Annual Economic Outlook for Cotton

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2015 Cotton Economic Outlook
NCC Annual Meeting
Memphis, TN
February 6-8, 2015

Introduction - Good morning. Thank you for the opportunity to present the National Cotton Council’s economic outlook for U.S. and international cotton markets. While the presentation will focus on a few highlights, the accompanying report, available at the conclusion of this session, provides a thorough review of the current landscape and the prospects for cotton and cottonseed for the coming year.

2014 – A Year of Changes - 2014 brought significant changes in both markets and government policies. The 2014 Farm Bill, which includes a number of necessary changes in cotton policy, was enacted and implementation is ongoing. The Stacked Income Protection Plan and several other new insurance provisions are available for the 2015 crop. China also implemented changes in the manner in which support is conveyed to its cotton farmers.

Commodity markets generally declined over the course of the year, with greater pressure occurring in the second half of the year. In addition to influences from other commodity markets and the general economy, cotton prices weakened as world production was projected to exceed mill use for a 5th consecutive year and China announced intentions to reduce the allotted import quotas.

U.S. Balance Sheet – Recap Current Marketing Year - To recap the current 2014 marketing year, USDA’s most recent estimate puts last year’s harvest at 16.1 million bales, up 3.2 million bales from the previous year. A 6% increase in planted area and generally improved growing conditions contributed to the increased production.

NCC estimates U.S. mill use at 3.6 million bales in the ’14 marketing year, up 50,000 bales from the previous year and marking the 4th year of increased use. The current estimate is in line with recent monthly consumption numbers. The Economic Adjustment Assistance Program for upland cotton remains an important contributor to the increased consumption. New investments continue with new spinning plants scheduled to begin production in the coming year.

The United States remains the largest exporter with 2014 shipments estimated at 10.2 million bales. Although down from 10.5 million bales in the previous year, the current export number represents a gain in overall U.S. trade share. The U.S. export estimate breaks down into 9.7 million bales of upland cotton and 500 thousand bales of ELS cotton.

The estimate may prove to be conservative for the 2014 marketing year as weekly export sales registered marketing year high’s for three consecutive weeks in January. The U.S. is benefitting from competitive prices relative to other growths, limited availability of higher quality cotton, and reduced exports in recent weeks of Indian cotton due to its Minimum Support Price (MSP) program. India’s management of cotton acquired under the MSP program will be a key factor in coming months.

The current marketing year began with cotton stocks at their lowest level in more than 20 years. Ending stocks are expected to increase by more than 2 million bales to 4.7 million bales as of July 31, 2014.

NCC Acreage Survey - With that review in mind, an overview of the outlook for the 2015 marketing year will begin with the prospects for U.S. cotton production. As in past years, the projections for the U.S. crop are based on the results of the NCC planting intentions survey with assumptions made for abandonment and yields.

Surveys were distributed on December 17 and responses collected through mid-January. Respondents were asked to give their plantings of cotton, corn, soybeans, wheat, and other crops for 2014 and intended acreage for 2015.

Pre-Planting Market Signals - As always, the survey results should be viewed as a measure of grower intentions prevailing at the time the survey was conducted. During the survey period, the cotton December futures contract averaged just under 65 cents per pound, the lowest since 2009. Corn and soybean prices are also below year-ago levels, but not to the same extent as cotton, so price ratios of cotton to competing crops are not as favorable as 2014.

It is important to call attention to the ratios because past experience has shown that these ratios are reliable indicators of changes in cotton acreage. Given the market signals, the consensus among analysts is that point acreage will be down, but the question is the magnitude. A review of the Council’s survey will begin with a look at the Southeast.

2015 Southeast Acreage - In the Southeast, survey results indicate an 11% decrease in the region’s upland area to 2.4 million acres. Declines are reported for each of the six states in the region as cotton acres move into competing crops. In Alabama, the survey responses indicate a shift to peanuts and soybeans, while Florida’s acreage is moving to peanuts. In Georgia, the acreage shifts are more varied with peanuts, corn and soybeans all expected to pull acres from cotton. A similar picture emerges for South Carolina. In North Carolina, the shift is to soybeans, while corn benefits from the modest decline in Virginia.

