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2013 Cotton Economic Outlook
NCC Annual Meeting
Memphis, TN
February 8-10, 2013
INTRODUCTION - For the coming year, there are significant uncertainties and questions that will shape the economic health of the U.S. cotton industry. With this outlook, NCC staff hopes to provide some perspective and insights on the economic landscape. Before summarizing the projections for the global cotton market, it is important to review the underlying assumptions for the general economy and government policies that are assumed to be in place for 2013.
WORLD REAL GDP GROWTH- The International Monetary Fund (IMF) calls for growth to continue for the next two years at slightly improved rates than observed in 2012. But, their forecast also notes that much of the growth is policy-dependent and that downside risks remain significant. Recovery in the Euro Zone is expected to be further delayed, and the outlook for the U.S. economy is contingent on fiscal policies. It is also worth noting that preliminary estimates for the 4th quarter of 2012 showed a modest contraction in the U.S. economy – the first quarter with a downturn in economic activity since the recession. In summary, economies are expected to grow, but the continued recovery is not robust.
No major changes in government policies are assumed relative to the policies applied to the 2012 crop. For the United States, the extension of 2008 farm bill, as in place for the 2012 crop, will apply to the coming marketing year. India is expected to maintain a minimum support price for cotton. Likewise, China is expected to continue their policy of supporting prices by purchasing domestic cotton production into government reserves. The key uncertainty, which will be discussed later, will be the extent to which China makes the reserve cotton available to the market.
NCC ACREAGE SURVEY- One of the key questions dominating the U.S. market is the expected change in cotton acreage given current market prices. Each year, the National Cotton Council surveys U.S. cotton farmers as to their acreage intentions for the coming year. Both 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 2012 and the acres planned for the coming season. Surveys were distributed on December 18th and responses were collected through January 23rd.
PRE-PLANTING MARKET SIGNALS- Cotton farmers are responsive to market signals. Relative prices of cotton and major competing crops, as measured by the harvest-time futures contracts, have been the primary factor influencing U.S. acreage. During the survey period, the December 2013 cotton contract averaged 79 cents per pound, as compared to 92 cents in the weeks prior to planting the 2012 crop. In contrast, corn and soybean futures are trading above year-ago levels. Price ratios of cotton-to-corn and cotton-to-soybeans are comparable to 2009, the year of the most recent low in cotton acreage.
U.S COTTON AREA & PRICES- Projections by market watchers have been calling for reduced acreage in 2013, and the NCC survey agrees with those expectations. For the U.S. as a whole, the survey indicates total cotton acreage of 9.01 million acres, down 27% from 2012 and the lowest since 1983.
2013 SOUTHEAST ACREAGE- Survey results vary by production region. For the 6-state Southeast region, respondents indicated a decline of 18%, lowering the regional total to 2.24 million acres. For additional insight into the survey, responses can be categorized one of three ways: increasing cotton acreage, maintaining acreage unchanged, or reducing acreage. Based on the number of responses for the region, two-thirds indicated a decrease in area, with the remaining one-third of responses equally split between those maintaining acreage and those increasing acreage. Respondents indicating a decline in acreage are shifting to corn and soybeans, with soybeans more heavily favored as the alternative. Respondents planning more acres of cotton indicated fewer acres in the 'Other Crops' category, which is peanuts in this region.
2013 MID-SOUTH ACREAGE- Collectively, the five states in the Mid-South will plant 1.00 million acres, which is half of last year's total. The significant reduction underscores the ability of farmers in the region to move between cotton, corn and soybeans. More than 85% of survey respondents said their cotton acreage will decline in 2013, with corn accounting for slightly more than half of the decline. Soybeans account for the remainder of the decline in acres, with many of the soybeans being double-cropped with wheat.
ARKANSAS CROP RETURNS- The decline in cotton acres is also consistent with relative returns for cotton and competing crops based on current futures markets. Using USDA costs of production and trend yields, the shortfall between cotton net returns and returns for corn and soybeans is substantially larger than in 2009 – the most recent low in acreage.
