Cotton has been on a roller-coaster ride over the past decade – to record high prices and then partial collapse. This was followed by China’s decision to build the world’s largest ever cotton inventory as part of its post-2009 stimulus programme, to protect cotton farmers.
This inventory, being off the market, means cotton has been an island of calm in the commodity storm over the past year. But there are signs this may be changing again.
Cotton prices are now under pressure from a vastly over-supplied polyester market – which has recently seen its raw material costs decline due to the oil price collapse. The chart showing historical cotton and PTA prices (PTA is the raw material used to make polyester) tells the complex story:
- Cotton and PTA prices normally move together, with manufacturers shifting blends between the two on relative pricing – if polyester becomes expensive, the cotton content of a shirt or blouse increases, to stabilise the price to the end-user
- But in 2005, the oil price began to rocket in the subprime bubble period.
- China and India took advantage of this to grow more cotton
- But while their production rose around 30%, US farmers nearly halved their production between 2005/6 and 2008/9 as other crops were even more profitable
The story then became even more complex in 2009, after the subprime collapse. Policymakers in the West rushed to do major stimulus, and once again this caused the oil price to rise to artificially high levels. And at the same moment, nature took a hand, with the major US cotton-producing areas of Texas and Louisiana suffering a major drought.
At the same time, China began its own, even larger, stimulus programme. And part of this was aimed at providing major support for cotton farmers by building massive inventory. By 2014, China’s stocks were up 4-fold versus 2010/11 and were sufficient to cover 6 years’ import needs
It was all a very long way off the simple story of the past, when cotton and PTA/polyester would compete against each other. But clearly, at some point, the markets would have to take the pain of leaving stimulus behind.
And it seemed, if you didn’t dig too deeply, that this was starting to happen. Cotton prices had already crashed from 230c/lb to 90 c/lb, as people began to recognise that global stocks were now sufficient to make 3 pairs of jeans for everyone in the world. And they fell again in March 2014, as it became clear that the US drought was over.
But then, another result of the stimulus programme began to impact the textile market – as China’s PTA capacity started to increase. Before long, China had opened enough capacity to supply the entire world market. Almost overnight, it therefore stopped its PTA imports – which fell from 6m tonnes in 2012 to virtually nothing in 2015.
Effectively, China had exported its over-capacity problem to the rest of the world, causing major problems for all those exporters who had relied on its demand. And while this madness was reaching its peak, financial markets were cheering, as I noted in July 2014:
“Cotton, polyester – and the fibre market they supply – are all major world markets. Financial players should therefore be panicking about what this downturn means for other parts of the global economy. But instead they remain convinced that ”central banks now rule”:
- They are therefore cheering China’s latest export data
- They fail to understand this is not due to the sudden return of robust growth in the West
- Instead it is driven by China’s need to support its own employment”
They are not cheering today, of course, as the message has finally begun to sink in about the real state of China’s economy. But the story doesn’t end here.
The reason that cotton has been an oasis of calm over the past year is that its major cotton producer is an army-owned company. This had the political clout to block necessary moves to sell off the cotton stocks. But clearly President Xi couldn’t allow this situation to continue forever.
So now, the government is starting to force the issue, and is able to use the additional argument that the stored cotton is starting to age, which will impact its colour and spinning properties. Thus Reuters has reported discussions are underway with the cotton industry and textile companies, with a government expert commenting:
“It’s completely unreasonable. Half of global stocks are in China, they have to release some.”
“Our 10 million tons of cotton in warehouses is no small thing, the financial burden is so huge and also it is impacting market prices.”
Clearly today’s cotton stocks have to be reduced to more normal levels. But the pain of doing this is going to be immense – not only for the cotton industry outside China, but also for the PTA producers.
The whole saga is an excellent example of the follies of the stimulus period. And it means the PTA industry desperately needs to find a new way forward. We have some ideas on this, which will be set out in our new 5 Critical Questions Study, to be published shortly.