By  on September 27, 2005

WASHINGTON — Millions of dollars in federal subsidies to cotton growers, exporters and textile mills hang in the balance as Congress grapples with a Bush administration proposal to eliminate a 14-year-old federal program ruled illegal by the World Trade Organization.

As the Senate and House agriculture committees consider the administration's proposal this fall, U.S. cotton growers, merchants and textile mills are assessing the potential financial hit they might take if Congress acts to comply with the WTO ruling and scrap the cotton subsidies.

"This is millions of dollars for certain mills that produce cotton yarns and cotton fabrics and it is a major issue," said Auggie Tantillo, executive director of the American Manufacturing Trade Action Coalition. "The cotton program as a whole is important for the entire production chain, and if there are going to be major revisions, it could definitely have a negative financial impact, especially from a mill perspective."

At risk are the U.S. "Step 2" payments, a crucial part of the farm program to cotton farmers, textile mills and exporters, that have amounted to $2.4 billion between 1995 and 2004, according to the Environmental Working Group, a consumer advocacy group opposing agriculture subsidies, based on figures from the U.S. Department of Agriculture. Each year, the amount of subsidies fluctuates based on a formula established by Congress that is intended to offset the higher price of U.S. cotton when the world cotton price average falls.

During the 1995-2004 period, Parkdale Mills Inc., in Gastonia, N.C., the largest U.S. cotton spinner, received the fourth-largest subsidy of $135.4 million from the federal program, while Avondale Mills Inc., of Sylacauga, Ala., received the sixth-largest subsidy of $92.2 million and National Textiles, of Winston-Salem, N.C., received the seventh-largest subsidy of $90.2 million, according to the EWG.

Under current law, U.S. mills must buy U.S. cotton unless the price reaches a certain threshold over a period of four consecutive weeks, at which point a quota limit is triggered and mills can import cotton.

However, the quotas were last triggered in the late Nineties and mills did not have time to build relationships with foreign cotton suppliers, according to Tantillo."The [Step 2] program makes the industry highly dependent on U.S. cotton growers," he said.

The administration also has proposed removing a 1 percent cap on fees that can be charged under export-credit programs and the elimination of the Intermediate Export Guarantee Program.

The administration's proposal stems from a September 2002 WTO complaint filed by Brazil that maintained U.S. cotton subsidies depressed global cotton prices and were illegal. Brazil said the subsidies cost its farmers more than $600 million in lost sales.

Developing countries have argued that subsidized cotton from rich nations floods the global market with cheap goods and gives U.S. producers an unfair advantage.

Cotton subsidies also have played a crucial role in the ongoing round of global trade talks in the WTO, as negotiators from 148 nations struggle to find a compromise and avoid another collapse of the talks, which is what occurred in September 2003 in Cancún, Mexico.

In the U.S., hundreds of companies and farmers that have relied on the subsidies are closely watching Congress' next move on the Bush administration's proposal and trying to determine the potential impact. Many textile companies have received millions of dollars in subsidies to compensate for the higher price of U.S. cotton over the life of the Step 2 program, which went into effect in fall 1991.

Stephen Felker Jr., manager of corporate development at Avondale Mills, said he is concerned about the adverse impact the removal of subsidies might have on his business and that of other textile mills.

"The problem for us and other domestic textile manufacturers is that our business models and cotton procurement models have relied on the current legislation, which says we must buy U.S. cotton," Felker said. "People have business models and they are out there buying cotton futures based upon the cotton prices and everything with Step 2 in place."

Removing Step 2 from the equation in midstream, after mills have committed to cotton contracts, has many executives concerned, he said.

"If you buy December cotton today and you're locked in at that price, you negotiate and then you take Step 2 cotton prices out and cotton prices drop, you are vastly overpaying for raw materials and you can lose your competitive edge," Felker said.He added that the uncertainty of how Congress will act "leaves us with a big question mark. It could be potentially very harmful."

Cotton exporters also are expected to feel the pinch with the elimination of federal subsidies.

