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The ‘ethanol effect’ on cotton

Like a mysterious stranger in a Hollywood movie, the ‘ethanol effect’ is riding into rural towns all across the Mid-South. He promises change for the better, but what are his real intentions? Does he really want to push commodity prices higher or is he just out to steal cotton’s heart?

According to a study presented by Mark Welch of the Cotton Economics Research Institute, Texas Tech University, presented at the 2007 Beltwide Cotton Conferences in New Orleans, the ethanol effect on cotton over the next few years will be decreased plantings, lower production, higher cotton lint market prices and substantially higher cottonseed prices. The culmination of these effects would increase cotton producer net revenue, particularly from the sale of cottonseed.

The study includes mid-year revisions of projections from the Food and Agriculture Policy Research Institute, necessary because of blockbuster new developments.

In January 2006, FAPRI projected U.S. ethanol production to increase from 4 million gallons to close to 7 billion gallons by 2010. FAPRI now says it underestimated the increase by over 2 billion gallons.

The study presented at the Beltwide used a combination of FAPRI data and computer modeling to create a baseline of projected cotton acres over the next five years, then plugged in figures for increased ethanol production to determine the impact.

The study indicated that over the next five years, the ethanol effect will result in increased net returns for corn and soybean producers, while cotton producers with the production flexibility to grow alternative crops may switch their planting intentions to corn or soybeans. Rising prices for soybean oil may mean higher prices for substitute vegetable oils such as cottonseed oil, which may mean higher cottonseed oil prices, the study said.

The study says the ethanol effect will lead to an average decline in cotton acreage of 2.1 percent for each year versus the baseline projection. But cotton producers who remain loyal to cotton won’t necessarily be in too much distress. During that time, overall net farm income from cotton production (lint plus seed) increases about $120 million per year due to the ethanol boom, an increase of 2.4 percent per year over the baseline projections.

At the farm level, any decision to shift out of cotton should be carefully considered, according to Texas A&M Extension economist John Robinson. Pull together information on your production costs for each of your crops and check online for planning budgets from your state Extension Service.

Compare budgets for cotton with those for soybeans, soybean/wheat and corn budgets. If you’re a cotton producer, figure the price of cotton (farm price plus LDP) required to get the same amount of revenue as you would from the other crops. To do this, multiply the yield by the expected price minus the cost of production.

One of Robinson’s examples indicates that a producer would need to sell cotton at 67 cents per pound to compete with corn, 72 cents to compete with soybeans and 75 cents to compete with a soybean/wheat rotation. “It may be different for your operation or region, but it’s worth doing this kind of exercise.”

Costs are another factor to consider when deciding what crop to plant. “Remember that energy costs hit harder in areas that are more dependent on water, where during a dry year, pumping costs really eat into bottom lines.”

For example, diesel price fluctuation up or down doesn’t have as much of an impact on bottom line in some Delta cropping systems as they do on a budget in an area where irrigation is a must each year.”

While there has been an increase in the price of natural gas, which is a major input in producing fertilizer, “FAPRI is expecting it to level off,” Robinson said. “They assume that overall, energy prices will peak and come down by the end of this decade.”

Oil has a similar outlook, according to Robinson. “In long-run projections, FAPRI says oil and gas prices are going to peak. Oil prices have been making notable lows as of late, due in part to a change in short-term fundamentals.

“We’ve built up a big inventory, particularly because we were expecting to burn a lot of home heating oil. But up in the Northeast, they’ve had a mild winter. So the demand is a lot less that what they projected and there is a large inventory of oil available. So prognosticators are expecting fuel prices to drop.

“I expect that the price we pay for diesel next season will be less that what we paid in the past year. But we didn’t have any disruptive hurricanes this winter and a lot of people were concerned about that. Will we have hurricanes this summer in the Gulf? We don’t really know. The point is that a lot of things could change the fundamentals.”

If you do stick with cotton, pay close attention to managing high-cost inputs, Robinson suggests. Cost categories that jump out for Robinson are tech fees, chemicals and chemical applications which account for over 50 percent of total expenses. “That’s not surprising if you’ve been following trends in production. We’ve been substituting genetics and chemistry for tillage and other operations.

“With that much cost tied up in these types of inputs, it behooves you to stay on the edge of cutting edge technologies for chemicals, biotechnology and variable-rate technology. You can gain control of some factors by managing them better, paying attention to them, for example, making sure your sprayer is calibrated correctly. Focus your management attention on things worthy of that focus — large shares of expenses.”

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