Clyde Russell
LAUNCESTON, Australia, Jan 23 (Reuters) - China's decision to end stockpiling of cotton may not be as bearish for prices of the fibre as the market fears.
Much will depend on how the Chinese switch from buying cotton from domestic farmers at elevated prices to paying them subsidies related to international prices.
What happens to China's massive hoard of cotton will also be important, given the total stockpile is believed to be in excess of 10 million tonnes, or more than half the world's total.
So far Chinese authorities have said the subsidy scheme will start after the autumn harvest and will take into account domestic supply and demand and international prices.
This isn't exactly specific, but let's assume that the authorities will more or less pay local farmers the same as the landed cost of imports.
The result of this should be that more domestic cotton flows to the Chinese market, instead of piling up in state warehouses, as has happened under the buying scheme that started in 2011.
This would appear to be bearish for global cotton as it implies China's import demand will slow, thus removing a pillar of price support.
However, it may not work like this in reality.
The Chinese government was paying farmers about 20,400 yuan ($3,370) a tonne for cotton last year, which was a 60 percent premium to the landed cost of cotton in December, put at $2,102 a tonne by Chinese customs data.
If the government was to subsidise domestic cotton to put it on a par with the cost of imported supplies, this implies a drastic reduction in payments to farmers.
Such a significant cut in farmers' incomes will undoubtedly result in much-reduced cotton plantings, and the likelihood of some sort of protest by farmers.
At any rate, the risk is that China's 2014 domestic cotton output is well below the 6.3 million tonnes reported for 2013.
Nonetheless, it does imply that in the absence of buying for stockpiles, more domestic cotton will be available.
DEMAND TO RISE?
But this might not overwhelm the market and cut imports by a huge amount, given the pent-up demand inside China.
Not only did the government stockpiling distort the growing of cotton, it also affected domestic supplies as spinners couldn't afford to buy the high-price local crop and were forced to turn to imports, or move production offshore.
Spinners were also subject to strict import quotas, meaning they probably couldn't get enough cheaper cotton from overseas to meet their demand.
Making domestic prices cheaper may result in an increase in demand from China's spinners, thereby increasing the size of the overall market for cotton.
It's also doubtful that the government will be in a hurry to offload its cotton stockpile.
Firstly, the authorities will want to bed down the new subsidy system, and secondly, they will be reluctant to sell at a loss, and will likely prefer to slowly reduce inventories by selling a smaller amount at higher prices.
While none of the above factors are bullish for cotton prices, they do serve to put a question mark over just how bearish the end of government stockpiling will be.
While cotton prices at the front end of futures curves haven't reacted to the news, the further-out contracts have been weakening, sending the curves into steeper backwardation.
The front-month contract for benchmark ICE cotton <0#CT:> was at 87.79 U.S. cents a pound in midday trade in Asia on Jan. 23, a premium of 9.3 percent over the six-month.
One month ago, the front-month contract was 6.4 percent above the six-month, while as recently as nine months ago the curve was actually in contango, with the six-month future being 3.7 percent above the front-month.
The shift in the curve indicates market participants believe China will demand less cotton from global markets, but how much less is still uncertain and the risk is imports will hold up better than many anticipate.
