Drought decimates Australia's cotton prospects

Drought decimates Australia's cotton prospects

Cropping
It is not only Australia facing a lower cotton crop next season - Rabobank anticipates tighter US margins.

It is not only Australia facing a lower cotton crop next season - Rabobank anticipates tighter US margins.

Aa

It is not only Australia facing a lower cotton crop next season - Rabobank anticipates tighter US margins.

Aa

Drought has decimated prospects for Australia's 2019/20 cotton crop, with seasonal production forecast to be touching just 735,000 bales - just some 16 per cent of the national crop picked in 2017/18.

There is one explanation for this collapse - drought, and the subsequent lack of irrigation water.

While the hardship facing cotton growers is very real, it is not only Australia facing a lower cotton crop next season - Rabobank anticipates tighter US margins and early-season Indian dry weather to deliver lower seasonal production.

This leaves Brazil to pick up the slack on the global export stage - but does this mean the market is putting all its eggs in one basket?

The demand side is also displaying some curious features. Not in terms of overall consumption growth - globally this appears limited to 2 to 3 per cent year-on-year in 2019/20 - but absolutely in terms of import demand. This falls to one country in particular - China.

China's policy of building extensive government stocks before selling them back to the internal market is reaching an inflection point - stocks have fallen back to historical lows meaning further destocking looks very limited.

This season, and next, Rabobank sees the need for China to ramp up imports extensively - up 15pc year-on-year - to prevent domestic stocks reaching lows similar to 2010/11.

This means more demand for cotton exporters, therefore good news for Brazil, India, West Africa, Australia and, potentially, the US.

The US could hold the answers to China's upcoming need for cotton, but there are simply no guarantees for a trade deal in the short term.

But with 2020/21 set to bring year-on-year cotton production dips in Indian, US and Australian output, this becomes quite interesting. So if China requires more imports and remains unable to purchase US supplies, it will need to source largely Brazilian cotton, a somewhat risky strategy.

While the numbers work on paper, there are a number of significant risks that lie ahead. For one, Brazil's rain-fed cotton production system, and second-crop nature makes for significant seasonal risk.

A late-harvested soybean crop and/or an early start to the dry season could have devastating impacts on cotton production.

Secondly, there are still questions over Brazilian capacity to gin and ship cotton - right now the country is almost running 'flat out' on both these counts. The key point here is that China will be walking a very fine line if it intends to increase imports from a new - and somewhat untested - partner like Brazil.

So what if this all becomes a step too far? If Brazil becomes unable to deliver the imports China requires?

In our view, further Chinese destocking is not an option - this invokes bad memories from 2010 where Chinese stocks fell towards 10 million bales and prices surged to more than US200c/lb. The US would likely come back into play, and quickly, probably through a sudden US-China tariff reduction - either temporary or longer-term.

This sudden shift in Chinese demand towards the US would be monumental for the ICE #2 Cotton market - a market which has traded out Chinese demand for the past 24 months.

The result would be bullish and remarkably volatile.

Brazil will play a huge role for cotton in the six to nine-month time frame, and beware of the great Chinese cotton squeeze!

Aa

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