2015 Mid-South Acreage - In the Mid-South, growers have demonstrated their ability to adjust acreage based on market signals. This year’s survey results are no different with growers planting 1.1 million acres, a decrease of 26% from the previous year. The 2015 acreage represents the lowest for the region in recent decades. Without exception across the five states, the respondents indicate that cotton acres will move into soybeans for 2015. The survey results also show cotton moves into neither wheat nor corn in any significant amount as acres devoted to those crops by survey respondents are expected to decline.

2015 Southwest Acreage - Growers in the Southwest intend to plant 5.6 million acres of cotton, a decrease of roughly 13%. In Kansas, land shifting out of cotton is moving into corn and the ‘Other Crops’ category, likely grain sorghum. Wheat is the expected beneficiary based on the Oklahoma survey results. In south Texas, respondents indicate a shift out of cotton and into grain sorghum. Respondents from the Blacklands are moving predominantly to wheat, with a smaller shift to corn. In west Texas, the acres shifting away from cotton are split between wheat, corn and grain sorghum.

2015 West Acreage - The West region accounts for the largest percentage reduction across the four production regions. With upland intentions of 134 thousand acres, cotton producers in the West are expecting to plant 47% fewer acres of upland cotton. The survey results for Arizona suggest a shift from cotton to wheat, as well as the ‘Other Crops’ category. Arizona upland growers also indicate a shift to ELS cotton. In New Mexico, the reduction in cotton coincides with responses indicating more acres of grain crops.

2015 ELS Acreage - The survey indicates that growers intend to plant more ELS cotton in 2015, in some cases due to expectations of increased water allocations, and in other instances, due to reductions in upland cotton. Overall, U.S. cotton growers intend to increase ELS plantings 23% to 236 thousand acres in 2015. All states show increases with the largest percentage increase in Arizona.

U.S. Cotton Production - Summing together the upland and ELS cotton intentions shows U.S. all-cotton plantings in 2015 of 9.4 million acres, approximately 15% lower than 2014. The intended acreage is very similar to the U.S. total in 2008 and almost 300 thousand acres above 2009.

Once again, it is important to remember that the survey is a snapshot in time based on grower intentions. Changes in markets and weather will cause actual plantings to differ from early-season intentions.

Planted acreage is just one of the factors that will determine 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. However, it is important to remember the volatility around projected production given the uncertainty of weather patterns.

With average abandonment for the U.S. at 12.8%, Cotton Belt harvested area totals 8.2 million acres. Weighting individual state yields by 2015 area generates a U.S. average yield of 817 pounds. Applying each state’s yield to its 2015 projected harvested acres generates a cotton crop of 14.0 million bales, with 13.3 million bales of upland and 700 thousand bales of ELS.

U.S. Balance Sheet - Returning to the U.S. balance sheet, we can turn our attention to the prospects for U.S. cotton demand. First, let’s look at cotton consumed by U.S. mills.

U.S. Cotton Mill Use - Increasing consumption by the domestic textile industry is projected to continue into the 2015 marketing year. The benefits of the Economic Adjustment Assistance Program (EAAP) are evident with new investment continuing to occur. U.S. mill use is projected to increase by a little more than 100 thousand bales, bringing the total to 3.7 million bales.

Textile trade estimates for 2015 suggest that the overwhelming majority of products manufactured by the U.S. textile industry will move into export markets for further processing.

U.S. Export Markets - Export markets continue to be the primary outlet for U.S. raw fiber production. Just a brief reminder of the key markets for U.S. exports. For 2010 through 2012, China was overwhelmingly the largest export destination for U.S. fiber, accounting for 42% of the total. However, China’s import position has declined in the last 2 years for reasons that we will discuss in more detail. For the 2013 marketing year and 2014 year-to-date, China remains the largest market, but its share has declined to 25%. Turkey, Vietnam and other markets in Asia have gained in importance in recent years.

