Despite bullish futures prices, U.S. and foreign supplies this month are even more excessive than last month. Futures prices, driven by speculative buying, are substantially higher than cash market prices. The basis has widened (cash minus futures) and has become extremely volatile along with futures.
Fixing cash prices off of futures is not dependable when futures abandon supply/demand fundamentals. The result is very volatile futures price movements and unpredictable basis. Pricing cotton and managing price risk will now focus on delivering cotton on the futures market. Given delivery regulations, this alternative is not expedient or cost-effective.
Cotton quality must be reclassed by USDA to meet delivery specifications and be in approved delivery locations during a specified period of time. Deliverable locations are not the most convenient for exporting cotton to the Far East. These warehouses are in Galveston and Houston, Texas; New Orleans, Louisiana; Memphis, Tennessee; and Greenville/Spartanburg, South Carolina. Delivery forces the two markets of futures and cash prices to converge at a time and place of delivery. The resulting economic opportunity is to sell futures and deliver cash; and to buy futures, take delivery, and deliver against cash.
However, excessive deliveries will combine the two markets into mostly a cash market. Consequently, the use of the futures market to manage the price risk of buying and selling cotton (hedging price risk) will be substantially limited. The futures market as a price risk stabilizer will essentially become that of forward cash market.
The threat of delivery is the primary force that causes the two markets to converge. Perhaps the threat to delivery large amounts of cotton will return the futures market to its primary role of price discovery and hedging price risk for buyers and sellers.
The latest USDA supply/demand report dropped estimated U.S. cotton exports from 15.7 million bales to 14.5 million. The result increased expected U.S. carryover by 1.2 million bales to a surplus 9.4 million. Exports were decreased because of lower import demand by China and Turkey, and greater competition from India.
World cotton estimates show lower production, consumption, and trade, relative to last month. However, with weak textile demand in the U.S. and foreign countries, the decrease in use more than offsets the decline in production. World carryover increased by 1.8 million bales to an abundant 47.5 percent stocks-to-use (s/u). That is well above the 40 percent s/u needed to support world price.
Producers with 2007 cotton in loan need to watch for favorable opportunities to sell cotton. Low risk pricing opportunities for the 2008/09 crop are limited. It is not advisable to place a ceiling on 2008 cotton unless you are willing to sell at whatever ceiling set. Out-of-the-money put options are useable but expensive. Reduced U.S. cotton acreage will cut U.S. cotton supply for the 2009/10 crop. As a result, much higher prices are expected for 2009 futures prices.
Cotton Price Risk Management & Pricing Strategies for 2008/09 Crop (Sponsored by Cotton, Inc.)
Workshop Dates and Locations:
- March 26th, San Joaquin Valley-Harris Ranch, California
- April 2nd, Lubbock, Texas, Holiday Inn Civic Center
Instructors: Carl Anderson, Mike Stevens, Kelli Merritt, John Robinson, O.A. Cleveland
