Policy change could trim Chinese cotton acres

The announcement of China's new target price subsidy is most important for what it doesn't say.

Chinese cotton acreage could decline significantly over the next few years on the heels of China’s new target price subsidy program, according to Ed Jernigan, president and CEO, Jernigan Global Commodities.

Speaking by phone at the 2014 Cotton Roundtable in New York City, Jernigan said information on the target price model is sketchy, but appears to resemble the target price previously used by the U.S. farm program.

Jernigan says China is “moving to free its domestic cotton market from state domination, just like it did in soybeans many years ago. This is a great development for the United States and the world cotton industry.”

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Jernigan said the announcement included a “vision statement” that China was switching its focus to food crops and was ending cotton as a state-controlled commodity.

Jernigan said the target price announcement “is just as important for what was not said, as there was no mention of a subsidy for areas outside Xinjiang Province. In 2013-14, Xinjiang produced over one third of the Chinese crop, 11.578 million bales.”

“The new Chinese leadership was bold enough to realize it was simply uneconomical to grow cotton in the small farm plots of eastern China where scale and mechanization is impossible,” Jernigan said. “However the announcement has been lacking in detail and we are still waiting for full detail.”

In Xinjiang, the government subsidy will be the difference between the target price, announced at $1.44, and the average market price. “The details of how this will work have yet to be announced and the market is full of rumors.”

One of those rumors, according to Jernigan, is that there may be limitations on the subsidy, which may lower payments. There was also a rumor that eastern Chinese cotton producers may receive a flat subsidy.

Jernigan told listeners that China’s textile mills will be needing cotton in September, but may not be able to get it from domestic sources, which could lead to some short-term volatility in the cotton market.

China cannot fill the need with its state reserve stocks, estimated at 61 million bales, because the stockpile has apparently deteriorated significantly, according to Jernigan. “Cotton is not a commodity suited for long periods of storage. It suffers weight loss, reduction in color grade and deterioration in spinning quality. This means that each day, the quality of the reserve stocks is declining.”

Quality declines

Jernigan said quality declines in the reserves contributed to the volume of imports into China exceeding expectations in 2013-14.

“Mills buying reserve stocks have found they have to blend it with imported cotton or new crop cotton to improve yarn quality. Reserve stocks cannot be used as a sole source of cotton consumption in China,” Jernigan said.

Jernigan says the Chinese will halt sales of its reserve stocks in August and sales will not be resumed until the new crop is harvested. This will create new demand for cotton until the new crop comes off.

 “As we move into September, spinners will either have to buy new crop cotton, or import cotton,” Jernigan said. “In Xinjiang, new crop will not reach the eastern mills until after January. Therefore all the domestic demand from Sept. 1 to Dec. 31 will have to be met from old crop inventories on hand, from the eastern new crop, which comes off earlier, or from imports.

“The eastern new crop will total about 8.27 million bales. This crop is hand-picked, and the progress of the harvest will depend on uncertain fall weather. In addition eastern Chinese growers may balk at selling their cotton 40 percent or 50 percent below last year,” which may happen in the absence of a government subsidy.

Jernigan estimates that Chinese spinners will need about 12 million bales from September through December. “It remains to be seen what will happen, but it does raise the possibility for larger imports to meet demand if quotas are available during the September through January timeframe. The price spread between the January Chinese futures and the landed mill price of U.S. cotton of the same quality will be will be very important as we move into the movement of new crop.”

In the long-term, If Chinese leadership holds firm, and there’s no subsidy outside of Xinjiang, Jernigan believes cotton production outside the province “will virtually come to an end. That means that China’s total cotton production would range between 18 million and 21 million bales. Consumption is not going to explode back in China because a lot of the capacity has moved offshore. But I do anticipate a better market moving forward in China and a steady increase in imports.”

India, another major export market, has faced a sporadic monsoon this year, which could affect its production and exports, Jernigan said.

“The size of the Indian crop is such a sensitive issue because domestic consumption in India is about 30 million bales. So any volume of production above that level will determine the level of exports.

“India will play a pivotal role in 2014. It is now the second largest textile exporter in the world. If cotton production is reduced because of the monsoon, this will have a major influence on prices.”

World stocks

USDA recently forecast that 60 percent of world cotton stocks outside of China will reside in the United States in 2014-15, one reason why Jernigan remains bearish. “The large U.S. crop has resulted from the end of the drought in West Texas. It has changed the balance of stocks outside of China and been one of the largest contributors to the sharp drop in prices.

“We think the United States is likely to produce a crop of between 16 million and 17.5 million bales. We are concerned about a long-range weather model which suggests that the entire U.S. cotton belt will experience a wet fall.”

Several factors will hold the key to cotton prices, according to Jernigan. “World stocks outside of China are estimated at 43.4 million bales, the highest in over 10 years. If Indian production falls by 7 million to 8 million bales, stocks will drop to 35 million bales to 36 million bales, which would be the second tightest in 10 years.”

Other factors include how well China implements the free market in new crop cotton, how fast the crop will move to mills, the quality of the crop and whether or not there is a subsidy outside Xinjiang Province.

With China’s reserve cotton continuing to deteriorate, “low-grade quality needs will be met with reserve stocks or cotton yarn imports for many seasons. Therefore, Chinese mills will need the longer-staple, inch-and-an-eighth cotton, and better grades.”

The Cotton Roundtable is sponsored by Intercontinental Exchange, Cotton Incorporated, Certified FiberMax, Ag Market Network and Farm Press Publications.

TAGS: Outlook
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