Cotton Trading Manual

Cotton Trading Manual

CTM Cotton Trading Manual

Edited by the Secretariat of the International Cotton Advisory Committee

Cambridge England

Published by Woodhead Publishing Limited, Abington Hall, Abington Cambridge CB1 6AH, England www.woodheadpublishing.com Published in North America by CRC Press LLC, 6000 Broken Sound Parkway, NW, Suite 300, Boca Raton FL 33487, USA First published 2005, Woodhead Publishing Limited and CRC Press LLC © 2005, Woodhead Publishing Limited The authors have asserted their moral rights. This book contains information obtained from authentic and highly regarded sources. Reprinted material is quoted with permission, and sources are indicated. Reasonable efforts have been made to publish reliable data and information, but the authors and the publishers cannot assume responsibility for the validity of all materials. Neither the authors nor the publishers, nor anyone else associated with this publication, shall be liable for any loss, damage or liability directly or indirectly caused or alleged to be caused by this book. Neither this book nor any part may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, microfilming and recording, or by any information storage or retrieval system, without permission in writing from Woodhead Publishing Limited. The consent of Woodhead Publishing Limited does not extend to copying for general distribution, for promotion, for creating new works, or for resale. Specific permission must be obtained in writing from Woodhead Publishing Limited for such copying. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation, without intent to infringe. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library. Library of Congress Cataloging in Publication Data A catalog record for this book is available from the Library of Congress. Woodhead Publishing ISBN-13: 978-1-85573-439-5 (book) Woodhead Publishing ISBN-10: 1-85573-439-7 (book) Woodhead Publishing ISBN-13: 978-1-84569-092-2 (e-book) Woodhead Publishing ISBN-10: 1-84569-092-3 (e-book) CRC Press ISBN-10: 0-8493-9546-1 CRC Press order number: WP9546 ISSN 1748-8354 Typeset by SNP Best-set Typesetter Ltd., Hong Kong Printed by Astron On-Line, Cambridgeshire, England

Contents List of contributors Preface Index

Part 1: The cotton trade: history and background 1 History of the cotton trade from origin to the twentieth century John Baffes Early history Competition between cotton and wool and emergence of the West Rise of the US and dominance of England Globalization Statistical appendix 2

The cotton trade today Paul A Ruh Introduction to the cotton trade Trends in world fiber consumption The international cotton trade Who are cotton merchants? What is the added value cotton merchants provide? Information gathering Forecasting cotton prices Pricing of cotton Hedging and the New York futures market E-trade Positions Summary Contents/page i

Contents

Part 2:

The global picture

3 The cotton environment: macro issues Secretariat of the International Cotton Advisory Committee The economic importance of cotton Market forces drive prices lower Competing crops Competing fibers Government policies affecting cotton Environmental issues 4 Trends in the world cotton market Stephen MacDonald and Carol Skelly Fundamental trends and structural change The dominance of the US Importance of China (Mainland) Role of Australia, West Africa and Central Asia Conclusion 5 Cotton agronomy and production Fred Gillham Background Cotton improvement Cotton agronomy Plant growth regulators Irrigation practices Crop protection Harvesting and initial processing By-products Ecological considerations National programs to limit/control cotton production vs yield as a potential ceiling on cotton production 6 Cotton consumption Cotton Incorporated Cotton cultivation and consumption over the years Components of cotton consumption Current advances and promising technology Promotion efforts around the world Summary Contents/page ii

Contents

Part 3:

The physical trade

7 Cotton as an industrial raw material Dean Ethridge Major uses of cotton Major determinants of cotton’s market value Blending cotton with other fibers Conclusion 8 Cotton quality Anton Schenek Physical characteristics and properties of cotton Varieties and types of cotton Impact of production and ginning conditions on quality Contamination Classing and grading Acknowledgments 9 Cotton pricing Don Ethridge, Darren Hudson and Sukant Misra Factors affecting cotton prices Cotton pricing arrangements Sources of price information and price predictions Summary and conclusions

Part 4:

Derivatives

10 The New York Board of Trade® The New York Cotton Exchange® Futures and options contracts The Certificate System The Clearing House Development of the NYCE® The current cotton contract and futures market Conclusion Appendix Contents/page iii

Contents 11 Cotton futures and options as hedging tools Herman S. Kohlmeyer Jr Origins of trading Why hedge? Options Who hedges? Summary 12 Over-the-counter derivatives Nigel Scott Features of the global cotton markets and their impact on OTC derivatives A typical risk management problem in raw cotton How OTC instruments work in practice OTC and exchange-traded instruments compared Potential difficulties with OTC instruments Postscript: risk management using OTC instruments in the developing world 13 Technical trading H Rogers Varner Jr Combining technical and fundamental aspects Candlestick theory Traditional methods The open Reasonable risk, or trip to the casino? Much left out . . . Conclusion

Part 5:

Administration and management

14 Cotton controlling Peter Wakefield Sampling Classing Weighing Surveys Contents/page iv

Contents Who appoints the controller? Where are the controllers located? Conclusion 15 Freight and insurance Peter Hirschfeld Freight Insurance 16 Payments and documents Peter Hirschfeld Terms and definitions Letters of credit 17 Taxation, accounting, finance and risk management Peter Hirschfeld Taxation Accounting Finance Risk management 18 Contracts and arbitration Secretariat of the International Cotton Advisory Committee Cotton sales contracts Sanctity of contracts General principles of arbitration Arbitration in cotton trade Quality disputes and technical disputes Awards Appeal Enforcement of judgments Defaults and sanctions

Part 6: References Part 7: Appendices 1 Pricing and risk management glossary Secretariat of the International Cotton Advisory Committee Contents/page v

Contents 2 International cotton organizations and associations Secretariat of the International Cotton Advisory Committee 3 Cotton trading organizations Secretariat of the International Cotton Advisory Committee 4 The rise and fall of cotton futures exchanges John Baffes 5 The increasing role of cotton exchanges in China Secretariat of the International Cotton Advisory Committee 6 Cotton promotion Brooke Lewis 7 The enforceability of arbitration awards Neal P Gillen 8 World cotton supply and use Secretariat of the International Cotton Advisory Committee 9 Conversion factors Secretariat of the International Cotton Advisory Committee

Contents/page vi

Contributors John Baffes John Baffes is a Senior Economist with the Development Prospects Group of the World Bank, the Department that publishes Global Economic Prospects which also includes commodity price forecasts. His current responsibilities include commodity market monitoring and price projections for tropical commodities (including cotton) as well as research on market structure and policy reform issues. Since joining the World Bank in 1993, he has worked in the operational complex of the World Bank, first in Mexico and then in Bangladesh. Mr Baffes has a B.S. degree in Economics from the University of Athens, an M.S. degree in Agricultural Economics from the University of Georgia, and a Ph.D. in Agricultural and Resource Economics from the University of Maryland. He has published extensively in leading academic journals in agricultural economics and trade policy issues. He is currently working on the trade policy aspects of the cotton market as well as issues regarding policy reforms in the agricultural sectors of OECD countries.

Cotton Incorporated Cotton Incorporated is a not-for-profit research and promotion organization dedicated to increasing the demand for and the profitability of upland cotton. Founded in 1970, the company is funded by the US growers of upland cotton and importers of cotton and cotton textile products. Through its seven offices worldwide, Cotton Incorporated builds consumer demand and increases profitability for cotton through value-added programs and services in the US and international markets. From agricultural, fiber and textile research, new fabric developments, consumer and market information and technical services, to the highly successful television advertising campaign, fashion forecasts and retail promotions, Cotton Incorporated impacts cotton fiber demand – its production and consumption – from the field to the consumer. Cotton Incorporated’s worldwide headquarters is located in Cary, North Carolina. 1 919-678-2220; www.cottoninc.com.

International Cotton Advisory Committee (ICAC) The International Cotton Advisory Committee is an association of governments having an interest in the production, export, import, and conContributors/page i

Contributors sumption of cotton. It is an organization designed to promote cooperation in cotton affairs, particularly those of international scope and significance. It affords its members a continuous understanding of the world cotton situation and provides a forum for international consultation and discussion. The Committee was formed in September 1939. There are currently 41 member governments. The Secretariat of the Committee is located in Washington, DC, and is composed of an international staff headed by an Executive Director. The Secretariat assists the Committee in carrying out its work program by developing and publishing statistics and analyses of the world cotton situation, by carrying out a program of work to disseminate information on cotton production research, by cooperating with other organizations to promote a sound world cotton economy and by facilitating discussions on matters related to cotton prices. 1 202 463-6660; www.icac.org.

Dean Ethridge Dr Dean Ethridge is Managing Director of the International Textile Center of Texas Tech University, where he administers the Center’s total program of research, technology transfer and education. His advanced degrees are from Texas Tech University and the University of California at Berkeley. He has held other academic appointments at the University of Georgia and at Texas A&M University, where his research programs encompassed cotton production, processing and marketing, fiber quality measurement and application to processing and market efficiency, and policy issues affecting the cotton/textile industrial complex. He also worked at the National Cotton Council of America, in the private sector, and as a Presidential appointee in the US Department of Agriculture. During his 30 years of work related to fibers and textiles, he has executed numerous international research and development projects.

Don Ethridge Dr Don Ethridge is Professor and Chairman, Department of Agricultural and Applied Economics, Texas Tech University. Among his research activities are numerous projects, publications, and presentations related to cotton, including production, marketing and processing, pricing, textile manufacturing, policy, and international trade. Recognized for his expertise in cotton economics, he has authored a widely adopted graduate level textbook on Research Methodology in Economics.

Neal Gillen Neal Gillen serves as the Executive Vice President and General Counsel of the American Cotton Shippers Association and as the Contributors/page ii

Contributors Legal Counsel to the American Cotton Exporters Association and the World Cotton Exporters Association. Since 1966 he has been continually involved with domestic and foreign arbitrations between merchant and mill, merchant and merchant, merchant and producer, and merchant and cooperative. He served as an advisor to the US Delegation to the United Nations Committee on International Trade Law (UNCITRAL) as the United States reviewed the Model Law on International Commercial Arbitration in preparation for its approval. Since 2002 he has served as the International Cotton Advisory Committee’s Permanent Representative to UNCITRAL as an observer and participant in the discussions of its Working Group on Arbitration.

Fred Gillham Dr Fred Gillham was born in Johannesburg, South Africa in 1926. He served in the South African forces in Italy during World War II, and obtained a B.Sc. (Agriculture) degree at Stellenbosch University in 1949. He worked for the Division of Horticulture in the South African Department of Agriculture as a vegetable breeder from 1950 to 1953 and then took up the post of Plant Breeder in Charge of the Cotton Research Station at Gatooma in Southern Rhodesia (now Kadoma, Zimbabwe). He attended the North Carolina State College from 1960 to 1962 and graduated with a Ph.D. in 1962. He returned to the Cotton Research Station in Rhodesia as Senior Plant Breeder until 1969 when he took up an appointment with J.L. Clarke Cotton Company in South Africa. He moved to Australia in 1971 and worked as a plant breeder at the Tobacco Research Institute in Mareeba, Queensland and then at the Cotton Research Station in Narrabri, New South Wales until 1979. After several consulting assignments with the Asian Development Bank, the UNDP and the Food and Agricultural Organization, he was appointed to establish the Technical Information Section of the International Cotton Advisory Committee. He retired from the ICAC in 1988, and worked for two years as cotton advisor to the Nusa Tenggarra Agricultural Support Programme for the Australian company ACIL in Indonesia. He then worked for ContiCotton in North Carolina, for GTZ in Egypt and the World Bank in several countries. In 1992, he headed the World Bank study on the Cotton Production Prospects for the Next Decade. While semi-retired in Australia since 1996, he has had several assignments to assess the cotton crop in Uzbekistan.

Peter Hirschfeld A native of Germany, Peter E. Hirschfeld learned the cotton business with Texanische Baumwollgesellschaft in Bremen. He emigrated to the US in 1954 where he first worked with Hohenberg Bros. Co., in Contributors/page iii

Contributors Memphis, and then for 30 years was employed by H. Molsen & Co., Inc., Dallas to reach the position of Vice President, exports and general administration. From May 1986 he was employed as Senior Vice President in charge of US cotton business, with emphasis on export sales by Volkart Taylor Cooper, Inc. and then by Volkart, Inc. He kept the same position when Volkart, Inc. Dallas was sold to Paul Reinhart AG, Switzerland, and the name changed to Paul Reinhart, Inc. He retired on Dec 31, 1997. During his career, he held several honorary positions: president of the Texas Cotton Association, the Dallas Cotton Exchange, the American Cotton Shippers Association and American Cotton Exporters Association; president and chairman of Cotton Council International.

Darren Hudson Darren Hudson is Associate Professor of Agricultural Economics and Coordinator of the Masters of Agribusiness Management program in the Department of Agricultural Economics at Mississippi State University. He has authored or co-authored numerous articles on cotton and textile pricing, policy, and trade, and serves as the cotton specialist on the S-1016 Regional Research Committee on US domestic policy and international trade agreements.

Herman Kohlmeyer Herman Kohlmeyer has worked in the cotton trade as a futures commission merchant and analyst for nearly thirty years. He is a native of New Orleans, a graduate of Yale University, and served in the US Navy before joining his family partnership in the securities business in his home town. Presently employed by A. G. Edwards & Sons, Inc, as Senior Vice President – Investments, he has served on the board of the New York Cotton Exchange, and then on its successor body, the New York Board of Trade, for over twenty years.

Brooke Lewis Brooke Lewis was Communication Manager of Cotton Australia, Cotton Australia, a not-for-profit company and the peak industry body for Australia’s cotton growers (www.cottonaustralia.com.au). She was Vice Chairman of the International Forum for Cotton Promotion (IFCP) from its creation in 2000 to 2003. The IFCP is a non-governmental body composed of national and international cotton industry organizations. The mission of the IFCP is to increase consumer demand and consumption of cotton and cotton products through the implementation of national cotton demand enhancement programs. The Forum serves as Contributors/page iv

Contributors a clearinghouse for information about proven techniques of cotton promotion, best practices in retail-level communication, and cost-effective measures of boosting consumer demand (www.cottonpromotion.org).

Stephen MacDonald Stephen MacDonald is a senior economist with the US Department of Agriculture’s Economic Research Service (ERS). He has been with ERS since 1984 after receiving degrees in Biology and International Affairs from Cornell University and George Washington University, respectively. During this time he has worked on trade-related issues, focusing on cotton since 1993. As the ERS representative for international cotton analysis on the Department’s Interagency Commodity Estimates Committee for Cotton he provides analytical support for USDA’s monthly supply and demand estimates, and USDA’s annual review of its long term projections. Related research on cotton, forecasting methodology, textiles, and exchange rates is also undertaken to inform USDA policy-makers and for publication in trade and academic journals. He was a co-recipient of an award for excellence from the Secretary of Agriculture for his work on the economic impact of racial discrimination, and has a degree in economics from George Mason University.

Sukant Misra Sukant Misra is Professor and Associate Dean for Research, College of Agricultural Sciences and Natural Resources, Texas Tech University. He conducts research in the areas of production, processing, marketing and price analysis related to cotton.

Paul A. Ruh A native of Switzerland, Paul Ruh is a life-long commodity trader with 46 years of experience, mainly in the cotton business. Mr Ruh started his career with Volkart Brothers, Switzerland, in 1957 and spent 31 years in Brazil, Mexico and Switzerland. He took charge of the company’s worldwide cotton division as Managing Director in 1987 and moved to Dallas, Texas, in 1988 in the same capacity. At the same time, he served as President and CEO of Volkart, Inc. In 1992, he was instrumental in the acquisition of Volkart’s Dallas organization by Paul Reinhart AG, one of the world’s largest cotton trading companies. He became president and CEO of Paul Reinhart, Inc., Dallas, leading the growth and the expansion of the new US company, which handles all US growths, Australian and Mexican cotton, until the end of 2003. A well-known cotton merchant respected throughout the industry for his Contributors/page v

Contributors knowledge of the cotton market, trading skills and experience in risk management, he has established a consulting company to conduct seminars on all aspects of the cotton trade, and is the owner and President of Cotton Market and Risk Management Consulting, Inc. During his career, he served on numerous boards and held office in the following organizations: President of the Texas Cotton Association, President and Chairman of Cotton Council International, Chairman of the National Cotton Council Public Relations and International Marketing Committee, Member of the Board of Directors of the New York Cotton Exchange, the National Cotton Council of America and the American Cotton Shippers Association, Member of the New York Board of Trade.

Anton Schenek Dr Anton Schenek has been Professsor of Textile Technology at Reutlingen University, Reutlingen, Germany, since 1988 and lecturer for Textile Raw Materials, Quality Management, Materials Science, Fiber and Yarn Technologies and Nonwovens. From 1984 he has been Chairman of the Technical Committee on Cotton Testing Methods in Bremen of the International Textile Manufacturers Federation, Zürich, Switzerland. Until 1995 he was Head of the Textile Processing Department at the Institute for Applied Science in Reutlingen. From 1984 through 1990 he was a Member of the Board of Directors of Interwoollabs, Brussels and ITMF Delegate to the International Cotton Calibration Committee of USDA in Washington. From 1982 to 1989 Dr Schenek was Managing Director of the Bremen Fiber Institute (Faserinstitut Bremen e.V.) and General Organizer of the International Bremen Cotton Conferences. Before then he worked on projects for several textile machinery manufacturers in Germany and was engaged in Textile Technology Research for his Ph.D. Degree, which he obtained from Stuttgart University promoted by Prof. Dr G. Egbers at the Institute of Textile Technology Reutlingen/Denkendorf. Before studying Civil Engineering, he was an officer in the German Air Force.

Nigel Scott Nigel Scott works for JP Morgan, London (2005–present), as Senior Vice President in ‘Credit and Rate Markets’, where he is a senior member of the Commodity Derivatives team. He acts as a specialist for JP Morgan in structured commodity products for both risk management and financing. Prior to his current role at JP Morgan, Nigel was (2000–2005) Executive Director in Global Financial Markets, Rabobank International, London where he was Global Head of Commodity Financing and Commodity Price Risk Management. Nigel is a director of the International Cotton Association, Liverpool, and is an Contributors/page vi

Contributors experienced arbitrator. He is a member of the Private Sector Advisory Panel to the ICAC, and is a lead participant in the World Bank’s International Task Force on commodities. Nigel is a member of the Futures and Options Association Agricultural Reform committee. He was Consultant Editor for Agribusiness Risk: Strategies and Management published by Risk Books, in 2003. Nigel started his career working for Cargill in Grain, NGFI and Vegetable Oil as a Merchant (1991–1993) under Cargill’s Commercial Management Trainee scheme. He then became a Cotton Trader for Ralli Brothers and Coney, UK, and Hohenberg Brothers (1993–1998), after which he worked in Cargill’s Financial Markets Platform as a Senior Structurer for Cargill Investor Services in 1998, and started a number of soft commodity swaps markets, including the Cotton Swaps markets and the Fertilizer Swaps markets. Nigel obtained a BSc (Hons) from Imperial College, London, in Microbiology.

Carol Skelly Carol Skelly is the Fibers Analyst for United States Department of Agriculture’s (USDA’s) World Agricultural Outlook Board. She is the chairperson of USDA’s Interagency Cotton Estimates Committee, which makes the official US government estimates of cotton supply and demand for the United States and the world. She also serves as an economic resource on cotton for the Secretary of Agriculture and the Department’s Chief Economist. Prior to coming to the World Board in 1997, she was an agricultural economist in the Farm Services Agency, where she provided economic and budget analysis of policy issues related to the cotton domestic farm program, including estimates for a variety of supply management, price support, and competitiveness provisions.

New York Board of Trade The New York Board of Trade® (NYBOT®) is New York’s original futures exchange, where the world trades food, fiber and financial products. For well over a century, the New York Board of Trade has provided a global marketplace for cocoa, coffee, cotton, ethanol, orange juice, wood pulp and sugar, as well as currency and index futures and options. Information about the New York Board of Trade can be found at www.nybot.com and www.nybotlive.com.

H. Rogers Varner, Jr. Since 1984, Rogers Varner has been an analyst and commodities trader, beginning with Clayton Brokerage, later setting up his own Contributors/page vii

Contributors company with his brothers (Varner Brothers). Prior to that, he was a registered engineer, serving in areas of design, contract management, cost estimating, and forecasting. His specialty area is cotton, and roughly two-thirds of his trades are in the options and futures on the New York Board of Trade, which houses the Cotton Exchange. He also trades grains, metals, soft commodities, currencies and stock indexes. Having two degrees that rely heavily upon science and mathematics, Rogers also relies on technical theories and ideas in trading. Due to his education and early professional career, he relies heavily on his knowledge of mathematics and use of computers to analyze markets, with heavy emphasis on long range fundamental research in order to spot major price changes.

Peter Wakefield Peter Wakefield has been Managing Director of Wakefield Inspection Services Ltd – UK (WIS), a leading firm in cotton inspection, since 1993. WIS handles a majority of all raw cotton shipments that are subject to weighing, sampling or quality inspection before shipment or after landing worldwide. Peter Wakefield also serves as the current First Vice President of the International Cotton Association. Prior to joining WIS, he worked in cotton warehousing, handling and controlling in the UK, Thailand and Taiwan. The editor would also like to thank Peter Scott, past president of the Liverpool Cotton Association, for his help and advice during the preparation and the editing of this manual.

Contributors/page viii

Preface ‘Oh, Heaven help us! What is that dreadful noise? Run, run! Has somebody been killed?’ ‘Do not distress yourself, kind-hearted sir. It is only the merchants of Alexandria, buying cotton.’ ‘But they are murdering one another surely.’ ‘Not so. They merely gesticulate.’ EM Forster, Pharos and Pharillon, 1923 Cotton is one of the most sophisticated and complex of all the international commodity trades. The Cotton Trading Manual is the first work to provide a comprehensive reference source to the conduct of the international cotton trade. Cotton is produced primarily for its fiber, which is universally used as a textile raw material. Cotton is harvested in the form of seed cotton and requires ginning to separate the fibers from the seeds. Modern trade in cotton fiber began with the invention of the saw gin by Eli Whitney in 1793. Only raw cotton, or lint, is traded internationally, whereas cottonseeds – a major source of edible oil and high-protein stock feed – are mostly used domestically. Grown in more than 100 countries, cotton is one of the most important and widely produced agricultural and industrial crops in the world. Cotton is unusual in being both a labor-intensive crop in developing countries and a capital-intensive crop in developed countries. Cotton played a major role in industrial development starting in the eighteenth century, and continues to play an important role today in the developing world as a major source of revenue. Cotton provides employment and income for hundreds of millions of people involved in its production, processing and marketing across all continents. And yet, for all the importance of cotton, the cotton industry is a very small component of the world economy. The value of world raw cotton production was estimated at US$30 billion in 2004/05. Cotton is a heavily traded agricultural commodity, with over 150 countries involved in the export or import of cotton. World cotton trade reached 3.6 million tons in 1926/27, which remained a record until the late 1950s. Trade rose steadily thereafter to surpass 7 million tons in 2003/04. However, the share of world trade in global production fell from 56% in 1926/27 to about 30% now, as world production quadrupled from 6.4 million tons to a record of 26 million tons in 2004/05. The Preface/page i

Preface largest producing countries (China, USA, India and Pakistan) are also the largest consuming countries at the industrial level. Still, most producing countries are simultaneously importing and exporting cotton, signaling the globalization of the cotton industry. The value of world cotton exports is estimated at US$8 billion in 2004/05. According to UNCTAD export statistics by product, cotton ranked 159th by average 2001–2002 values, accounting for 0.12% of world exports of all commodities. Yet, cotton is still a major source of export revenue in many developing countries. Cotton trade expanded along with the geographic dispersion of cotton production and shifts in the textile industry. Cotton imports laid the foundation for the industrial revolution in Great Britain, and cotton textiles accounted for half of England’s exports in the nineteenth century. The USA played a leading role in the history of world cotton trade. In 1858 Senator James Henry Hammond of South Carolina declared that cotton ruled the world: ‘What would happen if no cotton was furnished for three years? England would topple headlong and carry the whole civilized world with her. No, you dare not make war on cotton! (. . .) Cotton is King.’ From 1803 to 1937, excluding the Civil War and two other years, raw cotton was the USA’s largest merchandise export. The USA has always been the top exporter, except in 1985/86. However, US share of world cotton exports dropped from two-thirds in 1926/27 to an average of 26% from 1960/61 through 2000/01. In recent years, the patterns of trade have changed as textile production moved from the developed to the developing world. As US domestic mill use plummeted, its market share of world exports rebounded to 41% in 2003/04. Cotton trade is now a global and highly professional industry composed of numerous specialized markets. One dominant characteristic of the contemporary world economy is consolidation, driven by intense competition. Also, some concentration is occurring in the cotton trade. However, the number of participants in the world cotton trade has actually increased since the mid-1990s because of the dissolution of parastatal monopolies and marketing boards in several countries. The world cotton trade is not highly concentrated by the standards of industrial markets and the international cotton shipping industry is highly competitive. Some 500 firms are engaged, at least in part, in the cotton trade, and the 20 largest cotton organizations handle about one-third of world production. Cotton was one of the first agricultural commodities to be sold on the basis of quality. In contrast to other widely traded commodities such as wheat, corn and soybeans whose characteristics are limited to relatively few grades and specifications, cotton trades in hundreds of combinations of grade, staple and micronaire. A good knowledge of these specifications is essential in cotton trading. Cotton standards are the backbone of cotton fiber quality measurements, and the Universal Preface/page ii

Preface Cotton Standards Agreement has largely obviated risks related to cotton fiber quality since 1923. Technology has progressed through the years. High Volume Instrument classing first became available to growers in Texas in 1980 and the USDA adopted HVI classification in 1991. However, classing remains a rather subjective process in many countries, and further developments of objective standardized methods of evaluation are needed to meet the requirements of the modern spinning industry. Substantial changes in the ginning, handling, storing and transportation of cotton have taken place over the years. In the USA, inland transportation, formerly by river, was turned over to railroads and then to paved roads. During the last three decades, the maritime transport of cotton shifted from conventional to container ships, leading to shorter transit times and lower freight rates. Risks connected with transportation and storage have gradually been reduced. Improved storage has resulted in less expensive credit, using warehouse receipts as collateral for banks. As efficiency in the marketing functions has increased, costs have decreased. In the old days, cotton trading activity was based upon the precept that ‘my word is my bond’, and cotton was sold on a handshake without documentation. However, it became necessary to do more than shake hands when forward contracting – before the crop is actually harvested or even planted – became the dominant marketing practice. Nevertheless, most transactions remain based on trust. Personal relationships are still paramount and merchants have built up broad networks of offices and agents across the globe to maintain personal contacts with their clients. The commercial reputation of a trading firm is arguably its most valuable asset since contracts worth millions of dollars can be concluded during a one-minute telephone call. Cotton trade is founded on the principle of the ‘sanctity of contracts’ because quality variations and price fluctuations make the respect of commercial commitments vital for the health of the cotton industry. Speculation and corners mark the early history of the cotton trade, in particular the Big Speculation of 1824/1825 and Nicholas Biddle’s attempt to corner the US cotton market in 1837 by purchasing most of the supply to raise export prices. Advances in communication have revolutionized the international cotton trade, greatly reducing the risks due to lack of information or misinformation. The first transatlantic mail service by ‘steam packet’ started in 1840, the first submarine cable service with North America came into operation in 1866, and telephone service began at the end of the nineteenth century. Improved means of communication made it possible for information to arrive in advance of cargo vessels. Market information became more readily available to sellers and buyers making the process for offering and bidding more efficient, and, merchants complain, reducing profit margins. However, Preface/page iii

Preface as long as prices remain volatile, fortunes will continue to be made and lost in the cotton business. The largest bankruptcy in the history of the cotton trade, US$350 million, happened in 1990. Throughout history, merchants have made their money from the quality and rapidity of their information. Modern technology has increased the flow of information, allowing all participants to have better access to the same information at the same time. Yet information in itself was never as important as analysis. Being able to anticipate how particular news will affect the market has always given some people an edge over others, and that is unlikely to change. Market information from all over the world is becoming instantaneously accessible on the screen of every trader. While this reduces the need for in-house networks to source market information, it also creates the need for intermediaries who are able to filter the information overflow and deliver it in a timely and pre-digested fashion to producers, traders and manufacturers around the world. The price of cotton is crucial to all segments of the cotton industry, and international cotton prices have fluctuated wildly over the years. The international cotton trade was among the first to develop a reliable pricing system and to use futures contracts distinct from the traditional commodity ‘spot’ trading. The New York Cotton Exchange was established in 1870, and has been operating continuously ever since. Hedging in the futures market has reduced price risks, but it offers less protection for non-US cottons. Notwithstanding, little progress has been made in the capacity to predict at what price cotton will sell at some time in the future, primarily because weather forecasts are not accurate beyond a few days. As long as the future is unknown, prices will reflect that uncertainty and remain largely unpredictable. World cotton trade is likely to expand during the next several seasons because of increasing dependency on imports of major producing countries with rising mill use, such as China, and, to a lesser extent, India, Pakistan and Turkey. Cotton trade will continue to evolve at a speed that will probably accelerate. Technical change will alter the way cotton is grown, harvested, ginned, stored, transported and processed by the textile industry. Meanwhile, the cotton industry will develop and implement much needed standardized testing methods and trading rules. The revolution in information technology will enhance all the new technologies and affect the way cotton is traded. Price discovery, contracting and back office work will increasingly be done electronically. Government intervention in many countries exerts a direct or indirect influence on cotton production and trade. Most of the support provided to cotton comes in the form of direct payments, with relatively few barriers to raw cotton exports and imports. Although economists disagree when it comes to quantifying the impact of subsidies, there is a broad consensus that distortions lead to overproduction and price declines, Preface/page iv