2013 SOUTHWEST ACREAGE- Results for the Southwest indicate total upland acres of 5.23 million, down 24% from last year. For the region as a whole, 2013 acreage is very similar to the years 2007 through 2009. The respondents planting less cotton, which was the case in approximately 65% of responses, said they intended to move those acres into grain sorghum, wheat and corn, in that order. Between 10 and 15% of the responses are intending to plant more cotton, with some of those acres coming from grains, but the larger reason underlying the increases appears to be weather. More specifically, additional cotton acres will come from growers that were unable to plant in 2012 due to drought conditions.
2013 WEST ACREAGE- In the West, a 12% reduction is expected with the regional total at 341 thousand acres. Approximately 50% of the responses indicated reduced acres, with the vast majority of those acres moving into the 'Other Crops' category. In 30% of the responses, growers plan to maintain acreage at the same level as last year, while the remaining 20% said they intend to plant more cotton, largely at the expense of wheat.
2013 ELS ACREAGE- For extra-long staple cotton, U.S. acreage is pegged at 203 thousand acres, down 15%. As in the case of upland cotton, Pima prices down from year-earlier levels are inducing a shift to other crops.
% CHANGES IN FUTURES PRICES- The NCC survey captures the intentions of producers at the time of the survey. Changes in markets and weather will affect final planting decisions. Since the time of the survey, cotton prices have strengthened relative to corn and somewhat relative to soybeans. As a result, the survey could err to the low side when compared to current expectations. Overall, a reduction is coming, with the final magnitude to be determined.
U.S. COTTON PRODUCTION- Planted acreage is just one variable determining production. Weather is often a more significant determinant of the final crop. The standard approach to the Council's projections is to assume abandonment rates for each state in line with historical averages and state-level yields consistent with recent trends. Doing so would give a U.S. crop of 13.3 million bales.
In this outlook, slightly above-average abandonment rates and yields marginally below trend are assumed in the Southwest region due to the dry conditions. Those assumptions, coupled with average conditions for the remaining regions of the Cotton Belt, generate a U.S. cotton crop of 12.9 million bales.
However, past experience tells us that actual production can deviate greatly based on variation in yields and abandonment. Applying deviations from the past 25 years to planting intentions for each state produces a distribution for the U.S. crop ranging from a low of 9.5 million bales to a high of 17.2 million bales.
U.S. BALANCE SHEET- Staying in the U.S. market, let's turn our attention to cotton demand. Consumption of cotton can be measured at different points along the textile supply chain. Initial demand occurs at the mill that produces yarn from cotton fiber. Final demand occurs with the consumer's purchase of finished apparel and textile products. Although purchases of finished consumer goods are generally measured in units, it is useful to convert the products into an equivalent pounds of fiber based on product weight and fiber blend. The proxy of the retail market equals the sum of the amount of cotton consumed by U.S. mills and the fiber equivalence of textile net imports into the United States.
COTTON'S SHARE OF U.S. NDC- Recent data for the U.S. consumer market demonstrates the challenges the industry faces in terms of competition from synthetic fibers. Cotton's market share has ranged between 36 and 40% over the past two years.
APPAREL IMPORT PER-UNIT VALUES- In part, the loss in market share is the result of cotton prices that have been uncompetitive with polyester. As raw fiber prices have moderated in recent months, prices of cotton textile products have also become more competitive with manmade fiber products.
NET DOMESTIC FIBER CONSUMPTION- Based on 11 months of data, calendar 2012 net domestic consumption of cotton fiber by U.S. consumers is estimated at 17.0 million bales. Since 2005, net domestic consumption in the U.S. is down by 10 pounds per person. The 2012 U.S. retail cotton market fell to the lowest level since 1996, amid a 4th consecutive year of declining market share on a volume basis.
U.S. BALANCE SHEET- Assuming relative prices continue at levels comparable to current values, market share is projected to stabilize, leading to a modest growth in cotton net domestic consumption for 2013. However, cotton is unlikely to reclaim market share unless cotton prices trade at levels below polyester.
Cotton consumed by U.S. textile mills has presented a more stable appearance over the past several months. Monthly consumption is currently running at 3.5 million bales on an annualized basis. This compares with 2.7 million bales at this time last year. For the current 2012 marketing year, U.S. mills are estimated to use 3.4 million bales. For the 2013 marketing year, a modest increase is projected with a total of 3.5 million bales used by U.S. mills.
