*This is the sixth article in our 2022 Southwest Economic Outlook series. Hear from Oklahoma State University and Texas A&M AgriLife Extension economists about the 2022 outlook.
The outlook for U.S. cotton prices appears not as high as for the 2021 crop, but still decent. And perhaps volatile. The market has been signaling the possibility of somewhat lower prices for many months. For example, the old crop ICE Mar’22 contract has, like the expired Dec’21 contract did, traded higher than the deferred contracts since the summer of 2020 (Figure 1). This “inversion” is not the normal pattern. It implies a near-term shortage of cotton, either from excess demand and/or inadequate supply. In 2021, it also appeared to be influenced by a large amount of speculative buying.
Demand for U.S. old crop cotton has been relatively good. The supply of old crop cotton turned out better than most analysts expected, assuming merchants can find enough trucks, shipping containers, and ocean vessels to deliver the U.S. cotton that has been sold. Sooner or later, the 2021 crop sales will be finalized, and those 2021 bales will get shipped. Then the remaining speculative interest may fade, taking dollar cotton with it. That is what the futures spreads imply (i.e., the difference between the blue and red lines in Figure 1).
Looking ahead, the picture is influenced by high pre-plant prices of corn and cotton, along with high input costs and the possibility of variable yields. Relative crop prices suggest U.S. cotton plantings between 11million and 12 million acres. But roughly half that acreage will likely be into drier than normal La Niña conditions across the Central Cotton Belt. If more southwestern cotton gets planted as a result of the drought and a high insurance price, it will lead to a guessing game about the size of the U.S. crop. We expect the result of this will be a volatile weather market situation until the size of the U.S. crop becomes clearer next fall.
New crop cotton futures are already signaling these possibilities with the new crop Dec’22 trading around 90 cents. If the drought story becomes a bigger deal, there is the possibility of long speculators jumping on the bandwagon. They could buy this market up back over a dollar… for a while. But if growers plant 13 million acres and there are widespread planting rains, there is downside risk, too. I am also assuming that new crop demand remains strong, which implies no pandemic worsening or unexpected recessions.
Given these possibilities, growers might consider either forward selling or hedging some portion of their expected production (which is admittedly harder to do in a drought situation). Some forms of hedging, like buying put options, will protect from lower prices while leaving the upside open. The price of this flexibility is part of the expense of the option premium.
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