Preface reducing export opportunities for developing counties. Pressures for change are increasing and an unprecedented aspect of the current round of WTO trade negotiations is the emphasis on cotton. Reaching an agreement to reduce subsidies that distort production and trade in agriculture will involve complex tradeoffs and will not be easy. Nevertheless government interference will eventually diminish and cotton prices will better reflect market forces. The Cotton Trading Manual covers not only a historical perspective of cotton but also all the essential components of the cotton trade. It will meet the needs of an increasingly sophisticated trading environment, linking physical cotton, futures, regulation, transport and many other issues. The Cotton Trading Manual is intended as a practical guide for the uninitiated and as a comprehensive reference work for professional traders. The purpose of this work is not to teach anyone how to trade cotton; its ambition is to become a companion for all those involved in the international cotton trade. This manual fulfils its ambition thanks to the expertise of its contributors. Being a multi-contributor work with a very broad coverage, the manual inevitably contains some imbalances. Some sections are longer than others and writing styles between contributors vary, which reflects the cotton trade’s diversity. The Cotton Trading Manual is divided into five sections. Part 1 deals with the cotton trade from origin to present. Part 2 assesses the global picture, with chapters on the cotton environment, market trends, production and consumption. Part 3 looks at the heart of the physical trade with chapters on cotton as an industrial raw material, quality and pricing. Part 4 deals with derivatives, with chapters on the futures market, hedging tools, over-the-counter derivatives and technical trading. Part 5 deals with administrative and management issues with chapters on cotton controlling, back office, contracts and arbitration. Finally, appendices include chapters on the history of cotton exchanges and promotion of cotton, a glossary, conversion factors, and lists of cotton associations and trading organizations. The International Cotton Advisory Committee (ICAC) is an association of 41 governments of cotton-producing, -consuming and -trading countries. The mission of ICAC is to assist member governments in fostering a healthy world cotton economy. The ICAC accepted to serve as editor of the Cotton Trading Manual on the basis that it would benefit the global cotton industry. Providing better education and better information, promoting the use of good trading practices and standardized trading rules will improve the efficiency of the international cotton trade and enhance opportunities for expanded trade in cotton as a component of a healthy cotton economy. Terry Townsend Executive Director of the International Cotton Advisory Committee Preface/page v

Index Abd al-Rahman III, Caliph of Andalusia 1/4 Acala (Chiapas (Mexico)) 8/31 Acala variety 8/31 acaricide resistance 5/16 accounting by cotton traders 17/1–2 ACM, Inc, Collierville, USA Appendix 3/3 ‘ACSA Container Rules’ 15/3 additional cotton fiber quality problems 8/23–25 additional fiber property measurements needed 7/10–11 adjusted world price (AWP) 4/7, 8/19, 12/7 advanced Fiber Information System (AFIS) 8/11 measurements 8/19 Advisory Committee for Arbitration and Supervision of the Types (of cotton) (AFCOT) Appendix 2/3 ADX 13/16 Africa 3/11, 5/1, 9/11 cotton futures exchange, history Appendix 4/1–3 cotton in 3/1 role of in cotton industry 4/13 and Bt cotton 5/7 seed cotton handling 8/40 southern 5/13, 5/17 African Cotton Association/Association Cotonnière Africaine (ACA) Appendix 2/1–2 African Growth and Opportunity Act (AGOA) 4/10 aggregate measurement of support (AMS) 4/9 Agreement on Textiles and Clothing (ATC) 1/3, 4/9, 6/7 Agricutural Development Bank, China 4/11 agricultural futures (CSCE) 10/5 Agricultural Marketing Service (US, Department of Agriculture) 4/5, 9/16, 9/18 Agrochemicals Used on Cotton Appendix 2/14 Aiglon Dublin Ltd, Geneva, Switzerland Appendix 3/2 air jet weaving 8/6 air-jet spinning 7/3. 7/6, 7/7, 7/9. 8/5, 8/7–8, system 7/11

Alabama, cotton producing 2/2 Albrecht, Müller-Pearse & Co Gmbh & Co, Bremen Appendix 3/2 Alexander the Great 1/4 Alexandria Cotton Exporters Association (ALCOTEXA) Appendix 2/2 Alexandria 1/2, 11/4, Cotton Futures Exchange 1/18, Appendix 4/1, Appendix 4/2, Appendix 4/8, Appendix 4/11 All-China Federation of Supply and Marketing Co-operatives (SMC) 4/11, Appendix 2/7 Allenberg Cotton Co, Cordova, USA Appendix 3/2 Almeter system (Belgium) 8/11,8/27 Amcot Appendix 1/7 American Civil War 1/2, 2/1, 5/2, 10/5, 11/3, 11/4, 11/5, 13/2 and effects on cotton production 1/12, 1/13, 1/18, Appendix 4/9 American cotton contract Appendix 4/7 American Cotton Manufacturers Association Appendix 1/7, Appendix 2/3 American cotton production 2/1 American Cotton Shippers Association (ASCA) 2/3, 15/3, Appendix 2/2 American Cotton Suppl. Intl, Lubbock, USA Appendix 3/3 American cotton Appendix 4/6, 4/7, 4/8 American mid-South 11/13, 11/4 American Pima cotton, classification 8/48 American spindle picker 5/17–18 American Textile Manufacturers Institute (ATMI) Appendix 1/7–8, Appendix 2/3 American Upland cottons 5/2, 8/48 Americas, history of cotton in 1/5 Anderson Clayton Corp, Fresno only, USA Appendix 3/2 Anderson, Clayton (US cotton merchant/firm) 2/2 anti-cotton legislation, England and France, historic 1/6 aphids 8/21 Aphis gossypii Giov (Cotton aphid) 8/36

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Index apparel demand 6/8 production, globalizing and consumer behaviour 3/7–8 Arab trade in cotton 1/4, 2/1 Arabian Sea 1/4 Aral Sea, shrinking of 3/13 arbitration 18/5–14 Arco Cotton Agents (ICT International Cotton Trading), Milan, Italy Appendix 3/3 Argentina 3/14, 4/3, 5/23, 5/24, 8/28, 9/16, 12/17 cotton disease in 5/14 Arizona, US 1/3, 4/4, 8/35 Arkwright, Richard 1/10, 1/11, 1/12 Armenia 2/5 Arrian 1/4, 6/1 ART 8/54 Ashmouni Appendix 4/2 Asia and textile industry 6/4–5 Asia Pacific Textile Clothing and Footwear Forum Taipei Appendix 5/3 Asia, cotton in 3/1 Asia, seed cotton handling 8/40 Asian crisis of 1997 3/5, 4/6 Asian Dragons 6/4 Association Cotonnière Africaine/African Cotton Association (ACA) Appendix 2/1–2 Association Française Cotonnière (AFCOT) Appendix 2/4, Appendix 2/8 Associazione Tessile Italiana Appendix 2/4–5, Appendix 2/8 ASTM 8/9 Atlantic Cotton Association Appendix 2/2–3 Attaturk Dam, Turkey 5/13 Auscott Ltd, Sydney, NSW, Australia Appendix 3/3 Australia 3/14, 5/7, 5/9, 5/13, 5/16, 5/17, 5/23, 5/24, 6/13, 8/28, 8/32, 8/35, 8/48, 9/16, 9/17, Appendix 2/5 and cotton 3/13 cotton and bollworms 5/7 cotton export 2/5 cotton producers 12/1 cotton production 3/2, 4/14, 5/2 cotton trade 2/3, 4/13, seed cotton handling 8/40 Australian (type of cotton) 2/5 Australian Cotton Shippers Association (ACSA) Appendix 2/1, Appendix 2/5 Austria Appendix 2/6 automated comb-sorter 8/11 automated cotton classing 6/11 automatic image analysing systems 8/22

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automatic thermodetection plate device 8/22 automatic thermodetection rotating drum device 8/22 automation and cotton industry 8/6 average total range 13/16 averaging methods 12/8 AWP 4/8, 12/7 Bacillus thuringiensis (Bt) 5/7, 5/8, 5/16 bacterial attack 8/25 Bacterial blight (or Angular leaf spot) 8/36 Bahamas 1/5 bale by bale weighing 14/5 bale pressing 8/41 sizes 8/41 storage and transportation 8/42 variation between and within 8/42 weighing of cotton bales 14/3–5 weighing/weights in different countries 14/4 wrapping 8/41–42 Bale Survey Appendix 2/14 Bales, Universal Density (UD) size 4/5 baling 4/5 Balls-Sorter 8/11, 8/27 Bangladesh Textile Mills Corporation, Dhaka, Bangladesh Appendix 3/4 Bank of England Appendix 4/6 Bank of the United States 11/3 banking 16/3, including bank charges, Bank rules banks providing services to cotton industry Appendix 3/1 Barcelona Contract (CAN) Appendix 2/6 Barre 7/11 base rate 15/6 ‘Basic risk’ 12/6 BASIS 2/13 Battistel Amiotti Srl, Milan, Italy Appendix 3/3 Baumann Hinde & Co Ltd, Southport, UK Appendix 3/2 Belgian Cotton Association Appendix 2/5, Appendix 2/8 Belgium Appendix 2/3, 2/5, 4/7 Berger, J. 1/3 Bid and Ask Prices 13/3 Biddle, Nicholas 11/3 bilateral global textile trade policies 6/7 bills of lading (on board, custody, intermodal) 15/5 biological fineness 8/22 Biotechnology 5/5–8 Black, Fisher 11/7 Black-Scholes formula 11/8 blending cotton with other fibers 7/13 Bloomberg 12/8 blow offs and selling climaxes 13/12 blue leaf disease 5/14

Index Board of Trade, Chicago 11/5, cotton ring at 11/4 bobbin shapes and sizes 7/5 boll weevil (Anthonomus grandis Boh.) 3/12, 8/36 boll, ripening of 5/12 bollworm species, (Helicoverpa spp.) 5/7, 5/15 Bolsa de Mercadorias & Futuros in São Paulo, (BM&F), Brazil Appendix 2/5–6 Bombay Appeal Board Appendix 2/3 Bombay/Mumbay (India) 11/4, Appendix 4/8 futures exchange Appendix 4/9, Appendix 4/11 Brazil 1/5, 2/17, 2/5, 3/3, 3/9, 4/2–3, 5/23, 5/24, 9/16, 12/17 cotton production 1/7, 1/8, 1/16, 3/2, Appendix 2/5–6, Appendix 2/13, Appendix 4/1, Appendix 6/3 cotton spinning 4/1 breakbulk shipping 15/3, 16/1 break-even price for cotton 13/4 breeding programs 5/5–8 breeding, influences on properties 8/32 Bremen (Germany), cotton trading 2/1, 2/2, 11/4, 15/3, Appendix 4/7, Appendix 4/8 Bremen Cotton Exchange (Bremen Baumwollbörse) 8/1, 8/10, 8/24, 8/29, 8/32, 9/15–16, Appendix 2/6, Appendix 2/8, Appendix 4/7, Appendix 4/11 Bremen Cotton Exchange Arbitration 8/10 Bremen Cotton Practices Appendix 4/7 Bremen Cotton Report Appendix 2/6 Bremen cotton trading rules Appendix 2/6 Bremen Fiber Institute 8/54, Appendix 2/6 Bremen Roundtests 8/3 Britain, role in textile trade 6/3, 6/4 British cotton exporting colonies Appendix 2/13 British East India Company 1/1, 1/5 brokerage 2/9 Bromoxynil (Buctril ®) 5/7 Bruce Allbright Cotton, Fresno, USA Appendix 3/3 Bt cotton 3/13, 3/14, 5/16, 5/6, 8/31 Bt gene 5/8 Bulgaria 5/2 bull market of 1995 13/1–2 bundle measurements 7/3 bunker adjustment factors (BAF also OTAC) 15/6 Bureau of Cotton and Jute (BCJ), China 4/11 Burkina Faso Appendix /21

by products of cotton crops 5/20 see also cottonseed C.A. Galiakowtwala & Co Ltd, Mumbai, India Appendix 3/3 calcium arsenate 3/12 Calcot Ltd, Bakersfield, USA 9/17, Appendix 1/7, Appendix 3/2 calico production 1/6 calico 1/8 California SJV cotton 2/17 California 8/35 Californian San Joaquin Valley (SJVPima) 8/31 call options 11/10 purchase of by cotton farmers 11/15–16 Canada 4/2, 4/9 Candlestick theory 13/5–8 candlewick 1/9 carbamate insecticides 3/12, 313 ‘Cardinals and Corners’ 13/10 carding machines 7/12 Cargill Cotton (a Division of Cargill Plc), Liverpool only, UK Appendix 3/2 Cargill Cotton, Cordova & Liverpool, USA Appendix 3/2 Cargill Tanzania Ltd, Dar Es Salaam, Tanzania Appendix 3/3 Caribbean Basin Trade Partnership Act (CBTPA) 4/10 Carolina, North and South, US 4/5 Cartwright, Edmund 1/10, 1/11 Castellano & C Snc, Milan, Italy Appendix 3/4 cavitoma infestation 8/25 cavitoma test 8/25 cellulose 8/8 CEN-Standard Propostion CEN/TC 248 8/22 Census of Agriculture, US, 1997 4/5 Central Africa 8/35, 8/37 Central America 8/30, 8/48 Central and South America 5/13, 8/32 Central Asia 5/9, 5/13, 5/17 cotton trade 4/13 cotton production 8/38 classing of cotton 8/46 output 9/17 Central Asian republics and cotton production/consumption 2/5 Central Bank of Brazil, NYCE contract Appendix 4/5 Central Cotton Company Limited, Liverpool, UK Appendix 3/3 central European mills 15/3 Centro Algodonero Nacional (CAN), Spain Appendix 2/6–7, Appendix 2/8 certificate systems 10/2–3

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Index CF/CFR 15/1, 15/2, 15/8 chalazal end of seed 8/5 Charleston cotton production 1/12 charter terms 15/2–3 charter trade 15/2 chemical fibers 3/4, production 3/6 chemical residues 8/24 Chicago 12/10, Appendix 4/2, Appendix 4/11 Chicago Board of Trade Appendix 4/4 China 1/3, 2/5, 2/11, 3/3, 3/4–5, 4/3, 4/15, 5/2, 5/13, 5/24, 6/4, 8/5, 8/30, 8/41, 9/3, 9/16, Appendix 4/1, Appendix 4/8, Appendix 5/1–3 ancient cotton textiles 2/1 cotton consumption 1/19, 6/15 cotton distribution 4/13 cotton industry, structure and history 44/10–13 cotton production 19th century 1/18 cotton spinning 4/1 cotton stocks disposal 4/12 drainage and cotton 3/13 government assistance to cotton growers 3/9 importance of 4/10–13 membership of the WTO 4/12–13 Ministry of Civil Affairs Appendix 2/7 Ministry of Finance 4/11 subsidies 3/10 trade balance 2/11 China Cotton Association (CCA) Appendix 2/7 China National Cotton Exchange (CNCE), Beijing 4/12, Appendix 5/1–2 Chinatex, Beijing, China 4/11, Appendix 3/2 Chinese Cotton Appendix 4/8 CIE – Color 8/20 CIELAB color measurement (CIE) 8/20 CIF 15/2, 15/9, 16/7 CIP 15/2 CIRAD, Montpellier, France 8/23 Citrus Associates of the New York Cotton Exchange, Inc 10/4 Clark Cotton Group of Companies, Johannesburg, South Africa Appendix 3/3 classer, Cotton 8/46 Classer’s Color Grade 8/52 Classing and Grading of Cotton Appendix 2/14 classing 14/3, including ‘manual classing’ classing and grading 8/45–54, 14/3, principles 8/45–47 ‘Clearing Corporation’ see New York Clearing Corporation clearing house 10/3

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clothing tariffs 4/3 clothing, trends 4/1 Coefficient of Variation CV (L) 8/3 Coffee, Sugar and Cocoa Exchange, Inc (CSCE) 10/1, 10/5–6; 10/9, 11/4 backup facility in Queens, NY 10/5–6 see NYBOT collateral 17/2–3 paper and electronic 17/3 Colly Cotton Marketing Pty Ltd, Sydney, Australia Appendix 3/2 Colly-Houchin, Inc, Bakersfield, USA Appendix 3/3 Colombia Appendix 5/3 color 7/14, 14/3 color grade 8/47 Color and Leaf Grade classification for Pima cotton 8/52 color instruments 8/20 color parameters 8/54 color testing, cotton 8/14–16 Columbus, Christopher 1/5 comb sorter methods 8/11 methods of fiber measurement 8/19 length measurements 8/25 length array 8/27 combined transport operator 15/4 combining technical and fundamental aspects 13/3–5 Commitments This Month Appendix 2/14 Committee for International Cooperation between Cotton Associations (CICCA) 2/1, 2/2, Appendix 2/3, Appendix 2/5, Appendix 2/6, Appendix 2/8, Appendix 2/9, Appendix 2/11 Committee for International Cooperation between Cotton Associations (CICCA) Appendix 2/1, ff Committee for the Trade of Cotton (Germany) Appendix 4/7 Committee of Experts on Pesticides, Council of Europe 5/22 Committee on Value Differences (AFCOT) Appendix 2/3 Commodities Exchange (COMEX) 10/5 Commodity Credit Corporation (CCC), US 1/3, 4/8, 10/3–4, Appendix 4/4, Appendix 4/11 loans 2/8 Commodity Exchange Act (1974), US 10/4, Appendix 4/4 Commodity Futures Trading Commission (CFTC) 10/4, 11/8, Appendix 1/2, Appendix 4/3 Commodity Research Bureau Index (CRB) 13/7, 13/8 Commodity futures exchange and its demise Appendix 4/8 Commodities 11/2

Index commodity swaps markets 12/14 commodity trends 4/1 Common Agricultural Policy (CAP), EU 3/9 Common Fund for Commodities (CFC) (Amsterdam The Netherlands) Appendix 2/13 ‘compact spinning’ 7/9, 7/12, 8/6 Compagnie Cotonnière Copaco, Paris, France Appendix 3/2 Compagnie Français pour le Développement des Fibres Textiles (CFDT) 4/13 Compagnie Ivoirienne pour le Développement des Textiles (CIDT), Cote d’Ivoire Appendix 3/4 Compagnie Malienne pour le Développment des Textiles (CMDT) 4/14 compensating technology 7/11–12 competing fibers 3/6 Competitiveness Provisions, 1990 Farm Bill, US 9/9 Complete Elliott Wave Writings of A. Hamilton Bolton, The 13/11 computer readable barcodes or numbering systems, for bales 8/42 conditioned cotton samples 8/3 conditioners, seed cotton 8/40 conference system 15/6 ‘Conservation Tillage Production’ 8/38 consumer end-uses 6/8 consumer market research and campaigns Appendix 5/2 consumers and cotton Appendix 5/4 ‘container base to,’ 15/4 container base 15/4 container freight station (CFS) 15/4 container terms and definitions, terms used 15/3–5 container trade 15/3 container transport document 15/4 container yard (CY) 15/4 container yard, house to 15/4, door to 15/4, pier to 15/4 contamination of cotton 7/11, 8/23–24, 8/23–24, 8/43–45 contingency insurance 15/9 contracts 18/1–14 contrarian risk, and cotton market 12/16 controllers 16/3 Cook Industries, Memphis, US 2/2 CoolMax® Appendix 5/1 cooperation between sectors of the cotton textile industry 6/12 Coromandel coast (India) 1/4 ‘corrective’ wave 13/11 cost of production 9/4–5

Cotlook A Index 3/2, 3/3, 3/5, 3/6, 12/5, Appendix 4/3–4 Cotlook Cifquotes 9/16 Cotlook Daily 9/16 Cotlook Dual Index Appendix 1/2 Cotlook Indices 2/12, (A and B) 9/1/6–17 Cotlook Ltd Appendix 1/2 Cotlook Priscope 9/16 Cotlook quotes Appendix 11/2 Cotlook, Liverpool (UK) 2/10, 9/16 cottage industry 1/1 Cottagon Italia Srl (Paul Reinhart), Milan, Italy Appendix 3/3 Cottip SA, Geneva, Switzerland Appendix 3/2 COTTON cotton 1/6, 8/32, 8/37, 8/48 as global agricultural commodity 1/1 cotton: origin of word 1/3, uses of plant 3/1 cotton in various languages 1/3 Cotton Contracts Act Appendix 4/8 Cotton Contracts Appendix 4/1, and futures market 10/6 Cotton Controllers 14/1, 14/6 ‘cotton famine’ 1/13 cotton improvement 5/4–8 cotton information gathering 2/10–11 cotton quality 8/1ff, quality determination (HVI) 8/42 cotton research and promotion program 4/6 cotton samples 8/45 cotton stripper 5/17–18 ‘cotton systems’ 7/3 cotton testing 8/1, US 8/25 CULTIVATION AND AGRICULTURE cotton breeding and resultant changes in quality parameters 8/30–33 time schedule 8/31 cotton crop, requirements 5/9–10 cotton cultivation and consumption, historical perspective 6/1–2 cotton farmers 4/11, 7/3 hedging by 11/12–16 and water resources 3/13 cotton, cultivated, Pakistan, China, Pakistani Desi 8/29 contamination types 8/43 defects in processing 7/11 effects of moisture on testing 8/3 factors affecting variation 5/4 cotton pests, disease and insect control 8/36 cotton plant and fiber development 8/1 cotton plant breeders 7/3 cotton plant development, effects of soil and nutrition, water supply and weather 8/35

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Index cotton plant 5/2–4, influence of heat on 5/3 cotton plantations 2/1 cotton agronomy 5/8–11 irrigation of 5/14 diseases affecting 5/14 harvesting and processing 6/5 cotton aphid (Aphis gossypii Giov) 8/36 cotton bollworm (Heliocoverpa zea) 5/7 cotton development and structure of cotton fiber 8/4–5 cotton nematodes (Meloidogyne incognita) 5/14 cotton root knot (Heterodera radiciola) 8/35 cotton seedling development 5/10 HISTORY cotton’s place in history 1/1–2, 1/3–24 cotton usage, 19th century 1/14 (table) and the Industrial Revolution 1/1, 3/1 production post WWII 2/3–4 cotton textiles, popularity of 6/1–2 cotton fabrics, protectionist measures, UK 17th–18th centuries 1/6 ORGANIZATIONS Cotton Australia Ltd 6/13 Cotton Brokers’ Association 12/10 ‘Cotton Brokers’ Bank’ Appendix 4/6 Cotton Company of Zimbabwe Ltd, The, Harare, Zimbabwe 6/13, Appendix 3/3 Cotton Corporation of India Ltd, The, Mumbai, India Appendix 3/2 Cotton Council International (USA) 6/15, Appendix 6/3 Cotton Distributors Inc, Lausanne, Switzerland Appendix 3/4 Cotton Exchange now New York Futures Exchange Cotton Export Corporation Appendix 4/8 Cotton Incorporated (USA) 6/14, Appendix 6/3, Appendix 6/4 Cotton Marketing Organisation, Aleppo, Syria Appendix 3/2 Cotton Outlook’s (Cotlook) A-index 4/8, 4/9 Cotton Producers Institute 6/14 Cotton Production & Marketing Board Ltd, The, Herzlia, Israel Appendix 3/4 Cotton Program, AMS, USDA 8/53 Cotton ring, Chicago 11/4 Cotton States Arbitration Board (Memphis) Appendix 2/3 Cotton Testing General Organization (CATGO), Alexandria, Egypt 8/49 Cotton Textile Institute Appendix 1/7 PRODUCTION classification of cotton samples 14/1 cleaning of raw cotton 5/18–19

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‘cotton classing’ 8/46, 10/7, automated 6/11, cotton fiber applications 7/2 colours, factors affecting 8/17 natural colors of 8/25, quality demands for classing and HVI measurement 8/9–14 strength testing 8/13–14 development and structure of 8/4–5 drying in the boll 8/5 maturity of 8/5 cotton fiber problems 8/23–25 cotton gin 1/10, 1/12, 2/1, 6/1 US distribution 4/5 cotton grading, evolution of 9/11 cotton growers 2/9–10 cotton growing regions 5/8–9 cotton mixes, selection of 6/11 cotton producing countries and regions 8/28–29 cotton production 1/2, 2/8–9, 3/1, 4/3 production areas 5/2, 5/24, 8/34 Franc Zone 4/14 future prospects 5/24, US 1/8. 1/11–12, 1/15 (table) cotton single growing conditions and maturity 8/4–5 cotton spinners 2/9–10 cotton spinning and weaving 2/1 cotton spinning factory, Pawtucket Rhode Island 1/12 cotton spinning trends 4/1 cotton storage and transportation systems 5/18 cotton supply/production 3/4, 3/5, 9/3 cotton weaving 8/6 cotton yarn and cloth, costs of 1/16–17 cotton yarn, antiquity of 6/1 cotton yarn, production of 1/10, 1/11 PUBLICATIONS cotton associations Appendix 2/1ff Cotton Counts Its Customers 7/2–3 Cotton Goes to Market (Garside) 11/2 Cotton Outlook (magazine) 9/16 COTTON Review of the World Situation Appendix 2/14 Cotton This Month Appendix 2/14 Cotton this Week Appendix 2/14 COTTON World Statistics Appendix 2/14 TRADING cotton and the internet 6/9–10 cotton as a global agricultural commodity 1/1 as share of total fiber production 1/2–3 imports into to England 1/6–7 consumer perceptions of 3/8 marketing and trade interventions 3/9 cotton brokers association in Liverpool, formation of 2/2

Index cotton consumption, composition of 6/2–9, growth in 8/5 cotton exchanges 8/42 cotton futures 13/2, 13/5–7 market 4/5, 10/3–4 limitations on futures market holdings imposed by US government 11/3 contracts Appendix 4/1 exchanges, history of Appendix 4/1ff prohibition of cotton futures market by Indian Government Appendix 4/8 cotton market 12/10, 13/16 and impact on OTC derivatives 12/1 American 13/1 fashion Appendix 6/3–4 industrial Appendix 6/4 cotton marketing 4/3, US 4/5 contribution to world economy 3/1–2 and foreign exchange 5/23 cotton mills, hedging by 11/9–12 cotton mixes, selection of 6/11 cotton options 12/9 cotton prices 3/3–4, 9/10, 9/15 price forecasting 2/12, 2/13 price support, US 4/6–7, 11/13 price swap 12/9, 12/14 pricing 2/13–14, 9/1, 9/10–15 pricing policies 9/5–9 factors affecting 9/10 arrangements 9/10 cotton subsidies 3/11 cotton swaps 12/5, in detail 12/8–9 cotton tariffs 4/3 cotton textile trade 6/1 decline in prices 2/18, 2/19–20 in the New World 6/1 current situation 10/6–8 as a commodity, influence on global markets etc 10/8 purchase of by mills 11/10 international trade 2/4–5, 3/1 cotton traders, electronic 6/10 cotton trading futures CBOT 12/10 cotton trading 2/1, 4/15, and technical analysis 13/15–16 ethos Appendix 7/1 cotton world industry 1/13, 1/16 cotton’s market value, Major determinants of 7/3–12 economic importance of 3/1–2, and trading, US 2/2–3 TYPES brown cotton Appendix 4/2 cotton properties of 8/3–4 strength of 8/26–27 types 5/5 cottons with naturally coloured lint 5/8 cottons, medium and short staple 7/12 organic 3/15

genetically engineered (GE) 3/3, 3/13 cotton varieties 8/29–30, 8/34 with herbicide tolerance 5/7 with resistance to Lepidopterous insects 5/16 USES demand 9/2–3 cotton, major uses of 7/2–3 apparel 6/1, 6/2, 7/2 cotton balls and swabs 7/8 in explosives 7/1 in home furnishings 6/2, 7/2–3 industrial uses 6/2–3, 7/2, 7/13–14 as insulation 7/2 as padding 7/2 promotion of 6/13–15 share of the retail market 6/15 use in padding, batting and insulation 7/3 cotton, raw, used for handling liquid spills 7/1 by-products 5/20 cotton as cellulose, uses of 8/8 cotton garment manufacture 1/4 cotton lint 9/2 harvesting 6/1 standards 8/9 cost of 9/4–5 cottonseed 1/12, 5/1, 5/20. 5/21, 6/1, 7/1, 8/29 oil production 5/6, 6/9 contract Appendix 4/2 seed coat fragments 8/43, 8/45, 8/54 seed cotton cleaning 8/40–41 seed cotton feeding system 8/40 seed cotton grading 5/23 seed selection 8/34–35 seed, cotton, epidermis cells 8/4 cotton seed varieties (GMO) 2/11 Council of Europe 5/22 counter-cyclical payment (CCP) 4/8–9 country damage risk 15/8 counts to new highs and lows 13/7–8 cowboy wiggle, the 13/9–10 CPT 15/2 Crawford 1/4, 1/16 credit and OTC instruments 12/15–16 credit risk 12/3 crimp, cotton fiber 8/5 Crompton, Samuel 1/10, 1/11 crop establishment 5/9–10 failure, reasons for 5/9 price insurance 11/15 rotation 3/3, protection 5/14–15 residues 5/15–16 stocks 13/2 crops competing with cotton: foodstuffs 3/5–6, fibers 3/6

Index/page vii

Index cross-currency swaps and options 12/12–13, cotton option 12/13 Cukurova Cotton Cooperatives Association Cukobirlik, Adana, Turkey Appendix 3/2 cultivated cottons of the world 5/1–2 currency 12/8 current advances and promising technology 6/9–13 current price data 9/15–16 Current Research Projects in Cotton Appendix 2/14 Cyprus 1/5 Daewoo Corporation, Seoul, R. of Korea Appendix 3/3 Daily Cotton Market Report (KCA), KCA Institute of Cotton Grading and Classing Appendix 2/10 Daily Rates Committee EICA Appendix 2/8 Daily Spot Cotton Quotations (DSCQ) 9/16, 9/18 dark-cloud cover 13/7 Data Transmission Network, Omaha, Nebraska, US 9/17 DDT 3/12, 8/24 dead fibers (cotton) 8/5 Decitex (dtex) 8/23 decolonization of Africa Appendix 4/7 definition of staple length classes 8/12 definitions of organic and other agricultural practices 8/37–38 defoliants 5/12–3, 8/24, herbicidal 5/12, hormonal-5/12–13 defoliation US 8/37 Deltapine DP 5415 8/32 Demand Activated Manufacturing Architecture (DAMA) 6/10 demand for fiber quality 8/6ff denim 4/4, Appendix 6/1 Depression, 1930s 6/3 derivatives 12/4, 12/5, 12/6, 12/10 description of cotton types 8/33–34 desertification 8/35 Devcot SA, Lille, France Appendix 3/3 developing countries/nations 4/1–2, 6/6, 12/16–18 rise and fall of government control in 4/2–3 availability of market information 5/24 and textile production 6/4 imports 4/1 Digital Fibrograph 8/29 Dimethipim (Harvade) 5/12 Diparosis castanea (red bollworm) 5/7diseases of cottton 9/3, resistance 5/6 DNA analysis 8/31 dollar, strength of and cotton prices 13/17

