By Jim Lambert
Director of Sales
FCStone Merchant Services, LLC
Nashville, Tenn.
Considerable ink has been dedicated to China’s cotton consumption for the 2015/16 marketing year and beyond. As the world’s driver of the cotton economy, however, there must be constant analysis. It’s too important a market to neglect or make faulty assumptions on. For this article, I’ve taken a look at the present research from several industry publications, notable market pundits as well as in-house sources. I will fuse together all the information while musing over consumption for the coming year and going forward. To begin, it is essential to have a firm understanding of why we are here.
Cotton’s current doldrums began in 2010 when Upland prices reached $2 per pound. The world, including at the time the largest cotton-growing country, China, planted row to row cotton. By the time harvest had rolled around, prices, while still historically high, had ultimately moved lower, prompting the Chinese government to embark on a massive buying program of domestic cotton. Between 2011 and 2013, the Chinese government bought more than 60 million-plus bales with average prices of $1.40 per pound (and higher) and placed it in state reserve warehouses all across the country. Most of the accumulation was domestic cotton, but some imports were repackaged and delivered to the reserves due to the inflated prices.
There was widespread malfeasance as the local industry responded in an expected fashion, delivering just about anything to the reserve that could be considered as cotton. Recent estimates peg the amount of cotton in China’s state reserves at 51 million bales, which equates to nearly half the current World Agriculture Supply and Demand Estimate (WASDE), world production, consumption and carryover. The implications on the cotton balance sheet are staggering, despite most in the industry agreeing this cotton, at least for the moment, is unavailable. This sort of logic has led to the belief that 100 million-plus bales of carryout is actually, in fact, only 50 million-plus bales. In turn, prices and production for cotton have continued to act as one publication put it, “artificially tight on world supply.” Producers have kept on growing cotton, and cotton prices remain uncompetitive with synthetics (i.e. polyester). Lastly and expectedly, domestic cotton prices in China have remained 40 percent to 50 percent higher than global prices.
There’s no easy solution in dealing with the massive stockpile. The overall quality of the reserve cotton is poor, probably very poor. With this opinion, it is easier to make a case for China to continue importing high grades to mix with the reserve cotton. This has been widely speculated and makes a case for those who think China has no choice but to continue importing – the key question being “when?” Secondly, the Chinese traders and end users don’t seem to want the cotton from the reserve if judged by the results of the recent auctions where the calamity of the buying program came full circle. Two months ago, China attempted to sell more than 4.4 million bales from the reserves. Prices were set well above current world prices, while quality discounts were minimal at best. As a result, only 300,000 bales were taken up, and the auctions stopped. The state press lauded the results, but the rulings were very clear. No one wanted to buy the cotton. One domestic trader told us in no certain terms that the quality of the cotton offered was terrible, and the prices expected to be paid were a joke. This trader told us it would be cheaper for him to go out of business than do business with the auction.
This finally brings us to the issue of Chinese consumption for 2015/16, which the recent WASDE has estimated at 34 million bales. I’m inclined to believe this number is an overestimation, but let’s build a scenario as to why this might be the case, beginning with U.S. exports. Figure 1.1 offers a quick look at outstanding US export sales. China’s 69,800 bales represent a fraction of the previous year. In fact, China wasn’t even represented in the Top 10 until the rollover from 2014/15 exports.
Secondly, while global consumption has increased, albeit slightly, there is still tepid demand in the market. Again, I refer to U.S. outstanding export sales in the below chart. For the current 2015/16 marketing year, only 2.27 million bales have yet to be shipped. This clearly illustrates, compared to previous years, the low amount of sales on the books (and not shipped) at this stage of the marketing year. Shipments, which have been slow, are nevertheless managing to outpace new orders.
A final but slightly different look considers the overall U.S. commitments, which include both shipped and unshipped as a percentage of final exports. At this stage, the United States has sold and shipped only 30 percent of the total 2015/16 projected exports of 10.2 million bales. Only two other years in the last 10 years had lower percentages at this point of the marketing year. The chart below shows how much cotton has been sold for export plus actual shipments up to the seventh week of each respective marketing year. At this point of the year, the United States has usually committed an average of 41.5 percent of final exports. As you can, this year’s commitments are far behind the usual pace.
Some other final relevant points are worth mentioning, beginning with a revision in China’s yearly consumption. It’s safe to say the country will never consume 51 million bales again. This will play out in a much lower import number, probably closer to the current USDA estimate of 5.75 million bales but also possibly higher. Secondly, China’s cotton acreage is moving west, and we believe will fluctuate in the 3.5 to 5.0 million ton production range, depending on weather and land availability. If this plays out more drastically, the import window would expand to about 6 to 7 million bales. Third, and perhaps most contentiously, we see Chinese yearly consumption hovering just over 30 million bales.
The economics of continued heavy cotton imports simply don’t bear out especially when it is (and will likely remain) cheaper to import cotton to Vietnam or China’s Free Trade Zones (namely Qingdao) and “export” cotton yarn duty free to China. There’s simply too many ways to bring cotton to China without it necessarily being in a bale. While this may sound overtly negative, it shouldn’t be construed that way. The United States is firmly positioned to benefit from this change. The demand from China, although smaller, will be extremely focused only on high grades, and the United States is still the largest supply of high quality cotton in the world.
**Comments in this article are market commentary and are not to be construed as market advice. Trading is risky and not suitable for all individuals.
Contact Jim Lambert at jim.lambert@intlfcstone.com.