, she pointed out that cotton’s balance sheet, stable stocks outside of China, Brazilian competition, a recovery in Australian production, and low manmade fiber prices will have a bearish influence on cotton prices for 2020 – with possible price support coming from two uncertainties: a quick containment of the coronavirus and successful implementation of the Phase 1 agreement.
That was then. This is now. Since Campiche’s presentation, several evolving factors threaten to dampen the cotton market outlook for 2020 even further.
Demand, Consumption and Competition
During his annual outlook report at the Mid-South Farm and Gin Show in late February, Joe Nicosia of Louis Dreyfus Commodities asked a simple question – is the future looking better? The answer is complicated.
“As tensions grew during the trade war, Chinese demand definitely took a downturn,” he said. “Their consumption had four consecutive years of increases. When the trade war came, their cotton consumption dropped by almost 4 million bales. And with polyester costs of in the 41-43 cent range in China, they’re going to try to make their profits with cheaper fiber.”
He noted that, for a while, cotton looked like it was going to hold its own in market share – maybe even see some growth. And although the current U.S. employment and business activity numbers remain encouraging, that’s not the case in China. In essence, China bore the economic brunt of their trade war.
Yet, as Nicosia pointed out, not much has changed in the past several years in terms of world ending stocks, production and consumption. They’ve remained “amazingly stable.” But Chinese stocks continue to shrink, almost back to 2011-2012 levels. That could be good news for the U.S., but the battle for world market share with Brazil, Australia and West Africa is intense.
“In the past four years, Brazil’s world market share has grown from 7% to 20%,” said Nicosia, “and they’re not standing still. They’re coming for more. But U.S. exports are healthy, with big numbers now shipping nearly every week. We have outstanding commitments of 2 million bales for China, and that’s good. But we’ve shipped only 760,000 bales due to rollovers of orders during the trade war. It could be difficult to confirm some of those sales now.”
What About Phase 1 and Coronavirus?
According to the terms of the trade agreement, China is supposed to buy $80 million of U.S. agricultural products over the next two years. The question is, are they ready, willing and able to do so?
“When you look at the products that are listed as agricultural goods, they can absolutely buy $80 million worth,” agreed Nicosia. “But they haven’t told us where and how cotton fits in. Traditionally, about 60% of what China buys comes from bulk commodities, and, over the last few years, cotton’s share of that 60% has been between 4% and 18%. Based on those percentages, we can come up with just under 10 million bales of potential cotton imports into China over the next two years.
“I don’t know if it’s right. But it’s good insight into the potential with China.”
The coronavirus is trickier, because it is so closely tied to consumption – and no one knows how long it’s going to last. But there is precedent for what may happen when it’s no longer a factor.
“Since 1997, there have been three occasions when consumption dropped two years in a row,” explained Nicosia. “In each of those occasions, consumption spiked back up in the following season. I think that once the coronavirus is no longer a factor, consumers are going to come back with a vengeance.”
Impact on Trade?
Looking ahead, Nicosia believes that 2021 is going to be the “Year of Exports,” despite the trade war’s impact with China.
“For many years, the U.S. has shipped 7.5-9.5 million bales to the world outside of China,” he said. “But about 5-6 years ago, there was a definite dynamic change in the world in how cotton is used, where it’s used, and what type of cotton is being used. For the past four years, we’ve been shipping between 12-14 million bales to everyone else but China. We’ve been able to move our non-China market share to just over 40%. And that’s 40% of an ever-increasing customer base, because the rest of the world has been gaining in consumption. That’s the good news.”
Short Term Appears Bleak…For Now
Nicosia prefaced his comments about 2020 with this statement: “I’m in the cotton business. I love the cotton business. But I have to tell you what I think.”
Long story short, 2020 is not shaping up to be a good year for cotton. And Nicosia’s not the only market analyst saying so. Several university economists, including Dr. O.A. Cleveland of Mississippi State and Dr. John Robinson of Texas A&M, have also tempered their expectations for the year.
Over the past year, cotton prices have dropped 14% – further on a percentage basis than other commodities like corn and soybeans. Going into 2020, the commodity playing field is anything but level. Based on net returns per planted acre for 2020-21, cotton sits last in projected returns above variable costs.
“Is planting cotton your best choice this year,” asked Nicosia. “Realistically, the answer is probably not. How can you make money at 62 cents? We don’t know if prices are going to go up soon. So if you’re waiting for prices to go up, buy a call at 4 cents in the futures market and let them do the work to make you money. You can buy your production for $20 a bale and profit if prices go up. And, you can shift to a crop like soybeans and make almost 15% more in return.
“The good news is that the PLC and ARC payments are decoupled,” he pointed out. “You’re going to get those anyway.”
Longer term, Nicosia believes the cotton market is set up nicely for a strong price rebound.
“When the coronavirus subsides, the cotton trade is poised to quickly expand,” he said. “I think China is going to make substantial purchases, which will push prices up. But we’re going to have to be ready to fight with Brazil.”