With spot cotton prices seemingly stuck several cents below the loan rate for much of this season, a significant portion of the U.S. crop seems destined for the Commodity Credit Corp. loan this fall.
Normally, that means growers must play a waiting game until merchants look at the classing sheets and bid their cotton out of the loan. But this year could be different because of a new program from The Seam that enables merchants to purchase grower equities and redeem the cotton from the loan – all with a few keystrokes on a computer.
The electronic redemption process is one of two new offerings from The Seam, the cotton industry’s electronic trading platform that has just begun its fourth year of operation from its headquarters in Memphis, Tenn.
The other, which will allow growers to sell cotton on a basis contract, could help growers in the Southeast and Mid-South receive more for their cotton through basis contracts.
“The model that The Seam was built on was developed in Texas,” said Phil Burnett, president and CEO of the company. “As we have moved into other areas, we have learned we needed to make adjustments.
“In the Southeast, we added a program for basis trading – which also works in the Mid-South – because that’s the way they like to do business.”
As growers know all too well, cotton futures have been trading in the mid- to upper 40s for most of the growing season. In late August, futures rose above 50 cents, but spot prices remained below the 52-cent loan rate for base grade and staple.
“This crop season is setting up to be a big loan year,” said Burnett. “Unless prices rise significantly, growers will be trying to decide whether to take the LDP or stick the cotton in the loan.” (Growers may elect to receive a loan deficiency payment or LDP – the difference between the adjusted world price and the loan rate – and forgo the loan.)
In the past, purchasing a grower’s equity and redeeming the cotton from the CCC loan has been a paper-heavy process that involved merchants wading through lists of USDA Classing Office recap sheets to find cotton they wanted to buy.
Then the merchant had to contact the grower to make an offer on his “equity,” the difference in the AWP and futures minus any storage and handling costs. If the grower agreed, the merchant went to the county Farm Service Agency to execute Form 605s and present a check to redeem the cotton.
Under The Seam’s new program, merchants will be able to look at HVI classing data on each bale, decide which equities they wish to purchase and complete the redemption process electronically.
“The current process takes some lead time,” says Burnett. “But it may be in the grower’s – and the merchants – interest to complete the process quickly, particularly during times of volatile markets.”
A case in point occurred when New York cotton futures rose nearly 700 points in mid-August. Most observers expected the adjusted world price to be higher – and the loan deficiency payment to be lower, as a result – when USDA announced the new AWP on the following Thursday.
“Under those circumstances, a grower with cotton in the loan might want to sell his equity before the AWP went up and capture the greater difference in the loan rate and the AWP,” said Burnett. “In that case, time would be of the essence and we can help facilitate that process.”
Another feature of The Seam’s program is that it provides quality factors down to the bale on its electronic trading system. “The merchant can take those details, put them in the system and calculate what the bale is worth,” said Burnett.
“When the merchant receives the equity recap or summary of what the cotton is worth, he therefore can make a higher bid to the grower because he knows there aren’t any hidden charges that he might have to pay.”
“Another thing to note is that the grower will have 85 firms that participate in The Seam looking at his cotton,” said Kevin Brinkley, vice president for marketing and business development at The Seam. “In the local market, there might be three or four local buyers.”
The Seam’s new grower-to-buyer basis trading system allows growers to negotiate the basis (the difference between futures and cash or spot prices) rather than seek a firm offer on price.
Using this method, the grower and the buyer negotiate a basis level of so many points of New York futures. (A buyer might offer 400 points off New York, the grower counter with 250 and they might settle on 325, for example.) Once they agree on the basis, The Seam will execute a futures order on behalf of the buyer. The executed futures sale and basis are used to determine the physical settlement price to the buyer and seller.
Basis contracts help protect farmers who are concerned that the basis might “move away from them,” reducing the actual price they receive for their cotton. On the other side, the buyer is hedged with New York futures after agreeing to the contract.
“The seller negotiates the best basis level he can obtain through our electronic system,” said Brinkley. “The buyer gets his cotton and is fully hedged. The only risk he has is the basis risk, which he is accustomed to working with.”
Brinkley says timeliness has been one of the key ingredients in helping The Seam trade more than 7 million bales of cotton since its inception in 2001.
“It’s not only a factor of exposing a grower’s cotton to the right people – merchants who are actively seeking cotton – it’s also a matter of timing,” he notes. “The sooner you can get cotton into the market, the better your chances are to do well with it. Growers who had cotton in the system when prices rose above 80 cents per pound last October. Many of them sold their cotton before the market went south.”
Figures from The Seam’s trading platform show that growers who marketed their cotton on the system in the 2003/04 marketing year received an average of 11.14 cents per pound over the CCC loan rate. Based on average yields of 634 pounds per acre nationwide, the year’s return yielded an average $70.65 per planted acre above cotton that sold for the loan rate.