China’s Cotton Policy - After three years of amassing more than 50 million bales of cotton in government reserves, China instituted a target price program for the 2014 crop at a level of approximately $1.45 per pound. The new target price program was applicable to the Xinjiang province, while the remaining cotton-producing provinces receive a direct subsidy of $0.15 per pound. While details regarding the exact implementation of the new policies have been slow to emerge, this outlook assumes that the policies remain in place for the 2015 crop.

China has indicated that import quotas will be limited to the WTO minimum of 4.1 million bales, and there is still no clarity on management of the existing reserves.

Fiber Prices - China’s policies have direct implications on its internal prices. During the years when cotton was purchased into reserves, the support price essentially acted as floor on the market price. Cotton prices in China were supported at levels well above the “A” Index and above polyester prices.

With the transition to the target price program and the government no longer accumulating reserves, cotton prices have declined to $1 per pound, still well above the “A” Index. Perhaps more importantly for cotton demand, the internal cotton price is almost twice the price of polyester. That price relationship is not allowing cotton mill use in China to recover.

China Balance Sheet - Given the structure of the policies, acreage decisions in Xinjiang must be evaluated separately from the decisions in the eastern provinces. In recent years, the trend in Xinjiang cotton area stands in stark contrast to the other provinces. Since 2008, cotton area in Xinjiang has steadily increased while area in the remaining provinces declined by more than 50%.

For 2015, those trends are expected to continue as the target price program is expected to encourage a modest increase in Xinjiang’s area devoted to cotton. In the eastern provinces, area is expected to decline as China’s internal cotton prices are below year-ago levels. The presence of the direct support can serve to temper the reduction, but nonetheless, a decline of more than 20% is expected. For the country as a whole, a decline in harvested area of 10% is expected.

Barring weather problems, China’s cotton production will not fall as much as area since yields in Xinjiang are much higher than those in other provinces. A 2015 crop of 28.3 million is projected, down 6% from 2014.

Despite being the largest spinner of cotton, China’s mill use remains a concern as domestic use struggles to recover. Between 2009 and 2013, China’s mill use fell by almost 16 million bales as high cotton prices relative to manmade fibers forced spinners to turn away from cotton. In the current marketing year, China’s internal cotton price has dropped by approximately 50 cents per pound, but at close to $1.00, is still almost twice the level of polyester prices. As a result, cotton mill use is expected to show only modest growth in the current marketing year, and the outlook takes a conservative view for 2015 as well.

China’s policy change for cotton farmers was coupled with an announcement that import quotas for 2015 would be limited to the required WTO minimum tariff rate quota (TRQ) of 4.1 million bales. Considering the massive stockpiles of cotton and expectations for limited quota, China’s imports are expected to fall further in 2015. Under the assumption that some additional import licenses will be available, total imports are projected at 6.2 million bales.

The adjustments in China’s supply and demand will allow a modest reduction in stocks, but only down 1.4 million bales to 63.2 million. The stocks remain a burden on the 2015 cotton market.

Value of U.S. Apparel Imports - In addition to China’s cotton policies, there is significant concern with polyester production capacity. As reported by PCI Fibers, China’s 2014 capacity to produce polyester was estimated at almost 220 million bales. China is not fully utilizing capacity, which in part may explain polyester prices in the low 50’s.

The manmade fiber pricing is reflected through the supply chain. Data for U.S. apparel imports show the disparity between a manmade fiber apparel product from China and either a cotton apparel from any country or a manmade apparel from any country outside China. The difference ranges between 30 and 35%, and that is a discount that is hard to overcome.

Other Issues of Note - While there is not enough time to review all of the countries covered in the outlook, it is important to point out a couple of key issues.

Turkey, the second largest export market for U.S. cotton is also being impacted by government actions. In this case, the action is a self-initiated antidumping (AD) investigation of imports of U.S. cotton launched by Turkey in October 2014. A review of publicly available price data indicates no evidence of dumping, and public statements by Turkey’s Minister of Economy suggest that the investigation is conducted in retaliation of U.S. investigations of imported steel products from Turkey.

Regardless of the motivations, the investigation is ongoing and already having a detrimental impact on sales to Turkey due to the uncertainty of not knowing when or if a duty will be imposed. Assuming the investigation follows a conventional timeline, it should be concluded at some point during the 2015 marketing year. For this economic outlook, NCC assumes that the investigation results in no duty applied to imports of U.S. cotton.

