2008 Cotton Economic Outlook
NCC Annual Meeting
Memphis, TN
February 7-11, 2008
INTRODUCTION – Good morning. Thank you, Mr. Chairman, for the opportunity to present the Council’s economic outlook for U.S. and world cotton. We hope the outlook will provide a necessary foundation as the delegates begin the process of developing the Council’s resolutions.
MACROECONOMIC ENVIRONMENT – The general economy is dominating the headlines as pessimism over 2008 economic performance grows. In fact, a search on google.com of the word “recession” produced almost 150,000 news hits – and that was after narrowing the search to those stories posted in just the past hour. CNN’s website even has a portion of their website devoted to a ‘recession watch.’
USREAL GDP – Based on recent reports from the labor market and the services sector, some analysts suggest that the US is already in a recession, but it’s just not reflected in the data yet. However, let’s remember that a recession is defined as negative growth in real GDP for two or more successive quarters.
Relatively strong performance in the second and third quarters of 2007 was followed with sharply slower growth in the fourth quarter. Preliminary estimates from the Department of Commerce put growth at just 0.6%, with a downturn in inventory investment and a slowdown in exports being the primary factors.
While there is growing concern that the US could slip into a recession in 2008, a recent survey puts growth at 1.5%, which is similar to levels assumed in the latest projections released by the Congressional Budget Office.
WORLD REAL GDP – There is an ongoing debate about the extent to which a slowdown in the US economy will impact other economies. The debate invokes a term that we’re familiar with from farm programs – that is decoupling. Last year, there was broad speculation that a slowdown in the US economy would not necessarily spill over into the global economy. In other words, the world economy could be decoupled from US performance.
Apparently, that view is becoming less accepted, and now the phrase is ‘re-coupling.’ In particular, European economies are generally viewed to be more tied to the US economy than Asian economies. For the Council’s economic outlook, we incorporate the latest projections of the IMF, which put ’08 growth at 3.3%, down from 3.5% in ’07.
U.S. CRUDE OIL SPOT PRICE – 2007 was another year of increased energy prices, with the West Texas spot price ending the year at more than $90 per barrel. For 2008, global markets are expected to remain tight as world demand will continue to grow faster than production outside of the OPEC. There is some thought that OPEC might boost production in ’08 but any decision along those lines has been delayed until March.
In general, the outlook for 2008 calls for prices in the $80’s – down slightly from current levels – on the expectation of boosts in OPEC production.
CHANGE IN THE VALUE OF THE US $ – The dollar continued to weaken against most major currencies in 2007. Against the euro and the yen, the dollar declined by 12% and 9%, respectively. The decline against the Brazilian real was 18% with a cumulative change of 45% over the last four years. This is especially notable for two countries that are direct competitors in the export market as the stronger Brazilian currency dampens their competitiveness. The dollar has also weakened against the India rupee and China’s yuan.
For an export-oriented agricultural sector, a weaker dollar generally translates into a positive for exports. For importing countries, the weaker dollar serves to partially offset the effects of higher commodity prices.
U.S.CROP FUTURES – We continue to see crop prices move higher. In the case of soybeans, nearby futures closed above $13 – $6 per bushel above year-ago levels. Corn futures were at $5 and wheat has surpassed $10. These higher prices are having ripple effects throughout the ag sector. For cotton, there’s the competition for available acres. The livestock sector continues to feel the impacts of higher feed costs. Obviously, the current and future expansion of renewable fuels is part of the reason behind the strength in prices. For the current marketing year, ethanol production is expected to account for 25% of corn production. Under the energy bill signed last year, that percentage is expected to approach 40% over the next 5 years.
WORLD STOCKS-TO-USE – However, beyond ethanol, strong demand growth, coupled with production problems – as in the case of wheat – have led to a much tighter balance sheet. Corn and wheat stocks are projected to fall to less than 20% of use. Barring a slowdown in demand or above-average crops, short-term projections call for these crop prices to remain high.
INTERNATIONAL COTTON MARKET & COTTON TRADE – As we turn our attention to the cotton market, let’s start with an overview of key international markets and the overall trade picture.
CHINACOTTON BALANCE SHEET – For the ’07 marketing year, China’s mill use is estimated at 54.3 million bales – which is slightly slower growth than we’ve seen in recent years. However, the slowdown is consistent with the recent pace of yarn production. Internal cotton prices that are 15% above year-ago levels, tighter access to credit, and a strengthening currency are contributing to the slower growth. Even with a slowdown, mill use in China is projected to reach 57 million bales in the 2008 marketing year.
