5 factors affecting cotton prices

Is cotton hanging by a thread? Will soft growth fray the cotton markets nerves? Will a soft market leave cotton with no cushion or is the cotton market unraveling?

Whatever, it is the only major commodity futures market to have registered a significant increase in price during 2015 – up 7% at 64 cents per lb.

Feld mit reifer Baumwolle.jpeg
Feld mit reifer Baumwolle“. Licensed under Public Domain via Wikimedia Commons.

1) Declining cotton production

The US Department of Agriculture, in its first forecasts for 2015-16 forecast world cotton output falling 5.4% to 133 million bales, sapped by lower, or flat, harvests in all major producing countries. US output will fall particularly far, by 2.1 million bales to 14.1 million bales, a reflection of lower sowings due mainly to relative prices and net returns that favour alternative crops.

Chinese output will fall 2.0 million bales to 28.0 million bales, the lowest since 2003-04, a reflection of a revised subsidy regime that favours farmers in Xinjiang, the top growing province, over producers in other areas (more on that later).

2) Higher economic growth

A shaky economy tends to dent consumer spending on discretionary items such as cotton sheets, shirts, and jeans. However, according to the USDA consumption will grow at an “unusually high rate” of 4.2% in 2015-16, lifted by the knock-on effects of stronger world economic growth. Despite this world inventories are seen ending next season at 106.8 million bales, equivalent to some 11 months’ needs.

3) End to Chinese stockpiling

In China Beijing has pledged to end a costly stockpiling program that has artificially inflated cotton prices and replace it with a subsidy program instead. However, the Xinjiang Production and Construction Corps (XPCC), a quasi military body that employs about 200 thousand in the cotton industry in Xinjiang is resisting calls for change.

XPCC which produces around 30% of China’s cotton has been keeping prices around $80 per tonne higher than other producers. The group may have to slash its price later in the season if the state doesn’t intervene and purchase its leftover stock, putting pressure on benchmark local prices while also weighing on international cotton prices.

Another factor is the quality of the cotton bales held in storage. If the quality of the cotton in the reserve is poor, then Chinese import demand will persist, or perhaps even improve, because quality foreign cotton will be needed to blend with inferior Chinese cotton. There are no statistics on quality however although some estimate that about half of the Chinese reserve is likely to be of inferior quality.

4) Falling oil prices

Cotton has the largest per-acre energy costs of all agricultural commodities and so so changes in the price of oil can also directly affect the price of cotton. According to a recent report from Societe Generale the historical correlation between cotton and crude is the highest across all commodities at 0.45:1.

Cotton competes with polyester in the worlds fibre and apparel markets. The post-2009 jump in cotton prices led China to vastly expand its capacity for purified terephthalic acid (PTA), the oil-based raw material for polyester. PTA prices in China have declined sharply since mid-2014 improving the price competitiveness of polyester vs cotton, a further drag on cotton prices.

5) Seasonal factors

Finally, cotton prices tend to peak around Feb/Mar before bottoming out in August.

Related article: Which commodities are most affected by lower oil prices?

 

Europe set to benefit from surge in LNG supply

European gas markets are set to benefit from a surge in liquid natural gas (LNG) from Asia over the next few years, helping to allay fears over geopolitical uncertainty emanating from Russia and a welcome boost for European manufacturers.

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Asian gas prices have slumped by 60% over the past year due to mild weather and new supplies. The sharp drop in Brent crude prices has also weighed on LNG prices linked to oil. The decline now means that European gas prices, as measured by UK NBP are now higher than Asian LNG for the first time since early 2011.

The trend is likely to continue for some time yet. According to Energy Aspects global LNG supply will increase by 7.3% in 2015 and a further 10.6% in 2016 with new volumes from Australia and the U.S.

The new supplies are also running into a market facing uncertain demand. Japan is considering restarting at least two nuclear reactors shuttered after the Fukushima crisis as early as May this year. This could lead to lower demand for imported energy such as LNG and may lead to further falls in Asian gas prices, potentially resulting in even more supplies heading to Europe.

Related article: Crunch time for European gas supplies?

Commodities explained: Malthus

“Yet in all societies, even those that are most vicious, the tendency to a virtuous attachment is so strong that there is a constant effort towards an increase of population. This constant effort as constantly tends to subject the lower classes of the society to distress and to prevent any great permanent amelioration of their condition”

Thomas Robert Malthus was a British cleric and scholar. His principle work “An Essay on the Principle of Population” published in 1798 suggested that while population rises exponentially, agricultural output could only increase arithmetically due to the finite amount of land available. As a result, “positive checks” (described by Malthus as higher mortality caused by famine, disease and war) were necessary to bring the number of people back in line with the capacity to feed them.

In the second edition, published in 1803 Malthus softened his original harsh message by introducing the idea of moral restraint. Such a “preventive check”, operating through the birth rather than the death rate could provide a way to counter the otherwise inexorable logic of too many mouths chasing too little food. If couples had fewer children, population growth could be sufficiently arrested for agriculture to cope.

However the basic tenets of his theory has, until now at least proved to be false. What Malthus didn’t really count on was human ingenuity. Since the 1800’s dramatic improvements in agricultural productivity, the expansion in international trade and legislative reform (for example the abolition of Britain’s corn import duty, known as the Corn Laws in 1846) resulted in vast increases in food production and lower prices enabling a much larger population to be supported.

The writings of Malthus are by no means the last time concerns about population growth and the ability of the planet to cope have been voiced and probably won’t be the last. By the late nineteenth century, it was coal, not corn, that was the focus of a kind of Malthusian scarcity. More recently the book The Limits to Growth, commissioned by The Club of Rome was published in 1972. In a similar vein to Malthus the book stated that if the world’s consumption patterns and population growth continued at the same high rates of the time then the earth would hit its limit within a century.

What later became known as the Malthusian Catastrophe continues to be popular to this day. The recent food price hikes of 2008-2011 have reinvigorated proponents of Malthus’ theories that the world is facing a much more difficult future that may check population growth.

Environmental degradation of agricultural producing regions (lack of water, pollution etc.) and the likelihood that it will get worse over the next few decades may represent one of the greatest threats to the continued growth in agricultural productivity and the ability to feed a growing and increasingly wealthy human population.

However, agricultural productivity may well continue to rise as investments in farm equipment, genetically modified food and improvements in the way food is handled from farm to plate boost food availability.

Takeaway

Malthus thought that since agricultural output could only increase arithmetically, population would continue to rise exponentially meaning that sooner or later population growth would be checked by famine and disease. So far he has been proved wrong.