Whether this is a valid assumption will depend on the outcome of the investigation, but this assumption is appropriate for two reasons. First, this assumption is supported by the economic analysis of available data. Second, this assumption allows the outlook to serve as a baseline projection against which alternative duties could be evaluated.

Under these assumptions, Turkey’s mill use is projected to show a modest expansion in 2015. Weaker cotton prices relative to grains are expected to reduce cotton production, and Turkey is projected to import 3.8 million bales, up from 3.6 million bales in 2014.

In terms of the global trade picture, government policies in India will play a role in the outlook for the coming year. Under the current climate of weaker market prices, an increased Minimum Support Price (MSP) for the 2014 crop has caused a significant amount of India’s production to move into government stocks. In the short term, procurements by the Cotton Corporation of India have reduced India’s presence in the world, which is significant since India normally occupies the spot as the second largest exporter. However, unlike the Chinese government, India generally does not hold stocks for an extended period of time, and at some point, the cotton will be sold from reserves and enter the marketing channels. A key question becomes timing and at what price.

With internal market prices below the MSP, the decline in India’s 2015 cotton acreage is mitigated by the support from the MSP. The resulting production reaffirms India’s position as the largest producing country. India’s domestic use of cotton is projected to continue to grow, but not enough to reduce India’s export potential. For the 2015 marketing year, India is expected to export 5.9 million bales, but the potential for greater exports exists if the government chooses to be more aggressive in the pricing of cotton from reserves.

World Cotton Trade - As the net effects of the trade adjustments are aggregated together, world cotton trade for 2015 is estimated at 34.6 million bales, up from 34.1 million in 2014 but well below the 2009-13 5-year average of 41.2 million bales. The United States is projected to capture 31% of world trade by exporting 10.6 million bales in the upcoming year.

U.S. Balance Sheet - When exports are added to U.S. mill use, total offtake is 14.3 million bales. Recall that the U.S. crop is estimated at 14.0 million bales, thus leading to a decline in ending stocks of approximately 250 thousand bales.

World Balance Sheet - For the world balance sheet, smaller crops in the U.S. and China account for about 60% of the 6 million bale decline in world production. At 113.2 million bales, the projected crop is the smallest since 2009. World mill use is projected at 113.7 million bales, exceeding production for the first time since 2009.

World cotton stocks decline in the 2015 balance sheet, but the modest decline of 440 thousand bales does little to reduce global inventories that begin the year at 109.8 million bales. In addition, stocks outside of China – an important barometer of price conditions – are projected to increase by 900 thousand bales.

Cotton Prices - While the Council’s economic outlook does not attempt to project cotton prices, it is important to review some of the factors shaping the current price situation. Record levels of cotton stocks, smaller imports by China, weakness in other commodity markets, and a strengthening dollar have created a bearish climate for U.S. and world cotton prices. The “A” Index and December cotton futures are at levels not seen since 2009.

Final Thoughts - Based on the underlying assumptions and resulting cotton balance sheet, many of the same factors remain prevalent in the outlook for the coming year.

While projections of global production exceeding mill use would normally be supportive of prices, the projected differential is not large relative to global stocks. Perhaps more important to the price situation will be stocks outside of China increasing for a second year.

As with any projections, there are always uncertainties and assumptions that can dramatically change the balance sheet. If U.S. export sales continue at their recent pace, ending stocks in the U.S. balance sheet could be sharply lower than currently projected.

We still face a number of uncertainties in cotton mill use, particularly as the global economy struggles. With competitive prices, growth in cotton mill use will occur, but look for that growth to be largely outside of China.

Another question will be acreage response outside of the United States. This outlook does not project that other countries will match the 15% reduction in cotton area in the U.S. To the extent that acreage response is mitigated by government policies, that eventually puts more pressure on producers in the U.S.

2015 is shaping up to be another challenging year for the U.S. cotton industry. Council economists hope this outlook can provide insights to help the industry address those challenges.

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