Index/page viii

domination of England in cotton markets 1/11–17 Dow Theory 13/11 Dow Appendix 4/8 drawing process 7/3 drying of seed cotton 8/40 dumpling top 13/7 Dunavant Enterprises Inc, Memphis & Australia, USA Appendix 3/2 Dunavant Enterprises Pty Ltd, Morese NSW only, Australia Appendix 3/3 DuPont Appendix 6/1, Appendix 6/3 dyeing of natural colored cotton 8/25 Earias insulana (spiny bollworm) 5/7 East Asia 8/54 cotton spinning 4/1 cotton futures exchanges, history of Appendix 4/7–8 East India Cotton Association (EICA). Appendix 4/8. Appendix 2/7–8 Eastern Trading Co. Inc, Bakersfield, USA Appendix 3/3 ecological considerations of cotton growing 5/20, 5/22–23 Ecom Agroindustrial Corp Ltd, Pully only, Switzerland Appendix 3/4 Ecom USA Inc, Dallas & Switzerland, USA Appendix 3/2 Economic Research and Statistics Bureau (Associazione Tessile Italiana) Appendix 2/4 economic slumps and cotton industry 6/12 economic theory, and cotton production 3/10 eCOPS® (Coffee industry) 10/9 ‘eco-textile’ market 3/15 Edward III, banning imported cloth 1/4 Egypt drainage and cotton 3/13 cotton growing in 1/4, Appendix 4/1 cotton production 1/16, 3/9, 4/2, 5/13, 7/5, 8/348/38, 8/41, Appendix 4/1, Appendix 4/2, 4/3, Appendix 4/6 Egyptian Classification System 8/46 Egyptian Cotton Gazette The Appendix 2/2 Egyptian cotton seed 8/31 Egyptian cottons 2/2, 8/30 long staple cottons 8/26 development of cotton production 2/1, 5/2, Egyptian Mitafifi (Afifi) cotton 8/31 Egyptian standards 8/49 Egyptian Testing House Terms Appendix 2/2

Index Egyptian/Pima cotton 5/18, 8/33 El Niño phenomenon, and effects on cotton trading 2/11 El-Attal, Hassan A. 8/49 electronic commodity delivery and documentation platform 10/9 electronic data interfaces, use of 6/13 electronic warehouse receipt (EWS) 10/2 ‘Elliott Wave Principle – Key to Stock Market Profits’ 13/11 Elliott, Ralph Nelson 13/8, 13/10–11 Ellison, T. 1/3, 1/5 elongation of fibers 8/19–20, cotton fiber 8/33 endotoxins 5/16 end-user consumption 6/9 Engineered Fiber Selection Cotton Fiber Management System (EFS ®) 6/11 England 1/1, 1/2 1/5 cotton consumption 1/19 cotton spinning 6/1 imports of cotton 1/4, 1/12–13, engulfing patter 13/7 entry point 13/13 environmental degradation 5/23 environmental issues 3/12–15 Environmental Protection Agency, USA 5/22 Esteve Brothers & Co, Inc, Dallas, USA Appendix 3/3 Etem Ozsoy Tarim, Ticaret Ve Sanayi As, Izmir, Turkey Appendix 3/3 Ethaphon (Prep) 5/12 Ethiopia 9/11 e-trade 2/15–16, futures 2/16 EU 3/9, 3/10, 12/17, cotton production 3/2 Europe 3/10, 3/15, 5/13, 8/32, 12/18, Appendix 2/3 imports of cotton, in historical periods 4/4 cotton consumption 1/19 cotton imports 1/16, 2/5 Arab introduction of cotton into 2/1 cotton trade 2/1–2, Appendix 4/7 cotton spinning 4/1 cotton standards 8/22 cotton production 8/38 Europe, cotton futures, history of Appendix 4/5–7 European Community see European Union European Contract Appendix 2/8 European Cotton Confederation (ECC) Appendix 2/8 European cotton market Appendix 4/7 European trade with rest of world 1/5 European Union 2/5, 9/17 evening star 13/5–6

events of 9/11 10/5, Appendix 4/11 exchange 17/6 exchange based derivatives 12/10 Exchange For Swaps (EFS) 12/15 exchange-traded futures 12/14–15 exchange-traded or OTC, choice between 12/11–12 exchange-trading instruments 12/1 export subsidies 3/11, 9/6 export subsidy program (‘Step 2’) 13/2 export tax, Pakistan 9/9 Extra-Fine Cotton This Month Appendix 2/14 Extra Long Staple Cotton (ELS) 2/13, 4/4, 7/5, 8/30, 8/39, 8/49 ELS cotton traders 2/8 Extra Long Staple Egyptian, American Egyptian or Pima, Sea Island cotton (sp Gossypium barbadense) 5/1 Extra-long staple Egyptian cotton 8/46 extraneous matter 8/47 fabric contaminants 8/44 fabrics, effects of blending cotton with other fibers 7/13 factors affecting cotton prices 9/2–10 factors affecting cotton production 5/8–9 Crop establishment 5/9–10 Plant nutrients 5/10–11 Fair Trade environment Appendix 2/3 ‘Far East Cotton’ 14/3 Far East, cotton imports 2/5 Farfalla system 8/38 farm income and cotton production 5/23 farm program spending 4/7–8 Farm Programs 10/3 Farm Security and Rural Investment Act (2002) 4/8 farmer cooperatives 17/2 Farooqui Keaton and Miller Appendix 4/10 FAS 15/1, 15/2, 15/8 fashion trends and demand for cotton 9/3 FCA Comexim Ltd, Moscow, Russia Appendix 3/3 Federal Agricultural Improvement and Reform (FAIR) Act, US 4/7, 9/6 Federal Reserve policies 4/2 fertilizer rates 5/10 fertilizers 1/1, 1/2 fibers 8/22 blending 7/13 characteristics in yarn spinning 7/4 quality demands for future classing and selected measurements 8/6, 8/18–23 quality, non-wovens 8/8–9 strength 7/5 testing 5/6

Index/page ix

Index fiber length distribution 8/11 measurements of 8/19 fiber properties as determining cotton’s use-value in spinning 7/10 measurements required 7/10–11 properties, as price determinant 7/3 fibers and yarns, improvement of 7/12 Fibonacci sequence/numbers 13/7, 13/10 Fibrograph 5/6, 8/27–28 fibrous defects 7/11 finance 17/2 Financial Results of Speculative Holding of Wheat (H. Working) 11/1 Financial Times 12/5, 12/8 financing cotton stocks 17/2 fineness 8/22 FINEX® division, NYCE, financial futures and options 10/5 First American Cotton Co., Lubbock, USA Appendix 3/4 Five waves technical analysis 13/8 Five-point (buy or sell) signal 13/8–9 flax 1/9 Florida, cotton production 6/1 flying shuttle 1/1, 1/4, 1/10–11 FOB 15/1, 15/2, 15/8 FOB stowed 15/1 Food and Agriculture Improvement and Reform (FAIR) Act (1996), US 4/7 Food and Agriculture Organization (FAO) 5/15, 9/15, Appendix 2/13 Food Research Institute, Stanford University 11/1 Food Security Act (1995) 4/7 forecasting cotton prices 2/12–13 foreign matter in cotton 8/43 Former Soviet cottons/Central Asian cottons 2/5, 8/32 Former Soviet republics of Central Asia 5/2, see also Kazakhstan, Turkemenistan, Uzbekistan Former USSR 3/4, 5/13 Forte Handelsgesellschaft MbH, Vienna, Austria Appendix 3/3 Forward Contracts Regulation Act Appendix 4/8 forward contracting 17/5 forward contracts 9/13–14, 10/1, cash 9/13–14, basis contract 9/14 FQT-Fibro-Lab 8/54 Franc Zone, West Africa, cotton trade 4/13–14 France 2/2, cotton spinning 6/1, historical use of cotton 1/4–5, Appendix 2/3, Appendix 4/1, Appendix 4/6, Appendix 6/3 Frances & Company, Inc, Memphis, USA Appendix 3/4 freight rates 15/5–6

Index/page x

freight swaps markets (FFAs) 12/7 freight, interior, ocean, delivery to final destination, FOB, interior landed mill, FOB 15/1 freight, terms and definitions 15/1 French cotton exporting colonies Appendix 2/13 Friedrich W. Kaemena & Co GmbH, Bremen, Germany Appendix 3/3 frozen concentrated orange juice (FCOJ) futures 10/4, 10/9 fry pan bottom 13/7 Full Container Load (FCL) 15/4 Fundamental Analysis (Schwanger) 11/2 fundamental analyst and trader 13/4 fundamental trends and structural changes 4/1–4 fundamentalists 13/16, 13/17 Fusarium wilt (Fusarium vasinfectum ATk.) 5/14, 8/35 fustian 1/9 futures 2/9, 13/12 contracts 10/1–2, Appendix 4/3, Appendix 4/11 markets, cotton 2/17, 9/12–13, 11/14, 12/14 and options contracts 10/1–2 trading 9/17, Appendix 4/11 Gama, Vasco da 1/4 Gann, W. D. 14/10 Gap Pazarlama AS, Istanbul, Turkey Appendix 3/3 Garside, Alston Hill 11/2, Appendix 4/6 GATT/WTO 4/3 Gdynia Cotton Association (GCA) Appendix 2/8 General Agreement on Tariffs and Trade (GATT) (replaced by WTO) 3/10, 4/2, 5/24, 6/7 genetic engineering and cotton 1/2, 3/3, 3/13, 3/14; 5/5, 5/6–7 and general agriculture 3/13–14 genetic modification and the environment 3/14–15 genetically engineered cotton, Bt cotton 8/31 Georgia, US, cotton production 1/11–12, 4/5 Germany 2/3, 6/13, Appendix 2/3, Appendix 2/6, Appendix 4/1, Appendix 4/7, Appendix 6/3 Gezira Scheme, Nile, Sudan 5/13 Ghorashi, H. 8/53 Gill & Co. Ltd, Mumbai, India Appendix 3/3 gin, roller 5/18 gin, saw 5/18

Index ginning principles 8/39–40; saw 8/39 roller 8/40 ginning system 5/18–20 Gin-Wizzard 8/39 Giza cotton 7/5, 8/31 Glencore Grain Rotterdam Bv, Rotterdam, Netherlands Appendix 3/3 Glencore International Ag, Baar, Switzerland Appendix 3/3 global communications, developments in 6/10 global cotton markets, features and impact on OTC derivatives 12/1–3 global fiber consumption 6/7 global marketing systems 7/3 Global Monitor The Appendix 6/3 Globalization of cotton 1/17–19 Globalization 1/17–19 Glyphosate (Roundup) 5/7 gold standard, abolition of, US 10/8, Appendix 4/11 Gossypium species 8/29 Gossypium hirsutum 8/29, 8/30 G. arboreum 8/29 G. barbadense 8/29, 8/30, 8/31 G. brasiliense 8/30 G. herbaceum 8/29 G. nangking 8/29 G. peruvianum 8/29 G. purpurascens 8/29 government, role of control, developing countries 4/2 intervention in cotton prices 5/23–24 involvement in markets 9/3–4 measures and cotton prices 3/3 policies affecting cotton 3/8–12 government programs and price changes 13/2–3 GPT tolerances, cotton 2/14 ‘Grade boxes’ 8/46 grain futures contracts Appendix 4/1 gravimetric fineness 8/22 Gray, Roger 11/1 Great Lakes 11/5 Greece 1/4, 2/17, 3/9, 5/2, 5/13, 9/16, 9/17, 12/7 cotton exports 2/5 Greef, Muell 8/35 Greek Box 4 cotton 12/3, 12/5 Greek OTC market 12/7 green fibers 8/25 Growing Organic Cotton Appendix 2/14 Growth enhancers, cotton 8/35 Guatemala 5/23 Gutknecht-correlation 8/23 Hafez Appendix 4/2 hair weight 8/22

hammer 13/7 ‘hand’ (feel of yarn) 7/9 hand picking of cotton 5/17, 8/37 Hanging man 13/7 Hargreaves, James 1/10, 1/11 Harvade (Dimethipim) 5/12 harvest aid chemicals 5/12–13 harvesting and initial processing 5/17–23, 8/37 Heap, A. 8/53 hedging 10/8. 11/1, 12/4, 13/15, 17/4, 17/5, Appendix 1/4, Appendix 4/11 reasons for hedging 11/5–7 who involved 11/8–16 cotton 12/2, 12/4, 12/5 transactions 12/17–18 New York futures market 2/14–15, 2/17, 9/17, Helicoverpa armigera 5/7 H. punctigera 5/7 H zea (cotton bollworm) 5/7 Heliothis virescens (tobacco budworm) 5/7 Heliothis/Heliocoverpa populations 5/7 herbicides 5/17, 8/24, 11/14, resistance 3/12 Herodotus 1/4, 6/1 Hertel, Knoxville 8/27 Hieronymus Appendix 4/11 High Plains area, Texas 4/4 High-volume instrumentation (HVI) machines 6/11, 8/46, 9/11 HVI – Bremen Roundtests, USDA Round Trials 8/53–54 HVI – calibration 8/53 HVI – classing 8/39, 8/51–2, Appendix 2/1, Appendix 2/6 HVI – Color 8/14–15 HVI Color Grades for Upland Cotton Color Classification 8/51–2 HVI – grading 9/11 HVI instrumentation 5/6, instruments 8/47, 8/48 HVI lay-downs 2/9 HVI – length (including definition) 8/11, 8/12, length testing 8/28 HVI – measurements 8/20, 8/34 HVI, micronaire 8/9 HVI results 2/9 HVI – Strength 8/13–4, 8/26, 8/27 HVI – supplements 8/1 HVI – testing colour 8/14–15 HVI – test line Appendix 2/6 HVI – testing 8/12, 14/3, Appendix 2/11 HVI – Trash 8/17–18 HVI – Uniformity Index 8/12–13 historical data on cotton prices 9/19

Index/page xi

Index historical development of exchangetraded and OTC markets 12/10–11 Holland Appendix 4/7 Holland, cotton industry 1/7 Homoptera insects 8/21 Honeydew 8/24 Hong Kong Commodity Exchange Appendix 4/8 Hong Kong cotton futures exchange Appendix 4/7, 4/8 Hong Kong Futures Exchange Appendix 4/8 Hong Kong 6/4, Appendix 4/1, Appendix 6/3 hosiery 1/9 Hungary 12/17 Hunter Dr L 8/53 HVI see High volume instrumentation hybrid varieties, development of male sterility in 5/8 hybridization 5/5–6 ICAC Documents on CD-ROM Appendix 12/14 ICAC Recorder, The Appendix 2/14 IIC-Shirley Fineness/Maturity Tester (FMT) 8/22 Illinois Elevator Bill (1887 US) Appendix 4/1 impact of cotton ginning on cotton quality 8/39–42 impact of cotton production and ginning conditions on quality 8/34–42 impact of cotton production on quality 8/34–38 impact of quality measurement 9/10–11 impacts of spinning technology on fiber requirements 7/5–10 ‘Impulse’ wave 13/11 India 2/5, 3/13, 3/14, 4/2, 4/3, 4/15, 5/1, 5/13, 5/24, 8/25, 8/30, 8/37, 9/3, 9/12, 9/16, 10/8, 12/17, 13/5 Appendix 2/7, 2/8, Appendix 2/13, Appendix 4/1, Appendix 4/8 ancient cotton textiles 2/1 cotton disease in 5/14 cotton production in 1/8, 2/1 cotton production 19th century 1/18, 1/16 commercial production of cotton in 2/1 cotton spinning 4/1 development of cotton production 5/2 as origin of cotton manufacture 1/3, 1/4 textile development in Indian subcontinent 6/4 wheat competition with cotton 3/5 Indian Cotton Contract (ICC) Appendix 4/9 Indian cotton goods, imports into UK 1/6 Indian Cotton Appendix 4/8

Index/page xii

indirect subsidies 9/6 indirect tax 9/8 Indonesia 3/14 Indus river valley 1/4 Industrial revolution, cotton and 1/1, 3/1 Industrie Cotonnière Beninoise, Cotonou, Benin Appendix 3/4 Indutech Spa, Milano, Italy Appendix 3/3 information gathering, for cotton merchants 2/10–12 information technology 6/10 inorganic matter as contaminants 8/44 insect infestations and pests 8/29 control 8/36–7 control strategies, development of 5/15 honeydew 8/21 insecticides 8/24, 8/36 and cotton 3/12 and effects on other creatures 3/12–13 and the environment 3/14–5 resistance 3/12, development of by pests 5/15 synthetic, development of 5/14 Insecticide Resistance and Its Management in Cotton Insects Appendix 2/14 Institute Commodity Trade Clauses (A) War Risks Insurance 15/7 Institute of Cargo Clauses (A) 15/7 Institute of Textile Technology (ITT), Charlottesville, US 8/25 Institute riots and civil commotions insurance 15/7 Institute Strikes Clause (Cargo) 15/7 Institute Strikes Clauses (Commodity Trades) 15/7 Institute Strikes 15/7 Institute War Clauses (Cargo) 15/7 Institute War Clauses (Commodity Trades) 15/7 insurance of cotton 15/6–7 insurance policies 15/8–9 ‘Integrated Pest Management’ (IPM) programs 3/13, 5/8, 5/15, 5/16, 8/38 ‘Intelli-Gin’ 8/39 Intermodal transport 15/4 International Chamber of Commerce 15/1, 15/2 international controller 14/1 International Cotton Advisory Committee (ICAC) 2/10, 6/14, 9/5, 9/15, Appendix 2/11–14, Appendix 6/2 collection of historical data 9/19 research 3/7, 3/9, Appendix 2/11, Appendix 6/1 International Cotton and Textile Trading Co Ltd, Lugano, Switzerland Appendix 3/2

Index International Cotton Association (previously the Liverpool Cotton Association) Appendix 2/8 International Cotton Conferences Appendix 2/6 International Cotton Meeting (Washington DC Sept 1939) Appendix 2/12, Appendix 2/13 international cotton species, range of 8/10 international cotton trade 8/48 International Forum for Cotton Promotion (IFCP) 6/13, 6/14, Appendix 6/2 international markets 9/3 International Monetary Fund (IMF) 9/15 International Round trials 8/10 international short staple cottons 8/12 International Sugar Agreement 3/6 International Swaps and Derivatives Associations (ISDA) 12/9 International Task Force (ITF) 12/17 International Textile Manufacturers Federation (ITMF) 8/22, 8/44, Appendix 2/211 surveys 8/44, 8/45 Committee on Cotton Testing Methods 8/3, 8/53, 8/54 HVI User Guide 8/53 International Wool Trade Organization (IWTO) 8/27 IWTO Test Standard 32–82 8/27 Internet and cotton industry 6/10–11 inventory management 6/12 ‘Inventory Protection Program’ 13/2 Iran 5/13 Iraq 5/13 irrigation management 3/3 irrigation practices 5/13–14 ISO and ASTM D2818-1979 8/22 Israel 5/13, 5/17, 5/23, 8/25 Italy 6/13, Appendix 2/4, Appendix 6/3 ITC swaps 2/11 Izmir Mercantile Exchange (Turkey) 9/16, Appendix 2/9 J. G. Boswell Company, Pasadena, USA Appendix 3/3 Japan 3/15, Appendix 2/3, Appendix 2/9, Appendix 4/1, Appendix 6/3 cotton trading 2/2, 2/3, 6/13, 13/5 economic development and textile production 6/3, 6/4 Japan Cotton Traders Association (JCTA) Appendix 2/9 Japanese Candlestick Charting Techniques 13/5 Jaume Artigas, Barcelona, Spain Appendix 3/3 Jernigan Group, Memphis Tennessee, US 9/17

Johannsen-Zweigle 8/11, 8/27 Joint venture enterprises (JVE), China 4/11 Joint-Stock Company Innovatsia, Tashkent Uzbekistan Appendix 3/2 Josephus 1/4 Jumel (French engineer) 8/31 just-in-time inventory management 6/13 Karachi 1/3, (Pakistan) futures exchange Appendix 4/9, Appendix 4/11 Karachi Cotton Association (KCA) Appendix 2/9–10, Appendix 4/10 Karachi Cotton Exchange Appendix 4/10 Kay, John 1/10 Kazakhstan 8/28 KCA Institute of Cotton Grading and Classing Appendix 2/10 Keynes, John Maynard 11/1 Knowles-Taylor Cotton Co Inc, Malador, USA Appendix 3/4 Knowlton, J. 8/53 Korean War 11/4 Kotak & Co Pvt Ltd, Mumbai, India Appendix 3/3 Ktesias 1/4 Label Coton, Cotonou, Benin Appendix 3/4 labeling laws Appendix 6/2 laboratory conditions for testing 8/3 laboratory tests, selected traditional 8/25–28 lab-to-lab reproducibility of tests 8/1ff Lal and Parmar Appendix 4/8 Lancashire cotton mills 2/1 Lancashire, cotton spinning and weaving in 2/1 Lancaster 1/5 Latin America, cotton in 3/1, 3/11, 5/17 LCA Appendix 2/2, Appendix 2/3 LCA Arbitration 14/2 Byelaw 334 14/3 Rule 205 15/7 Rule 206 15/7–8 Rule 207 15/7–8 Rule 211 14/3 Rule 216 14/14 Rule 217 14/5 Rules 4/2, 14/3 terms 14/4 trade rules on insurance 15/7 Le Havre 1/2, 11/4, Appendix 4/6, Appendix 4/11 cotton futures exchange 1/18 cotton trading 2/1 cotton exchange Appendix 4/7 Le Havre General Rules (AFCOT) Appendix 2/3

Index/page xiii

Index leaf curl virus 5/14 leaf grades 8/47, 8/51 leaf 14/3 leaves, abscission of 5/12 length classes for cotton species 8/12 Lepidopterous insects 5/7 Letter of credit (L/C) 15/1–2 (irrevocable 16/1–2, 17/5, confirmed 16/2) Lifestyle MonitorTM Appendix 6/3 Lindall wiggle 13/9 linen 1/3, 1/6 linen/flax production 1/9 liner terms 15/2 lint, cotton 5/3, 6/2, 8/21 cleaning 8/41 linters quality 1/11, 8/8–9 trading 8/9 different cuts 8/9 Lintronics 8/54 Liquidity risk and OTC instruments 12/15 Liverpool (UK), 1/2, 1/6, 1/12, 11/4, Appendix 4/8 cotton trading 2/6, 2/18, 2/1, 2/2, Appendix 4/5–8 Liverpool Cotton Association (LCA); now International Cotton Association (ICA) 14/2, 15/3–7, 17/5, Appendix 2/10–11, Appendix 2/8, Appendix 4/6 formed 2/2 By-laws and Rules, Liverpool Arbitration Appendix 2/10 Liverpool Cotton Brokers Association Appendix 4/6 Liverpool Cotton Exchange (American contract; empire and miscellaneous growths contract; Indian cotton; Egyptian Contracts Appendix 4/6), 1/13, 12/10, cotton futures exchange 1/18, Appendix 4/6, Appendix 4/7, Appendix 4/11 Liverpool Rules Appendix 2/10 Liverpool, Cotton futures trading, history of Appendix 4/5–7 Lloyds’ agent 15/7, 15/8 ‘Loan’ program, American cotton industry 13/1 London 11/3, cotton industry 1/6 long staple cottons 8/6, 8/30, 8/33, 8/38, 8/39, 8/49 long staple cotton traders 2/8 long staple Egyptian cotton 8/46 Louis Dreyfus Cotton International NV, Antwerp, Belgium Appendix 3/2 low till and no-till production systems 3/3 Luid Jover SA, Barcelona, Spain Appendix 3/4 LYCRA ® Appendix 6/1

Index/page xiv

Lyons Cotton inc, Memphis, USA Appendix 3/4 M. Schiefer Trading Co, Lubbock, USA Appendix 3/3 M/O/T cotton 2/14 machine picking 8/37 Macquarie Cotton International, USA Appendix 3/3 macroeconomics 9/4, 9/20 Madras, India 1/4 Magellan, Ferdinand 1/5 maize 3/5 Malaysia 12/17 Mallow family of plants 8/29 Malvaceae 8/29 Mambo Commodities, Paris, France Appendix 3/3 Manchester Act 1/6 Manchester cotton textile industry 1/6 man-made fibers (MMF) 2/3–4, 6/2, 6/7, 6/16, 7/2, 9/19–20 Manual Thermodetection device 8/22 marine cargo insurance 15/7 marine insurance 15/8–9 ‘mark to market’ 17/1, default 17/1 market forces driving prices lower 3/2–5 market: forces and cotton prices 3/2–5 fundamentals 9/2 risk 12/3 movement 13/6 psychology 13/16 rally 13/13–14 reaction commodity trading 13/16 research Appendix 5/3 marketing loan program, US 4/7, 4/8 marketing pools 9/14–15, in US marketing technology 6/10 markets 9/20 Marsh, A. R. 1/18 Mato Grosso, Brazil 3/3 maturity of cotton 8/22 maturity 8/54 maximum price contracts 2/9 McFadden (US cotton trading house) 2/1, 2/2 McMillan, Lawrence 11/8 mealy bugs 8/21 measurements of cotton fibers 7/11 mechanical picking of cotton 5/17–18, 5/19 mechanical testing 14/3 Mediterranean region 5/17 cotton production 1/7 and cotton 3/13 medium grade cotton 4/4–5 Medium Staple American and African Upland cottons (sp Gossypium hirsutum) 5/1

Index medium staple cottons 8/39 Memphis, Tennesee 11/3 Memphis No 2 cotton Appendix 4/2 Mendelian genetics 5/5 Mepiquat Chloride (PIX ®) 5/11 merchants, hedging 11/8–9 Merton, Robert 11/7 ‘Mexicali Effect’ 8/36 Mexicali 8/24–5 Mexico 2/5, 3/9, 3/14, 4/2, 4/9–10, 5/13, 5/23, 8/32, 8/36, 8/48, 9/16, Appendix 2/13 ancient cotton textiles 2/1, 8/30 Mexico, Peru (pre-Inca), China, United States, India, historic production 6/1 microbiological infestations 8/25 micronaire 3/5, 4/9, 5/1, 5/6, 7/10, 8/7, 8/9–10, 8/33, 8/34, 10/7, 14/3 NCL 2/15 general measurement 8/9–10 measure 5/5, 5/6 values 7/10, 8/23 microspinning technology 5/6 Middle East 5/17, cotton production in 2/1 mill financing 17/3, hedging by 11/9–13 mills 15/2, 15/5 see under cotton, textile, spinning Minimum GPT 25 2/15 Minimum Price Contracts 2/9 Mississippi 4/4–5, cotton production 2/2 Missouri 4/4 Modern Nile Cotton Co, Alexandria, Egypt Appendix 3/4 moisture content, cotton fiber 8/18 momentum 13/16 Monroe, President 11/3 Monsanto and GE cotton 3/13 Montgomery Co, Inc, Lubbock, USA Appendix 3/3 Morgan, JP 11/3, 11/6 Morning star 13/6 motes (linters grade) 8/9 Multifiber Agreement (MFA) 1/3, 3/10, 3/11, 4/3, 4/15, 6/7 and textile industries 3/10 multilateral global textile trade policies 6/7, 4/7 multilateral trade negotiations 4/2 multimodal transport 15/4 multiphase weaving technology 8/6 Munro, J. M. 1/3 Murata Vortex Spinning (MVS) 7/6, 7/12 muslin 1/9 Namoi Cotton Cooperative Ltd, Wee Waa, NSW, Australia Appendix 3/2 National Agricultural Statistics Service, US Department of Agriculture 9/19

National Cotton Council, Memphis, Tennessee US (NCC) 2/3, 2/11, 6/14, 7/2 national cotton promotional organizations Appendix 5/2 national programs to limit/control cotton production vs yield as a potential ceiling on cotton production 5/23–24 natural plant sugars 8/21 natural resources, measures to conserve 9/7–8 Natural squares 13/10 Nearchus 1/4 neps, seed coat fragments 8/21, 8/41, 8/54 Netherlands 12/17 New England Cotton Buyers Association Appendix 1/7 New England Mill Terms Appendix 1/7 New Mexico 8/35 New Orleans 1/2, 1/13, 11/3, 11/4, Appendix 4/11 establishment of rice futures market 11/5–6 New Orleans Cotton Exchange 2/1 cotton futures exchange 1/18, Appendix 4/4, Appendix 4/6 New York Board of Trade ® (NYBOT ®) 2/11, 4/5–6, 10/1, 10/3, 10/5–6, 10/9, 11/4, 11/5 No 2 Contract 2/13, 2/16, 2/17 NYBOT exchanges 10/8, 12/7, 12/10, 12/15 NYBOTlive 10/9 New York Clearing Corporation (NYCC) 10/3 New York Cotton Exchange® (NYCE®), now NYBOT 12/1, 12/10, 12/11, 12/13, Appendix 4/1, Appendix 4/3–4 Appendix 4/6, Appendix 4/8, Appendix 4/10 historical beginnings 2/1, 10/1, 11/2, 11/4 Development of 10/2, 10/3–5, 10/9 NYCE contract see NYBOT Cotton No. 2sm Contract NYCE exchange-trade options 12/9 New York Cotton Exchange Clearing Association 10/3 New York cotton futures 2/12, 17/1, Appendix 1/8 cotton futures market 10/6 cotton futures exchange 1/18 futures contract 4/5–6 New York Futures Exchange (NYFE), (formerly the Cotton Exchange) 9/12, 9/14, 9/16, 9/17 NYCE purchase of 10/5 New York Futures Prices 9/17

