U.S./China Trade: Deal or No Deal
When it comes to forces impacting the cotton market, one glaring factor overshadows all the rest. The ongoing trade dispute between the United States and China is the single most important variable in determining what cotton prices will do in 2019.
Unfortunately for American cotton producers, there is no crystal ball able to predict when, if, or to what extent a trade deal will be struck between the two nations. But we can speculate about the results of a worst-case scenario – extended, ongoing trade wars. And we can speculate about the results of a best-case scenario – a timely trade agreement that benefits both sides. That’s just what commodity expert Joe Nicosia of Louis Dreyfus tried to lay out during his Ag Update seminar address, delivered to an audience of hundreds at the Mid-South Farm and Gin Show in early March.
The situation is best understood, he said, by examining where we currently stand.
“Who is feeling the pain from this?” Nicosia asked. “There’s plenty of it to go around. A little bit everywhere.”
Last June, just before the trade dispute broke out, cotton prices in the United States were hovering at nearly 95 cents. Then, when trade talks between the two nations ended without a resolution, President Donald Trump ordered a list of Chinese products targeted for $200 billion in tariffs. From there, the two countries have sparred.
“As time went along, things didn’t get any better,” Nicosia noted, citing charts to highlight the diminishing exports of U.S. cotton into Chinese markets. “If you were in the medical profession you’d say (U.S. cotton exports to China) flatlined. It has essentially gone to almost zero. If you look at it over the years relative for total imports over a period of time, you can see how well we did. We were always the first- or the second-largest importer to China. Now we’re headed straight down to the bottom.”
Other crops, particularly soybeans, have seen much of the spotlight when it comes to agricultural impacts of the trade dispute. But Nicosia noted that cotton suffered as much or more than any other crop. Price impacts were masked initially due to in-season factors such as drought in the Southwest or hurricanes in the Southeast.
“You don’t really hear the same amount of press or the same amount of concern when you’re talking about the cotton community,” Nicosia said. “We’ve had just as big of the brunt of it as soybeans or any commodity that’s been up there.”
Before he examined the two paths American cotton can take from here, Nicosia went into detail to take stock of where the U.S. cotton industry, and the economy at large, currently sit.
The nation’s GDP growth is reasonable, but slightly tempered relative to expectations that existed before the trade disruptions. There exists a 1.1 million bale increase in consumption, which again Nicosia noted, was expected to be higher before the trade dispute began.
We have a consumption deficit situation of 5.2 million bales, meaning we are still consuming more than we produce in the current year, and are helping to draw down world stocks – a good thing, to be sure.
The United States finds itself with a reasonable 35% share of global exports, although there is emerging competition from new production markets. In short, Nicosia said, the current situation is perhaps tolerable, but won’t have anyone too terribly excited unless things change.
Benefits of a Deal
If there were a path to optimism and price relief for U.S. cotton growers, it begins with the two nations striking a deal. In that scenario, the positive benefits would be quickly evident.
A reduction in tariffs would have obvious benefits for U.S. cotton, but Nicosia points to a reduction in non-tariff barriers, such as bagging issues and quotas.
Those non-tariff barriers are “critically important,” says Nicosia, who cites quotas as a perhaps creative way for the Chinese to navigate around WTO regulations. Again, a trade deal would alleviate many of these issues.
The result would be an increase in market share in the United States from Chinese imports, he said, and a temporary bump in demand for U.S. exports, And, importantly, there would be incentive for production in the United States for future years to come because we would secure the world’s largest buyer.
“If we get that in the old crop, I think prices move up very quickly,” said Nicosia. “They will move to 80 to 95 cents in the old crop, if we can get a deal done with China here fairly soon.”
Endless Trade War
Of course, the other possible scenario would be far less beneficial to American cotton. If the U.S. and China continue to engage in a lingering trade dispute for an extended period, the damage could begin to take a toll. In some ways, according to Nicosia, it already has.
“We’re going to get higher import tariffs,” he said of the possibility of lingering trade disputes. “We’re going to get more non-trade barriers – those are real in the cotton industry. Disruption and displacement of trade and goods and services will continue.”
That scenario would begin to impact global cotton demand, as higher costs of trade would be passed down through the supply chain to retail. Rising U.S. stocks, resulting from a loss of demand, would be another difficult reality.
“We’re going to end up with a price of about 55 cents to 65 cents, and that might be optimistic,” Nicosia said. “If that happens with China, they’ll get half of nothing, we’ll get half of nothing, and as Foghorn Leghorn said, two halves of nothing equals a whole nothing.”
But some of those negative impacts have already begun to shape up. And in the case of a new challenger to U.S. production, they won’t be going anywhere soon.
In the absence of U.S. cotton imports, the Chinese have turned in large part to Brazil. The quality of the cotton has made for a tough competitor, said Nicosia.
“We’ve created new foes, new competition. And formidable ones,” he said. “As we look at today, China wasn’t buying from the U.S. today. What do you think they did? They bought something else. They bought Brazilian.”
The Chinese have always had alternative sources for the cotton they’ve imported. Australia and West Africa, among others, have found a home for their cotton in China – the world’s number one cotton importer.
But the pace at which China has begun to engage Brazilian exporters is changing the face of the industry in the large South American country. Booming export sales have increased prices there, leading Brazilian producers to exponentially increase their investments. Across the growing regions, producers have invested in new gins, new production area, and new pickers, according to Nicosia.
One side-effect of the U.S. trade dispute? “It has changed their world,” Nicosia said. “You know they’re serious about production. We’re talking about farms that are miles and miles and miles long.”
This has the potential to be the most lasting effect of this Chinese trade dispute. Brazilian producers are energized and are making investments that will stand to benefit their industry for years to come.
“Brazil is going to increase production,” Nicosia said. “And it’s going to increase a lot, and it’s going to be increased for years to come.
“So, the thing that worries me the most about this is not that they’ve made a sale, but that their excitement level is up, and they’ve made the investment, and those investments are here for years to come.”
In America’s absence, Chinese importers are forging relationships within the Brazilian cotton industry. The export market is zero sum – meaning every bale that the Brazilians sell to the Chinese is one that America does not.
Nicosia noted that eight years ago the Indians emerged as a primary competitor for the Chinese import market.
“The more difficult part here with Brazil is that their cotton is good – it’s very much like the cotton grown here in the Mid-South,” Nicosia said from the Memphis event.
A Wide Trading Window
The pricing possibilities for 2019, then, hinge almost entirely on the ability of the Americans to strike a deal with the Chinese. Absent that, cotton prices could hover at or below loan levels. If a deal were to come along soon, though, current crop prices could shoot skyward.
“If the Chinese were to make substantial current crop U.S. purchases, I think current crop prices could explode,” Nicosia said. “Because this crop that we have, it only has so much of that cotton that they want.”
Without a deal, however, “we’re in trouble,” according to Nicosia.
The stage is set, given good weather, for the U.S. to break production records in 2019. Conditions in the Southwest in particular are prime for a strong-yielding crop. As such, the country has the potential to export a record number of bales in the coming year.
But America must compete for export sales like never before. Not only on price, but with “quality, delivery and service.”
Nicosia closed his speech with a strong recommendation for the growers in his audience to hedge themselves in options.
“I have never felt stronger, and never could I believe more in this last statement. The risks in prices in front of us right now are huge,” he said. “I see where old crop could trade 85 cents to $1.05 if it had to. And I see where new crop could trade in the 50-cent range. And the price of options is relatively cheap.”