This will once again be well above their domestic cotton production, which we estimate at 36.2 million bales for ’08. This compares to an ’07 level of 35.5 million. While there is significant speculation about the possibility of acreage shifts into grains, we believe that higher cotton prices will lead to a marginal increase in cotton area. That coupled with slightly better yields gives the larger crop.
For 2007, net imports are estimated at 13.7 million bales. For 2008, the growth in mill use increases imports to 16.6 million bales. Imports by China account for almost 40% of world trade.
INDIACOTTON BALANCE SHEET – After China, India is now the second largest producer and processor of cotton. They also devote more area to cotton production than any other country. While their textile industry has been expanding, the most notable development in the Indian market is cotton production that has more than doubled in the last 5 years, and is estimated at almost 25 million bales in 2007.
The growth in production is largely the result of improved yields. In 2002, India averaged about 270 pounds per acre. In 2007, India’s yield surpassed 500 pounds per acre. Much of the yield growth can be attributed to better inputs and better varieties.
Currently, more than half of India’s acreage is planted to biotech varieties.
Improved yields have improved the profitability of cotton – leading to an increase in area. Assuming weather cooperates, our expectation is for increased area and yields to push India’s crop above 26 million bales. We should expect them to remain a significant cotton exporter in 2008 – perhaps as much as 7 million bales. They have also been very aggressive in pricing their cotton below comparable growths from other countries. A comparison of India’s quote for 31-3-35 type cotton and the average of the other 5 lowest quotes show a consistent gap of 2 to 4 cents. While China is in many ways still the primary concern, India is a close second.
COTTON TRADE #1 – Time does not allow us to go through all countries in great detail, but instead, I’ll do a brief overview of the trade picture and implications for US exports. Total cotton trade for the ’07 marketing year should fall just shy of 41 million bales. After 2005, it would be the second highest level of trade. For the coming year, growth in mill use should allow total trade to expand by 1.5 million bales, but as you can see, China more than accounts for the increase in the total. China will also continue to be the largest export customer for US cotton.
COTTON TRADE #2 – Moving through the top importers of US cotton, Turkey’s total imports are estimated at 3.7 million bales for 07/08. The US accounts for roughly 60% of Turkey’s imports. Their ’07 imports would be higher if not for a reduction in their stocks to offset the smaller crop. For ’08, a slight improvement in imports is projected.
COTTON TRADE #3 – Mexico currently ranks as the third largest customer with US cotton capturing 95% of their imports. Unfortunately, their textile industry also faces strong competition from products produced in Asia. For the current marketing year, imports of 1.5 million bales will supply approximately 75% of the needs of their textile industry. For the coming year, lower mill use should reduce their imports to 1.4 million bales.
COTTON TRADE #4 – The next category of countries is the seven countries that complete the Top 10 list of US cotton importers. To name a few, these include Indonesia, Thailand, Pakistan and Korea. For ‘07/08, total imports by those seven countries are estimated at 11.6 million bales. That’s the largest total in recent memory, bolstered by increased imports by Pakistan due to their production problems. For ‘08/09, that total is projected to decline by 1.1 million bales with lower imports by Pakistan, South Korea, Japan and Taiwan. Pakistan’s drop in imports is due to an expected recovery in their crop, while Korea, Japan and Taiwan are likely to see lower imports due to mill use.
COTTON TRADE #5 – The rest of the world beyond the Top 10 US customers account for approximately 10 million in imports – or 25% of world trade. Only a modest reduction is projected for ’08.
COTTON TRADE #6 – Moving over to the major exporters, we already covered in some detail India’s recent emergence as a cotton exporter. For ‘08/09, they could be in position to increase exports by more than 1 million bales from the ’07 level.
COTTON TRADE #7 – For the current marketing year, Brazil is expected to export almost 3 million bales, which would be a record level for them. For ’08, our projections call for a further increase in exports, surpassing 3 million bales. There is still a question about the competition for acreage with soybeans. And if soybean prices maintain these levels until Brazil’s next planting season, then that could draw acres away from cotton. However, at this point, we’re hearing that acreage devoted to both cotton and soybeans is increasing.
COTTON TRADE #8 – The former republics of the Soviet Union export just over 7 million bales and little change is expected in 2008.