INT'L AREA (EXCLUDING CHINA)- For more than a decade, international markets have comprised the largest outlet for U.S. cotton production. Over the past five years, exports have consistently accounted for 75 to 80% of total offtake. Exports not only depend on available supplies of U.S. cotton, but also on changes in production and mill use in other countries. Before looking at the Council's outlook for U.S. exports, it is necessary to review projections for the international market. For purposes of this summary, a separate focus will be given to China, while other countries will be addressed in a more collective manner. The distinction between China and all other countries is justified by the disparity in price signals brought about by China's current stocks policy.
In 2012, 61.8 million acres of cotton were harvested outside of the United States and China, with India accounting for almost half of those acres. Last year's area was down almost three million acres from the 2011 season, which was a record high. The Council expects another modest drop in area for 2013 in response to lower cotton prices, and in some countries, the lower price of cotton relative to grains and oilseeds. Although cotton prices are down from year-ago levels, the expected decline in acreage is modest as cotton remains the most attractive alternative in many countries.
INT'L MILL USE (EXCLUDING CHINA)- Turning our attention to international mill demand, we will first focus on countries outside of China. A shift is underway in terms of where cotton is spun into yarn. For the current 2012 marketing year, mill demand outside of China is estimated at 67.2 million bales, up 5.4 million bales from the previous year. India and Pakistan together account for 33 million of the 67 million bales. After the detrimental effects of the recession followed by the loss of demand in the aftermath of $2 cotton, cotton spinning has regained its footing and is showing solid growth. For the coming year, NCC economists expect mill use in these countries to grow by almost 4 million bales, approaching 71 million bales. India and Pakistan account for slightly more than half the growth.
YARN EXPORT VALUES – COTTON PRICE- Continued growth in mill use is being supported by the relatively stable price pattern of recent months, more competitive prices when compared to polyester and more favorable spreads between yarn values and fiber prices. For India and Pakistan, the differential between yarn export values and fiber spot prices has been much improved in recent months.
FIBER PRICES- The other factor supporting mill use in these countries is China's current policy of buying cotton for their strategic reserves. While the spread between yarn values and local prices is attractive to spinners in other countries, the same relationship does not hold for China. By purchasing their domestic production at prices 40 to 50 cents above world prices, China is insuring that their internal prices are well above world prices, and causing their cotton spinning to be uncompetitive.
YARN EXPORT VALUES – COTTON PRICE- For China, differentials between yarn values and fiber prices are only one-third of those in India and Pakistan.
CHINA COTTON YARN IMPORTS- Fabric manufacturers in China are increasingly looking to fill their yarn demand with imported product. If China continues to import at the current pace, China will import cotton yarn equivalent to 7.5 million bales of fiber in the current marketing year. This compares to 5.0 million bales in the 2011 marketing year.
CHINA COTTON USE- China's current policy, while supporting prices received by farmers, acts as a tax on textile mills and has furthered the shift to manmade fiber. Over the 2009 through 2012 marketing years, mill use in China declined by almost 15 million bales. Over that same period, China's use of manmade fiber grew by 40 million bales, dropping cotton's market share from 30% to 19%. Although no official announcement has been made regarding the 2013 policy, this outlook assumes that the government support price remains at a level comparable to 2012. Continuing to operate the program in a manner similar to the past year will maintain pressure on cotton spinning mills. As a result, mill use for the 2013 marketing year is expected to decline further, falling to 34.3 million bales.
CHINA'S RESERVES: THE BIG UNKNOWN- With the support price well above world market prices, the vast majority of China's domestic production will enter government reserves. From the 2012 production of 33.5 million bales, current information suggests that more than 28 million bales will be purchased by the reserves. A similar scenario is assumed for the 2013 crop. Despite the high support levels, cotton acreage in 2013 is expected to decline by 4% due to strong competition from food crops. Assuming average yields, China's 2013 cotton crop is projected at 30.7 million bales. It is assumed that as much as 26 million bales of the 2013 crop will enter government reserves.