Index/page xv

Index New York Mercantile Exchange (NYMEX) 10/5, Appendix 4/8 New York 1/2, 1/13, 11/3, 12/10, 17/4 cotton production and exports 1/12, 1/13, 1/14 Newcot Ltd, Chene-Bougeries, Switzerland Appendix 3/4 Nicaragua 2/5, 12/17 Nickerson-Hunter colorimeter 8/15–16, 8/47 Nison, Steve 13/5 nitrogen deficiency and effects on growth 5/10–11 Nolte, Vincent 11/3 Non-Conference carriers 15/6 Non-transferrable Specific Delivery Contract of EICA Appendix 2/8 Non-US cotton 2/15, 2/18 nonwovens production and demand for fiber quality 8/8–9 normal backwardation 11/1 North America, cotton futures, history Appendix 4/3–4 North American Free Trade Agreement (NAFTA) 4/9–10 North Carolina cotton production 1/12 nutrition and cotton growing 8/35 nutrient deficiency, effects of 5/10 NY futures 17/4 NYBOT Cotton No. 2sm Contract 10/2, 10/3, 10/6, 10/7–8, 10/10–11 NYK 2/13, 2/14, 2/15, 2/17, non-US cotton 2/15 NYSE Composite Index ® 10/9 Oceania, Middle East, Africa, textile development 6/4 OECD countries 3/8–9; 4/2 agricultural support 3/9 Secretariat 3/8 oil and cotton, interrelationship between prices 3/7 oily substances/chemicals as contaminants 8/45 Olam International Ltd, Singapore Appendix 3/2 Old World or Asiatic species of cotton 8/29 Old World Short Staple diploid cotton species (Gossypium herbaceum and G. arboreum) 5/1 online procurement and supply chain management strategies 6/10–11 OPEC 4/2 open end rotor spinning 8/6–7 open interest totals 13/2 Open Interest 2/15 open spinning 8/5

Index/page xvi

open stores (go-downs) 8/38 open-end rotor spinning 7/3, 7/5–6 opening prices 13/12–14 split openings 13/13 bid and ask 13/13 option style 12/9 Options as a Strategic Investment (McMillan) 11/8 options traders 2/11, 2/15 options 2/9, 9/13, 10/2, 11/7–8, 11/10–16 organic agriculture, consumer market for 3/15 organic cottons 8/34 organic matter as contaminants 8/44 Organic Trade Organization (OTA) 8/38 organophosphate insecticides 3/12 Orleans Cotton Exchange Appendix 4/6 Osaka 11/4 Osaka Japan, cotton futures exchange Appendix 4/7–8 Osaka Sampin Exchange Appendix 4/8 Oscillators SR 13/16 OTC Appendix 1/8 Outlook for Cotton Supply, The Appendix 2/14 over-the-counter (OTC) 12/1, 12/6 instruments – working in practice 12/5–9 derivative markets 12/7 products 12/8, 12/14–15 and exchange-traded instruments compared 12/10–15 (Historical development 12/10–11) commodity swap markets 12/11 market maker 12/14 cotton markets and OTC derivatives 12/1 term structure extension 12/13–15 potential difficulties with OTC instruments 12/15–16 packbales, foreign matter in 14/5–6 Pakistan Cotton Standards Institute (PCSI) 8/49–50 Pakistan Cotton Standards 8/49 Pakistan Ministries of Agriculture Commerce Finance and Industry Appendix 2/9 Pakistan 1/3, 2/5, 4/1, 4/2, 4/3, 4/15, 5/1, 5/24, 8/30, 8/32, 8/37, 9/6, 9/16, Appendix 4/1, Appendix 4/9–10 wheat competition with cotton 3/5 and cotton 3/13 cotton spinning 4/1 cotton disease in 5/14 Ministries of Agriculture, Commerce, Finance, and Industry Appendix 2/9

Index Palestine 1/4 Panic of 1907 (US) 11/3 ‘paper’ markets 12/11 Paraguay 9/16 cotton disease in 5/14 partial shipments 16/1 Pateks AS, Adana, Turkey Appendix 3/3 Paul Reinhart AG, Winterthur & Richardson, Switzerland Appendix 3/2 Paul Reinhart Inc, Richardson only, USA Appendix 3/2 Paul Reinhart, Switzerland 2/1–2 Pavaskar Appendix 4/8 Pawtucket, Rhode Island, cotton spinning factory 1/12 payment against letters of credit 16/1 including destination, upon first presentation of documents, arrival of the cotton at port of destination payments to producers 4/8–9 Pectinophora gossypiella (pink bollworm) 5/7 pepper trash 8/41 performance fabrics Appendix 6/1 Persia and Persian Gulf 1/4 Peru 1/3, 8/25, 8/30, Appendix 2/13, commercial production of cotton in 2/1 pest control and economic returns of crops 5/15 pests and disease control 8/36 ‘pesticide treadmill’ 5/15 pesticides 3/3, 8/24 and the environment 3/14–5 and regulatory authorities 5/22, toxicity and availability 5/22 pH, effects on plant growth 5/11 Philadelphia cotton plant 1/12 physical contracts 12/10 physical hedge 12/4 piercing pattern 13/7 Pima (type of cotton) 2/5, 7/5, 8/15, 8/52, Pima-type cotton 4/4 pink bollworm (Pectinophora gossypiella Sound.) 5/7, 5/8, 8/36 Plains Cotton Co-operative Association (PCCA) , Lubbock, USA Appendix 1/7, Appendix 3/2 plant growth regulators (PGR) 5/11–13 plant improvement programs 5/6 plant nutrients 5/10–11 Plexus Cotton Ltd, Liverpool, UK Appendix 3/2 Pliny the Elder 1/4 point of destination 15/4 point of origin 15/4 Poland 6/14 Polo, Marco 1/4

polyester 3/6–7, 6/2, 7/13, 9/2, Appendix 6/4 and cotton, competition 3/6–7 fibers, availability of 2/4 polyethylene fibers 8/24 polypropylene bale wrapping 8/41–42 polypropylene fibers 8/24, Appendix 6/4 potential difficulties with OTC Instruments 12/15–16 Power International, Moscow Appendix 3/3 power loom 1/1, 1/10, 1/11, 2/1 Premier Technologies 8/54 Prep (Ethaphon) 5/12 preparation, cotton 8/47 Pressley-Strength Tester 5/6 Pressley-strength (psi) 8/25–26, 8/27 Pretcher, Robert R 13/11 price controls: effects of war 11/4 price determination 9/1, 9/3–4 price discovery 9/1, 9/18, 9/20, 11/5–6, 13/15 futures market as a means of 9/12 pricing arrangements, types 9/11–15 pricing of cotton 10/2 primary processing/harvesting 5/18–20 Proceedings and Statements of the Plenary Meeting Appendix 2/14 procurement and supply chain management, online 6/10 producer financing 17/3 product quality versus fiber quality 8/5–6 production and ginning conditions, impact on quality 8/34–42 Production and Trade Policies Affecting the Cotton Industry Appendix 2/14 production costs, variations in 9/5 prohibition of cotton futures market India Appendix 4/8 promotion and marketing of cotton 6/13–15, Appendix 6/2 properties of cotton 8/3–4 provision of arbitration Appendix 2/6 ‘pseudo markets’ 9/10 Pseudomonas malvacearum (bacterial blight or angular leaf spot) 8/35 purchase of physical cotton 12/14 put options, purchase of by cotton farmers 11/12–15 ‘pyramiding’ 13/4 Pyrethroid Resistance Management 5/15 Pyrethroids, use of 5/15–16 synthetic 3/12 quality 9/9–10 Quality Arbitration and Appeal Appendix 2/11 quality of cotton, variability of 12/2 Queensland Cotton Corp Ltd, Fresno only, USA Appendix 3/4

Index/page xvii

Index Queensland Cotton Corporation Ltd, Brisbane & Fresno, Australia Appendix 3/2 Quetta Corporation Ltd, Moscow, Russia Appendix 3/3 quick response management 6/13 quota 9/6 R. N. Elliott’s Market Letters 1938–40 13/11 ‘R. N. Elliott’s Master Works’ 13/11 Rabobank International 12/18 rapid conditioner 14/3 Raw Cotton and Other Fibers Section (Associazione Tessile Italiana) Appendix 2/4 Raw Cotton Arbitration Chamber (Associazione Tessile Italiana) Appendix 2/4 raw cotton consumption 6/3–7 Real body 13/5 Reasonable risk or trip to the casino? 13/15 recurring price ‘waves’ 13/10–11 red bollworm (Diparosis castanea) 5/7 Red Sea 6/1 relative strength 13/16 repeatedly and reliability of HVIinstrument determinations 8/52 reserves, accounting 17/1–2 retail globalization 3/8 Reuters 12/8 Reuters/Jeffries CRB Index 10/9 reversal signal 13/5 Rew, Mr, and cotton markets, 19th century 1/18 Rhein-Scheide Handelsgesellschaft Fp Mostert Kg, Neuss, Germany Appendix 3/3 Rhodes University, Memphis, Tennessee Appendix 2/3 rice – competing with cotton in China, India, Pakistan 3/5–6 rickshaw man 13/7 ring spinning 7/3, 7/5–6, 7/9, 7/10, 8/6, spindles and rotor spin boxes, floor space 7/7 rise of the US in cotton markets 1/11–17, Appendix 6/1 risk (market and basis) 17/4 risk supplier 17/5 customer and financing risk 17/5 weather risk 17/5–6 exchange risk 17/6 risk management 17/3–6 using OTC instruments in the developing world 12/16–18 problem in raw cotton, example of 12/3–5

Index/page xviii

Risk: Market; Supplier; Customer; Financing 17/5 ROC ADX 13/16 roller drafting systems 8/7 roller ginning 8/39, 8/40 roller-ginned Cottons 8/54 Roman empire and cotton 1/4 Romania 5/2 rotor spin box 7/7 rotor spinning 7/7, 7/10–11, 8/5 relative costs 7/9 round tests 8/3 roving, cotton 7/3 Russell Equity Indexes 10/9 Russian Cotton Association Appendix 2/11 São Paulo, 11/4 São Paulo Commodity Exchange Appendix 4/1. Appendix 4/4–5, Appendix 4/7 SA Goenka, Barcelona, Spain Appendix 3/3 Sacaton (Arizona) 8/31 Sakellaridis and Giza 7 Appendix 4/2 salt tolerance 5/8 sampling 14/1–3 pre-shipment 14/1–2 post-landed 14/2–3 procedure, from bales 8/42 for traditional classing 8/46–7 Samuelson, Paul 11/1 San Joaquin Valley, California 4/4 SARS outbreak, Far East, and effects on cotton 2/11 Sasser, Dr P. 8/53 Savannah River Cotton Company, Waynesboro, USA Appendix 3/3 saw gin 1/1, ginning 8/39 scales for weighing cotton 14/4 Schaffner Technologies Inc 8/39, 8/54 Schleth, A. 8/53 Scholes, Myron 11/7 Schwanger, Jack D. 11/2 Sea Island cotton 7/5, 8/31 SEAM, The 2/12, 2/14, 2/17, 6/10, 9/12 Secretariat ICAC list of cotton trading companies and categorisation Appendix 3/1 seed, cotton see cotton, cultivation and production; cottonseed Sekhsaria Exports, Mumbai, India Appendix 3/3 Shadow 13/5 Shanghai Appendix 4/8 Shanghai China cotton futures exchange Appendix 4/7, Appendix 4/8, Appendix 4/11 shippers’ load and count 15/4 shipping documents 16/2–3

Index Shofner, Dr F 8/19 Short Fiber index 8/11 short fibers 7/11, content of cotton 8/18–19 short staple cottons 8/39 shorter-staple cottons 4/4 short-staple fibre spinning technologies (‘cotton systems’) 7/3 Shukov 8/27 Shukov-tester 8/11 shuttleless weaving 8/6 Sicily 1/4 silk 1/1 silk-linen mixture 1/9 Sincot Pte Ltd, Singapore Appendix 3/2 Singapore 6/4 SJV Cotton 2/17 Slater, Samuel 1/12 sliver, cotton 7/3 SLM 2-1/16 (41-4-34) Micronaire 3/5-4.9 NEI, minimum GP 2/15, 7/20 small developing country farmers 12/16–17 ‘smart’ fabrics Appendix 6/1 SME cotton producers 12/16–17 Smyrna 1/5 Société Beninoise de Representation Sobère, Cotonou, Benin Appendix 3/4 Société Cotonnière du Tchad Cotonchad, Paris, Chad Appendix 3/3 Société d’Importation et de Commission, Le Havre, France Appendix 3/3 Société Nationale pour la Promotion Agricole Sonapra, Cotonou, Benin Appendix 3/4 sodium chlorate 5/12 soil and nutrition 8/35 soil residues 8/24 Sorrady Dr 8/49 Sounders Dr D. A. 8/31 sources of price information and price predictions 9/15–20 South Africa 3/14, 8/28, 8/37, 12/17 development of cotton production 5/2 South America 8/30 cotton production in 2/1 cottons 8/31 cotton futures, history of Appendix 4/4–5 South Asia; history of cotton futures exchanges Appendix 4/9–10 South Korea 6/4, Appendix 6/3 South Sea Bubble 11/2 South-east Asia 2/3, 5/1, 5/13, 6/4 Southern Cotton Association Appendix 2/2 Southern cotton trade 11/4–5 Southern Mill Rules Appendix 1/3, Appendix 2/3

Southwestern Irrigated Cotton Growers (SWIG) Appendix 1/7 Soviet cotton classing system 8/46 Soviet Union see USSR soybean and cotton, competition between crops US and Brazil 3/6 soybean farmers 11/15 Spain 1/4, 3/9, 5/2, 5/13, 9/16, 9/17, 12/7, Appendix 2/3, Appendix 2/6–7 cotton exports 2/5 cotton production in 1/4 span length methods 8/11 Spanish conquest of South America 8/25 speculation 2/15, 11/2, in cotton prices 1/18 spindle-picking of cotton 4/4 spinners, cotton 4/6 spinning by machine 8/43 spinning frame 7/3 spinning jenny 1/1, 1/10, 1/11, 2/1 spinning mills, England, displacement by American 5/2 spinning mule 1/1, 1/10, 1/11 spinning staple fibers, fundamental requirements 7/35 spinning techniques 8/5 spinning technologies 5/4 market shares in 7/9 impact on fiber requirements 7/5–10 ‘spinning triangle’ 7/9 spinning, manual 8/43 spinning, staple fibers, fundamental requirements 7/3 Spiny bollworm (Earias insulana) 5/7 split openings 13/13 spot markets 9/11–12 ‘Square of Nine’ 13/10 St. Louis Merchants exchange 11/5 Staple Cotton Cooperative Association (Staplcotn) Appendix 1/7 Staple Cotton Cooperative Association, Greenwood, USA Appendix 3/2 staple length 8/32, 8/48, 14/3 stars 13/5–7 State Joint Stock Foreign Trade Company ‘Uzmarkazimpex’ Tashkent, Uzbekistan Appendix 3/2 state-owned enterprises (SOEs), China 4/11 steam engine 1/10, 1/11 Steamship Conferences 15/6 stelometer 5/6, 8/33 -strength 8/26–27 Step 2 Competitiveness Provision 9/7–8 Step 2 market 12/7 Step 2 payments 4/9 STI RapidTester 8/54

Index/page xix

Index stickiness (contamination) 8/21–22, 8/43, 8/45, 8/54 stochastics 13/16 Stoneville (Mississippi) 8/31 Stoneville 506 8/32 stop-loss 13/9 storage and module averaging 8/38 Strabo 1/4 ‘strains’ (cotton) 8/29 strategic choice of target markets Appendix 6/3–4 strength, cotton 8/32–33 Strict Low Middling 1 and 1/16 inch, leaf grade 4 4/8 ‘strike price’ 10/2 string as contaminant 8/44 ‘string’ contracts 12/11 stripper-harvesting of cotton, US 4/4 stripper-type harvesting machines Texas 8/37 struggle between cotton and wool, and emergence of the West 1/5–11 Sub-Saharan Africa 5/13 cotton production 4/13 subsidies 3/10, 9/6–8 successful trading strategy 13/4 Sudan 8/38, Appendix 2/13, Appendix 4/6. development of cotton production 5/2 Sudan Cotton Company Ltd, The Khartoum, Sudan Appendix 3/2 sugar and cotton 3/6 Sukor Barrage, Indus River, Pakistan 5/13 sulfonylurea based herbicides 5/7 Sumitomo Corporation, Osaka, Japan Appendix 3/3 supply and demand 9/2–4 supply of cotton, variability of 12/2 Survey of Cotton Production Practices Appendix 2/14 Survey of the Cost of Production of Raw Cotton Appendix 2/14 surveys 14/5–6 foreign matter 14/6 mixed pack bales 14/5–6 pre-shipment 14/5 Suter-Webb 8/11, 8/27 Switzerland 12/17, Appendix 2/6 cotton spinning and weaving in 2/1–2 synthetic fibers, 1/2 alternatives to cotton, Appendix 6/1, Appendix 6/2, Appendix 6/3, Appendix 6/4 Syria 4/2, 5/13 system of weights used in cotton 16/3 Taevertex, Ghent, Belgium Appendix 3/3 Taiwan 6/4, Appendix 6/3 Tanzania 4/3, 9/16, 12/17

Index/page xx

Tasuki 13/7 taxation 17/1, including export taxes, import taxes taxes 9/6, 9/8–9 TCT United SA, Uruguay Appendix 3/3 tea trade 13/5 Technical Analysis (Schwanger) 11/2 ‘technical analysis’, as applied to cotton industry 13/1, 13/2, 13/15–16 technical trader 13/3–5 technician 13/5, 13/6, 13/7, 13/11 technology and cotton 3/3, 5/7 technology, developments in 6/10–15 Telcot spot market 9/12 TELCOT system (later part of The SEAM) 2/15 term structure extension 12/13–15 Terminal receiving charge (TRC – also THC-CYC) 15/6 Texas 4/4 cotton producing 2/2 cotton Appendix 4/4 Department of Agriculture 8/38 Texas Cotton Association 2/3, Appendix 2/2 Texas-type low grades 2/17 textiles and apparel industry 1/3, 6/6 consumption 3/7 fairs Moscow Appendix 2/11 industry, entry into 6/4–5, strategies 8/5 machinery developments 5/4–5 mills 9/2 production, 9/2, world 6/3 quotas, removal of 6/7, 2/11 textile trade trends 4/1–2 development of barriers to 6/7 global 6/5–6 Thidiazuron (Dropp®) 5/12 throughs (linters grade) 8/9 Tien Shan mountains, China, Hindu Kush, Pamirs 5/13 tobacco budworm (Heliothis virescens) 5/7 total quality management 6/13 tower driers, seed cotton 8/40 Township-village enterprises (TVE), China 4/11 Toyo Cotton (Japan) Co, Osaka & Dallas, Japan Appendix 3/2 Toyo Cotton Co, Dallas only, USA Appendix 3/3 Toyoshima & Co Ltd, Nagoya, Japan Appendix 3/2 Toyoshima USA Inc, Cordova, USA Appendix 3/3 trade policies 9/3 trade US West Coast to Far East 15/2 traders 13/7 traders, knowledge requirements 9/20

Index trader psychology 13/15 Trading advantage 13/10 trading, origins of 11/4–5 trading pit 13/13 trading strategies 13/4 traditional methods of analysis 13/8–12 Transatlantic cable, and effect on cotton production and sales 1/17–18, Appendix 4/1 Transatlantic trade, and effect on cotton production and sales 1/17 transit insurance 15/7 transport to house, to container yard, to door, to pier, to container freight station, to container base 15/5 trash etc, from seeds 8/6, 8/7, 8/39, 8/40, 8/41, identification 8/21 Treatise on Money (Keynes) 11/1 trends in world’s fiber consumption 2/3–4 tropics, cotton growing in 5/9 tulip mania, Holland 11/2 Turkemenistan 12/7, cotton production 4/14 Turkey 2/5, 3/3, 3/9, 2/17, 3/13, 4/3, 5/13, 5/24, 8/25, 9/12, 9/16, 9/17 wheat competition with cotton 3/5 cotton production 1/7, 1/16 cotton spinning 4/1 Turning Point 13/10 tweezer 13/7 twist factor 7/3 two crows 13/7 types of mechanical cotton picker 5/17 typical classing systems of selected cotton-producing countries 8/48 US Dollar Index ® 10/9 Uganda 12/18 UK Appendix 2/3, Appendix 4/1, Appendix 6/3, 17th century protectionist measures on textiles 1/5–6 Ulm, Germany 1/5 UN Appendix 2/13 UNCITRAL Model Law Appendix 7/3 UNCTAD 3/1F United Nations 9/15, Appendix 2/11, Industrial Division, New York 2/11 New York Convention Appendix 7/2 United States Congress, 1791 request for statistical record of cotton production 1/7–8 United States 1/1, 1/2, 1/4, 2/5, 3/9, 3/10, 3/11, 3/14, 4/1, 4/2, 4/3, 4/15, 5/2, 5/9, 5/13, 5/17, 5/23, 5/24, 6/13, 7/2, 8/30, 8/36, 8/46, 8/51, 8/54, 9/1, 9/3, 9/7–8, /17, 12/18, Appendix 2/2, Appendix 2/12 Appendix 2/14 Appendix 4/1, Appendix 4/6

Agriculture, Department of, 9/6, 9/16–17 and European barriers towards textile imports 6/5–6 as cotton exporter 4/7 bale wrapping 8/41 beginning of cotton production in 2/1 California-Arizona 9/16 Coordinating agencies; cotton production 3/2 cotton and bollworms 5/7 cotton consumption 1/19 cotton exports 2/5 cotton farm cotton provision 4/8 cotton farm production, development of 4/6–7 cotton farms in 4/5 cotton imports 4/6 cotton merchants and trading 2/2, 2/17 cotton production 1/8, 1/11, 4/4, 5/2, 8/25, 19th century 1/18 cotton production regions 9/18 cotton retail market 4/6 cotton trading 2/1 cotton yarn production 4/6 Department of Commerce 2/10 dominance 4/4 export dominance, world cotton market 4/10 Farm Bill 2/8, 2/9, 3/9 Farm Program 12/10 Federal Reserve 4/2 first cotton production and exports 1/11–12 futures exchange 12/10–11 Government program 12/7 government 13/1, 13/2, Appendix 4/4 ICAC membership; Plenary meetings; Standing Committee Appendix 2/13 legislation on agro-chemicals 5/22 Memphis Territory 9/16 monetary policy 4/2 Orleans/Texas cotton 9/16 Pima cottons 8/30, 8/31 rise to dominance 1/1, 1/11–17 Secretariat Appendix 2/13–14 seed cotton handling 8/40 textile industry 6/4 textile market, manufacturers fears over imports 6/5 textile mills 4/5 Treasury, Department of the, US 1/7 western US 3/13 US Adjusted World Price 9/17

Index/page xxi

Index US Congress, outlawing of options 1930s 11/7 US Department of Agriculture (USDA) 2/10, 4/5–6, 9/15, 8/31, 8/48, 8/53, 9/16–17, 10/2, 10/7, 13/1 USDA Green Card HV1 2/14 calibration cottons 8/9 classification 8/8–9 cotton classification 8/51–2, 10/7 Guidelines for HVI Testing 8/53 HVI class 2/15–16 ‘premium range’ 8/10 research 8/38 Roundtests 8/3 USDA-AMS 8/7, 8/14, 8/47, 8/48, 8/54 Universal Cotton Standards (USDAUpland cotton) 8/48 Universal Cotton Standards Agreement 8/48 Universal Cotton Standards system 8/46 UNM length and mean length 8/29 upfront fee 12/9 ‘Upland’ cotton 5/18, 8/10, 8/12, 8/13, 8/15, 8/32, 8/33, 8/44 Uruguay Round’s Agreement on Textiles and Clothing (ATC) 4/3, 4/6, 4/13, 6/7 USDX® futures, NYCE 10/5 USSR 1/3, 2/11, 3/5, 4/1, 4/14, Appendix 2/12. See also Armenia, Kazakhstan, Turkestan, Uzbekistan, USSR, Former USSR UV lamps, use of 8/25 Uzbekistan 2/5, 5/2, 5/24, 8/25, 8/28, 8/30, 8/32, 9/16, 12/7 and cotton 3/13 drainage and cotton 3/13 cotton trade 4/13 cotton production 4/14 Uzbekistan picker 5/17 Uzprommashimpeks, Tashkent, Uzbekistan Appendix 3/2 Value Differences Circular Appendix 2/11 value rate 13/14 ‘variety tables’ 8/29 vegetative growth, control of 5/11 Venice, Italy 1/5 Verticilium wilt (Verticillium albo-atrum Reinnke and Berth.) 5/14, 8/35 Vincent Nolte, New Orleans cotton merchant 11/3 Violar SA, Larisa, Greece, Cargill Zimbawe Pvt Ltd, Harare, Zimbabwe Appendix 3/3 Virginia 4/4, cotton production 1/12 virus control 5/8 Volcafe 12/18

Index/page xxii

Volcot America Inc, Phoenix, USA Appendix 3/3 Volcot Switzerland Ltd, Winterthur, Switzerland Appendix 3/4 volume and open intent 13/11–12 vortex spinning system 8/5 water frame 1/1, 1/10, 1/12 water management 8/34 water supply 8/35 Watson and Crick 8/31 Watt, James 1/10 ‘wave principle’ 13/11 weather conditions 8/35, 17/5–6 weathering of cotton 5/18 weeds 8/29 weed control 8/37, chemical 5/16–17 weeding, hand 5/16 weighbridges, use of 14/4, 14/5 weighing of cotton 14/4–5 pre-shipment 14/4 landed 14/4–5 Tare measurements 14/5 Weil Brothers & Stern Ltd, Liverpool only, UK Appendix 3/3 Weil Brothers Cotton Aust Pty Ltd, Queensland, Australia Appendix 3/4 Well, Brothers & Rountree, Inc, Las Cruses, Montgomery & Liverpool, USA Appendix 3/2 West Africa 4/13–14, 9/16 cotton 2/14, 8/37, 8/48 cotton export 2/5 cotton strength 8/32 Franc Zone, cotton production 4/13 OTC market 12/7 West Indies 1/5, 8/30, 8/32 cotton production 1/7, 1/16 Western Cotton Shippers Association Appendix 2/2 Western Hemisphere cottons 7/5 Wheat Studies (Food Research Institute) 11/1 wheat 3/5 White Soldier 13/7 whiteflies 8/21 Whitney, Eli 1/10, 1/12, 2/1, 6/1 William III 1/6 Williams, J., T. A. Hieronymus Appendix 4/8 Window 13/6 Winterthur (Switzerland), cotton trading 2/1 Wool Associates of the New York Cotton Exchange, Inc. 10/3 wool 1/1, 1/3,1/5, 8/20 Wool production 1/9 woollen shrouds, Act for using 1/5–6 Working, Holbrook 11/1, 11/2, 11/6

Index World Bank 3/10, 4/3, 9/15 Appendix 4/8 as facilitator 12/17 world cotton trade 2/2–3 future of 4/3–4 World Cotton Trade Appendix 2/14 World Market, The – Projection to 2005 Appendix 2/14 World Textile Demand Appendix 2/14 world textile fiber consumption 3/6 World Trade Center, New York 4/4, 10/4–5 World Trade Organization (WTO, previously GATT) 3/10, 3/11: 4/3, 4/4, 4/7, 4/12, 4/15 agreements on cotton 4/9 China’s entry into 4/12–13 new round of multilateral trade negotiations, Doha, 2001 3/10–11 world trade, growing openness of 4/1–2 world cotton futures and options contract Appendix 4/3 WWI Appendix 4/4 WWII 11/4, Appendix 4/2, Appendix 4/6

Xinjiang Autonomous Region 4/11 Xinjiang Uigar Autonomous Territory (Western China) 5/2 Yamachu Mengyo Co Ltd, Osaka, Japan Appendix 3/4 Yangtze River Valley, cotton production 4/11 yarn clearers 8/24 production 7/3–4 quality 7/9 spinners 7/11 spinning industry 7/6 spinning systems 8/6–9 Yarney, B. S. Appendix 4/6 Yellow River Valley, China, cotton production 4/11 yield 8/32 Yuma 8/31 Zellweger-Uster Inc. 8/19, 8/27, 8/39, 8/54 Zhengzhou Commodity Exchange Appendix 5/2 Zimbabwe 4/3, 5/16

Index/page xxiii

Part 1 The cotton trade: history and background

1 History of the cotton trade from origin to the twentieth century* John Baffes

Early history Competition between cotton and wool and emergence of the West Rise of the US and dominance of England Globalization Statistical appendix

* The views expressed here are those of the author and should not be attributed to the World Bank. I would like to thank all concerned for comments and suggestions on earlier drafts of this chapter. The staff of the Joint Bank-Fund Library, who kindly helped me gain access to historical material through numerous interlibrary loans, deserves great appreciation.