COTTON TRADE #9 – A smaller crop in ’07 lowered West African exports. Lower incentives to the producer – largely due to an unfavorable exchange rate – and weather combined to reduce production. For ’08, the assumption of normal weather and stronger prices are expected to bring a recovery in production and exports.
COTTON TRADE #10 – All other countries account for 6.5 to 7 million bales of exports. We anticipate that total to remain relatively stable in ’08.
COTTON TRADE #11 – That brings us to the prospects for US cotton exports. For the current marketing year, we estimate total exports of 15.2 million bales, which is several hundred thousand bales below USDA’s current estimate. And, we still have some work to do to get to that number. Normally, shipments improve in the second half of the marketing year. We need to average just over 300 thousand bales per week for the remainder of the marketing year. Purchases by China will dictate our ability to hit that number.
For the ’08 marketing year, we project a decline to 14.7 million bales due to increased competition from India, Brazil and West Africa and lower US supplies available for export.
U.S. COTTON DEMAND – To complete the demand side, let’s look at the US market.
U.S.COTTON RETAIL MARKET #1 – We’ll start with the retail market in the United States. Data on cotton textile trade, converted to a raw fiver-equivalent basis, are combined with US mill use to derive an estimate of retail purchases. For calendar 2007, our estimates indicate retail purchases of 23.3 million bales – down slightly from the 2006 level. The decline is likely a result of higher energy prices claiming more of consumer spending. For 2008, a slowing US economy and continued high energy prices are expected to limit any expansion in the US retail market. As a result, we project relatively flat consumer purchases.
U.S. COTTON RETAIL MARKET #2 – As we know, the US retail market is increasingly supplied by imported products. For 2007, imports are estimated at 22.7 million bales, which are down slightly from 2006. China accounted for just over 30% of total imports. Adding Pakistan and India, those three countries comprise just over 50% of total imports. For 2008, we expect imports to be stable. Looking farther down the road, 2009 will bring additional pressure as the safeguards on 34 categories of imports from China are scheduled to expire.
U.S.COTTON MILL USE – Unfortunately, the impacts of the increased textile imports is a story that we’re all too familiar with. Plant closings and job losses in the US textile industry continued in 2007, with employment data showing a loss of 51,000 textile jobs in 2007. For the current marketing year, mill use is estimated at 4.6 million bales – 400 thousand bales below the ’06 level.
For the coming year, we expect further losses to be modest with mill use estimated at 4.4 million bales. It is important to note that is based on the assumption of the economic assistance provision included in the House and Senate farm bills. That should help temper losses – despite the slowdown in the US economy and the elimination of China safeguards.
U.S.COTTON SUPPLY – Next, we’ll review the numbers from NCC’s acreage survey.
2008 U.S. PLANTING INTENTIONS – As you heard from Steve Slinsky in yesterday’s meeting of the American Cotton Producers, NCC’s annual survey of planting intentions put this year’s acreage at 9.5 million acres, almost 12% below the’07 level.
For upland cotton, there are decreases in all regions with the West and Mid-south showing the largest declines in percentage terms, with 39% and 26%, respectively. The Southeast indicates a reduction of 11% while the Southwest responded with 2% fewer acres. Respondents in the Southeast and Mid-South intend to plant more wheat and soybeans at the expense of cotton. In the West, concerns over water and competition from specialty crops are causing the decline. The survey of ELS producers calls for a 21% decline.
U.S.COTTON PRODUCTION – Ultimately, weather will be the primary determinant of overall production. Applying an average abandonment rate of 8% and assuming yields in line with recent trends gives an all-cotton crop of 15.4 million bales, with 14.8 million bales being upland and 600 thousand bales of ELS. This would be 3.5 million bales below the ’07 level and the smallest crop since 13.9 million bales in 1998.
ABANDONMENT & YIELD VARIABILITY – As a final point on US production, we need to keep in mind the potential variability around the estimate, particularly with 50% of all cotton acres in Texas. For the Cotton Belt as a whole, we’ve seen as much as 20% of planted area go un-harvested due to adverse weather. We’ve also seen as little as 3% un-harvested – which was the case last year. Likewise, yields have ranged from 12% above trend to almost 20% below trend.
Applying this range of outcomes to our 2008 plantings gives us a better idea of potential crop size. Years like 1994, 2004 or 2007 give an 18 million bale crop. However, experiences like those of 1995, 1998 and 2000 produce a crop closer to 12 million bales.
