Cotton commodity price risks – haven’t we seen this before?

Volatility in the international cotton market has resulted in prices trading to new four-year highs ($652/bale 2018 season and $648/bale 2019 season). The recent surge in cotton prices is a result of global weather concerns, paired with a shortage of world cotton ending stocks and an improvement in the world economy.

Extreme temperatures in the USA

The USA, the world’s third largest cotton producer, is experiencing extreme temperatures of up to 41ᄋc causing a lack of moisture in the key cotton growing areas. West Texas is particularly stressed by drought. Compounding the lack of topsoil and subsoil moisture, the high temperatures are exacerbating the challenge of keeping water on the fields. Cotton is being planted by most dry land farmers, however there are high expectations dryland crops will not be successful and there are also concerns that irrigation farmers could run out of water. No weather relief is predicted and the long-term forecast is also grim.

Drought in China

Whilst the cotton market is focussed on the dry conditions in Texas, the continued deterioration of weather conditions in parts of China, the world’s largest cotton producer, is also a key driver of the recent spike in cotton prices. Historically, China utilises their reserved cotton stocks thereby reducing their import requirements. With China’s Xinjiang Province stressed by drought, it is expected that China will issue additional import quotas to meet its commitments due to looming concerns of how much domestic new crop cotton China can produce to rotate their reserves.

Cotton ending stocks

World cotton stocks are at an all-time low due to increased global consumption. With cotton stocks being used at a faster rate than anticipated, and given current low forecast production, there will be increased market competition. It is expected that cotton stocks will fall to their lowest in 14 years to 2.2 million tonnes at the end of the 2017/2018 season.

History repeats

In February 2011 world cotton prices peaked at levels not seen for 150 years. Tightening world supply, flooding in Pakistan and cotton export bans from India, all contributed to push cotton commodity prices to record levels nearing $1,000/bale. World inventory levels had again been run down with world cotton ending stocks at 9 million tonnes.

With AUD/USD exchange rates at near parity at the time, and substantial summer rainfall in most Australian cotton producing regions, the opportunities for substantial profitability gains were high. Producers who benefited from the positive price increases were able to repay debt, invest in infrastructure and plan for the future crops. Legitimately, the problem for producers was how to accurately forecast future production levels and commodity prices that bore semblance of ‘normality’.

Current Australian outlook

Whilst world prices might be high, Australian farmers are also currently facing drought conditions. The 2017/2018 cotton season in Australia is in its concluding stages, with most growers having completed picking, although large parts of the harvested crops are yet to be ginned. Some farmers were fortunate enough to take advantage of a rising cotton market that intersected with harvesting, selling uncommitted but harvested crops as the cotton price increased.

For the 2018/2019 season there currently is a lack of irrigation water available in most cotton growing areas, as well as low soil moisture profiles. Current commodity market prices (and potential profit margins) provide significant encouragement for growers who have water available to take advantage of the current market trends. The urge to secure high forward prices must be mitigated with the risks associated for non-delivery and the penalties that can apply.

Irrigation farmers who have reliable or secure water to ensure delivery risk on future production will forward sell a percentage of their 2018/2019 crop to secure these high cotton prices. It may be too early to “take it to the bank”, but developing prudent forward sales strategies and forecasting for future seasons is critical to the success of Australian agribusinesses.