Annual Economic Outlook for Cotton

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2014 Cotton Economic Outlook
NCC Annual Meeting
Washington, DC
February 7-9, 2014

Introduction - Good morning. Thank you for the opportunity to present the Council's economic outlook for U.S. and international cotton markets. It is our hope that this presentation and the accompanying report will provide a thorough review of the current landscape and the prospects for the coming year.

Situation for 2011-2013 Crops - In terms of where markets have been and where they may go for the coming year, China stands above all others in terms of the potential impact on the global cotton market.

By this time, you are well aware of China's cotton policy over the past three years. Prompted by the 2010/11 spike in cotton prices, the Chinese government initiated, beginning with the 2011 crop, a policy of purchasing the vast majority of their domestic production into government reserves at a price well above the world price – in total approximately 75 million bales from the 2011-13 crops.

During the duration of the policy, prices have traded in a relatively narrow range, with "A" Index averaging about 90 cents, above historical averages, despite world production consistently exceeding mill use.

China Absorbing Surplus - The market has not sent signals to producers to stop planting cotton. Any reductions in acreage have generally occurred because of signals from competing crops, rather than the cotton price.

Looking outside China, production exceeded mill use by almost 57 million bales over the 2011-13 period, and exporters found a home for their cotton in China as China imported 56 million bales. In effect, China absorbed extra supplies from the world market, thus supporting world prices.

However, the imports were not occurring to keep pace with growing demand. Instead, the imports were needed by the textile industry because supplies of domestic cotton were limited (or deemed too expensive) since much of China's crop moved into reserves.

Based on USDA's latest estimates, China's stocks at the close of the 2013 marketing year will have increased by 48 million bales since the end of the 2010 marketing year. During that same timeframe, stocks outside of China have tightened by 300 thousand bales.

But that is where we've been. All indications point to a change for the 2014 crop. China has announced their intention to cease building reserves and offer support through a target price mechanism. Based on several reports, the new policy will begin as a pilot program implemented in the country's western region of Xinjiang, which accounts for 60% of total cotton production. Presumably, if market prices fall below the target price, growers receive support based on the difference between the market price and the target price.

While details of the policy have not been finalized, there are several questions that are as of yet unanswered. What, if any, support is provided to cotton in the eastern regions of the country? How will China manage the current government reserves? And what will be the impact on China's imports of raw cotton?

China has been importing the world's surplus while its own production has entered the reserves. For the 2014 marketing year, that dynamic appears poised to change. During the course of the presentation, we will complete this picture for the coming year.

Production outside China - Let's begin the process of building the balance sheet outside China with an assessment of 2014 production.

NCC Acreage Survey - To determine expected U.S. production, the National Cotton Council begins by surveying farmers as to their acreage intentions for the coming year. Regular mail and email are used in an effort to reach all cotton farmers, asking the number of acres devoted to cotton and other crops in 2013 and the acres planned for the coming season. As always, the survey results should be viewed as a measure of grower intentions prevailing at the time the survey was conducted. Changing weather and market conditions could cause actual plantings to be significantly different from growers' stated intentions.

Pre-Planting Market Signals - Cotton growers are approaching the 2014 planting season with the December contract trading about 5 cents below year-ago levels. However, the decline in corn and soybean prices is even larger, and as a result, relative price ratios are more favorable to cotton than in 2013. Cotton's improved competitiveness is more pronounced relative to corn, with soybeans expected to again provide strong competition for acres.

U.S. Cotton Area - History has shown that U.S. farmers are responding to relative prices when making planting decisions. Focusing on the years from the previous table, cotton acres increase when cotton prices improve relative to competing crops, and decline when cotton loses competitiveness.

Coming off of last year's 10.4 million acres of all cotton, the survey suggests that growers are again responding to relative prices by increasing the intended plantings by 8%, bringing total U.S. area to just shy of 11.3 million acres.

However, as the state-level results will show, the increase is not universal across the states and production regions.