The effect of terminating the program could adversely impact domestic consumption of cotton, as well as reduce exports," said Neal Gillen, executive vice president and general counsel of the American Cotton Shippers' Association. "Insofar as the export situation, the program allows U.S. cotton to compete against lower-priced foreign growths of cotton and the offset payment allows us to be price competitive."

Only 6 million to 7 million bales of the 21 million bales of cotton grown in the U.S. are consumed in the U.S., according to Felker, which means exporters could feel the brunt of the elimination of subsidies.

"It will make it harder for us to sell U.S. cotton [overseas]," said Gillen. "That price reduction [in the form of the subsidy] is shared with the foreign buyer and in many instances it is also shared with the U.S. grower."

The administration's proposal to eliminate the Step 2 program also has sparked concern about another unrelated USDA program that funds Cotton Inc.

Under the unrelated USDA program, cotton apparel importers and cotton producers are charged annual fees based on volume of production or volume of imports and price, and pay into a cotton advertising and research fund administered by the Cotton Board, a quasi-governmental organization. The board contracts with Cotton Inc. to promote the consumption of cotton apparel and home furnishings, as well as research into cotton's use in textiles and improvements in cotton agriculture.

Bill Crawford, president and chief executive officer of the Cotton Board, said his program has no direct connection to the agency's price support programs or market development programs.

"We're totally removed from that," he said.

Cotton Inc.'s budget this year is slightly under $73 million — the highest ever — based on two factors, a larger cotton production level and a strong volume of imports, according to Crawford.

There are two components to the program's revenue. On the domestic cotton production side, every bale of cotton grown and sold in the U.S. is assessed and the second component is an assessment on imported cotton and cotton products. Apparel importers pay about $25 million a year into the advertising and research program, while cotton farmers and producers pay another $45 million a year based on their volume of production.Crawford said the only way the removal of Step 2 could negatively impact Cotton Inc.'s budget is if it has a negative impact on acreage.

"I don't want to minimize that," he said. "No one knows for sure what impact Step 2 will have on acreage and it will have some effect, but we don't know what it is."

He stressed, however, that other primary factors, such as world demand and the price of competing crops, will have a bigger impact on U.S. acreage than the elimination of Step 2 overall.

Brazil, which won the WTO case against the U.S., is allowed to retaliate with $3 billion in punitive duties on U.S. exports if the program isn't eliminated, but the Brazilian government has entered into a procedural agreement with the U.S. to give America more time to comply this fall with the WTO ruling.

Many industry officials said there is not much of an appetite in Congress to eliminate Step 2 before the end of the marketing year in July 2006, while others argue they don't expect to see a change until the end of the farm bill, which runs through fiscal year 2007.

"At the current time, there is sympathy on Capitol Hill to let the [Step 2] program run its course," said Gillen. "The cotton industry's position is to let it run through the entirety of the farm bill."

Rep. Robin Hayes (R., N.C.), a member of the House Committee on Agriculture, said, "What we're focused on is making sure, if at all possible, we don't reopen the farm program because farmers and manufacturers have made projections based on the cost of cotton futures.

"We will agree to do away with it [when the farm bill expires], not now because it really could throw everything into a state of chaos," Hayes said.

Agriculture Secretary Mike Johanns has indicated to the Senate that the administration is fully aware that a large portion of the cotton harvest may have been marketed with the expectation that the Step 2 program would be in place and is willing to work with Congress to accommodate that situation."We therefore recognize that some accommodation to avoid adverse impacts may be desirable," Johanns wrote in a letter to senators in July. "The administration would be supportive of efforts by the Congress to address such concerns in a manner that would be consistent with administration priorities and the WTO obligations of the United States."

Keith Williams, communications director for the Senate Agriculture, Nutrition & Forestry Committee, said there are many legislative vehicles to make changes to the Step 2 program, including budget reconciliation bills, which were pushed back on the agenda to late October, due to the relief measures Congress is considering tied to the hurricane disaster in the Gulf Coast region.

"The main thing is the chairman [of the agriculture committee Sen. Saxby Chambliss (R., Ga.)] says we're going to abide by this ruling even though we disagreed with it," said Williams. "This chairman has said he will go forward with [the administration's proposal], but he will go forward with the input from the industry and the administration."

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