China plans to end the cotton stockpiling program it began in 2011 and will instead consider subsidizing domestic producers, according to a Reuters news report. Details are sketchy, however, and the new policy may take a year or more to implement.
China’s reserve-building policy paid its domestic cotton producers significantly higher-than-market prices and essentially kept over 60 percent of the world’s cotton supply off the market, allowing cotton futures prices to remain higher than fundamentals might have suggested.
The policy forced Chinese textile mills to purchase domestic cotton at uncompetitive prices, import cheaper cotton under a rigid quota system and increase the percentage of man-made fiber in its polyester-to-cotton blend.
Since 2010, Chinese consumption of raw cotton has fallen, and Chinese textile mills have increased imports of cotton yarn. Global ending stocks of cotton have risen to a record 94 million bales, which is almost a year of consumption.
The Reuters article quoted Du Min, China’s director of the Research Center for Rural Economy at the Ministry of Agriculture. “All parties are working to change the (cotton) policy. Farmers are not planting cotton anymore, while mills are no longer spinning (domestic) cotton. The stockpiling has to come to a stop, otherwise the whole industry chain will be ruined.”
There was little doubt that the change in policy was coming. In July, Joe Nicosia, global cotton platform head, Louis Dreyfus, said he didn’t think that China would be able to sustain its stock-building policy much longer. “With the December 2014 cotton futures contract currently trading at 78 cents, the market has started to price in some sort of change,” Nicosia said.
“It’s already built into the commercial opinion that price weakness in cotton is coming,” said Texas A&M University Extension economist John Robinson. “Futures contracts are inverted – near-term futures contracts are higher than the ones 12 months out – which suggests that there is a built-in expectation of some level of unwinding (of the Chinese reserve).”
The policy change, “is a bit of a bureaucratic signal, but it’s still about as fuzzy as it was 12 months ago, when we knew China was going to unwind, we just didn’t know when,” Robinson said. “It’s been a fuzzy world of uncertainty ever since they started building the stockpile.”
Robinson says he doesn’t expect China to quickly unload large chunks of its reserve. “If I was absolutely sure that China was dumping the bulk of it tomorrow, I would expect a 30-cent decline in prices. But nobody really expects that. They expect tapering.”
Sharon Johnson, with KCG Futures in Atlanta, Ga., said China’s huge investment in the stockpile is in itself a consideration for a slow unwinding of the reserve. “They will not take a large loss on the cotton they own. Nor are they getting out of the business of keeping some cotton in stock, just not to the same degree as the past three years.
“Given the costs tied up in cotton state reserves, a modest annual reduction over the next several years is likely. China’s stocks as a part of the global total will decrease although it will be painfully slow.”
Another consideration for releasing China’s reserve is that cotton sitting in storage for a long period of time might start to deteriorate in quality, analysts said.
Johnson says it could be as long as a year before any new policy takes effect in China, “so the market will have a lot of time to digest those changes. The biggest market impact could come next spring with confirmation of a change and the accompanying details.”
Johnson noted that Beijing wants to keep its producers engaged in cotton production “but any change away from the (current) procurement program is likely to lead to reduced income and therefore reduce producer interest in growing cotton. A smaller crop would increase their import needs and hold prices up.”
Johnson says another thing to watch is the impact of the change in policy on Pakistani and Indian cotton yarn exports to China. Larger domestic supplies in China “should result in a drop of Chinese cotton yarn imports in the current crop year and (imports) could fall off a cliff in 2014-15. Are we gaining consumption in China over time just to lose it in Pakistan and India?”
Chinese imports are projected at 11 million bales in 2013-14, significantly less than in previous years.
The Reuters article said China “has completed a draft plan to change to subsidies and is seeking opinion from experts and the industry.”
Johnson also said that “the implementation and logistics of a subsidy program in the eastern cotton provinces of China would be extremely difficult and would lead to a sizeable drop in area as producers would receive far less compensation than with the current program.”
At press time, no more details were available on China’s plan for a subsidy program or how and when China might release its reserve stocks.
Due to uncertainty about China and the possibility of spec funds “downshifting their net long positions,” Robinson said U.S. cotton producers should focus marketing efforts on downside risk. “Set a price floor strategy for this year. Puts and put spreads have made sense to me for the current crop.”
Current price signals suggest further declines in cotton acreage in the Mid-South and Southeast next year, Robinson says. “Even if the price of corn and soybeans go down, 77-cent futures (December 2014) suggest more cuts in the Delta and Southeast. Texas growers are going to grow cotton regardless. Their cost structure is lower and they could probably make money at 77-cent futures with normal yields.”