Shurley on Cotton: Looking Back and Looking Ahead

By Dr. Don Shurley

It’s not news that 2014 turned out to be a disappointing year for many growers. Prices have declined roughly 25 percent since last spring, and, for some growers, yields turned out to be less than expected due to late season drought or other problems.

Many producers tell me they wish they had sold (fixed) more of the crop when it was at 80 cents or better. This is always the case after prices take a big dip like this, so there’s no reason to beat yourself up about it. But it does – and should – make us all wonder what we can do about it.

I’m not sure what the answer is. This has always been a challenge. The reasons producers don’t do more forward (fixed) pricing include (1) uncertainty in production, and (2) thinking prices may go even higher. There are tools available (Options, minimum price contracts, etc.) to help remedy these problems, but these tools also have their disadvantages.

So, in some ways, you have to pick your poison. I do think, however, that several things might help, such as (1) developing or knowing your “near zero risk” yield and being willing to fix no less than that amount at the first good opportunity you have, and (2) purchasing revenue insurance rather than yield insurance to perhaps help offset losses. The latter point needs further investigation, but it seems to me if you have guaranteed revenue, this could help offset the fear and cost of non-delivery on bale contracts.

In conversation with growers over the past few weeks, it seems many have taken the available LDP and sold any remaining uncommitted cotton. Others have used the Loan to provide cash flow and will wait to see what happens over the next few months. Others have taken the LDP, sold the cotton, and purchased Call Options. All these seem to be reasonable strategies.

Growers in the Southeast have traditionally used the Loan very little. Aside from taking the LDP (or POP payment as many still like to call it), there is not much experience in actually marketing cotton through the Loan. Marketing associations are big users of the Loan, but individual producers have not been. I am not a big fan of the Loan as a marketing tool/risk management strategy. The Loan wasn’t designed or intended to be a producer marketing tool. It is intended to provide cash-flow and assist in the movement of cotton.

A producer’s marketing of his/her cotton crop could span a period of 16 to 18 months or more – from the winter prior to planting until spring and summer following harvest. If cotton will automatically go into Loan without any consideration of other available alternatives, the marketing window is automatically cut in half, and available pricing opportunities prior to harvest forgone. A better option is available – a contract that allows the producer to fix a price at any point prior to placing the cotton in Loan.

Producers have had to re-familiarize themselves with A-Index, AWP, and LDP this season, and 2015 could be the same. An important principle to remember is that U.S. prices (New York cotton futures) and the A-Index (commonly called the Far East Price or “World Price”) tend to move together. If one goes up or down, the other will typically also move up or down.

While this is happening, the AWP and LDP/MLG changes only weekly. It is set for the week based on the A-Index for the previous week. If the A-Index goes up one week, that will be reflected in the AWP going up and LDP going down the following week.

In other words, if the LDP is 4 cents and you take the LDP and sell cotton for 64 cents, the total is 68. If the LDP increases to 6 cents but prices have fallen and you sell cotton for 62 cents, the total is still 68 cents. Because U.S. futures and the A-Index tend to track together, the trick to making more money is to time the selling of cotton while the LDP is high and the marketing going up before the next weekly adjustment in the LDP which could bring the LDP down. There’s a one week lag.

The market (currently pricing off March futures) seems to have found support and trying to trend upward. March15 is currently around 62 cents. Prices are likely to encounter headwind at 63 cents and more resistance at 65 to 66 if the improvement continues.

2015

Prices for next year’s crop (Dec15 futures) are currently around 66 cents. This is not a profitable price, and most observers seem to feel U.S. cotton acreage will decline, perhaps significantly. I would encourage producers, however, to look at cotton and all crop alternatives very carefully. Our early/preliminary comparisons here in Georgia show even 65-cent cotton being competitive with corn, soybeans and irrigated peanuts, and better than corn and soybeans if non-irrigated.

The comparisons can be online in the 2015 Georgia Cotton Production Guide. Look on page 8.

This same publication/link also contains a discussion of STAX, Generic Base, and Loan/LDP issues. In particular, STAX for cotton and ARC/PLC for covered commodities on Generic Base are going to be important issues to consider as we look ahead to planning for 2015.

There is also a series of slide presentations from 10 regional farm bill education meetings conducted by myself and colleague Nathan Smith around the state of Georgia. PLC/ARC, Base Reallocation, Payment Yield Update, Generic Base, and STAX were among the topics covered. Those presentations can also be found online. Look under “What’s New” or under “Presentations”.

The assignment of “covered commodities” to Generic Base is likely to impact planting decisions for 2015. Corn and soybeans acres planted, for example, assigned to Generic Base will be eligible for any PLC or ARC payment. The estimated amount of such payments for the 2015 crop should be considered, therefore, when making planting decisions. In reality, however, we do not know with certainty what PLC, ARC, or STAX payments, if any, will be. The only exception might be peanuts. It seems most likely that peanut base acres and peanut temporary base acres on Generic Base will receive a PLC payment.

STAX is the “safety net” for cotton. Cotton is not a “covered commodity” and not eligible for ARC/PLC. Cotton producers must decide if they want STAX (it’s optional), and, if so, what band of coverage and what type and level of Companion Policy do they want. Producers will also have to decide if they want HPE (Harvest Price Exclusion).

With cotton already in the low to mid 60’s, I would suggest staying with the Harvest Price Option (including the revision of the Revenue Guarantee if prices are higher at harvest time). It will cost a bit more premium, but may pay off. Hopefully prices won’t stay as low as they are now.

I’m somewhat optimistic on the price outlook for 2015. Due to low prices, it is likely that U.S. and World acreage will decline and the supply-side (production) retract. If this occurs and if demand continues to show improvements, this should provide a foundation for improving prices. I’m not expecting 80 cents, but the market should currently be at or near the lows, and hopefully we’ll eventually track back to the 70’s.

Growers have asked me when they should start 2015 pricing and how much. I don’t see much incentive to do anything until Dec15 gets back to at least 70 cents. That is because, in my mind, the worst case scenario for 2015 is that we do a repeat of 2014 – in which case, we have prices in the low 60’s or worse and an LDP.

This Fall, the combination of taking the LDP and selling cotton (with 2-3 cents premium for good grades) has been a total of around 68 cents. So, I don’t see much reason to start contracting for anything less than that.

Will land rent come down? Rents should come down due to low prices and changes in the farm bill, but this will be determined by competition for the land. Some producers are giving up some of the land. Others fear giving it up for fear of never getting more land to replace it. It’s important for both owners and producers to realize that Direct Payments are gone. There are no guarantees in this new farm bill. Everything is a crap shoot, and any PLC/ARC or even STAX payment could not be received until the following year after harvest.

 

Shurley is Professor Emeritus of Cotton Economics, Department of Agricultural and Applied Economics, University of Georgia