Cotton has a place in history for a number of reasons. First, cotton has been the dominant source of clothing for almost two centuries. Secondly, the cotton industry is the first one to capitalize the benefits of the industrial revolution during the end of the eighteenth century and of the information technology advancements of the mid-nineteenth century. Thirdly, cotton is the first ‘global’ agricultural commodity in the sense that since the mid-nineteenth century its price has been determined in various cotton exchanges in response to world supply and demand conditions; hence one can argue for the existence of two-century-long global cotton market. This chapter focuses on the socio-economic events that shaped the evolution of the world cotton market. For convenience, the presentation is divided into five periods, marked by important milestones in the history of the cotton industry (Table 1.1). The first period, referred to as the early history of cotton, goes up to 1600 when the British East India Company initiated regular trade of goods (including cotton) from India to England. Data and description of events during this period come mainly from anecdotal evidence, typically recorded by historians. The second period goes up to (and inclusive of) the industrial revolution. The earlier part of this period is marked by the competition between cotton and other fibers (wool and to a limited extent silk) and a number of (mostly unsuccessful) attempts to restrict or even prohibit the uses of cotton and cotton products in England and continental Europe. Numerous inventions and improvements of existing technology took place towards the end of this period. The flying shuttle, the spinning jenny, the water frame, the spinning mule and the power loom, along with the steam engine, improved coal extraction technology and the development of canal building, moved the textile industry from its ‘cottage’ stage (ie small home-based factories) to becoming the dominant industry in England and perhaps the world. The third period is characterized by the rize of the United States as the dominant player in the world cotton industry. It starts with the invention of the saw gin in 1793, which transformed the south-eastern part of the US into one of the world’s major cotton producing areas. In 1790, the US produced 600 tons of cotton, accounting for less than 0.5% of global output and it exported only 73 tons. In 1834, its cotton output exceeded 200 000 tons, accounting for more than half of global output, a dominant position that it maintained throughout the remainder of the century. The trade of cotton also increased enormously during this period, aided in part by the transition from sail ship to steam ship, which halved the time it took to cross the Atlantic. England, on the other hand, by reaping the benefits of the industrial revolution, became the world’s dominant textile producer and exporter. The share of cotton in total fiber consumption increased ten-fold between 1800 and 1860. Chapter 1/page 1

Cotton Trading Manual Table 1.1 History of cotton in brief Period

Year

Characteristics

Early history

–1600 Limited use of cotton in textiles; lack of accurate and consistent statistical records; trade is vertically integrated and sporadic Emergence 1600–1793 Gradual emergence of the West (mainly England and to of the West some extent continental Europe) on the demand side; competition between cotton and wool; most inventions take place; no dominant player on the supply side Rize of the 1793–1865 US emerges as the world’s dominant cotton supplier; the US first steamer crosses the Atlantic in 1838; cotton’s share in total fiber consumption increases ten-fold Globalization 1865–1912 The successful instalation of the transatlantic cable takes place in 1865; cotton becomes a ‘global’ commodity; five cotton exchanges trade futures contracts in three continents exchanging information instantly through cable Government 1912– The introduction of improved varieties, chemicals, intervention irrigation and mechanical harvesting increased yields almost three-fold within a 40-year period; competition between cotton and synthetics; most cotton produced under considerable government intervention Source: compiled by the author

The fourth period begins with the successful installation of the transatlantic cable in 1865, which rendered communications between England and the US instantaneous. During this period, cotton becomes a ‘global’ commodity. By the mid-1880s, five exchanges (New York, New Orleans, Liverpool, Le Havre and Alexandria), all connected by cable, were trading cotton futures contracts in three continents. The disruption of cotton supplies during the American Civil War brought a number of other cotton producers into the market, eventually becoming important players. By the turn of the century, cotton exports from the US accounted for more than two-thirds of its agricultural exports and about one quarter of its merchandise exports. Lastly, one may argue for a ‘modern’ period starting after World War I. This period is characterized by the considerable decline of production costs and heavy government intervention in cotton (and other commodity) markets. Use of improved varieties, fertilizers, pesticides, irrigation and mechanized harvesting pushed world cotton yields from 200 kg per hectare in the mid-1940s to 575 kg/ha by the end of the century, an almost three-fold increase. More recent advances in precision farming and genetically modified seed technology have further reduced costs of production (and hence prices). Despite low cotton prices, fierce competition from synthetics has lowered the share of Chapter 1/page 2

History of the cotton trade from origin cotton in total fiber consumption; the share during the 1990s was the same as that of the 1820s (wool and linen being the main competitor fibers then). Heavy government intervention is another characteristic of this period. Up to the mid-1980s, most cotton was produced either under state control (China and the Soviet Union) or extensive government intervention (Commodity Credit Corporation in the US and various cotton parastatals in African and Asian cotton-producing countries). The world textile market has been significantly affected by the Multifiber Agreement and its successor, the Agreement on Textiles and Clothing, which through various quotas and differential tariff rates, has distorted the location of textile industries. The remainder of this chapter discusses the first four periods. It does not discuss the last period since this forms the subject of another chapter.

Early history The English word cotton comes from the Arabic word qutun or kutun, a term used to describe fine textiles. The same root is found in a number of other languages: katoen (Dutch), coton (French), cottone (Italian), algodón (Spanish), kattun (German), kutnie (Romanian) and kotunja (Russian). The scientific term for cotton, gossypium, comes from the Arab, Persian and Afghan words goz, gozah and gozeh (Berger 1969). Both the earlier literature and scientific evidence suggest that cotton growing and manufacturing has taken place in three continents (Asia, Africa and the Americas), although its spread to Europe came from the Indian subcontinent. Ellison (1886, p. 1) wrote: India appears to be the birthplace of cotton manufacture. It is known from the sacred books of the country that the industry must have been in existence there, in a high state of perfection, three thousand years ago; but how long before that is not known. Moreover, it may be gathered from numerous authorities that the arts of cotton spinning and weaving, as practiced there twenty and thirty centuries ago, differed very slightly from the methods followed throughout India until within a very recent period. The oldest archaeological record of cotton textiles was found in Pakistan (200 miles north of Karachi) and dates back to 3000 BC, according to sources cited in Berger (1969) and Munro (1987). Cotton specimens made into textiles have also been located in northern Peru, dating as far back as 2500 BC. Prehistoric traces of cotton have also been located in the US (Arizona). The archaeological records are most likely incomplete because cotton fabrics have survived only in dry areas. Cotton may have been cultivated in areas with humid climates but have not survived. Chapter 1/page 3

Cotton Trading Manual The first historical reference to cotton comes from the ancient Greek historian Herodotus (484–425 BC) who gave the following account: ‘The wild trees in that country [India] bear for their fruit a fleece surpassing those of sheep in beauty and quality and the natives clothe themselves in cloth made therefrom’ (quoted in Crawford 1924, p. 62). Nearchus (c. 360–c. 300 BC), the admiral of Alexander the Great (356–323 BC), also reported about 325 BC on cotton growing in the Indus river valley and around the shores of the Arabian Sea and Persian Gulf, and described cotton clothing as follows (Crawford 1924, p. 62): ‘The natives made linen [cotton] garments, wearing a shirt which reached to the middle of the leg, a sheet folder over the shoulders and a turban around the head.’ The Greek geographer Strabo (63 BC–c. AD 24) mentions cotton as a product of Persia before the start of the Christian era. Cotton growing in Egypt is first reported by the Roman historian Pliny the elder (AD 23–79), while the Hebrew scholar Josephus (AD 37–100) notes cotton cultivation in Palestine. Trade of cotton and cotton goods on an extensive basis appears to have taken place between India and Persia as early as the fifth century BC, which is how Herodotus may have acquired his early account on cotton. The Greek physician Ktesias (c. late fifth century BC), for example, mentions the colorful cotton cloths that Persian women were wearing, which were imported from India. A later account on cotton trade comes from the Greek philosopher and historian Arrian (c. AD 95–180), who enumerates cotton fabric imports by the Romans from India around AD 150. Cotton was brought to southern Europe (Greece, Sicily and Spain) on a large scale by Arab traders during the ninth and tenth centuries (Ellison 1886). Cotton cultivation and manufacture was established in Spain under the rule of the self-proclaimed Caliph of Andalusia, Abd al-Rahman III (AD 891–961). By 1050 the Arabs of Spain had excelled in cotton manufacture, according to Crawford (1924). In the thirteenth century, Marco Polo mentioned the coast of Coromandel (Madras, India) as ‘producing the finest and most beautiful cotton that are to be found in any part of the world’ (Berger 1969, p. 12). Cotton fabrics, however, became frequent objects of trade between the East and the West after Vasco da Gama opened the ocean route to India in 1497. Cotton was imported to north Europe during the thirteenth century. Cotton imports to England are reported in 1298 for the manufacture of candlewicks. By 1375, numerous references in the English records indicate that cotton products were imported on a regular basis. It is worth mentioning that following the first cotton imports, resistance against the use of cotton goods arose. Edward III (1327–77), for instance, in order to protect the English wool industry, prohibited the wearing of any cloth made beyond the sea as early as 1337. In France, cotton was used to Chapter 1/page 4

History of the cotton trade from origin make hats during the thirteenth century. Cotton was also traded regularly between Venice and Ulm (Germany) as early as 1320 and soon spread to other cities in northern Germany. The known history of cotton in the New World begins with the arrival of Columbus in the Bahamas in 1492. Legend has it that it is because the natives were clothed in cotton Columbus thought he had reached India, hence the name West Indies. Magellan, while circumventing the globe in 1519, found that Brazilians used cotton in making their beds; shortly thereafter, cotton trade between Brazil and Europe was initiated and by 1570 substantial quantities of Brazilian cotton were marketed at Ulm (Donnell 1872).

Competition between cotton and wool and emergence of the West Although identifying when cotton trade took place within a ‘modern’ setting is a somewhat subjective opinion, the beginning of the seventeenth century is the date most authorities have agreed on; this date is also frequently cited as the beginning of cotton manufacture in England. In 1599, the British East Indian Company was founded and subsequently established regular trade of goods (including cotton and cotton products) between East and the West. As soon as the first cotton goods arrived, however, domestic interests in England resisted. For example, wool merchants made the following complaint in 1621 (Crawford 1924, p. 92): For about twenty years divers people in this kingdom, but chiefly in the county of Lancaster, have found out the trade of making fustians out of a kind of down, being a fruit of the earth growing on little bushes, or shrubs brought into this kingdom by the Turkey merchants from Smyrna, Cyprus, etc., but commonly called cotton wool and also of linen yarn, and not part of the same fustians of any wool at all. There is at least 40 000 pieces of fustian of this kind yearly made in England, and thousands of people set on working of these fustians. A number of protectionist measures followed. A colorful account of such a measure is given by Ellison (1886, p. 8): . . . and the only legislative result of the agitation was the passage of an Act designed to secure the more effectual observance of the somewhat grim, but constantly evaded measure (originally passed in 1666), which enacted that every dead person should be buried in a woollen shroud, in default of which the persons directing the funeral should forfeit the sum of £5. If the people while alive were so perverse and unpatriotic as to prefer foreign to domestic fabrics Chapter 1/page 5

Cotton Trading Manual for their vestments, they should at all events not be allowed to carry their fripperies with them to the grave. The first law explicitly prohibiting imports of cotton products to England was passed in 1700 by William III, again following protests by woollen manufacturers and sheep farmers. Another Act was passed in 1712 prohibiting the use of all printed cotton goods. In 1721, the English parliament passed a third Act imposing a £5 on the wearer and £20 on the vendor of cotton goods. Cotton products faced similar resistance and legislation in France following intensive lobbying from the silk industry. However, because imports to Holland were duty-free and without any quantitative restrictions, cotton goods were imported into continental Europe and England unrecorded, thus making the trade restrictions ineffective. Recognizing the failure of the Acts to achieve their stated objective, the English parliament passed the Manchester Act in 1736, which allowed the use of cotton and linen mixed with calico to be manufactured; the use of Indian cotton goods, however, was prohibited, effectively granting the Manchester textile industry a monopoly on cotton goods. The secrets of manufacturing were also fiercely protected. An Act was passed in 1720 inflicting a fine of £100 or three months’ imprisonment to anyone who ‘. . . endeavoured to entice any manufacturer or artificer out of his majesty’s dominions’ (Ellison 1886, p. 28). By the same Act the export of any type of machinery associated with cotton manufacturing was prohibited. On the trade side, not much growth took place during the first half of the eighteenth century. According to Donnell (1872), who compiled the first attempt at a comprehensive account of the cotton trade, cotton imports to England between 1697 and 1745 fluctuated around an average of 650 tons, with no significant upward or downward trend. It was only later in the century that cotton imports begun increasing, aided in part by the diffusion of John Kay’s invention of the flying shuttle in 1733 (see Table 1.2). Considerable growth in cotton trade took place towards the end of the eighteenth century, mainly as a result of the inventions and technological improvements of the industrial revolution. For example, during the five-year period starting 1782, cotton imports into England doubled to reach 10 000 tons. This growth, in turn, made apparent the need for an efficient trading centre as well as adequate port facilities; note that the existing cotton trading centers of London and Manchester did not serve the industry well. In 1758 cotton imports to England begun arriving through the port of Liverpool; within a few decades Liverpool became the world’s dominant cotton trading centre (Dumbell 1923). A breakdown of sources of cotton imports into England is given by Ellison (1886), but this starts only in 1786 (Table A.4). Cotton supplies Chapter 1/page 6

History of the cotton trade from origin Table 1.2 Cotton imports into England, 1697–1800 Year

Tons

Year

Tons

Year

Tons

1697 1700 1701 1702–05 a 1710 b 1720 b 1730 b 1741b 1743 1744 1745 1746 1747 1748

897 454 901 531 324 895 701 746 514 854 667 1028 1009 2202

1749 b 1751b 1764 b 1771–74 a 1775 1776–80 a 1781 1782 1783 1784 1785 1786 1787

752 1 351 1 756 2 162 2 178 3 070 2 359 5 367 4 417 5 210 8 349 9 029 10 345

1788 1789 1790 1791 1792 1793 1794 1795 1796 1797 1798 1799 1800

12 563 14 780 14 268 13 025 15 838 8 639 11 052 11 799 14 576 10 596 14 465 19 682 25 413

a. Period average b. Following year(s) are missing Source: Donnell 1872

to England around the end of eighteenth century were coming mainly from the West Indies. For example, during the years 1786–90 the West Indies’ share was 70%, the Mediterranean (mainly Turkey) share was 20%, and Brazil’s was 8%. One, however, may question the accuracy of these figures, which come from official sources. Substantial quantities of cotton were entering to the country unrecorded from Holland in order to avoid duties and other restrictions, so a more accurate interpretation of these statistics would be that they represent lower bounds, not averages. Cotton prices during the latter part of the eighteenth century exhibited considerable variation. Table 1.3 reports the lowest and highest recorded cotton import prices to England for the last quarter of the eighteenth century. Between 1771 and 1800, cotton was traded at Liverpool between a minimum of $160.19 per pound (low of 1771–75) and a maximum of $1.10/lb (high of 1799). There was also considerable within-year variability: prices moved from a narrow range of $0.31–$0.42 during 1776–80 to a wide range of $0.56–$1.10 in 1799. It is worth noting that the 1792 price range (equivalent to $0.88–$1.32 per kg) is remarkably similar to the price range observed almost 210 years later ($0.82 and $1.41/kg in October 2001 and January 2001, respectively). The earliest comprehensive statistical record of world cotton production was compiled by the Department of the Treasury at the request of the United States Congress (White 1836). In 1791, this report estiChapter 1/page 7

Cotton Trading Manual Table 1.3 Cotton prices,a 1771–1800

1771–75 c 1776–80 c 1781 1782 1783 1784 1785 1786 1787 1788 1789 1790 1791 1792 1793 1794 1795 1796 1797 1798 1799 1800

Shillings per pound

US cents per poundb

Low

High

Average

Low

High

Average

0.79 1.33 1.75 1.67 1.08 1.00 1.17 1.83 1.58 1.17 1.00 1.00 1.08 1.67 1.00 1.08 1.25 1.58 1.42 2.08 2.33 1.67

1.17 1.75 3.42 3.33 3.00 2.08 2.25 3.50 3.50 2.75 1.83 1.75 2.50 2.50 2.25 2.17 2.50 2.50 3.33 3.33 4.58 3.17

0.98 1.54 2.58 2.50 2.04 1.54 1.71 2.67 2.54 1.96 1.42 1.38 1.79 2.08 1.63 1.63 1.88 2.04 2.38 2.71 3.46 2.42

18.98 31.97 41.97 39.97 25.98 23.98 27.98 43.96 37.97 27.98 23.98 23.98 25.98 39.97 23.98 25.98 29.98 37.97 33.97 49.96 55.96 39.97

27.98 41.97 81.93 79.94 71.94 49.96 53.96 83.93 83.93 65.95 43.96 41.97 59.95 59.95 53.96 51.96 59.95 59.95 79.94 79.94 109.91 75.94

23.48 36.97 61.95 59.95 48.96 36.97 40.97 63.95 60.95 46.96 33.97 32.97 42.97 49.96 38.97 38.97 44.96 48.96 56.95 64.95 82.93 57.95

a. Import prices into England, West Indian origin b. The exchange rate used was 4.17 shillings per US$ (taken from Cox 1925) c. Indicates period average Source: Ellison (1886, pp. 50–1)

mated world cotton output at 213 000 tons. Major producers were India (accounting for 28%) and other Asian countries (not specified in White’s account but most likely China) accounting for 40%. The US share was only 0.4%. However, one may be tempted to question White’s accuracy. For example, according to his data average annual production in Brazil between 1811 and 1834 was about 15 000 tons. On the other hand, Ellison reports that between 1815 and 1835 annual cotton imports to England from Brazil averaged about 30 000 tons. Taking Ellison’s account as more accurate (this should also be viewed as a lower bound, as discussed earlier), adding the fact that substantial quantities of Brazilian cotton were imported to the US, and allowing for some domestic (ie Brazilian) consumption, Brazilian cotton production should have been at least three times as large, implying that world cotton production may have been much larger than White’s figure. Chapter 1/page 8

History of the cotton trade from origin Table 1.4 Uses of cotton in England, 1787 Uses of cotton Calicoesa and muslinsb Fustiansc Silk and linen mixture Hosieryd Candlewicks Total

Tons

Share (%)

5 263 2 722 907 681 681

51.3 26.5 8.8 6.6 6.6

10 254

100.0

a. All-cotton fabric woven in plain, or tabby, weave and printed with simple designs in one or more colors. Originated in Calicut (city and port in south-west India, the first city reached by Vasco da Gama’s eastward expedition) by the eleventh century b. Plain-woven cotton fabric made in various weights. The better qualities of muslin are fine and smooth in texture and are woven from evenly spun warps and wefts, or fillings c. Fabric originally made by weaving two sets of cotton wefts, or fillings, on a linen warp, popular during the European Middle Ages. The term fustian most likely originated in Al-Fustat, now part of Cairo, about AD 200 d. Knit or woven coverings for the feet and legs designed to be worn inside shoes, particularly women’s stockings and tights; also socks for men, women and children Source: Ellison 1886, p. 50. Definitions taken from Encyclopedia Britannica

During the eighteenth and early nineteenth centuries, cotton accounted for only a small fraction of total fiber consumption. The balance was made up of wool and flax (the plant that produces linen). Berger (1969), for example, reports that around the end of the eighteenth century cotton accounted for only 4% of world fiber consumption, with wool (78%) and flax (18%) making up the lion’s share. These figures are in agreement with Scherer’s (1916) account (it is likely that they come from the same source). Ellison (1886), whose account refers specifically to England, gives the following shares for the 1798–1800 period: cotton 16% and wool and flax 42% each (see Tables A1, A2 and A3). To understand the consumption patterns during this early period one must look at the main uses of cotton, which at that time were: (i) making candlewicks; (ii) filling; (iii) blending with other fibers; (iv) manufacturing of heavy clothing (Table 1.4). The absence of fine clothing in this consumption pattern reflected manufacturers’ inability to make cotton yarn strong enough for warp thread. Chapter 1/page 9

Cotton Trading Manual Table 1.5 Inventions that transformed the cotton industry Inventor

Year

Invention

Description/Use

John Kay (1704–64)

1733

Flying shuttle

James Hargreaves (1720–78)

1764

Spinning jenny

Richard Arkwright (1732–92)

1769

Water frame

James Watt (1736–1819)

1769

Steam engine

Samuel Crompton (1753–1827)

1779

Spinning mule

Edmund Cartwright (1743–1823)

1785

Power loom

Eli Whitney (1765–1825)

1793

Cotton gin

Allowed the shuttle, containing the thread, to be shot backwards and forwards across a much wider bed. It also allowed the thread to be woven at a faster rate, thus accelerating the weaving process Capable of spinning eight threads of cotton yarn, instead of the spinning wheel’s one. It also improved the quality of the thread A larger version of the spinning jenny powered by a watermill. It took spinning away from home bases to specific areas where fast-flowing streams could provide water power Introduced into the cotton industry in 1785; in 1790 Arkwright adopted the steam engine in his own factory and by 1800 it was established as the main source of power throughout the industry An improved version of Arkwright’s water frame, capable of producing stronger and finer thread Improved the weaving process, initially powered by a bull and later by the steam engine Mechanical separation of seed and lint which considerably reduced the costs of producing cotton lint

Sources: Baines 1835; Crawford 1924; Scherer 1916

The growth in cotton demand was accelerated following the numerous cotton-related inventions as well as improvements of existing technology that took place towards the end of the eighteenth century (Table 1.5). Cox (1925), who calls the second half of the eighteenth century the ‘period of invention’, wrote (p. 8): ‘Hargreaves’ spinning jenny invented in 1764, Arkwright’s spinning-frame (1769), Crompton’s spinning mule (1779), Cartwright’s power loom (1785), and the harnessing of Watt’s steam engine to spinning and weaving machinery (1792) revolutionized the uses of raw cotton . . .’ The first important invention took place back in 1733 when John Kay invented the flying shuttle. This enabled the shuttle, which contained Chapter 1/page 10

History of the cotton trade from origin the thread, to be shot backwards and forwards across a much wider bed. As a result the thread could be woven faster, thus greatly accelerating the weaving process. The second invention, the spinning jenny by James Hargreaves, took place in 1764. This was capable of spinning eight threads of cotton yarn, instead of the single thread of the spinning wheel. For the first time, the quality of the thread was improved. A larger version of the spinning jenny was developed by Richard Arkwright in 1769, powered by a watermill. This took spinning away from home bases to specific areas where fast-flowing streams could provide water power. An improved version of Arkwright’s water frame, the spinning mule, was invented by Samuel Crompton in 1779, which was capable of producing stronger and finer thread. Finally, Edmund Cartwright invented the power loom, a machine that improved the weaving process. The power loom was powered by a bull initially and later by the steam engine, which had been invented in 1769 by James Watt. In 1790, Arkwright adopted the steam engine in his own factory, and by 1800 it had become established as the main source of power throughout the industry. These inventions set the stage for the transformation of the textile industry from its cottage state (ie home-based factories employing a few workers each) into the largest industry in England and perhaps the world. The inventions also induced impressive price declines in cotton goods, in turn making clothing affordable to people not necessarily wealthy, consequently greatly increasing the demand for cotton. Furthermore, the technological improvements made the cotton yarn much stronger compared to hand-made yarn, increasing the quality (and hence the durability) of cotton products. To gauge the effects of the technological improvements on cotton consumption, consider that during the first decade of the eighteenth century cotton imports into England averaged approximately 550 tons; during the last decade of the century they averaged 14 500 tons, a 26-fold increase.

Rise of the US and dominance of England Although there is no agreement on when cotton was first cultivated in the US, most authors place the event in the early seventeenth century. Donnell (1872, p. 17) wrote: ‘Cotton seeds were first planted as an experiment in 1621, and their plentiful coming up was, at that early day, a subject of interest in America and England.’ For the next 150 years cotton was mainly used for home consumption in the South – in a sense cotton was a non-tradable good. The first sample of cotton from Georgia was taken to England in 1741, but it appears that the quality was low and no follow-up was Chapter 1/page 11

Cotton Trading Manual undertaken. In 1770, three bales of cotton went from New York to Liverpool, 10 from Charleston, four from Virginia and three from North Carolina (Crawford 1924). In 1784, 14 bales of American cotton were shipped to Liverpool, of which eight bales ‘. . . were seized as improperly entered on the ground that so much cotton could not have been produced in the United States; and this was more than 150 years after the importation to England of cotton grown in the same country’ (Donnell 1872, p. 36). For all practical purposes, the US was absent from the cotton market until the last decade of the eighteenth century. Two events marked the entrance of the US into the world cotton market. First was the installation of the first cotton spinning factory at Pawtucket, Rhode Island, in 1790, by Samuel Slater, the English immigrant who had gained experience in cotton spinning by working with the inventor of the water frame, Richard Arkwright (Duggan and Chapman 1941). Because the British were fiercely protecting their patents at the time, Slater had to construct the mill by memory. One of the first plants to stay in operation for some time was a Philadelphia plant established in 1775 and destroyed by the British in 1777 (Fortenberry 1957); no accurate record, however, remains of this or any other spinning and weaving cotton mills. Second was the invention of the saw gin by Eli Whitney in 1793, which eventually transformed the south-eastern part of the US to one of the major cotton-producing areas of the world (the word gin is a contraction of the word engine). The invention of gin, which transformed the separation of lint and seed from a laborious to a simple mechanical process, freed labour which eventually became involved in cotton production. The importance of the US in the world cotton market is vividly presented in Table 1.6. During the 40-year period 1791–1831, world cotton production increased from 213 000 to 380 000 tons; most of this growth was accounted for by the US whose production increased from virtually nothing to 176 000 tons, or 46% of global production. By the midnineteenth century, the US had become the dominant cotton supplier, accounting for nearly two-thirds of global output, which at the time was approximately two million tons. It was also the main supplier to England and continental Europe, accounting for over 80% of their cotton imports. During the 70-year period between the invention of the gin and the American Civil War, cotton production in the US increased by an annual rate of 8%. By 1860 cotton consumption by major consumers exceeded half a million tons, 60% of which was accounted for by England. During the first half of the nineteenth century, England consumed more than half of total world cotton output, rendering it the dominant cotton importer, textile producer and textile exporter. Towards the end of the century, Chapter 1/page 12

History of the cotton trade from origin Table 1.6 World cotton supply, 1791–1834 United States Thousand tons 1791 0.9 1801 21.8 1811 36.3 1821 81.7 1831 175.7 1834 208.7 Share (%) 1791 0.4 1801 9.1 1811 14.4 1821 28.3 1831 45.9 1834 50.2

India

Other Asia

Africaa

Brazil

Latin Americab

Others

World

59.0 72.6 77.1 79.4 81.7 83.9

86.2 72.6 66.2 61.3 52.2 49.9

20.9 20.4 20.0 23.6 32.7 38.6

10.0 16.3 15.9 14.5 17.2 13.6

36.3 29.9 31.3 24.5 20.0 19.5

0.0 6.8 5.0 3.6 1.8 1.8

213.2 240.5 251.9 288.6 380.2 416.1

27.7 30.2 30.6 27.5 21.5 20.2

40.4 30.2 26.3 21.2 13.7 12.0

9.8 8.5 8.0 8.2 8.6 9.3

4.7 6.8 6.3 5.0 4.5 3.3

17.0 12.5 12.4 8.5 5.3 4.7

0.0 2.8 2.0 1.3 0.5 0.4

100.0 100.0 100.0 100.0 100.0 100.0

a. Includes Egypt b. Includes West Indies and excludes Brazil Source: White 1836, p. 375

however, the US begun absorbing part of its own cotton production. By 1880, total cotton imports to Europe exceeded one million tons, 70% of which was supplied by the US (Table 1.7). Following the eruption of the American Civil War, exports from the US declined to a few thousand tons, from half a million tons prior to the war (Table A.5, Fig. 1.1). Cotton prices, on the other hand, experienced the most dramatic rize in the history of the commodity to cause what was termed later the ‘cotton famine’. Cotton prices in New York, which by that time had become the second most important cotton trading center in the US after New Orleans, increased from 13 cents in 1861 to over a dollar during the height of the war in 1864 (see Fig. 1.2), an almost eight-fold increase. In some respects, however, this exaggerates the true picture in the sense that cotton was traded at that price only sporadically. A more accurate picture of prices can be obtained by examining the New Orleans prices, which increased from 8.6 to 27.5 cents per pound between 1861 and 1864, a more modest three-fold increase (see Fig. 1.3). The New Orleans price increase is also corroborated by similar price increases at the Liverpool Cotton Exchange, which by that time had become the dominant cotton trading centre of the world. Following the supply disruption from the US, other cotton-producing countries picked up the slack, especially following concerted efforts by Chapter 1/page 13

Cotton Trading Manual Table 1.7 Cotton use by major consumers, 1801–81

Thousand tons 1801 1811 1821 1831 1841 1851 1861 1871 1881 Share (%) 1801 1811 1821 1831 1841 1851 1861 1871 1881

England

Continental Europe

United States

Totala

23.5 48.0 63.1 172.8 227.5 325.9 512.5 582.9 713.7

14.7 19.6 37.3 81.9 134.9 187.5 337.8 386.5 627.1

5.9 8.8 14.7 35.7 58.2 79.6 197.8 244.7 429.8

44.1 76.5 115.1 290.4 420.6 592.9 1048.2 1214.1 1770.6

53.3 62.8 54.9 59.5 54.1 55.0 48.9 48.0 40.3

33.3 25.6 32.4 28.2 32.1 31.6 32.2 31.8 35.4

13.3 11.5 12.8 12.3 13.8 13.4 18.9 20.2 24.3

100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

a. Refers to the sum of the three consuming regions reported, not to the world total Source: Donnell 1872 and Ellison 1886, pp. 98 and 102

100

80

60

40

20

0

00 805 810 815 820 825 830 835 840 845 850 855 860 865 870 875 880 885 890 895 900 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 18 1 1 1 1

Note: Prices are annual averages for upland middling cotton, New York quotations

1.1 Annual cotton prices in New York (nominal, ¢/lb) (source: Brown and Ware 1958; original data from USDA). Chapter 1/page 14

History of the cotton trade from origin 30 Peak due to the war with England

25

Peak due to the American Civil War

20 15 10 5 0 18

11

18

15

18

19

18

23

18

27

18

31

18

35

18

39

18

43

18

47

18

51

18

55

18

59

18

63

18

67

18

71

18

75

18

79

18

83

Note: Prices are annual averages for upland middling cotton, New Orleans quotations

1.2 Annual cotton prices in New Orleans (nominal, ¢/lb) (source: Ellison 1886, Table 3, Appendix).

2,500

2,000 Production

1,500 Drop due to the American Civil War 1,000 Exports 500

0 00 04 08 12 16 20 24 28 32 36 40 44 48 52 56 60 64 68 72 76 80 84 88 92 96 00 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 19

1.3 Cotton production and exports in the US (thousand tons) (source: Scherer 1916).

Chapter 1/page 15

Cotton Trading Manual Table 1.8 Sources of cotton imports to Europe, 1860–83

Thousand tons 1860 1865a 1870 1875 1880 1883 Share (%) 1860 1865 1870 1875 1880 1883

United States

Brazil

Egypt

Turkey

West Indies

East Indies

Total

736.5 94.7 425.6 564.8 820.3 926.3

8.7 27.2 39.4 39.2 14.2 27.9

24.5 99.6 68.8 100.2 105.8 112.5

3.8 43.4 24.7 16.0 4.4 4.4

4.2 15.2 14.3 12.5 6.0 5.4

100.2 238.8 191.8 257.7 194.9 275.9

877.9 519.1 764.6 990.4 1145.6 1352.5

83.9 18.3 55.7 57.0 71.6 68.5

1.0 5.2 5.2 4.0 1.2 2.1

2.8 19.2 9.0 10.1 9.2 8.3

0.4 8.4 3.2 1.6 0.4 0.3

0.5 2.9 1.9 1.3 0.5 0.4

11.4 46.0 25.1 26.0 17.0 20.4

100.0 100.0 100.0 100.0 100.0 100.0

a. A small amount of cotton from China was imported that year Source: Ellison 1886, p. 91

England to keep its textile mills running. Crawford (1924, p. 141), for example, observed: But England did not submit tamely to the situation. This has never been her habit. She rimmed the globe with cotton plantations. Wherever cotton could be grown, there her deep purse and far sighted policy planted it, and many of the plantations thus founded, have remained fruitful to this day. . . . This was a great commercial achievement, and one in which British merchants and statesmen of those tempestuous times may well take pride. Between 1860 and 1865 (end of the war), imports of cotton to Europe increased three-fold from Brazil, five-fold from Egypt, more than tenfold from Turkey, three-fold from West Indies, and more than double from India (Table 1.8). In short, while the US’s share fell from 84% to 18%, cotton imports to Europe fell only from 878 000 tons to 519 000 tons. The first half of the nineteenth century also witnessed unprecedented declines in the prices of yarn and cloth, as a reflection of the reduction of costs of production (see Fig. 1.4 and Table A.7). For example, a pound of 40-hank yarn was selling at 16 shillings (equivalent to $3.84) in 1779, of which 14 shillings were the cost of labour and capital and 2 shillings were the costs of cotton. Five years later, the price of yarn Chapter 1/page 16

History of the cotton trade from origin 40 Cost of cotton

Cost of labor and capital

30

20

10

0 1786

1796

1806

1812

1830

1860

1882

Note: Price refers to yarn of 100 hanks per lb

1.4 Composition of yarn cost (shillings/lb) (source: Ellison 1886, p. 61).

declined to 10 shillings, with the whole decline accounted for by reduction in the cost of labour and capital. Yarn prices in 1799, 1812 and 1830 dropped to 7.5, 2.5 and 2 shillings per pound, respectively. The price of cloth experienced similar declines. Between 1815 and 1856, the prices of calicoes and fustians declined by 81 and 73%, respectively (Table A.8).