U.S. COTTONSEED PRODUCTION – For cottonseed production, an average seed-to-lint ratio gives a crop of 5.3 million tons – down from 6.6 million tons in ’07. The ’08 crop would be even lower than 1998. As grain and oilseed prices have improved, cottonseed prices have followed suit. Spot market prices range between $250 and $350 per ton, depending on the region of the country. At these prices, cottonseed constitutes 20% of total market revenue generated by an acre of cotton.
If competing feed prices remain strong, there’s little if anything that would call for lower cottonseed prices in 2008. In fact, just the opposite seems true. Cottonseed prices could push higher with the expectation of a 5 million ton crop.
STOCKS & PRICES – Next, we’ll complete the balance sheet by looking at stocks and prices.
U.S.COTTON PRODUCTION & USE – If we hit an export target of 15.2 million bales, then total use will exceed production, leading to a reduction in stocks. The same should hold true for ’08 as well – but to an even greater extent.
U.S.COTTON ENDING STOCKS – By July 31 of this year, stocks are expected to fall to between 8 and 9 million bales. Although down from the ’06 level, we still have a significant amount of stocks when compared to historical levels. For the ’08 marketing year, stocks are expected to fall sharply as total offtake exceeds the projected crop of 15.4 million bales.
WORLD COTTON PRODUCTION & USE – For the world balance sheet, mill use in ’07 marketing year is estimated at 127 million bales with a world crop of slightly more than 119 million bales. For 2008, world production is expected to increase to 122.4 million bales as larger crops in China, Brazil, India, Pakistan, Australia and West Africa more than offset lower US production. Demand is expected to grow but at a slower pace due to overall economic performance and stronger cotton prices. The result is another gap between use and production, which will further tighten stocks.
WORLD COTTON STOCKS – By the end of the current marketing year, world stocks are projected at 57 million bales, down from approximately 61 million at the beginning of the beginning of the year. A decline of almost 5 million bales is projected for the 2008 marketing year.
NEARBY NY AND A (FE) INDEX #1 – Wrapping up with prices, New York futures and the A Index are trading about 15 cents above year-ago levels. Tighter stocks and strength in other commodity markets moved prices out of the 50 to 60 cent range that we had been in since 2004.
NEARBY NY AND A (FE) INDEX #2 – Next, let’s add the recent values for the NY futures contracts to the chart. Those contracts are generally trading from the low 70’s to the low 80’s. Current futures values and the normal relationship between New York and the A Index imply an A in the mid ‘80’s.
COTTON STOCKS-TO-USE #1 – One question to ask is whether that price level is supported by the current fundamentals. Whether we look at the World stocks-to-use or the World less China, both measures decline in the current year and are projected to decline in ’08. However, there is a difference between the two measures when we compare back to historical values. The ratio for the world is at a level not seen since the early ‘90’s, but if we take China out of the mix, the ratios are tightening up but still high when compared to pre-2004 levels.
Another measure to look at is the relationship between available supplies by exporting countries and mill demand by the importers. We saw that relationship peak in 2005 at almost 70% and decline since then. But while declining, the relationship is still relatively high when compared to historical levels.
COTTON STOCKS-TO-USE #2 – Incorporating prices into the chart, we see the expected relationship that low stocks generally being related to high price. For the ’07 marketing year, it appears the A will average about 73 cents. As I mentioned earlier, current futures imply an A in the mid 80’s.
Declining stocks should continue to be supportive of prices in ’08, but I’m not sure that it supports an increase fully into the mid ‘80’s. The other factor taking cotton higher is the strength in other crop prices. Should that change, then I think cotton would follow suit.
GROWTH IN WORLD MILL USE – One concern will be the ability to maintain demand growth at these higher prices levels, particularly in light of concerns about the general economy.
FIBER AND YARN PRICES – In addition, the gaps between cotton prices and yarn prices and polyester prices have widened. So while the current outlook is supportive of prices, we can not forget the competition from manmade fibers.
NATIONAL COTTON COUNCIL – In closing, I hope this outlook provides an overview of some of the challenges and opportunities that we face in a very competitive global environment. I can assure the industry that Council economists will strive to provide accurate analysis to better enable the industry to meet these challenges.
Mr. Chairman, that concludes my report. Copies of the outlook are available at the close of this session, and the presentation will be available on the Council’s website. Thank you.