Both in the current marketing year and the year to come, the most important unknown is the extent to which China releases cotton from the reserves. If China's textile mills are to continue to consume between 34 and 35 million bales of cotton, then there will be either significant sales from government reserves or significant imports from the world market. In the 2011 marketing year, it was the case that the Chinese government was only a buyer and not a seller. As a result, 20 million bales from the 2011 crop were placed in reserves and the shortfall in domestic supplies was satisfied with imports of 24.5 million bales.
In the current marketing year, the government has commenced sales from the reserves. For the marketing year as a whole, it is assumed that 3.5 million tons, or 16.1 million bales, are sold from reserves. Even with significant sales, total imports by China are estimated at 12.5 million bales. Cotton in government reserves on July 31, 2013 would stand at 33.8 million bales, which is 95% of mill use. For the 2013 marketing year, China's decision regarding sales from the reserves and the allocation of import quotas/licenses is the key uncertainty.
In this outlook, China is assumed to sell 21 million bales of cotton during the course of the 2013 marketing year. When coupled with purchases of 26.1 million bales from this year's crop, China will continue to build government reserves, holding 38.8 million bales on July 31, 2014. In order to supply projected mill use of 34.3 million bales, China would import 6.8 million bales, which includes the WTO-required quota of 4.1 million bales. Under this scenario, total imports for the 2013 marketing year are slightly more than half the import level for the current marketing year.
WORLD COTTON TRADE- Reduced imports by China are only partially offset by increased imports in other countries, leading to a decline in world trade from 38.9 million bales to 36.0 million bales. With a reduction in exportable supplies, the United States is projected to see a decline in exports for the 2013 marketing year, down 1.6 million to 10.6 million bales.
U.S BALANCE SHEET- When combined with mill use of 3.5 million bales, total use of 14.1 million bales exceeds the U.S. crop by 1.2 million bales. Ending stocks for the 2013 marketing year fall to 3.6 million bales, giving a stocks-to-use ratio of 25%.
WORLD BALANCE SHEET- Summing individual country projections gives a 2013 world crop of 110.1 million bales, down 8.7 million bales from 2012. World mill use is projected to increase to 108.7 million bales, 2.6 million bales higher than 2012. The relative balance between production and use causes world stocks to grow to 83.1 million bales by the end of the 2013 marketing year. Although the projections initially appear bearish, that is not necessarily the case as increases in China's government reserves more than offset a decline in "available" cotton stocks.
COTTON TRADE BALANCE- The potential impact of China's management of their reserves must be reiterated. Should they choose to be a more active seller in the coming year, China's imports could fall to the required WTO quota of 4.1 million bales. That would be 2.7 million bales less than the 6.8 million bales projected in this outlook. Given current U.S market share of China's cotton imports, a 2.7 million bale decline in imports translates into almost one million fewer bales of U.S. exports.
China could also go to the other extreme and choose to sell very little of their reserves. Under that scenario, imports could increase to levels comparable to the current marketing year. Such an outcome is more bullish for U.S. exports in the short term, but the scenario only delays the inevitable outcome of working the cotton reserves back onto the market.
SUMMARY POINTS & QUESTIONS GOING FORWARD- The coming year is shaping up to be a challenging year where uncertainties regarding the market are magnified by the 40-million bale gorilla that is China's government reserves. The expected decline in U.S. acreage and production will present problems for businesses that are largely volume-dependent. But, as we have seen in the past, commodity markets are cyclical, and producers must be prepared to respond to markets that can quickly change.
GROWTH IN CHINA FIBER MILL USE? & SHIFTS IN COTTON MILL USE?- After consecutive declines, cotton demand has stabilized and is expected to grow in the coming year. However, the battle for market share with manmade fibers has never been fiercer. With a recovering global economy, there is excellent potential for growth in cotton demand. However, that full potential will not be realized as long as China continues to operate their current policy in a manner that stifles cotton demand.
MARKETS FOR U.S. COTTON? - It appears that shifts in demand for U.S. cotton are on the horizon. In recent years, China accounted for 30% of U.S. cotton offtake. U.S. mills bought 20% of the crop, while Turkey and Mexico accounted for another 20%. All other customers combined for the remaining 30%. With China's domestic production and mill use being much closer in line with each other, it is likely that they will not need 30% of the U.S. crop. It appears that market is now shifting to other countries in Asia.
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