Globalization With the arrival of the first steamer in New York in 1838, the time to cross the Atlantic was halved – from approximately 35 days to 18 days. For the first time in history, information on the demand and supply conditions of cotton in the two sides of the Atlantic was transmitted at twice the speed of the physical delivery of cotton. That gave rize to speculation in Liverpool whereby cotton traders would undertake short or long positions based not only on the their assessment of the local market conditions but also on the news that the steamers would bring regarding market conditions in the US, which would be reflected in the arrival of cotton two to three weeks later. Perhaps the single most important event that influenced the transformation of the world cotton industry into a global market was the successful installation of the first transatlantic cable in 1865. For the first time ever, information on market conditions in the US was transmitted Chapter 1/page 17

Cotton Trading Manual instantaneously to England and vice versa. The opportunities arising with the cable were so enormous that despite unsuccessful attempts (in 1857 and 1858), the textile industry in England was willing to undertake the risk and finance such a project. Consider the following excerpt from Marsh (1911, p. 592): In 1868 or 1869, Mr. Rew saw that the newly laid Atlantic Cable made it possible for a cotton merchant in Liverpool to ascertain with unheard-of quickness the price at which actual cotton could be bought in the southern states and the approximate date at which it could be shipped to England. He saw, also, that if the price that was being bid in Liverpool for ‘cotton to arrive’ was high enough to enable him to buy cotton in the South and sell contracts for this same ‘cotton to arrive’ in Liverpool, two or three months later, he could enter onto the transaction with entire safety, as when his cotton reached Liverpool, he could either deliver it to the parties to whom he had sold the contracts; or, if some spinner was willing to pay a higher relative price than the holder of the contracts had agreed to pay, he could buy back his contracts and sell the cotton to the spinner with the larger profit to himself. By the end of the 1880s, five cotton futures exchanges in three continents (New York, New Orleans, Liverpool, Le Havre and Alexandria) were trading cotton futures contracts and were connected by cable; the opening price of Liverpool was based on the Alexandria and Le Havre price while the opening price of New York was based on Liverpool (Garside 1935). (For more information see Appendix 4 at the end of this manual.) In addition to disseminating information and instituting standards for the physical trade of cotton, the futures exchanges enabled cotton merchants and textile manufactures to hedge, ie shift the risks of price fluctuations to people who were willing to undertake such risks, the speculators. Note that price variability was a very important impediment in cotton trade, especially during the Civil War. Trading of cotton reached its highest point in about 1900. In 1880, for example, of the 2.2 million tons of global production, more than 1.2 million tons (ie 55%) were traded, compared to about 30% today. Liberal trade policy in the domestic cotton markets of major cotton players during this period have certainly played its part. To put the picture of the late nineteenth century into perspective, it is worth comparing the cotton balance then with what it is now. To that end, Table 1.9 reports world cotton production and consumption for 1882 and for 2001. During this 120-year period cotton production increased almost ten-fold. Despite such growth, the production pattern did not change considerably. The three top producers – the US, East India [India and Pakistan] and China – accounted for 87% of global cotton output in 1882. In 2001 they accounted for 66%. The remaining Chapter 1/page 18

History of the cotton trade from origin is shared by a number smaller producers, as was the case in 1882. The consumption pattern, however, has changed entirely. The US and Europe accounted for 45% of cotton consumption in 1882. In 2001 they only accounted for 13%. More importantly, in 1882 England consumed close to one-third of global output; in 2001 it consumed no cotton at all. China and the East Indies consumed 18% of cotton in 1882; they now account for half of global consumption. Interestingly, Canada’s share was 0.4% in 2001, the same as it was in 1882. In some respects the cotton industry has changed a lot during the past 120 years. In others, it has not. Table 1.9 World cotton balance, 1882 and 2001

Production United States East Indiesa China Egypt Sub-Saharan Africa Latin Americab Japan Turkey and Persia Asiatic Russiac Greece Australia Others World consumption England Continental Europe United States China East Indiesa Africa Latin Americab Japan Turkey and Persia Asiatic Russiac Canada Others World

Thousand tons

Share (%)

1882

2001

1882

2001

1 277 445 259 113 68 54 24 22 18 2 1 0 2 282

4 400 4 361 5 320 314 1 101 1 029 0 1 050 1 601 410 670 1 026 21 237

55.9 19.5 11.3 5.0 3.0 2.4 1.0 1.0 0.8 0.1 0.0 0.0 100.0

20.7 20.5 25.1 1.5 5.2 4.8 0.0 4.7 7.5 1.9 3.2 4.8 100.0

682 621 413 277 141 68 26 24 14 9 8 0 2 282

2 981 1 655 5 400 4 686 301 1 678 234 1 370 789 76 2 764 19 936

29.9 27.2 18.1 12.1 6.2 3.0 1.1 1.0 0.6 0.4 0.4 0.0 100.0

0.0 4.9 8.3 27.1 23.5 1.5 8.4 1.2 6.9 4.0 0.4 13.9 100.0

a. India and Pakistan b. Includes the Caribbean c. Includes all Central Asian cotton-producing countries Source: Ellison 1886, pp. 145–6 and International Cotton Advisory Committee 2002 Chapter 1/page 19

Cotton Trading Manual

Statistical appendix Table A.1 World fiber consumption (shares), 1800–1946

1800a 1890 1924–28b 1946

Cotton

Wool & Flax

Silk

Rayon

Total

4.0 78.6 84.2 72.6

96.0c 21.1 13.5 15.4

0.0 0.3 0.7 0.2

— — 1.6 11.8

100.0 100.0 100.0 100.0

a. At end of the eighteenth century b. Period average c. 78% wool and 18% flax Source: Berger 1969

Table A.2 Fiber consumption in Europe and US (shares)

1783 1883

Cotton

Wool

Flax

Total

4.4 73.1

77.2 20.7

18.4 6.2

100.0 100.0

Source: Scherer 1916, p. 5 Table A.3 Fiber consumption in England, 1798–1882

Total consumption (thousand tons) 1798–1800 1829–1831 1859–1861 1880–1882 Share (%) 1798–1800 1829–1831 1859–1861 1880–1882 Per capita consumption (kg per annum) 1798–1800 1829–1831 1859–1861 1880–1882 Source: Ellison 1886, p. 120 Chapter 1/page 20

Cotton

Wool

Flax

Total

19.0 110.3 463.9 646.4

49.7 67.8 118.1 203.6

49.3 87.9 96.2 124.2

118.0 266.1 678.3 974.1

16.1 41.5 68.4 66.4

42.2 25.5 17.4 20.9

41.8 33.0 14.2 12.8

100.0 100.0 100.0 100.0

1.3 4.5 16.0 18.3

3.3 2.8 4.1 5.8

3.3 3.6 3.3 3.5

7.9 10.9 23.4 27.6

History of the cotton trade from origin Table A.4 Sources of cotton imports into England, 1786–1884

Thousand Tons 1786–90 a 1796–1800 a 1806–10 a 1815 1820 1825 1830 1835 1840 1845 1850 1855 1860 1865 1870 1875 1880 1884 Share (%) 1786–90 a 1796–1800 a 1806–10 a 1815 1820 1825 1830 1835 1840 1845 1850 1855 1860 1865 1870 1875 1880 1884

United States

Brazil

West Indies

Mediterranean

East Indies

0.0 4.1 19.5 36.9 54.9 76.9 112.3 138.5 224.6 272.2 214.9 294.7 468.4 83.8 302.0 337.4 478.0 501.8

0.9 1.9 5.9 16.5 32.7 35.2 34.7 26.1 15.5 20.0 31.2 24.4 18.7 61.8 73.1 76.9 22.3 44.6

8.2 6.0 6.0 0.2 0.5 20.1 2.7 7.9 6.9 14.9 14.5 20.8 19.9 75.1 39.9 51.1 43.6 53.0

2.4 3.1 0.5 9.4 5.2 5.8 2.1 4.1 4.0 1.6 1.0 1.6 1.8 23.8 20.3 16.2 13.3 9.1

0.1 4.9 4.9 4.1 10.5 11.0 6.4 21.4 39.3 28.1 55.9 71.9 102.2 255.6 193.0 191.4 103.4 145.5

11.5 20.0 36.7 67.0 103.7 149.0 158.2 198.0 290.3 336.8 317.5 413.4 611.0 500.1 628.4 673.0 660.6 754.0

0.2 20.4 53.1 55.0 52.9 51.6 71.0 69.9 77.4 80.8 67.7 71.3 76.7 16.8 48.1 50.1 72.4 66.6

7.9 9.7 16.1 24.7 31.5 23.6 22.0 13.2 5.3 5.9 9.8 5.9 3.1 12.3 11.6 11.4 3.4 5.9

70.8 29.9 16.2 0.3 0.4 13.5 1.7 4.0 2.4 4.4 4.6 5.0 3.3 15.0 6.4 7.6 6.6 7.0

20.4 15.7 1.3 14.0 5.0 3.9 1.3 2.1 1.4 0.5 0.3 0.4 0.3 4.8 3.2 2.4 2.0 1.2

0.8 24.4 13.3 6.1 10.1 7.4 4.0 10.8 13.5 8.4 17.6 17.4 16.7 51.1 30.7 28.4 15.6 19.3

100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

a. Period average Source: Ellison 1886, p. 86 and Appendix, Table 2

Chapter 1/page 21

Total

Cotton Trading Manual Table A.5 US cotton supply and exports (thousand tons), 1790–1900 Year

Supply

1790 0.6 1791 0.8 1792 1.2 1793 2.0 1794 3.2 1795 3.2 1796 4.0 1797 4.4 1798 6.1 1799 8.1 1800 14.1 1801 19.4 1802 22.2 1803 24.2 1804 26.2 1805 28.2 1806 32.3 1807 32.3 1808 30.3 1809 33.1 1810 34.3 1811 32.3 1812 30.3 1813 30.3 1814 28.2 1815 40.3 1816 50.0 1817 52.4 1818 50.4 1819 67.4 1820 64.5 1821 72.6 1822 84.7 1823 74.6 1824 86.7 1825 102.9 1826 141.2

Exports 0.1 0.1 0.7 0.7 1.8 2.4 1.5 3.6 3.7 6.9 8.1 9.2 14.5 13.5 14.8 13.8 24.7 4.1 19.7 36.0 23.9 11.1 7.4 6.8 32.0 31.6 33.0 35.7 33.9 49.3 48.2 55.8 67.0 55.3 68.1 78.9 113.5

Year

Supply

Exports

Year

Supply

1827 1828 1829 1830 1831 1832 1833 1834 1835 1836 1837 1838 1839 1840 1841 1842 1843 1844 1845 1846 1847 1848 1849 1850 1851 1852 1853 1854 1855 1856 1857 1858 1859 1860 1861 1862 1863

108.9 131.1 147.2 141.2 155.3 157.3 179.5 185.6 204.8 217.7 275.4 210.8 318.9 259.9 269.6 392.5 337.5 400.9 348.3 309.3 410.4 504.3 380.9 411.9 578.4 603.6 533.4 522.2 621.1 554.1 580.8 724.7 831.0 740.7 865.9 307.9 86.6

81.2 102.1 115.1 106.8 124.3 125.2 148.4 149.4 163.4 171.3 229.8 159.5 286.9 204.5 225.5 305.6 255.9 336.6 211.2 203.3 314.0 395.9 245.0 357.6 421.6 428.7 381.0 388.9 521.2 404.3 431.4 534.7 681.7 118.6 2.0 4.4 4.6

1864 1865 1866 1867 1868 1869 1870 1871 1872 1873 1874 1875 1876 1877 1878 1879 1880 1881 1882 1883 1884 1885 1886 1887 1888 1889 1890 1891 1892 1893 1894 1895 1896 1897 1898 1899 1900

57.7 403.7 375.7 452.3 423.9 464.6 776.1 531.6 704.0 747.0 680.4 829.7 794.2 866.6 915.0 1054.1 1225.8 990.5 1317.7 1064.8 1056.2 1228.2 1217.6 1327.6 1335.1 1440.9 1651.0 1724.1 1283.9 1433.3 1933.2 1378.1 1642.1 2118.3 2205.1 1802.1 1952.0

Source: Scherer 1916, pp. 419–21, Appendix F

Chapter 1/page 22

Exports 3.4 250.9 270.3 289.8 250.8 383.3 563.6 351.9 476.4 517.3 482.9 585.8 547.5 616.6 634.4 721.7 858.8 651.1 885.4 719.9 729.5 810.0 829.5 871.5 912.1 950.4 1128.1 1137.1 864.9 1023.4 1342.4 918.2 1180.9 1506.2 1470.6 1189.3 1312.5

History of the cotton trade from origin Table A.6 Cotton prices (US cents per lb), 1800–1900 Year

New York

New Orleans

Year

New York

1800 1801 1802 1803 1804 1805 1806 1807 1808 1809 1810 1811 1812 1813 1814 1815 1816 1817 1818 1819 1820 1821 1822 1823 1824 1825 1826 1827 1828 1829 1830 1831 1832 1833

24.00 44.00 19.00 19.00 20.00 23.00 22.00 21.50 19.00 16.00 16.00 15.50 10.50 12.50 25.00 21.00 28.96 27.25 31.70 21.86 16.92 14.32 14.32 11.40 14.75 18.59 12.19 9.29 10.32 9.88 10.04 9.71 9.38 12.32

— — — — — — — — — — — 12.50 16.75 23.00 29.50 20.25 18.25 20.13 20.00 13.50 11.50 9.50 8.25 8.25 8.50 11.63 6.75 6.50 6.75 5.75 6.88 6.00 6.63 8.50

1834 1835 1836 1837 1838 1839 1840 1841 1842 1843 1844 1845 1846 1847 1848 1849 1850 1851 1852 1853 1854 1855 1856 1857 1858 1859 1860 1861 1862 1863 1864 1865 1866 1867

12.90 17.45 16.50 13.25 10.14 13.36 8.92 9.50 7.85 7.25 7.73 5.63 7.87 11.21 8.03 7.55 12.34 12.14 9.50 11.02 10.97 10.39 10.30 13.51 12.23 12.08 11.00 13.01 31.29 67.21 100.02 83.38 43.20 31.59

New Orleans

Year

New York

New Orleans

8.63 10.25 8.88 7.00 7.00 7.88 6.00 6.25 5.38 4.63 4.13 4.13 4.13 6.13 4.13 5.13 7.00 5.50 5.31 5.75 5.38 5.63 6.33 7.75 6.13 6.75 6.25 8.60 17.25 23.25 27.50 19.00 15.50 10.88

1868 1869 1870 1871 1872 1873 1874 1875 1876 1877 1878 1879 1880 1881 1882 1883 1884 1885 1886 1887 1888 1889 1890 1891 1892 1893 1894 1895 1896 1897 1898 1899 1900

24.85 29.01 23.98 16.95 20.50 18.20 17.00 15.00 13.00 11.70 11.30 10.40 12.00 11.30 12.20 10.60 10.60 10.50 9.40 10.30 10.30 10.70 11.10 8.60 7.70 8.30 7.00 7.30 7.90 7.20 6.00 6.60 9.60

10.50 12.38 9.94 8.56 10.56 9.00 8.00 7.38 6.25 6.31 6.13 6.31 6.94 6.44 6.63 5.75 6.00 — — — — — — — — — — — — — — — —

— Not reported Source: Brown and Ware 1958 for New York, and Ellison 1886, Table 3, Appendix for New Orleans

Chapter 1/page 23

Cotton Trading Manual Table A.7 Composition of yarn cost in England, 1779–1882 Shillings per pound Cost of cottona 40 hanks per poundb 1779 2.0 1784 2.0 1799 3.3 1812 1.5 1830 0.6 1860 0.6 1882 0.6 100 hanks per pound 1786 4.0 1796 3.5 1806 3.0 1812 2.3 1830 1.1 1860 0.9 1882 0.8

Share (%)

Labor & capital

Selling price

Cost of cotton

Labor & capital

Selling price

14.0 8.9 4.2 1.0 0.6 0.4 0.3

16.0 10.9 7.5 2.5 1.2 1.0 0.9

12.5 18.3 44.4 60.0 53.4 59.8 67.9

87.5 81.7 55.6 40.0 46.6 40.2 32.1

100.0 100.0 100.0 100.0 100.0 100.0 100.0

34.0 15.5 4.2 2.8 2.2 1.4 1.0

38.0 19.0 7.2 5.1 3.3 2.3 1.8

10.5 18.4 41.9 45.2 34.0 39.3 43.8

89.5 81.6 58.1 54.8 66.0 60.7 56.3

100.0 100.0 100.0 100.0 100.0 100.0 100.0

a. Cost of cotton is based on 18 ounces instead of 16 ounces (one pound) to account for waste b. The number of hanks measures the fineness of yarn. More hanks implies finer, and hence higher-quality, yarn. Source: Ellison 1886, p. 61

Table A.8 Price of cloth in England, 1815 and 1856 Calicoes Shillings per yard 1815 1856 Change (percent) 1815–56 Source: Ellison 1886, p. 61

Chapter 1/page 24

1.08 0.21 -80.8

Printers 1.83 0.38 -79.5

Fustians 1.83 0.50 -72.7

2 The cotton trade today Paul A Ruh

Introduction to the cotton trade Trends in world fiber consumption The international cotton trade Who are cotton merchants? What is the added value cotton merchants provide? Information gathering Forecasting cotton prices Pricing of cotton Hedging and the New York futures market E-trade Positions Summary

Introduction to the cotton trade Cotton has been used as a textile fiber for thousands of years. Cotton material has been found in ancient burial sites in China, Mexico and India. The fiber was introduced into Europe by Arab traders in the Middle Ages. Commercial production of cotton was originally started in Egypt, India and Peru. In the eighteenth century, cotton was first planted in the southern United States. It took certain developments to turn cotton into a major textile fiber. These included the invention of the spinning machine in England in 1764, and soon after that, the development of the power loom. As far as raw cotton is concerned, the most important invention was the cotton gin, developed by Eli Whitney in the US in 1793. This freed cotton from the laborious process of removing the fiber from the seed by hand, a job performed by slaves on the Southern cotton plantations. During the first half of the nineteenth century, American cotton played an increasingly important role in the world supply of cotton. On the consumption side, the largest concentration of cotton spinning and weaving was in Lancashire (England), followed by Switzerland, at one time the largest cotton-importing country in continental Europe. But textile industries were soon started all over. Major trading places for raw cotton were Liverpool (England), Bremen (Germany), Le Havre (France) and Winterthur (Switzerland). The Civil War in the US (1861–65) disrupted cotton trading and practically destroyed the cotton growing industry in the country. Blockade of the southern ports and the destruction of cotton plantations in the course of the war cut the consuming countries in Europe from their main source of supply and drove prices to extremely high levels. Eventually, cotton was imported from other origins, such as Egypt, India, the Middle East and South America. Once the Civil War in the US was over, cotton production recovered in the South, but only very slowly. The old plantation system had depended on slave labor, which was gone forever after 1865. Cotton trading in the US is about 200 years old. In the early years, cotton was probably handled by general traders along with other agricultural products. The development of a specialized cotton trade started around 1850. For example, the formerly prominent trading house of McFadden was founded in 1852. To facilitate trading in cotton, the New York Cotton Exchange was founded in 1870 and another exchange established in New Orleans in 1871. At that time, the US cotton crop was about 4.5 million bales, of which some 2.5 million were shipped to the cotton mills of Lancashire. The European cotton trade can also look back on a 200-year history. Paul Reinhart in Switzerland was founded in 1788 at the peak of the Chapter 2/page 1

Cotton Trading Manual cottage industry phase of textile production. The company’s basic activities were importing of cotton, trading in cotton yarn and exporting cotton cloth from Switzerland. Some trading houses in Liverpool go back almost that far. The first cotton shipment was received there in 1709. In Liverpool, a cotton brokers’ association was founded in 1841, which led to the Liverpool Cotton Association (LCA) in 1882 (now the International Cotton Association (ICA)), and included cotton brokers and merchants. Similar organizations were created at about the same time in Germany, France and other European countries. These cotton exchanges were necessary in order to develop an orderly system for the trading of cotton. This included the development of quality standards, trading terms and arbitration rules for the settlement of disputes. The Liverpool merchants dominated the world trade in cotton for several decades. Some major houses had branches in the US and other producing countries. Bremen also became a major center of the cotton trade, supplying not only Germany but also Eastern Europe, including Russia. In the US, cotton merchants started operating mostly in cottonproducing states like Texas, Alabama and Mississippi. From 1900 until World War II, the firm of Anderson, Clayton dominated the world cotton trade as no other firm had, either before or after. But, as the firm grew enormously in the years between the world wars, it went more and more into ginning, warehousing, cottonseed oil, food and other industrial products. Cotton merchandising was de-emphasized and eventually abandoned altogether. As mentioned, McFadden, was at one time the most famous name in US cotton merchandising, but when the McFadden family died out in the 1970s, the firm was sold several times and eventually taken over by another merchant. This is actually quite common. Cotton trading is a highly specialized, personalized and risky business. It is not for everybody. Many well-known cotton trading firms have disappeared because the owner died or retired, and his heirs were not interested in or capable of continuing the business. Many others were forced to close down because of huge losses. Looking simply at the risk–reward relationship, cotton trading is not a very attractive proposition any more, particularly when comparing it to returns investors have obtained in mutual funds, high-tech and other stocks in recent years (with the exception of 2001 and 2002, of course). For this reason, very few newcomers have entered the cotton trading business over the last ten years. Cotton trading is not suitable for public ownership. This is the same in other commodities. Given the seasonal nature of the business, and the unpredictable profit or loss outlook, trading firms are privately held. Apart from the large Japanese trading houses, the only publicly traded cotton and grain company in recent times was Cook Industries of Memphis. The firm ran into trouble in the 1970s and closed down. Chapter 2/page 2

The cotton trade today Since World War II, the world cotton trade has been dominated by US merchants and the industry has gone through a long period of consolidation. Just like the grain and the coffee trade, we have today a small handful of very large cotton trading firms who annually handle several million bales each on a worldwide basis. These companies are heavily capitalized, and typically have warehousing and ginning operations in addition to cotton trading. The mid-size firms that were very active two and three decades ago have mostly disappeared, but there are still, and always will be, small traders who specialize in certain niche markets. Besides the US merchants, there are several major players in Europe, and a few of the big Japanese trading houses still handle cotton. One of the largest traders in Australia entered the arena of international cotton trading at about the turn of the millennium. The influence of Japanese firms has diminished over time, as their domestic raw cotton consumption has shrunk by more than 70% over the last 25 years or so. On the other hand, they supply an increasing volume of cotton to Japanese joint ventures and other mills in Southeast Asia. The exit of many large Japanese trading houses from the cotton trade gives a textbook example of how not to do the cotton business. Going after volume and market share does not contribute positively to the bottom line of any commodity trading company. Margins per bale are much more important! The founding of cotton exchanges and associations in Europe has been referred to. It has also become necessary to have associations to represent the interests of the trade with governments, which have always been heavily involved with agriculture all over the world. In the US, the oldest cotton trade organization is the Texas Cotton Association, founded in 1911 and the American Cotton Shippers Association was created in 1924. Cotton merchants are one of the seven segments of the National Cotton Council, founded in 1939. Both of these national organizations are headquartered in Memphis. Throughout this 200-year history, the world cotton trade has had a reputation for honesty and integrity. If growers and consumers of cotton could not rely on the performance of the cotton trade, regardless of circumstances, trading of cotton for forward delivery would be impossible.

Trends in world fiber consumption At the turn of the twentieth century, cotton had an 80% share of the world textile fiber market. Of course, at that time there were no manmade fibers (MMF). By the end of the War in August 1945, cotton Chapter 2/page 3

Cotton Trading Manual stood at 75% of the fiber market, with other natural fibers accounting for about 10%. Manufactured fibers had risen to 15% by that time. In the 1960s and 1970s, when polyester became available in volume, cotton’s market share declined drastically. This had less to do with price than with the fact that polyester was a novelty, and consumers wanted to try a fiber with new features, like ‘wash-and-wear’ that caught everybody’s attention. In those days cotton was literally fighting for its survival as a major textile fiber and its share of the world fiber market declined to almost 55% in 1970 from 68% in 1960. In 2003, cotton’s share of the world fiber market stood at 40%, down from 49% in 1991, when the world consumed 174 million bale equivalents of all kinds of fiber. Total fiber demand in 2003 was 246 million bale equivalents, a 41% increase from 1991. During that same period, cotton consumption increased by only 12 million bales, from 85 to 97 million, compared with an increase of 59 million bale equivalents for all other fibers combined. Cotton’s share of the fiber market fell under 50% for the first time in 1987 and has eroded further since. In calendar year 2003, world consumption of polyester, at 101.7 million bale equivalents, exceeded cotton, at 97.0 million bales, for the first time. Cotton consumption will reach a record high in 2004, at an estimated 103 million bales, early forecasts that polyester would further increase its market share were not borne out as cotton became more price-competitive. The drop in market share over the years is a consequence of price, fashion and the lack of buying power of the population in many parts of the world. In fact, cotton actually gained market share in some highincome countries (US, Europe and Japan), but not enough to offset losses in developing countries around the world. Owing to a huge increase in MMF production capacity worldwide, particularly in China, MMF prices have gone into a steep decline, but the combination of higher crude oil and lower cotton prices during 2004 served to increase the competitiveness of cotton versus polyester. Nevertheless, to hold on to its present market share, or even regain some recent losses, cotton must depend on consumer preference. For this reason the cotton industry has to promote cotton at the consumer level. It is too bad that the US (and Australia to some extent) is the only country that spends millions of dollars on worldwide promotion through Cotton Council International and Cotton Incorporated. Other cottonproducing countries enjoy the benefits of these efforts without contributing a dollar.

