China is unwinding its massive stockpiles of cotton and readying to implement direct-farmer subsidies, potentially depressing global prices of the raw material.
The dramatic downward price swing already under way and the possible impact throughout the supply chain brings to mind the chilling spring of 2011, when natural disasters from flooding in India to a drought in Texas provided the catalyst for cotton reaching historic highs that exceeded $2 a pound. The ensuing panic forced companies to seek out alternative fibers and fabrics, brought about a new era of cotton blends and a boost to New Age polyesters and fibers such as Tencel and flax.
The reversal of fortune three years later is more likely to impact bottom lines then material choices, but the fashion world can react in unpredictable ways.
Regulators have yet to give specifics on how subsidies will be calculated and distributed to farmers, but the price for cotton deliverable toward the end of the year has begun to decline on the Intercontinental Exchange’s market in response to the policy shift announced in January. Analyst predictions vary for when the government will announce the specifics on how the system will be administered, but agree that regulators must announce the rules before the growing season begins next month.
At the same time, China’s shift in cotton policy could have a more positive impact in the longer term. International Cotton Advisory Committee executive director José Sette welcomed the change, arguing it would improve the competitiveness of cotton, but said more details are needed before making long-term predictions on how the policy will affect world markets.
“The Chinese reserve policy has kept prices of cotton above their long-term equilibrium level,” Sette said. “While helpful to farmers in the short run, these high prices have hindered the long-term competitiveness of cotton vis-à-vis competing fibers and hurt demand for cotton substantially.”
The change could have broad implications for the apparel industry. In the short term, a steady fall in cotton prices should lead the inherent value of cotton in various stages of production, from the field to the underwear on the store shelf, to decrease, leading to “losses on inventory,” said Thomas Reinhart, head of sourcing in China for cotton trader Paul Reinhart AG.
“The moment where a bale of cotton is being sold to the industry until the underwear is being sold over the counter, I think even with the fastest possible logistics you will have three to four months…of consumption always somewhere in stock in the pipeline and that becomes worth less and less, that is a constant cost,” Reinhart said, predicting that cotton prices will fall steadily during the next six to eight months.
James Ma, on the trading desk at Chinese firm Founder Commodities, similarly warned of losses on inventory for those early in the supply chain, such as yarn spinners. But in the long term, as prices stabilize at a lower level, producers stand to gain from lower costs, Ma said.
China is by far the largest consumer of cotton, using an estimated 8.3 million metric tons in the 2012-13 season compared to the second-largest consumer, India, using 4.8 million metric tons, according to ICAC. China was also the largest importer in 2012-13, bringing in 4.4 metric tons of cotton.
China has additionally amassed the largest reserves of raw material under the government stockpiling program. ICAC, which represents cotton producing countries, projects that at the end of the current season, China will have 58 percent of the world’s cotton reserves.
The international market for cotton has not waited to react. Benchmark ICE Cotton 2 futures were at 68.74 cents a pound on Monday for October delivery, down from a high of about 95 cents in early May. The average spot price traded in the U.S. for the week ended Friday was 70.14 cents a pound, compared with 79.03 cents two weeks earlier and 81 cents a year ago, according to the U.S. Department of Agriculture.
“The world market is anticipating a strong decline in the market price between July and December,” said Reinhart.
Chinese government auctions have cut the sale price for cotton 750 yuan per metric ton, or about 5.5 cents a pound, to 17,250 yuan per ton, or about $1.26 a pound, driving the domestic benchmark price for cotton on the open market down 10 percent, according to Angela Chan, Shanghai-based representative for U.S. trade organization Cotton Incorporated.
The most important question facing the international cotton market is how much less China will import in coming crop years, Chan said.
Founder Commodities’ Ma said it could take two to three years to unwind the stockpiles, keeping the price for cotton depressed. However, some analysts said the government will maintain some stockpiles and, after a period of adjustment, international and domestic Chinese prices will be more in line in the long term. If prices stabilize at a lower level, those making cotton apparel would stand to benefit. Declining prices could also entice yarn spinners back to China, which has recently been losing ground to Southeast Asia, Reinhart said.
“The Chinese government are no fools and they don’t want to destroy the market for their own reserve,” he said. “So they most likely will try to dispose of that reserve in an orderly fashion and not lead to a market panic.”