With the U.S. cotton crop now estimated to be the largest since 1994, growers can expect continued weak prices and a sizable Loan Deficiency Payment (LDP) or POP, says Don Shurley, University of Georgia Extension economist.
The 2001 crop might be even larger than the 19.2 million bales predicted back in July, adds Shurley. “The USDA estimate is based on state average yields for the previous 10 years, but this crop still has plenty of opportunity to do better than the 10-year average,” he says.
Weather, export news
The market currently is reacting to weather and export news, says the economist. “However, any concerns about crop problems within the United States have not been enough to offset weak demand and prospects for favorable crops overseas. Prices have been unable to muster any strength, and any attempt at a rally has been short lived. Recently, 2001 crop prices — December futures — mostly have been in the 40.5 to 42.5-cent area.”
Despite this year's low prices, exports of the 2000 crop fell to 6.6 million bales, says Shurley, as a strong U.S. dollar kept U.S. exports relatively high-priced and kept imports cheap.
“Exports of the 2001 crop are looking much better as there already are about three million bales forward sold. It's doubtful, however, that exports will reach USDA's projected nine million bales unless China is a big buyer,” he says.
U.S. demand appears to be “irreversibly down the toilet,” notes Shurley. “Unless U.S. and world crop size is cut significantly, prices very likely will remain in the 40's and could move even lower. Very little of this year's crop has been committed to merchants and mills.
“A large share likely will end up in loan. If the POP at harvest time is large, and it probably will be, the least risky market strategy likely will be to take the POP, sell the cotton and buy options — let someone else take the risk,” he advises.
Relying on the POP
Cotton producers have relied on the LDP or POP in recent years to augment low cash prices, says Shurley.
“The POP is derived from the A-Index or ‘world price’ of cotton. When the A-Index goes down, the AWP declines and producers will be eligible for a POP payment if the AWP is less than the loan rate.
“This past year, the A-Index was strong during harvest time and the POP reached a maximum of about four cents. After harvest, the ‘A’ began to decline as did U.S. prices, as world production was larger than expected and demand began to slip. This resulted in producers getting a large marketing loan gain if cotton was stored in CCC loan or a POP of 15 to 20 cents or more if producers declined the POP at harvest and held the cotton in regular storage.”
In the past two years, the A-Index and New York price relationship has gone from what typically was a minus three to five cents to a plus three cents or more, says Shurley. “This is because U.S. cotton prices have weakened more relative to foreign prices. The result is that even though U.S. prices are low, we're not likely to get as much POP to help us out as we have in the past.”
44 cent level
With world production and stocks increasing, the A-Index currently is at about 44 cents and may go even lower, said Shurley in early August.
“Currently, if the ‘A’ stays where it is, we're looking at a 21-cent POP this fall. With futures prices in the low 40's, this translates into something in the upper 30's for a cash market. So, if the A-N.Y. relationship stays the same as it is now, producers are looking at a total of about 60 cents this fall, one way or the other.”
It's likely, says Shurley, that this year will be the opposite of last year. The A-Index, he adds, probably will increase over the winter months.
“The temptation will be to take the large POP this fall. Then, the major decision becomes what to do with the cotton. According to some of our latest data, only 4 percent of the Georgia crop and 5 percent of the U.S. crop is contracted. Profitable opportunities have been almost non-existent.”
The alternatives, says the economist, include POP and sell, POP and store, POP and place “on call” or price later, POP and sell plus call option, or place in loan. At 21 cents per pound, the $75,000 limit on LDP's and marketing loan gains will be reached at approximately 715 bales, he says.
“With cotton prices so low, it's natural for producers to consider spending as little as possible or nothing on late-season inputs. Every input always should be evaluated in good years as well as bad. But cost savings must be weighed against potential yield and quality losses. And remember — base this decision on 58 to 60-cent cotton and not 40-cent cotton.”