The international cotton trade World trade takes place when goods cross a national border. That means cotton has to move from one country to another to be considered as traded internationally. Over the last three seasons, international Chapter 2/page 4

The cotton trade today trade in cotton, both imports and exports, has averaged about 31.8 million bales. Cotton merchants are vitally interested in free and open exports and imports of cotton worldwide. In countries like Brazil, Pakistan, China, Turkey, Mexico, India and others, international traders can participate in both imports and exports. On the other hand, international merchants cannot sell Chinese cotton to mills in China, or Indian cotton to mills in India. Trading in those countries is handled by government organizations (Central Asia, Syria, etc), the domestic cotton trade (India, Turkey and Pakistan) or both (China). During the 2002/03, 2003/04 and 2004/05 seasons, an average of 101 million bales of cotton was grown in about 80 countries around the world (Table 2.1). The five largest markets account for 74% of the world crop: China, the US, India, Pakistan and Central Asia (the former Soviet Union). Cotton is consumed in more than 100 countries, with annual consumption running from over 32.0 million bales (China in 2003/04) to as little as 1000 bales (Armenia and Nicaragua, for example). Consumption during the same three seasons is projected to average 100 million bales. The seven largest consumers account for over 76% of world consumption. They are China, India, Pakistan, Turkey, the US, the EU (European Union) and Brazil. Much of the world’s cotton consumption takes place in countries where cotton is also produced. In fact, most of the growth in consumption over recent years has been in cotton-producing countries. This development has turned former large cotton exporters like Mexico, Turkey, India and Pakistan into net importers of the fiber. Similar developments can be anticipated in Uzbekistan and other republics in Central Asia. Taking care of quality imbalances is another reason for world trade. In India and Pakistan, for example, the textile industry is becoming a major supplier of yarn, fabric and apparel to the Far East, Europe and the US. In order to produce top-quality textile products, mills depend more and more on imports of US cotton, including pima, and Australian, which have a very low rate of contamination and/or allow spinners to produce a very special yarn. At the same time, Pakistan and India continue to export some of their lower-grade or shorter staple raw cotton to the Far East. World trade in cotton has been rather stagnant in the past 30 years. It passed 20 million bales for the first time in the 1970/71 season (23.5 million bales traded) and reached its peak in 1988/89 with 33.5 million bales. The average of the last three years has been about 32 million bales, just 33% of total production. The largest exporters are the US, Central Asia, West/Central Africa, Australia, Greece/Spain and Brazil. After participating for several years in the export market, China is now, by far, the largest cotton importer of the world (estimated at 8.8 million bales in 2003/04). Chapter 2/page 5

Chapter 2/page 6 33.300 13.933 9.800 6.598 6.500 4.073 3.917 2.217 2.067 1.933 17.208 101.547 US Central Asia West/Cent. Africa Australia Greece/Spain Brazil Syria Egypt India Sudan Others Total

Exports 12.886 5.193 4.179 2.304 1.371 1.084 0.717 0.583 0.494 0.385 3.071 32.268

China EU 25* Turkey Indonesia Mexico Thailand Bangladesh Russia S. Korea Pakistan Others Total

Imports 6.153 3.397 2.712 2.259 2.019 1.908 1.613 1.525 1.347 1.233 8.086 32.253

*EU 25 = Austria, Belgium, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Slovakia, Slovenia, Spain, Sweden, United Kingdom

China India Pakistan Turkey US EU 25* Brazil Indonesia Mexico Thailand Others Total

China US India Pakistan Central Asia Brazil West/Cent. Africa Turkey Greece/Spain Australia Others Total

24.634 19.572 14.167 8.950 7.178 5.435 4.891 4.143 2.138 2.060 7.831 100.999

Consumption

Production

Table 2.1 Cotton production, consumption, exports and imports averages of 2002/03 to 2004/05 (in thousands of bales of 480 lb)

Cotton Trading Manual

The cotton trade today Where do cotton merchants fit into this picture? Cotton merchants are the necessary link between farmers and textile mills. The most important single function of a cotton merchant is that of a market maker. By buying cotton from producers when they want to sell, and selling cotton to the mills when they want to buy, the merchant effectively creates a market where cotton can be bought and sold at all times. Cotton is traded as much as 24 months forward. Owing to the risk inherent in all commodity transactions, this requires a great deal of confidence on the part of all parties involved: producers, textile mills and merchants. Cotton merchants have a vital interest in free trade of cotton across national borders. As mentioned earlier, no international merchant can sell Chinese cotton to textile mills in China or wants to participate in the cotton movement within India or Pakistan. But when the US, China, India, Pakistan, Brazil, Turkey and Mexico import and/or export cotton, and when cotton-producing countries in Africa, the republics of Central Asia or Australia sell their cotton for export, the international cotton trade is very much a participant.

Who are cotton merchants? Cotton merchants provide service. It is a ‘people’ business; the most valuable asset in a cotton company is its people and their integrity. Merchants are not speculators, buying cotton at a low price and selling high, as many people may think. As with all other commodities, margins are razor-thin. To be able to buy, merchants have to pay the highest price of the day to a producer and, since competition is very tough, selling must be at the lowest price. We will see later how cotton merchants can make this work. Most cotton merchants are private companies, primarily located in the US, Europe, Australia and Japan. Some are owned today by the big grain merchants. Others are familyowned and operated. Under ten firms can be considered leading international merchants, handling, or capable of handling, a million bales or more. This excludes cooperatives in the US and elsewhere, which also handle very large volumes of cotton, but mostly in their home territories. The cotton trade has become more concentrated over time. There are fewer but larger trading firms than, say, twenty-five years ago. Even at today’s still depressed price of around $300 a bale, cotton merchants require huge amounts of capital to finance their operations. They need a high tolerance for risk in view of the greatly increased volatility in the market. For this reason, there have been almost no new players coming into the business recently, but several large merchants have ceased doing business. Cotton merchants can be divided into groups, as follows: Chapter 2/page 7

Cotton Trading Manual • international merchants, handling most major cotton growths, who can buy and sell large quantities and are able to deliver other origins if there is a problem in one producing country • regional merchants, handling only a few selected growths, such as US, Central Asian, West African, Greek, Australian or East African, etc. • local merchants, handling only cotton from their own country or a region within it • FOB merchants/brokers, usually handling cotton on commission • Long and Extra Long staple cotton traders. All of these have specific functions. The big, international merchant uses his large organization, financial strength and know-how to buy and sell cotton all over the world. The regional merchants do the same but on a smaller scale, usually concentrating their efforts in a limited number of markets. Local merchants exist in almost all cottonproducing countries, trading cotton both for export and the domestic market. Finally, FOB merchants or brokers in the US form the link between farmers and the large merchants, buying cotton in the interior markets and selling it to the big merchants. These FOB merchants perform very important functions. In addition to being the link between the grower/gin and the merchant, they act as consultants to growers in many aspects of their business: what variety to grow, when and to whom to sell. They also advise producers on the US Farm Bill, the use of the CCC loan and when to redeem it. For the rest of this chapter, the focus will be on the first group, the international merchants, principally those based in the US.

What is the added value cotton merchants provide? Before going any further, we have to see why merchants are necessary at all. Why does the farmer not sell directly to the spinning mills? Why do the spinners not buy their cotton directly from farmers or cooperatives? Experience shows that farmers rarely sell when mills wish to buy; and mills do not buy cotton when the farmers want to sell. In the old days, US farmers used to sell their cotton either at or before planting time to lock in a price; or when the cotton crop had shown some progress; or after the harvest was completed; or any combination thereof. At times of low prices, things are different in the US. Under the Farm Bill, US growers cannot afford to sell their cotton ahead of the harvest because that is when they can also fix the government payments. Spinning mills have no set pattern of buying cotton. They are guided by the level of cotton prices, the yarn and textile markets, their Chapter 2/page 8

The cotton trade today own order book, etc. Growing and spinning cotton are industrial enterprises. Farmers and spinners should not be speculating. Once a profit can be locked in, the price should be fixed. Since these buying and selling periods do not coincide, the cotton merchant steps in and provides a market for both sides. That means that merchants will always have a price when farmers want to sell; and they will always be prepared to sell, any quantity, any quality for any delivery period, when the mills want to buy. In addition to market-making, there are other vital services performed by the cotton merchant. For the cotton grower, the merchant: • • • • • • • • •

buys all qualities produced buys total quantity produced on contracted acres offers competitive pricing, fixed or ‘on call’ offers Minimum Price Guarantee Contracts offers forward contracting at any time, up to two years ahead takes delivery as cotton is produced gives prompt payment against delivery, at origin speaks the producer’s language gives up-to-date market information, advice on selling/fixing and option strategies • explains the influence of the US Farm Bill on their marketing • offers financing and assistance with foreign exchange • facilitates brokerage services, including futures and options. For the spinning mill, the merchant: • supplies cotton according to the exact specifications (HVI lay-downs in the US) • offers a contract that exactly determines quantities • in the case of US cotton, offers advance information of HVI results • holds large stocks of physical cotton • sells as far ahead as the mills wish to buy, up to two years • offers competitive pricing, fixed or ‘on call’ • offers Maximum Price Guarantee Contracts • sells cash on delivery or with credit terms up to 180 days • in some cases, sells with rejection clause, or selection of actual samples • contracts delivery in regular monthly, weekly or even daily shipments (‘just-in-time’) • offers a wide selection of growths as alternatives • speaks the mill buyer’s language • gives up-to-date market information, advice on buying/fixing and option strategies • offers assistance in foreign exchange • offers brokerage services, including futures and options. Chapter 2/page 9

Cotton Trading Manual Farmers and spinners must be able to rely completely on the merchant’s guarantee of performance, regardless of market conditions. With today’s high volatility in prices, this is no small matter. For that reason, a merchant’s reputation is extremely important. This is especially true for forward contracts, i.e. purchases and sales contemplating delivery of the cotton far in the future. A growing majority of both farmers and textile mills have come to realize that their only protection lies in the integrity of their contract partner, the merchant. Therefore, they have become much more selective as to whom they do their business with. When it comes to selling or buying, price is always very important. But it should not be the only consideration. Both cotton growers and spinners have to decide when they need to sell or buy cotton. Once they have decided to enter into a contract, they need to be sure that the contract will be honored, even if prices change a great deal between the date of contract and the actual delivery time. Dealing with an unreliable partner could mean that the highest price contracted may turn out to be a poor sale for the grower; and, the lowest price may become an expensive purchase for the spinner. By the same token, cotton merchants will also want to be sure with whom they do business. A contract default by either the farmer or the mill can be extremely costly since the merchant has entered into a hedge transaction, which will have to be covered at a loss. Cotton merchants usually rely on their agents in the various world markets for information on the financial and moral standing of their suppliers and customers. In addition, many trade associations keep so-called ‘default lists’, circulating the names of mills who have failed to honor a contract or an arbitration award. This is done as a warning to other exporters. Losses incurred by merchants for contracts not honored increase the cost of doing business. A very careful selection of contract partners will allow traders to work with lower margins; this will eventually benefit producers and consumers. The adherence to the principle of sanctity of contracts is therefore in everybody’s best interest.

Information gathering In order to buy and sell cotton, merchants require up-to-the-minute information on all factors that could affect the price of cotton. They have to analyze the supply and demand for cotton and competing fibers, not only in their home territories but worldwide. Primary sources of statistical information include • • • •

the US Department of Agriculture (USDA) the US Department of Commerce the International Cotton Advisory Committee (ICAC) Cotlook, Liverpool

Chapter 2/page 10

The cotton trade today • • • •

the National Cotton Council (NCC) of the US foreign governments United Nations, Industrial Division, New York private sources, which include the merchant’s own organization, customers and suppliers, buying and selling agents, country buyers, etc. • brokerage houses, news wire services and providers of instant futures/options quotes • the Internet. Primary factors that need to be considered in the global market picture include production and consumption statistics, estimated carryover levels, government and private stocks, and the ratio of ending stocks to consumption, as well as China’s cotton trade balance. These all have a direct impact on the price of cotton. In many countries, statistics are either not available or are very unreliable. The US government tries hard to provide exact information to the cotton industry. Government programs and actions for cotton and other commodities (US Farm Bills, changes in Chinese commodity and/or economic policies, etc.) can have profound long- and/or short-term effects on the market. The weather can play havoc with prices too (the El Niño phenomenon during the 1998/99 season with a drought in Texas and excessive rains in California, poor weather in China in 2003 and the drought in Australia are other examples). Secondary factors that influence the market include the state of the world or regional economies and of the textile industry in particular, as well as prices of competing fibers, such as polyester. Other elements are the cost of cotton production, including the cost and availability of irrigation water. Yield improvements through better seed varieties (GMOs), advanced harvesting and ginning methods may influence prices and qualities. Finally, prices for competing crops (such as soybeans, corn, rice and sorghum) and fashion trends can also affect cotton prices. The elimination of textile quotas in January 2005 also had an effect on cotton prices. Additional considerations in the general picture are, for example, the US dollar exchange rate, the outlook for inflation and interest rates, and political and economic developments around the world. Prime examples are the break-up of the former Soviet Union in 1989 and the Asian economic and currency crisis of 1997. Both had a profoundly depressing influence on world cotton prices. It is also important whether the price level of cotton is relatively high or low. Very often, activity by speculators or option traders on the New York Board of Trade may also have a significant influence on prices, but these are normally of a short-term nature. The SARS outbreak in the Far East in 2003 is another example of what an apparently unrelated event can do to cotton prices. Chapter 2/page 11

Cotton Trading Manual Finally, there are long-term factors, which over time may affect the cotton price: there include oil prices (which influence the price of synthetic fibers and add or decrease discretionary spending for many families), availability of land and water resources, and the increase of the world population. To sum up, almost anything going on around the world can have some influence on the price of cotton. Therefore, it is necessary for cotton merchants to be very well informed. Only with all the facts at his command can an international cotton merchant form a mental picture of the price outlook and act accordingly.

Forecasting cotton prices Cotton merchants try to estimate the direction of cotton prices. This is important for managing their own operations, and particularly for making recommendations to their customers and suppliers. Obviously, there is no exact, scientific way to calculate where cotton prices will be in the weeks, months or years ahead. Forecasting is an art based on experience. Some traders are very good at this over time, but everybody has to know that markets are bigger and more powerful than any one person or company. When trying to determine the course of prices, the merchant will take all known factors into account and adjust his mental picture every day for new developments. Among the information and tools available for price forecasting, we can consider: • • • • • • • • • • • • • • • •

New York cotton futures the level and composition of certificated stocks the positions of speculators at the NYBOT the Cotlook Indices (‘A’ and ‘B’) over-the-counter (OTC) swaps in London and at The SEAM the basis production cost the US loan level the effects of government payments to producers and exporters minimum export prices fixed by producing countries planting intentions for new crop crop progress supply/demand statistics and expectations mill coverage weather reports market information on cotton trading around the world (including China) • technical analysis, including chart patterns Chapter 2/page 12

The cotton trade today • currency developments • crude oil prices. Even taking every known factor into consideration, different traders will come to different conclusions. This, of course, is what makes the market. Nobody is always right, but to be successful, a cotton trader has to be correct more often than not. Information is the key to making correct decisions.

Pricing of cotton Cotton merchants must be prepared to buy and sell cotton at any time. The larger international merchants are departmentalized. While the top management controls the company policy regarding buying and selling, as well as the taking of market positions, these companies have traders who are in charge of certain production areas as well as selling markets. Management will have a general idea on price, but the fine points of day-by-day buying and selling are in the hands of those traders. The latter also have to know the ever-changing cost of shipping cotton from point of origin to various export markets around the world, as well as what exactly is going on in ‘their’ markets every day. There are two price indicators that apply to most of the upland cotton traded around the world: • the New York Board of Trade (NYBOT) No. 2 Contract • the Cotlook A Index. The daily trading on the NYBOT is the most important single price indicator for cotton in the world. In the US, all cotton, with the exception of Extra Long Staple cotton (ELS), is based on NYK futures. Foreign growths normally move in the general direction of New York, but never follow it on a day-to-day basis. Since cotton futures are traded 24 months forward, it is possible to price cotton for two complete seasons. This enables merchants to buy cotton from farmers even before it is planted. It is possible to sell to spinning mills as far ahead as they wish to buy. The difference between the NYK futures price and the actual cotton price is called the ‘BASIS’ (at origin, FOB vessel, delivered mill or wherever). The basis does not fluctuate day by day. Its movement depends on many factors, including supply and demand for a particular quality in a certain country or region, the weather, the outturn of the crop, competing growths, spinning value, availability of Step-2 certificates, shipping cost, etc. In the US, domestic mills usually buy their cotton ‘on call’, that is, at a contracted basis ‘on’ or ‘off’ NYK futures. Contracts for delivery over a longer period are based ‘on the cover’. For example, Memphis SLM 1–1/16” for delivery from November 2005 through October 2006 may Chapter 2/page 13

Cotton Trading Manual be priced at 150 on Dec05/Mch/May/July/Dec06 for the respective delivery months. On the export markets, an increasing number of mills are taking advantage of the benefits offered by buying ‘on call’. Non-US growths also look to NYK futures for guidance, but are not really based on the futures prices day by day; for them the daily Liverpool quotes, the lowest five of which make up the Cotlook A Index, are almost as significant. The Index reflects the prices of various growths quoted cost and freight (CFR) Far Eastern ports. The prices are collected daily from merchants and other sources all over the world. Even though the Index is established by a private company in Liverpool, their CIF N. European Index has been accepted by the US government as the official indicator of the world price of cotton; it is the best available measuring stick for world prices and for the relative competitiveness of US cotton. The Cotlook A Index has gained additional importance as large volumes of Central Asian cotton are traded ‘on call’ as its Central Asian component. The same applies to Spanish and Greek cotton. In the past, some Eastern European countries used to buy based on the Cotlook A Index. The OTC market in London and The SEAM in Memphis allow traders to buy and sell the Cotlook A Index at any time for future settlement. In addition, the Step-2 is now also traded over The SEAM. As to buying and selling prices, there is fierce competition both at the farm and at the mill level. Even the largest merchants cannot dictate the price. They must compete with everybody else. As mentioned earlier, prices paid to growers and sales prices to spinners will always reflect the best available in the market. It takes the highest price to buy cotton and the lowest price to sell. This is why profit margins in the cotton trade are always very thin. A frequently asked question by mill buyers is: why do different merchants offer different prices for, apparently, the same quality and shipment? Of course, there are many different reasons: opposing market opinions could be one. A quality with guaranteed USDA Green Card HVI will most likely be priced higher than an offer on ‘description’. Buyers should also watch out for the ‘fine print’ in many offers regarding weights (certified or landed), micronaire and GPT tolerances (NCL or not), crop year guarantee, clearly specified origins (not just ‘M/O/T’ or ‘West African’), points of delivery (CIF, CIP, DAF, DDP) and who pays bank charges. Another important difference may be the merchants’ view on the Step-2 payment at time of shipment.

Hedging and the New York futures market The sophisticated and professional trading of cotton as it is done today would not be possible without a futures market where hedge transacChapter 2/page 14

The cotton trade today tions can be made to offset the risk involved in purchases and sales in the physical or ‘cash’ market. Therefore, the merchant can only perform his basic function of market-maker if there is a reliable and liquid futures market, established in countries without foreign exchange control and with laws that allow foreign entities to repatriate their hedge and other profits made on exchange transactions without any tax consequences. Call and put options have now come into use as an additional tool for risk management. We have already seen that selling by growers and buying by spinners does not normally coincide. It is therefore necessary for cotton merchants to hedge their purchases and sales with a countertransaction in New York. By faithfully hedging every purchase and sale of physical cotton, the merchant can eliminate the market risk. What cannot be hedged, of course, is the basis risk. NYK futures are based on SLM 1–1/16” (41-4-34) Micronaire 3.5–4.9 NCL, minimum GPT 25. The basis for other qualities can and does fluctuate against the futures contract, sometimes a great deal, depending on their availability. For non-US cotton, NYK futures do not offer an effective hedge, but futures can still be used as a temporary offset against purchases and sales. As a rule of thumb, prices of non-US cotton tend to adjust by about 50% of the daily movement in NYK. Traders in non-US cottons have to find other ways to manage their risks and to minimize their exposure: by buying put or call options; or by off-setting a purchase of, say, Central Asian cotton with a sale of another foreign growth, West African for example. The OTC swaps markets in London and at The SEAM are additional tools available for hedging. The reason why New York does not serve as a good hedge for foreign cotton is because of the different directions prices of US and foreign cotton may take in one season. A tight supply situation for tenderable cotton in the US can drive NYK prices way above world market levels. The NYK futures market has basically two sets of traders: hedgers and speculators. Hedgers include the entire cotton industry, from the farmer, to the merchant, to the mill. All of these groups use the market for hedging. On the other side, speculators can be divided into four groups: individual speculators, commodity and index funds, the ‘locals’ on the floor of the NYBOT, and option traders. The exchange publishes the ‘spec/hedge’ report every Tuesday, which reveals the percentage of the Open Interest (i.e. the sum of all open trades) held by hedgers and speculators. The trade pays a lot of attention to these figures, as they can provide important leads to the future course of the market. Speculators are needed to provide liquidity to any commodity market. They look at technical indicators/charts for clues as to the direction of the market while hedgers usually consider ‘fundamentals’, that is, supply and demand. Chapter 2/page 15

Cotton Trading Manual Since the 1970s, volatility in the futures markets has increased a great deal. The bigger merchants are taking larger positions in both futures and actuals. The arrival of public commodity funds has brought huge amounts of speculative capital into all the commodity markets. Since these funds tend to be chart players, technical analysis has become more important. Finally, the introduction of cotton options has led to even greater volatility. A look at any weekly or yearly price chart clearly shows the tremendous volatility in cotton prices. This is a fact, regardless of whether or not such volatility serves a useful purpose for the industry. The more volatility, the more important it is to have a reliable futures market to hedge the risks. The NYBOT No 2 Contract has proven over more than a century that it is such a market. It is important here to emphasize again how important it is for growers and textile mills to have reliable trading partners who not only know how to manage their risks, but in effect hedge their operations in order not to be exposed to huge market losses. They must also have enough capital to pay large margin calls when required. Options are also a useful tool to hedge against market moves or to benefit from them. But, in contrast to futures, there is a big difference in the risk factor between selling and buying of options. As a hedge vehicle, only purchases of options should be considered: calls to benefit from a rise in the market, puts to benefit from, or protect against, a decline in prices. Sales of options are almost always speculative and best left to professional traders. Merchants offer so-called minimum or maximum price guarantee contracts, which are based on option purchases. However, given the perceived high premiums involved, these contracts are unfortunately not utilized as much as one might expect when looking at the price volatility and the need for producers and consumers to protect themselves in the volatile markets all commodities have experienced since the early 1970s. See also Chapter 12 below.

E-trade Buying and selling on the Internet probably is the fastest-growing business in the US. What makes it so easy and convenient? Buyers know exactly what they want to buy, such as a certain book, a DVD, a digital camera or apparel illustrated in a catalog or on the home page of the seller. The same applies to an airline ticket. The deal is always for immediate delivery and with credit card payment, so sellers do not have to be concerned about getting paid. There is no need for buyers and sellers to know each other. E-trade in cotton is nothing new. For well over 20 years now, the TELCOT system in Lubbock, Texas (which was later integrated into The SEAM) has offered cotton recaps based on USDA HVI class. Buyers

Chapter 2/page 16

The cotton trade today know exactly what they buy and the seller is paid within 24 hours, which means there is little or no risk on either side. Trading cotton on the Internet for future delivery is a different story. Most growers and mill buyers still want to know with whom they are dealing and who will respond in case any problem arises later on. E-trade in cotton made a giant step forward in February 2003 when The SEAM’s International Marketplace was launched. The volume of physical cotton, mostly West African and Brazilian (and some Central Asian and Greek), has increased steadily. Over 150 000 tons of cotton have already been traded on this electronic platform mostly through merchantto-merchant transactions. Also here, it is important to know your trading partner, as these trades are not guaranteed by The SEAM.

Positions As outlined above, it is possible to eliminate most market risks by hedging. However, some cotton merchants still take ‘positions’, i.e. they buy and sell for their own account; in other words, they speculate. Owing to the intense competition in the market place, these merchants try to enhance their financial result by taking on additional risks, as it is difficult to cover the overhead and make a profit purely on basis trading. Positions can be taken either in the futures market, in physicals or in the Cotlook A Index. Merchants can also take market positions by buying or selling put and call options. By being long or short, the merchant speculates on either rising or falling prices. For US cotton, where prices are closely tied to the futures market, it is easy to take positions in futures, either on the long or the short side. The advantage is that there is always a price to buy or to sell in New York, which may not necessarily be the case when trying to dispose of a long in physicals or to cover a short position. Also, all trades at the NYBOT are guaranteed through margin calls, which brokerage houses collect daily in the form of original and variation margins from traders suffering losses in their operations. Basis positions in the true sense work best with US cotton. In the normal course of their business, merchants can be long or short a very large quantity of physical cotton, fully hedged in NYK. The objectives are to be always able to buy and sell, and to benefit from a change in the basis. For example, the basis for California SJV cotton fluctuates a great deal. If the merchant thinks that SJV cotton is cheap, relative to the futures market, he can take a basis long position and make a profit if the basis for SJV goes up. Conversely, if a merchant feels that Texas-type low grades will be in surplus, he may sell this cotton short, protect himself against the market risk by buying futures, and then benefit if the basis for the low-grade cotton declines.

Chapter 2/page 17

Cotton Trading Manual For non-US cotton, merchants take positions in actual cotton: long or short positions held outright or partially hedged in New York futures or with options. Short positions in physicals can be taken with a reduced risk by including an option to supply the same cotton from two or more origins. While mills usually demand a discount for such optional contracts, the advantage for the seller is that he is not obliged to supply a specific quality of a specific growth, which may or may not be available at a reasonable price and/or in volume. Another tool to take positions is through OTC swaps trading in London or at The SEAM. In the case of non-US cotton, a pure basis position does not work, particularly at times of a small US crop. The price movements of cotton outside the US do not closely follow the futures market. Sometimes the risk is actually increased by selling futures as a ‘hedge’ against long positions in non-US cotton. In the worst case, the merchant can end up with two losing positions: a loss on the physical cotton bought in foreign growths (long position) because the level of foreign prices dropped and another loss on the hedge in New York (short position), because, for some reason, US prices and consequently the New York market went up. Both market and basis positions should be directly related to the size and capital of a merchant. The bigger the equity and credit lines available, the larger will be the annual trading volume and the positions firms can afford to take.

Summary Cotton merchants form a necessary link between the cotton grower and the spinning mill. They provide a ready market for the grower, for his entire crop or part of it, and they supply spinners with cotton according to the mills’ exact specifications, delivery and payment terms. If merchants were not performing an indispensable function, they would not exist any more. Again, whether a grower, a spinner or a merchant, there is one fundamental precept: know your contract partner. The merchant’s integrity and financial strength are the only protection at times of rapidly changing prices and market conditions. The size of the merchant producers and mills you are dealing with is not as important as his integrity, his financial means in relationship to the volume handled and his constant commitment to hedge his market exposure. The steep decline in cotton prices in 2004 once again put tremendous strain on the industry and the cotton marketing system. Producers are suffering, but the ones who sold their cotton to merchants a long time ago (like many US growers and producers in Australia) and at much higher prices are now enjoying the real benefits of the cotton trade and of forward contracting in particular. Today’s prices have Chapter 2/page 18

The cotton trade today recovered to some degree and are approaching the cost of production in many producing countries. In a rising market, mills will benefit from the reliability of the cotton trade. Cotton merchants will receive and deliver cotton purchased or sold at prices contracted, exactly according to the contract terms wherever the market may be, in six, twelve or twenty-four months. Once again, cotton trading is undoubtedly a risky business, making the job of a cotton merchant a very exciting and challenging one and it will continue to be so thanks to the ever-increasing popularity of the noble qualities of cotton, the 100% natural fiber.

Chapter 2/page 19

Part 2 The global picture

3 The cotton environment: macro issues Secretariat of the International Cotton Advisory Committee

The economic importance of cotton Market forces drive prices lower Competing crops Competing fibers Government policies affecting cotton Environmental issues

The economic importance of cotton Cotton is one of the most important and widely produced agricultural and industrial crops in the world. It is grown in more than 100 countries, and it is estimated that the crop is planted on about 2.5% of the world’s arable land, making it one of the most significant in terms of land use after food grains and soybeans. Cotton, unique among agricultural crops, provides food and fiber. A cellulosic fiber about 96% pure, cotton is one of the world’s most important textile fibers, accounting for more than half of all the fibers used in clothing and household furnishing. Cotton is also used in industrial fabrics, and the by-products derived from cotton seed and stalks provide edible oil for human consumption and soap, industrial products, firewood and paper, and high-protein animal feed supplements. In volume, cotton oil is the fifth largest edible oil consumed in the world. More than 100 million family units are engaged directly in cotton production worldwide. When family labor, hired-on farm labor and workers in ancillary services such as transportation, ginning, baling and storage are considered, total involvement in the cotton sector reaches one billion people. It also provides employment to millions of persons in allied industries such as agricultural inputs, machinery and equipment, cotton seed crushing and textile manufacturing. Cotton cultivation contributes to food security and improved life expectancy in rural areas of developing countries, in Africa, Asia and Latin America. Cotton played in important role in industrial development starting in the seventeenth century and continues to play an important role today in the developing world as a major source of revenue. Cotton is of major significance in the economic development in Africa: 35 of the 53 African countries produce cotton and 22 are exporters. Cotton is also a heavily traded agricultural commodity, with over 150 countries involved in exports or imports of cotton. World export revenue from cotton was estimated at $7 billion in 2000. This was nearly 2% of value of global export revenues from all agricultural products, excluding forestry, fisheries and semi-processed products. The level of dependence of developing countries on cotton exports is similar to that for other major commodities, such as coffee, cocoa, bananas and sugar. For eight countries in Africa and in Central Asia, cotton exports accounted for more than 50% of total agricultural export revenue in 2000. And yet, for all the importance of cotton, the cotton industry is a very small component of the world economy. The value of world cotton production is approximately $20 billion, and the value of annual trade in textiles and apparel is approximately $360 billion. In UNCTAD export statistics by product, cotton ranked 159th by average 2000–01 values, accounting for 0.12% of world exports of all commodities. Chapter 3/page 1

Cotton Trading Manual However, cotton traded internationally accounts for about 30% of production because the largest producing countries (China, USA, India and Pakistan) are also the largest consuming countries at the industrial level. The structure of world cotton production varies substantially from country to country and even from region to region in the same country, depending on relative resource endowments. Countries with abundant capital, sophisticated systems of research and education and developed infrastructure for the supply of credit and inputs to farmers tend to rely on highly mechanized production systems utilizing purchased planting seeds and chemical inputs, and employing very little labour per ton of output. Australia and the USA typify this production system, and the structure of production in the EU and Brazil is tending in this direction. Developing countries, with relatively abundant and less intensively developed networks for the distribution of inputs, tend to plant, cultivate and harvest cotton by hand and to use fewer purchased inputs per ton of production. About 55% of world cotton area is irrigated, accounting for about 75% of world output. About 30% of cotton production is machine-harvested. As a result, yields and costs of production vary greatly from country to country.

