• Influence of time on prices

    Chapter 1 - The world cotton market - Cotton prices 

    As the old saying goes, ‘Time is money.’ In the cotton world, the average cost of storing a pound of cotton lint for one month, including warehouse, insurance and interest costs, works out to between 0.5 cents and 2 cents. This amount varies substantially among countries, depending on interest rates, storage costs and insurance costs. Countries with high rates of interest have implicitly high costs of storage because of the foregone income on sales that cannot be put on deposit in a bank. Consequently, the seller of a bale will need more money for a sale several months in the future than for a sale involving prompt delivery in order to have the same net revenue. In some countries, cotton warehouse costs are treated as sunk or fixed costs, and there are no charges for storage, but in other countries, the cost of warehouse space is charged per month. Likewise, insurance can be purchased in some countries but not in others, and risks of theft, fire, flood or other forms of damage are higher in some regions than in others. Accordingly, insurance costs vary by location. Consequently, prices for a specific bale of cotton at a specific location can vary substantially based on whether the sale is for immediate delivery or future delivery.

    Spot sales and purchases

    Worldwide, the most common type of sale or purchase is probably ‘spot’, or a cash sale for current delivery. Most seed cotton is sold by farmers for cash on delivery. However, in many developing countries, prices are established before harvest, and farmers are paid months after harvest, but the price is still based on the assumption of delivery at harvest. Likewise, many textile mills establish prices paid based on immediate delivery, sometimes with delayed payment depending on terms negotiated with sellers.

    Forward cash sales and purchases

    Forward cash sales involve commitments to deliver or take delivery of cotton in the future at a price determined today. Farmers are often able to sell in advance of harvest, sometimes with pre-finance of inputs provided by buyers. Textile mills can arrange for the scheduled delivery of cotton in the future, with prices fixed at the time of negotiation.

    On-call sales and purchases

    Another common form of transaction in markets where it is possible to use the cotton futures contract traded on the ICE Futures U.S. is an on-call sale or purchase. In these instances a seller will negotiate the difference between the cash price and the futures price (called the basis) with the buyer, with the understanding that the seller can ‘call’ the buyer any time prior to expiration of a particular futures trading month and fix the actual cash price based on the futures price quoted at the time of the phone call. Similarly, a buyer can ‘call’ the seller to fix the actual price for delivered cotton based on futures prices quoted at the time of the phone call. On-call transactions allow buyers and sellers to eliminate the risk that cash prices in a local market could move differently than futures prices for United States cotton delivered to United States locations, and thus improve the efficiency of the futures contract as a hedging tool.

    Marketing pools

    There has been substantial growth in the use of cooperative marketing pools during the last 20 years. Marketing pools are usually operated by farmer-owned cooperatives, but they can also be offered as a marketing option by ginners and merchants. Individual farmers place some or all of their cotton lint under the control of the managers of the marketing pool. The managers sell cotton from the pool, and each farmer receives an average price for the season adjusted for the particular quality delivered. Marketing pools are offered in the United States, Brazil, Argentina, Colombia, Greece, Israel, Australia and other countries where farmers sell lint instead of seed cotton. In 2006, an estimated 40% of United States cotton was sold through some form of cooperative marketing pool, including those operated by farmer-owned marketing cooperatives, as well as the pools operated by private merchants under contract to a group of farmers in a particular region.

    Marketing pools are popular because they offer substantial economies of scale in marketing. A marketing pool representing several hundred thousand bales of cotton can afford to employ professional managers whose full-time jobs are to market cotton. They can also tailor cotton sales and deliveries to the quality and shipping preferences of individual textile mills. In contrast, a single producer with only a small quantity of cotton to sell cannot afford to hire a professional marketing manager and cannot easily meet the quality demands and timely delivery preferences of textile mills. Marketing pools also offer the advantage of a form of price risk management, since each producer will receive the average price achieved by the entire pool and does not have to worry that his or her particular cotton was sold when the market price was lowest in the season. By placing cotton under the control of a marketing manager, the farmer is then free to focus on production. 
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    Cotton Exporter's Guide

    Brochure - African cotton promotion
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