2014 Southeast Acreage - For example, survey results for the Southeast indicate a 1% decrease in the region's upland area to 2.63 million acres. The relatively modest change in the region's acreage is due to the largely offsetting effects of mixed results for the individual states. Alabama, Georgia and Virginia intend to increase cotton acres, while growers in Florida and the Carolinas indicate declines. In Alabama and Virginia, the increase in cotton acres is coming at the expense of corn. For states reporting declines in cotton area, respondents in the Carolinas indicated a shift into soybeans, while Florida's cotton acreage is moving into peanuts.

2014 Mid-South Acreage - In contrast to the Southeast, growers in the Mid-South indicate plantings of 1.39 million acres, an increase of 12.5% from the previous year. With the exception of Arkansas, all states indicate more acres of cotton relative to 2013, with the largest percentage increase in Mississippi. In Arkansas, survey respondents indicated a 4.6% decline in cotton area was due to an expected increase in acres devoted to soybeans. Responses for Louisiana, Mississippi and Tennessee indicated an increase in cotton acres coming at the expense of corn. For Louisiana and Mississippi, the reported declines in corn area were particularly pronounced as corn acres also appear to be moving to soybeans.

As we have seen in past surveys, cotton acres in Missouri typically show smaller changes on a year-to-year basis, and this year is no exception.

2014 Southwest Acreage - Growers in the Southwest are indicating an increase of 12%, bringing the regional total to 6.74 million acres. In general, respondents are indicating a shift out of grain and into cotton. For some respondents, improved moisture is also allowing some acres to be planted in 2014 that were left idle in 2013.

2014 West Acreage - In the West region, results are mixed as growers in Arizona and New Mexico intend to plant more acres in 2014, while California will decrease upland acres. For the region as a whole, the survey reports 2014 upland area of 275 thousand acres, down roughly 6% from 2013. In California, water availability and competition from other crops are limiting upland acres.

2014 ELS Acreage - Looking at ELS cotton, the survey suggests that some of the California acres moving out of upland are moving into ELS cotton. For the U.S. as a whole, survey results indicate that U.S. cotton growers intend to increase ELS plantings 12% to 225 thousand acres in 2014. The increase in acres is also consistent with Pima prices being above year-ago levels.

U.S. Cotton Production - Recapping the survey, approximately 11 million acres of upland cotton combine with 225 thousand acres of ELS cotton to give a total area of 11.26 million acres, up 8% from 2013.

Planted acreage is just one of the factors determining supplies of cotton and cottonseed. Ultimately, weather, insect pressures, and agronomic conditions play a significant role in determining crop size. Since the NCC economic outlook does not attempt to forecast weather patterns, the standard convention is to assume yields in line with recent trends and abandonment consistent with historical averages. With severe droughts gripping the Southwest in early 2012 and 2013, expected abandonment and yields were adjusted in the previous two economic reports. However, early in 2014, moisture conditions, though still drier than normal, are improved from each of the previous two years. As a result, this outlook returns to the standard convention of average abandonment and yields for all states.

With abandonment for the U.S. at roughly15%, Cotton Belt harvested area totals 9.59 million acres. Weighting individual state yields by 2014 area generates a U.S. average yield per harvested acre of 819 pounds. This compares to a 2013 yield of 826 pounds and a 2007-11 average yield of 814 pounds. Applying each state's yield to its 2014 projected harvested acres generates a cotton crop of 16.37 million bales, with 15.72 million bales of upland and 657 thousand bales of ELS. If realized, that would be an increase of 3.2 million bales from the current USDA estimate of the 2013 crop.

International Area outside China - Turning attention to other cotton-producing countries, an "A" Index in the range of $0.90 per pound is not signaling producers to reduce cotton area. In those countries where cotton competes with grains, the relative attractiveness of cotton is even more pronounced. For 2014, international area outside of China totals 62.1 million acres, up from 61.4 million acres in 2013. The increase is attributable to Northern Hemisphere countries as it is expected that Southern Hemisphere plantings that occur late in calendar 2014 could decline.

Cotton Production outside China - Again, looking at the markets outside of China, the outlook for 2014 suggests stable to increased area. When combined with yields for each country that are in line with recent trends, the expected crop, excluding China, approaches 88 million bales. For a rough breakdown, the United States is a little over 16 million bales, India is approximately 29 million, and Pakistan is just under 10 million bales.

