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Differences in cotton prices may be attributable to a number of factors. Cotton prices vary, in particular, depending on the variety grown and the quality of the harvested cotton. For examples, ad hoc quotations are set for long-staple Egyptian cotton.
In addition, cotton-pricing mechanisms are affected by government support programmes, especially in the United States. Subsidisation regimes in several producing countries have added to the relative fragmentation of price formation for cotton. According to a communication from the Commission of the European Communities to the Council and the European Parliament (COM(2004) 87), due to subsidisation, prices paid to domestic cotton farmers were 90% and 154% above world prices in 2001/02 in the US and EU respectively.
It should be pointed out here that there is no world futures contract currently used as an international cotton price benchmark. Indeed, standard specifications of futures contracts traded on the New York Commodity Exchange correspond mainly to US cotton market fundamentals. For the same reason, quotations at the Osaka Mercantile Exchange are not representative of world prices for raw cotton. Despite a punctual reduction of basis risk due to the increasing importance of US cotton on the world sector (and on price discovery mechanism), the use of future instruments for the other origins (with the exception of Mexico, member of NAFTA and which might be in a position to use US futures as both prices are well correlated) is not always easy as spot and futures prices might suddenly diverge. Any exogenous changes (e.g. trade policy) might eventually bring on the re-emergence of an important basis risk, with devastating spillovers on cotton hedgers.
The point of departure is generally the cash price for cotton set in actual transactions or through relatively short-term contracts for forward delivery (2 to 4 months). World prices are monitored by means of price indexes (the "Cotlook Indexes", A and B) compiled by Cotlook Limited, a private UK cotton consultancy, and published daily in the Cotton Outlook.
The Indexes are intended to be representative of the price level on the international raw cotton market:
The Cotlook A-Index is the average of the cheapest five quotations from a selection of the main upland cottons traded internationally (19 origins). The prices are CIF cash against documents on arrival of a vessel at a Far East port.
The Cotlook B-Index is an average of the cheapest three quotations for "Coarse Count" cotton - commonly in use for spinning coarse count yarn over the nine origins shipped to European ports.
Overall, fluctuations in cotton prices are determined by several factors, in particular: shifts in the level of demand and supply, which reflect changes in producing countries' cotton policies.
With output exceeding demand, world cotton stocks rose steadily in the middle of the 1980s, up to 10.3 million tonnes in 1984/85 and 11.4 million tonnes, the following year. There have then been continued increases in cotton stocks during the late 1990s and early 2000s, with stocks remaining high above 10 million tonnes. The rise in cotton stocks is attributable to excess supply, notably in China and the United States, were government incentives stimulated oversupply and added to the general downward pressure on prices. Cotlook A Index declined consistently during this period, with prices falling at 35US cents/lb in August 1986. Prices stood at 48.9 US cents/lb on average in 1985/86 and 62 US cents/lb in 1986/87, compared to 69.1 US cents/lb in 1984/85 and 72.2 US cents/lb in 1987/88 respectively. Following a meagre upward movement in 1989/90 (82.2 US cents/lb), the A-Index dropped again in the early 1990s, with major downward shifts occurring in 1991/92 and 1992/93. Prices averaged 57.6 US cents/lb in 1992/93. The lowest peak was recorded in November 1992 (52.7 US cents/lb).
Several factors contributed to drive cotton prices down, including:
- 1) A rise in cotton production. World cotton production increased from 19 million tonnes in the 1990/91 season to 20.7 million tonnes in 1991/92, at a growth rate of 9% over the period. Production sharply increased mainly due to the huge increase of China, whose production rose from 3.8 million tonnes in 1989/90 to 5.7 million tonnes in 1991/92.
2) On the demand side of the ledger, pricing was negatively impacted as cotton consumption declined in the former Soviet Union (consumption levels, which stood at 2 million tonnes in 1990, fell to 1.9 million tonnes over the next year and to 1.8 million tonnes in 1992).
Prices performance was more robust in the following years, with prices reaching the highest peak at 92.4 US cents/lb in 1994/95. This upward movement was recorded in conjunction with a steady decrease in cotton production in a number of countries (whose supply levels were closely linked to cotton quotations). In the first half of the 1990s, production of raw cotton dropped sharply in South America (it divided by 1.5), as the cotton area reduced in size. However, this regional slowdown in production was compensated by huge increases in the largest producing countries, notably China and the United States which has been going on until early 2000s (to which added an increase in cotton area in Brazil, Turkey and Australia). This overcompensation along with only a slight increase in demand and an important rise in direct subsidies (particularly at the end of the 1990s) led the price to reduce by more than half between 1994/95 (92,4 US cents/lb) and 2001/02 (41,9 US cents/lb). In 2007/08, cotton prices have reached pretty high level prices, especially from January to May 2008 when cotton prices averaged 75.6 US cents/lb. According to ICAC, this increase may not been totally explained by the analysis of market fundamentals and especially the significant decrease in the stock-to-mill use ratio forecasted at 53% in 2007/08 against 58% the crop season before.
With one fourth of global output, cotton stocks, and consumption, China plays a major role in cotton, affecting the movements in prices.
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