Looking at the past decade, there have been years when the crop outside of China falls into the low 70-million-bale range, but more often, production ranges between 85 and 90 million bales, 2014 appears to be another year in the upper end of that band.

Mill Use outside China - Turning attention to cotton demand, let's quickly review mill use in a few key countries.

U.S. Mill Use - The U.S. spinning industry has experienced some recovery since the decline brought about by the price spike in early 2011. After falling to a low of 3.3 million bales in the 2011 marketing year, U.S. mill use has moved higher and is estimated at 3.6 million bales in the current marketing year.

The U.S. industry has been energized by the Economic Adjustment Assistance Program (EAAP) that began with the 2008 Farm Bill. In recent months, several press reports have indicated new investments and expansions within the U.S. industry. With the help of the EAAP, which is continued in the 2014 Farm Bill, companies are upgrading existing facilities and/or building new facilities. New plants are scheduled to come online by early 2015 and beyond. As a result, U.S. mill use for the 2014 marketing year is projected to reach 3.7 million bales, up from 3.6 million bales in 2013.

Cotton Mill Use outside China - Taker a broader look at cotton mill use, the demand side appears to be gaining some traction after, first the recession, and then $2 cotton. Bouncing back from a low of 65 million bales in the 2011 marketing year to an estimated 73.5 million bales in the current 2013 marketing year. Cotton prices that were less volatile and more competitive with polyester contributed to growth of 8.5% and 4.4% in each of the past two years, respectively.

In addition, the fiber price prevailing in the Chinese market due to its reserves policy caused their textile industry to look to other countries to supply cotton yarn. Imports of cotton yarn by China have increased in each of past three years, with an estimated 10.2 million bales being imported in the 2013 marketing year. India and Pakistan have been the primary yarn suppliers to the Chinese market.

For the 2014 marketing year, mill use outside of China is projected to continue to expand, reaching 76.4 million bales. A world economy projected by the International Monetary Fund (IMF) to expand by just under 4% in 2014 and 2015 will support growth in mill use. In addition, cotton prices are expected to remain relatively competitive with polyester. Growth is expected in most markets with India, Pakistan and Vietnam accounting for 1.9 million of the 3.1 million bales of total growth.

China Absorbing Surplus - To quickly recap the balance sheet outside of China, production of 87.9 million bales and mill use of 76.4 million bales gives a surplus of 11.5 million bales. With a surplus similar to the current marketing year, the projected production-consumption differential would not appear burdensome. In recent years, China imports have been at least that level or larger. However, the key will be the extent to which China maintains that same pace of imports under the new policy.

China Supply & Demand - Projecting China's cotton situation is always a challenging task, but given the significant, but not yet clearly defined, change in policy, the outlook is more uncertain.

Key Assumptions - To date, the Chinese government has announced their intention to cease building reserves and institute a target price program in the western region of the country. Although not yet announced, speculation has suggested a target price of 18,300 RMB/ton, which at current exchange rates is approximately $1.36 per pound. No support mechanism has been announced for the eastern growing regions.

It is also assumed that there will be no change in operation of import quotas but quantities above the required TRQ are expected to be less than in recent years.

China Balance Sheet - In view of the uncertainty regarding the policy change and speculation that the eventual target price will be below the current reserve purchase price, China's cotton acreage is expected to decline in 2014. Recent surveys by the China Cotton Association and Beijing Cotton Outlook indicated a decline of approximately 9%. In this outlook, the acreage decline is estimated at 8%. When combined with average yields, China's production falls to 30.1 million bales, down from 33.0 in 2013.

With the reserves policy in place, cotton prices in China have traded at levels twice that of polyester prices. In response to those relative prices, China's yarn spinners sharply reduced their use of cotton, opting for the less expensive polyester. Between 2010 and 2013, annual mill use in China declined by 10 million bales, with 2013 mill use estimated at 36.0 million bales. For the 2014 marketing year, the change in cotton policy should alleviate some of the pressure on textile mills and provide more competitively priced cotton. As a result, mill use is expected to see modest growth to 36.4 million bales, leaving a 6.3 million bale differential with production.

With an estimated 58.3 million bales of stocks on hand at the beginning of the 2014 marketing year, there are more than ample supplies to satisfy the production shortfall. Strictly looking at the balance sheet, China does not need to import any cotton. However, that is not expected to be the case. China must open 4.1 million bales of import quota at a minimal duty in order to comply with their WTO accession commitments. In addition, it is expected that some amounts of quota for the processing trade will be made available. Under these assumptions, China is projected to import 6.4 million bales in the 2014 marketing year, down from 11.0 million bales in 2013. If realized, it would be the smallest level of imports in a dozen years.

As a final point, it was not the assumption or intention to simply hold China's stocks flat in 2014. It is the net result of the other changes in the balance sheet. However, it illustrates an important though – this supply & demand table does nothing to address China's massive stockpiles of cotton. Going forward, there needs to be a bigger reduction in area or more growth in cotton consumption in order to work through the stocks. It took three years for China to accumulate the cotton, but it may take longer for them to return to a more acceptable level of stocks.

China Absorbing Surplus? - Again, returning to the previous table, the balance for 2014 is changing as China's projected imports of 6.4 million bales falls short of the 11.5 million bale production surplus from all other countries, illustrating the highly competitive market facing cotton exporters in the coming year.

Cotton Trade - Next, we can turning attention to cotton trade.

U.S. Cotton Exports - Smaller imports by China will translate into smaller cotton exports by the United States, with exports projected at 10.0 million bales, down 500 thousand bales from the current marketing year and the smallest total since 2000. This is a number that was discussed at length as the projections were put together.

Competitive Export Markets - With China's imports projected to fall from 11 million bales to 6.4 million bales, it is conceivable that this number could go lower. However, in the total trade picture, there are other dynamics that can mitigate a further decline is exports.

The U.S. can regain market share from a '13 number that is well below average. Unlike the 2013 marketing year, exportable supplies are not constraint. Exports of 10.0 million bales are less than 60% of exportable supplies. Normally, that percentage would be between 70 and 75%. The United States will rely more heavily on other markets, at least when compared to the past two years, but the 2014 exports to other countries are well below totals from 2009 and 2010.

U.S. Balance Sheet - U.S. exports are a challenging, but achievable number for the 2014 marketing year. Putting the full balance sheet together, larger U.S. production and lower exports combine to give a significant increase in ending stocks. The 2014 marketing year is expected to close with stocks totaling 5.7 million bales, or 41% of total use. This total represents the highest since the end of the 2008 marketing year.

World Balance Sheet - Globally, the 2014 marketing year represents the fifth consecutive year with production exceeding consumption. Production of 118.0 million bales and mill use of 112.8 million bales adds another 5.3 million bales to global stocks. At 103.0 million bales, ending stocks are projected to surpass the 100 million bale mark by a rather significant amount.

In recent years, China has accounted for the increase in global stocks as stocks in other countries declined. For 2014, the situation is expected to be reversed as China's stocks are projected to remain stable and the increase in world stocks occurs outside of China.

China Absorbing Surplus? - The table referred to earlier in the presentation summarizes the difference in the balance for the 2014 marketing year, when compared to the previous three years.

Summary Points - Quickly summarizing a couple of take-away points, barring some major weather concerns or an even larger reduction in China's area and production, the 2014 crop is expected to exceed consumption. Cotton demand is expected to grow, based on competitive prices with polyester and continued economic growth. However, the growth is not enough to prevent an increase in stocks.

We do not foresee China importing as much cotton as in past years. Exportable supplies from other countries will be aggressively trying to capture a smaller Chinese market. For the U.S. cotton industry, being positioned to capture that market share is critical.

Cotton Prices - The recent movement in cotton prices was discussed at the outset of the presentation. However, the most-asked question is not where prices have been, but where are prices likely to go in the future. The Council has a long history of not projecting prices, and that will not change with today's presentation.

Having said that, the projections for available supplies of cotton, the disposition of stocks, and China's reduced imports paint a more bearish picture for prices. Provided China does not swing to the other extreme and consider exporting cotton, the bearish tone in prices can be tempered. With polyester prices in the low 70's, the potential for demand growth is there, provided the current unrest in developing economies proves temporary.

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