Market forces drive prices lower The price of cotton, adjusted for inflation, is tending downward over the long run. This is a phenomenon common to many primary commodity industries, and results naturally and inevitably from market forces in a competitive world economy. The long-run decline in real commodity prices is linked to technology change and competition with substitutes. Since World War II, agriculture has been transformed by increased mechanization, expanded use of chemical fertilizers, the development of pesticides and in developed countries the extension of electricity to rural areas. The process of technology change is continuing, and may even be accelerating. International cotton prices, as measured by the Cotlook A Index, have declined over time owing to more efficient production practices. During the 1950s and 1960s, as production rose while consumption was affected by growth in the use of chemical fibers, cotton prices generally trended lower. The Cotlook A Index, an indicator of world cotton prices, dropped from more than 50 cents per pound in 1950 to less than 30 cents by the end of the 1960s. During the 1970s cotton prices were influenced by the same factors of inflation, rising demand, concerns about trade embargos and increases in production costs that affected all commodity markets, and the Cotlook A Index rose to more than 70 cents per pound. During the ten years to 1985/86 international cotton prices averaged 75 cents per pound. Between 1985/86 and Chapter 3/page 2

The cotton environment: macro issues 1994/95, prices averaged 70 cents per pound, and in the eight years to 2002/03, prices averaged 63 cents per pound. When adjusted for inflation, cotton prices have declined since the 1950s. In 2003 US dollars, the Cotlook A Index fell from nearly $4 per pound in the early 1950s to approximately $1.2 in the early 1970s. With the rise in commodity prices in the mid-1970s, the Cotlook A Index climbed to more than $2 per pound but has tended lower in real terms since, and collapsed to $0.43 per pound in 2001/02, the lowest since the invention of the cotton gin in 1793. Despite the increase in average yields, the real average revenue per hectare of cotton has also declined over the last five decades. Several fundamental factors have influenced the decline in long-term average prices, among which are new technologies, more extensive use of existing technologies, expanded production in new cotton areas, and competition with chemical fibers. During the 1990s, another factor that depressed prices was the strengthening of government policies in various countries. Nevertheless, despite distortions caused by government measures, cotton supply and demand are price-responsive. Average international prices rebounded from a 19-year low of 42 cents per pound in 2001/02 to 68 cents in 2003/04. Improved technology and new areas dedicated to cotton cultivation contributed to boost world production from the mid-1990s. The world average yield climbed to a record of 729 kilograms per hectare in 2004/05. Among the new technologies, the most visible is genetic engineering of cotton. An estimated 24% of world cotton area was planted to biotech varieties in 2004/05, up from just 2% in 1996/97, accounting for about one-third of world production and trade. Biotech cotton varieties will probably account for half of world production by 2007. GE cotton lowers the use of insecticides and, although it does not guarantee that cotton yields will be higher than with a non-GE variety, it might lower the cost of production. The use of new area dedicated to cotton production has also contributed to increased world production. New cotton areas in high-yielding Xinjiang, China (Mainland), Mato Grosso, Brazil and south-east Turkey have contributed significantly to the increase in world production since the mid-1990s. Incremental advances in proven technologies such as irrigation management, pesticide formulations and pesticide applicators, low-till and no-till production systems, crop rotations and other management techniques are also contributing to lower production costs and expanded cotton production. All these technologies are being enhanced by the revolution in information technology, making possible great improvements in management efficiency and control of input applications. Another factor that has promoted cotton production despite relatively low prices is the appreciation of the US dollar between 1995 and 2001, which partly offset declines in prices in countries where the currency Chapter 3/page 3

Cotton Trading Manual devaluated, making cotton prices in domestic currency more attractive. The appreciation of the US dollar was a major factor in the deflation of commodity prices from 1995 to 2001. That upward trend has been reversed. The US dollar weakened since February 2002, after rising by about 40% from its 1995 lows against most major currencies. However, the value of the US dollar did not decrease as much against the currencies of major sources of textile imports to the US. As the Chinese (Mainland) yuan is virtually pegged to the US currency, a weaker dollar actually improves the competitiveness of China (Mainland)’s exports against many of its competitors. Farm support policies in the US, and elsewhere, have been an important determinant of world prices in the past as well as the recent period. One principal reason behind the 1985 decline in world prices was the structural shift of the support policy in the US. Changes in China’s stocks policy affected world prices in the 1990s. Demand shocks have also affected the levels of cotton prices. Cotton consumption collapsed in the former USSR in the 1990s, and demand tumbled in East Asia following to the financial crisis of 1997. In addition to these structural policy and cyclical demand effects, there has been a long-term decline of cotton prices similar to the trend characterizing prices in most primary agriculture. The first important reason is the reduction in costs of production owing to technological improvements and increases in yield. The second reason is that, while supply has increased, demand for cotton has grown relatively slowly. In the last four decades, per capita cotton demand in the world is almost constant, and the average annual growth rate of world cotton consumption is about the same as the world population growth rate, which is some 1.8% per year. The third reason is that the slow demand growth in cotton is mainly related to the strong competition from chemical fibers. Prices of chemical fibers have significantly dropped owing to technological change: supply and demand of world chemical fibers has tripled in the last three decades. The share of chemical fibers in world total fiber demand increased from 22% in 1960 to 58% in 2002, while share of cotton fell from 68% in 1960 to 39% in 2003. The volatility of cotton prices may be attributable to a number of factors, ranging from weather changes in cotton-producing regions to government policies. As with any other commodity, year-to-year changes in cotton prices are driven by changes in supply and demand, expressed as a ratio between world ending stocks and use. When the ratio rises, prices tend to fall, and vice versa. Interest rates, inflation, prices of energy, GDP growth, exchange rates, the prices of competing crops and other variables affect the cotton market. Nevertheless, those macroeconomic and cross-commodity impacts are linked to changes in prices of cotton through their impacts on cotton production and consumption. However, changes in China (Mainland)’s net trade Chapter 3/page 4

The cotton environment: macro issues with the rest of the world have been the major factor explaining yearto-year fluctuations in season-average international prices over the last three decades. Year-to-year changes in cotton production are determined by marginal costs, not by average production costs. Therefore, cotton prices tend toward the marginal cost of the most efficient producer, not the world average production cost. With advances in technology, including genetic engineering, cotton production costs worldwide are coming down. At current exchange rates, marginal production costs, and in the cases of more efficient producers, total costs, are below 50 cents per pound in several countries. The consequence will be lower average costs over the next decade compared with the 70-cent average of the last thirty years.

Competing crops The world has a limited amount of land on which cotton is a viable crop. The growth of population is putting pressure on arable land for food production. The most productive areas, which include land available for cotton, are also in demand for food production. Cotton is cultivated on about 2.5% of the world’s arable land. In theory, farmers make their planting decisions based on prices compared to their production costs and the profit margin on cotton in comparison to competing crops. In fact, historical evidence indicates that most farmers choose their crops based on current price differentials, ignoring price expectations and existing trends in different commodity prices. In many countries, farmers base their decisions about planting on the prices and the promptitude of payments they received the previous season. A comparison of the Cotlook A Index to a composite index of competing crops since 1990 shows a strong correlation between the two indices. This correlation could be anticipated given that macroeconomic shocks (ie the collapse of the Soviet Union and the Asian Crisis) and weather phenomena have affected the supply–demand balance of different commodities in the same direction. Nevertheless, international cotton prices moved much higher than other commodities in the mid1990s and declined much faster in 1999 and in 2001. Wheat competes with cotton in China (Mainland), India, Pakistan and Turkey. The ratio between the Cotlook A Index and wheat prices (US HRW No 2, FOB Gulf ports) averaged 11 during the 1990s, fluctuating between 7 and 17. Maize is competing with cotton in some areas. The ratio between the Cotlook A Index and maize prices (Corn No 2, Yellow, FOB Gulf ports) averaged 14.5 during the 1990s, with a low of 9 and a high of 23. Rice is a competing crop with cotton in China (Mainland), India and Pakistan. The ratio between the Cotlook A Index and rice Chapter 3/page 5

Cotton Trading Manual prices (White 5% broken, FOB Bangkok) averaged 5 during the 1990s, fluctuating between a low of 3.5 and a high of 9. Sugarcane competes with cotton in Pakistan. The ratio between the Cotlook A Index and international sugar prices (International Sugar Agreement; raw, FOB stowed at greater Caribbean ports) averaged 7 from 1990 to 1999, fluctuating between 5 and 11. Soybean is a competing crop with cotton in the US and in Brazil. The ratio between the Cotlook A Index and soybean prices (US, CIF Rotterdam) averaged 6.5 during the 1990s, with a low of 4 and a high of 10.

Competing fibers Cotton is not an essential agricultural foodstuff but an industrial raw material for the world’s textile industry, competing with manufactured fibers. Cotton is among the sensitive commodities whose markets are presumed to be among the first to be influenced by changes in economic conditions. Competition with substitutes is the bane of primary commodity industries. Timber must compete with fabricated wood products and the development of plastics. Coffee and tea must compete with each other, and with milk, soft drinks, powdered drinks, orange juice and other choices. Copper must compete with fiber optic cables. Sugar competes with corn and artificial sweeteners. Cocoa must compete with other types of candies. Grains compete with each other and with oilseeds, and other examples abound. For cotton, competition with polyester is an insidious challenge that is accelerating as chemical fiber production technology results in lower costs of polyester production and an increased range of uses for chemical fibers. Over the last five decades, cotton experienced an erosion in both price and non-price competitiveness. At the start of the twentieth century, cotton had a dominant share of the textile market. At the beginning of the twenty-first century, cotton is one of many fibers available and has been surpassed by polyester. While cotton use is rising in absolute terms, consumption per capita is not increasing and cotton’s market share is declining. Cotton’s share of world textile fiber use fell from more than 70% in the 1950s to less than 50% by the end of the 1970s and currently stands at 39%. World textile fiber consumption has increased at an impressive pace, from 9.6 million tons in 1950 to 52 million tons in 2002. Several variables are associated with changes in cotton consumption, including growth in income and population, changes in cotton prices relative to prices of competing fibers, consumer preferences and changes in fashion. Fibers competing with cotton include natural fibers and manmade fibers, primarily polyester. Polyester staple and filament output continues to grow rapidly, putting pressure on cotton prices. Chapter 3/page 6

The cotton environment: macro issues Around 40% of the polyester is staple fiber capable of being blend spun with cotton. There is a strong substitution effect as manufacturers minimize costs by using alternative fibers. At the consumer level, prices are far more influenced by international garment manufacturing costs than by raw fiber costs. Competition for market share between cotton and polyester is a function of changes in demand, process technology and cost. This competition takes place on several fronts. Prices are an important component of competition. A product is more competitive if it is sold at a lower price by means of higher productivity, lower labor costs, or, in international markets, by exchange rates. Nonetheless, being competitive includes not only the ability to offer a product at a lower price but also to provide a quality product and the technology necessary to expand existing markets or to create new ones. Accordingly, competitiveness can be broken into three main components: price, quality and variety of uses. Consumption of textile fibers takes place at three main levels. A first level of consumption is the consumption of raw fiber by mills; a second level is the consumption of semi-processed fiber in of yarns and fabrics by textile manufacturers; the final consumer then consumes a finished product. Regardless of where the intermediate levels of consumption take place, they are ultimately dependent upon consumption of end-use products. Many factors affect end-use demand, including income and consumer preferences, but cotton as a commodity industry must remain price-competitive with polyester and other chemical fibers. Research by the ICAC indicates that the rate of increase in world cotton mill use declines approximately 1% for every increase of about 6 cents per pound in the price of cotton relative to prices of competing fibers. Originally polyester was priced higher than cotton. By 1972 the price of polyester had dropped below that of cotton, and it has stayed below that price, except for brief periods. As the cost of production of polyester has fallen to less than 50 cents per pound mill-delivered in the past ten years, cotton prices are being forced lower over the long run in order to compete. Polyester prices are sensitive to changes in energy prices, but feedstocks account for less than 25% of the cost of production of polyester. As a rule of thumb, a $1 increase in crude oil prices translates into a 1 cent increase in polyester prices. Additional elements of competitiveness other than price relate to quality and diversity of uses. In addition to being cheaper than cotton, the use of polyester has offered performance advantages. As a result, polyester has gained market share in many countries. The globalizing economy has led to changes in consumer behavior. The globalization of fiber production and textile manufacturing is far advanced. The apparel industry has become more international as most products are freely traded or have become locally available. Chapter 3/page 7

Cotton Trading Manual Fashion itself has become more international in character, enabling similar types of apparel to be made and sold locally in many countries. The dominant characteristic of the contemporary world retail economy is consolidation driven by intense competition. Consolidation at retail level is leading to increased globalization in the manufacture of textile and apparel products, leading in turn to expanding market opportunities for cotton producers, but also to stronger demands from spinners for cotton of improved quality at competitive prices, delivered by merchants just-in-time. The largest retail chains are expanding in response to competitive pressures to reduce costs by capturing economies of scale. Retailers are being forced by competition with each other to restructure to reduce the costs of sourcing, logistics and inventory. Of greatest significance to the cotton industry, retailers are increasingly sourcing globally. The textile and clothing sectors can be seen as a supply chain consisting of a number of discrete activities, and each activity is located where it can contribute the most to the value of the end product. Costs, quality, reliability of delivery, access to quality inputs and transport and transaction costs are important variables when the location decision of each activity is being made. The major advantages of cotton over its primary competitors in the chemical fiber complex include wearing comfort, natural appearance, moisture absorbency, status as a renewable resource and its important economic role in many producing countries. Cotton has evolved from being seen by consumers as a mundane product to a prestige ‘natural’ fiber. However, cotton also suffers from several disadvantages relative to chemical fibers, including contamination introduced during harvest, ginning and handling, annual fluctuations in the quantity and quality of production and consequent variability in prices. Cotton also has difficulty meeting the needs of modern spinning equipment for strength, uniformity and other quality parameters. One of cotton’s opportunities will be in combination with synthetics to bring qualities that make the blend more attractive than the fibers with which it is blended.

Government policies affecting cotton Agricultural industries are among the most distorted markets in the world economy. The OECD Secretariat estimated in 2002 that total support to agriculture in OECD member countries alone totalled $330 billion on average per year between 1999 and 2001 or nearly $1 billion per day. The subsidies provided in OECD countries amounted to an average of 49% of farm revenues. The commodities receiving the greatest levels of support in OECD countries are meat, milk and rice, which together accounted for 47% of total support. Cotton is not even Chapter 3/page 8

The cotton environment: macro issues enumerated in OECD tables but is lumped together with ‘other’ at the bottom. Support to cotton represented less than 1% of total support provided to agriculture in OECD countries. For decades cotton has been subject to various marketing and trade interventions. In the early 1990s, more than 90% of cotton was produced under some type of government intervention. The two main policy parameters reflecting distortions in world cotton markets are tariffs and domestic subsidies. Countries would disadvantage their own textile industries by imposing effective import barriers to cotton lint. Therefore, most of the support to cotton provided around the world comes in the form of direct payments. There are many countries with barriers to cotton imports. However, in most cases, escape clauses, such as rebates on exported products or special quotas in times of shortage, render the constraints on cotton imports relatively ineffective. As is common in many commodity markets, the cotton sector is also subject to distortions in input markets, notably credit, fertilizer and irrigation. Direct income and price supports provided to the cotton industry worldwide are estimated by ICAC to have increased from US$3.8 billion in 1997/98 to US$5.8 billion in 2001/02 worldwide, equivalent to about one-quarter of the value of world cotton production. Fourteen countries representing three-quarters of world cotton production offered direct income and price support programs to cotton growers. Government support for cotton production declined to $3.8 billion during 2002/03, equivalent to about one-seventh of the value of world production. The lower levels of government expenditure during 2002/03 were the result of program formulas driven by lower production and higher market prices, not because of changes in government programs or policies. Should market prices turn lower again in future seasons, government spending in support of cotton under current policies would automatically rise. Direct income and price support expenditures on cotton by the US government reached $3 billion in 2001/02. New legislation came into effect in 2002, and the 2002 Farm Bill determines the levels of support for the US cotton industry for the next five years. Total direct income and price support in the USA for cotton amounted to $2 billion in 2002/03 and $1 billion in 2003/04. Government expenditures to assist cotton growers in China (Mainland) are estimated at $1.2 billion in 2001/02, $1.8 billion in 2002/03 and $1.3 billion in 2003/04. Cotton growers in Spain and Greece are offered assistance through the EU Common Agricultural Policy (CAP). Payments under the CAP amounted to about $1 billion in 2001/02 to 2003/04. Mexico, Brazil, Egypt and Turkey also had modest programs that supported cotton farmers. China (Mainland) and the US provide subsidies to exports of cotton. However, these subsidies are far smaller than the levels of support for production. Chapter 3/page 9

Cotton Trading Manual The cotton sector has also been affected by the Multi Fiber Arrangement (MFA), an international agreement created in 1974 under the auspices of the General Agreement on Tariffs and Trade (GATT) that allowed industrial countries to restrict textile imports from developing countries. The MFA effectively protected the textile industries in industrial countries and distorted the location of textile-processing activities. The World Bank estimates that quotas implicitly imposed a tax of about 20% on cotton products relative to synthetic fiber products. That whole construction of quotas was phased out by January 2005, ending approximately 50 years of textile market distortion. The elimination of quotas among WTO members is expected to encourage the relocation of textile-processing facilities to developing countries and reduce costs of production, boosting cotton demand. Economic theory suggests that in an open market prices tend to follow the costs of the most efficient producers, and that, over time, those producers with higher costs will eventually reduce production. Yet, this notion is highly distorted by government subsidies in the cotton market. Average costs of production in the US and in the EU are among the highest. Since fiscal year 1980, program benefits in the USA on the upland cotton program accounted for one-third of the farm value of production on average. Benefits to cotton in the EU averaged more than 100% of the farm value of production between 1997/98 and 2002/03. While economists inevitably disagree over assumptions and models leading to disputes over the specific impacts of government measures on individual commodities, there is broad agreement that distortions in agricultural markets, including direct payments and border protections, lead to overproduction and price declines, reducing opportunities for developing countries to expand exports. Even conservative estimates of the impact of subsidies to cotton producers in the US, Europe, China (Mainland) and elsewhere are substantial. In the absence of government measures, world production would still be large enough to satisfy demand, but the location of production would shift from countries that provide subsidies to countries that do not. Further, during years of declining prices, the responsiveness of supply and demand would be greater in the absence of government measures, meaning that the reductions in supply necessary to balance demand in years of economic growth would be spread over all countries rather than just among those subject to market forces. Even when the impact on the world market price is relatively small, there could be substantial shifts in production and trade, and so substantial gains for non-subsidizing countries. The pressure for change in agricultural policies in developed countries is growing. After six years of negotiations, members of the WTO launched a new round of multilateral trade negotiations in Doha, Qatar in November 2001. WTO trade ministers called for the reduction, with Chapter 3/page 10

The cotton environment: macro issues a view to phasing out, of export subsidies, as well as substantial improvements in market access and substantial reductions in tradedistorting domestic support. An agreement to reduce subsidies that distort production and trade in agriculture will not be easy. Many countries provide support to an estimated 160 agricultural commodities including cotton. The issue of agricultural support is complicated by the existence of state trading organizations, the use of export credits and credit guarantees, tariffs and tariff rate quotas on agricultural products, food aid and other agricultural issues. Further, many countries still impose tariffs on textile and apparel products, even though the quotas under the Multi Fiber Arrangement (MFA) were phased out on 1 January, 2005. An unprecedented aspect of the current round of world trade talks is the emphasis on cotton. The issue of cotton subsidies and their likely negative effects has attracted considerable attention and controversy. Cotton is unusual in being both a labor-intensive crop in developing countries and a capital-intensive crop in developed countries. The economic liberalization policies imposed by international lending agencies have required a restructuring of the cotton sectors of many African and Latin American countries, even while subsidies to cotton production in industrial countries have been maintained. This difference in treatment of growers in developed and developing countries, and the apparent inconsistency in adherence to free market principles, is a source of great resentment. Yet, a separate agreement just for the cotton sector is very unlikely. Cotton is important to the history of the US. Within the US and Europe, cotton farming occurs in lower-income regions, often in areas where economic alternatives are not attractive. Consequently, there is a long chain of political support for cotton among landowners, cotton input suppliers and small-town merchants with vested interests in continued cotton production. Both the US and the EU argue that as net importers on a whole trade pipeline basis, each is actually helping to sustain the world cotton market. The EU is the largest import market for textiles in the world, and the US is the largest retail market for cotton. The US industry and government contribute approximately $60 million per year in domestic and international cotton market development efforts. These efforts, begun in the 1950s, are boosting world demand for cotton. Farmers and rural sectors enjoy much cultural and political support in almost all countries, and support for agriculture will continue. Countries have the right to support their rural sectors, but distortions that insulate producers from market forces, causing producers in other countries to bear the burden of adjustment to declines in prices, should be changed. The direct payments to farmers tied to current production and high retail prices enforced through trade barriers are losing intellectual legitimacy as tools of public support for farming. As a Chapter 3/page 11

Cotton Trading Manual consequence, even though the negotiations to reduce government measures in agriculture involve complex tradeoffs, gradual and reciprocal changes in agricultural support programs are likely over the next decade. There will be an increasing tendency for governments to provide support for rural economic development, animal welfare and environmental protection decoupled from commodity production decisions. Therefore, it is likely that a reduction and an eventual elimination of agricultural subsidies, including subsidies to cotton production, will be negotiated within the WTO.

Environmental issues Cotton production relies heavily on the use of agrochemicals, pesticides (including insecticides, fungicides and nematicides), herbicides and fertilizers. Cotton uses approximately 9% of the world’s agrochemical pesticides, about 20% of the world’s insecticides and 8% of the world’s chemical fertilizers. More than 90% of total world cotton area is treated with one or more insecticide applications per season. Insecticides have become an integral part of the cotton production systems in the world because they are quick in action, killing insects as they are sprayed, and cost-effective. However, the consequences of insecticides use have been severely underestimated. The amounts of chemicals needed to grow cotton affect human health and the world’s ecosystem. Outbreaks of pests including insects, weeds and plant pathogens have been controlled in various ways over the years. In the early twentieth century, cotton insect pests were controlled primarily through cultural and physical methods. In 1918, calcium arsenate was found to be effective against the boll weevil. Organochlorine insecticides, including DDT, became commercially available during the 1940s and 1950s, and higher yields resulted from their use. Insects developed resistance to organochlorine insecticides over time, leading to the use of organophosphate and carbamate insecticides, which are effective but destroy natural enemies of cotton pests and develop secondary pests through the destruction of their natural enemies. Synthetic pyrethroids, modelled after natural, plant-derived insecticides, were commercially introduced in the 1970s. They are cheaper and safer but, as with previous insecticides, insect resistance developed. Insect resistance to insecticides is the major problem affecting agrochemical usage on cotton. Herbicide resistance is also becoming a problem. The major chemical classes presently in use are relatively inexpensive and broad-spectrum. However, insecticides are disruptive to beneficial insects, and they have significant environmental residue problems. Once a pesticide is applied to the soil, it remains in the soil or transfers to air or to surface runoff. Airborne residues represent a Chapter 3/page 12

The cotton environment: macro issues direct human hazard, as well as hazards to vegetation and wildlife. Although no longer used for crop protection, organochlorines persist in soils for years. Carbamates are more persistent in the soil than organophosphates. Improper use of chemical pesticides is hazardous to human health and may affect biological diversity, as well as surface and groundwater quality. In developing countries, pesticides intended to protect cotton are frequently misused, or applied in unsafe conditions. Farm workers working directly with pesticides are the most susceptible. Several pesticides used in cotton have been connected to cancer in humans. The use of water resources in cotton farming presents a significant environmental challenge. Irrigated cotton is frequently grown in regions where fresh water is in short supply, such as the Mediterranean and desert or near-desert areas in India, Pakistan, Uzbekistan, Australia and the western US. Extensive irrigation of cotton impacts on the regional water resources, possibly contributing to surface and groundwater depletion. Inadequate drainage in China, Egypt and Uzbekistan has contributed to the salination of fresh water. Extensive irrigation of cotton fields has caused the Aral Sea to shrink dramatically. Fertilizer practices increase risk of erosion, and diffusion of residues of synthetic fertilizer increases the risk of water contamination. As resistance to available insecticides develops, alternative insect control methods are sought. A new generation of pesticides, which are more selective, less disruptive to predators and the environment, and have modes of action capable of overcoming resistance problems, is being developed. Traditional insecticides continue to be used in integrated pest management (IPM) systems. Biological controls provide potential benefits. See also Chapter 5 below. Pest-resistant plants have been developed with the original goal of providing cotton farmers with an economic, environmentally friendly and efficient means to control specific cotton pests. Discovery of the DNA structure opened the field of gene manipulation. In the early 1980s, scientists discovered how to transfer a piece of genetic material from one organism to another. Cotton is one of the many crops that have been transformed. The first transgenic cotton was developed in 1987. Genes are extracted from soil bacteria and inserted in cotton. Once the gene is inserted into the cotton plant it is automatically transmitted to subsequent generations. Commercial production of transgenic cotton started in Australia and the US in 1996/97. The genetically engineered (GE) cotton in commercial use today has been genetically engineered to be tolerant to herbicides or insect resistant (the Bt cotton, from Bacillus thuringiensis). Some GE cottons contain both herbicidetolerant and insect-resistant traits. Monsanto controls about 90% of commercial GE cotton. Genetic engineering technology has been accepted in the world at Chapter 3/page 13

Cotton Trading Manual a faster rate than any other technology in agriculture. Transgenic cotton has been commercialized in eight countries: Argentina, Australia, China (Mainland), India, Indonesia, Mexico, South Africa and the US. Many more countries are interested in adopting Bt gene varieties and, based on production losses through pests, they are potential areas for the success of the technology. However, because a private company owns the genes inserted into cotton, countries are legally bound not to insert the genes into their own varieties and start using them. Countries have to pay a technology fee to owners of the genes, and this is limiting the adoption of the technology, particularly in developing countries. GE cotton is genetically modified to produce a toxin that kills certain insects or resists certain herbicides rather than modified to increase yields. Claims made about the ability of GE cotton to increase yields relate to its capacity to reduce damage caused by insects or weeds. As a result of the adoption of biotech varieties, the number of insecticide applications and the volume of insecticides used per hectare of cotton have decreased in the US. Planting of GE cotton varieties has resulted in a reduction of human pesticide exposures in China. Lower pesticide use reduces the risk of runoff in local ground and surface water. Genetic modification is a new technique that is far from fully understood, and the impacts on the environment and human health could take years to appear. One of the major concerns with Bt cotton is that target pests could rapidly develop resistance to the toxin, leading to increased pest problems. In light of these concerns, US and Australian farmers must adopt specific resistance management plans, leaving part of their fields as a refuge, where they can only cultivate non-GE varieties in order to maintain populations of susceptible pests. There is also potential for harmful environmental impacts. The use of those herbicides that GE cotton is designed to tolerate will undoubtedly increase. Foreign genes introduced into the cotton may be transferred from the GE cotton to related wild species and non-GE cotton being grown nearby. With biotech, as with traditional crops, crop residues are ploughed back into the soil. Therefore, repeated planting of biotech crops in an area may result in the accumulation of antimicrobial compounds in the ecosystem. Studies show no short-term acute effects on soil health, but longer-term effects are not known. Consumers may wish to avoid GE products because of ethical or safety concerns but there are no provisions for labelling in textiles or in cotton seed oil. The technology must be used without compromising the environment, sustainability, farmers’ interest and mishandling of the cotton genome. Challenges of GE technology include acceptability to the public, employment of the technology for creating non-existing combinations and improving yield. One of the other significant challenges in cotton production is to control insects with a minimum use of pesticides. Chapter 3/page 14

The cotton environment: macro issues There are more concerns about insecticides than other pesticides, and cotton-producing countries throughout the world wish to get away from pesticide-intensive production practices. One of the reasons is of course the high cost of pesticides, but this is not the only reason. Researchers and farmers are now more conscious about the longterm impact of pesticides on production practices, the environment, sustainability and the pest complex. But farmers will not stop using pesticides until they have alternate pest control. Integrated pest management has been much talked about but its implementation has been very low. In developing countries, the challenge remains to find effective ways to reduce pesticide use in cotton without reducing yields and without becoming dependent on expensive foreign-owned technologies. The solution lies in developing alternative approaches, which are less dangerous to human health and the environment. Using less pesticide also decreases the amount of pesticide residue in the soil, surface, groundwater and in the air. Conservation tillage – the practice of planting directly over the previous season’s crop residue instead of ploughing and disking the field – allows soil moisture conservation, leading to decreased irrigation needs in some regions, and reduces soil erosion by 90%. Organic agriculture is increasingly being perceived as a more viable and sustainable mode of agriculture than conventional agriculture. Organic farming practices produce positive effects on natural soil fertility, including higher organic content, lower oil acidity, better soil structure and activity, and more soil fauna. Some consumers are willing to pay a premium for food that originates from certified organic production. The international market for organic non-food crops such as cotton is more recent. Textiles and clothing made out of certified organic cotton fiber, and labelled as such, are traded on a small scale as ecological textiles or eco-textiles (fiber, yarns, fabrics, end-products). Organic cotton production and trade is promoted as an alternative to conventional cotton production. However, farmers generally do not adopt new production techniques unless they are profitable. Organic seed cotton yields tend to be lower than conventional ones, and even lower than what might be acceptable in view of lower production costs. Currently traded volumes of certified organic cotton fiber are estimated to be less than 10 000 tons per year. Most organic cotton is grown in Turkey and the US. Europe is by far the largest market, followed by the US and Japan. The ‘eco-textile’ market is likely to remain a ‘niche’ market in the medium term, as consumers are not very willing to pay higher prices for ecologically produced textiles.

Chapter 3/page 15

4 Trends in the world cotton market Stephen MacDonald and Carol Skelly

Fundamental trends and structural change The growing openness of world trade Rise and fall of government control in developing countries What does the future hold?

The dominance of the US Diversity of US cotton production Organization of the US cotton market The US cotton retail market and mill use of cotton Evolution of US cotton farm program from the mid-1980s Key US cotton farm program provisions, 2002–07 Marketing loan program Direct payments to producers ‘Step 2’ payments Trade policies and agreements affecting cotton WTO agreements The North American Free Trade Agreement (NAFTA) The Caribbean Basin Trade Partnership Act (CBTPA) and the African Growth and Opportunity Act (AGOA) US export dominance of the world cotton market

Importance of China (Mainland) Structure and history of China’s cotton industry Disposal of stocks in the reform period China’s entry into the WTO

Role of Australia, West Africa and Central Asia Conclusion

Fundamental trends and structural change Today’s tumultuous world heightens both the need for insight and the risk that insights are wide of the mark. The last few decades have seen markets and private initiative achieve a prominence in global economic decision-making unseen in nearly a century. Commodities, including cotton, were finally swept into this trend toward market-oriented governance well after it had gathered steam in international finance and industry. While this trend may slow, or even reverse, it is still likely to provide insights into future developments in world cotton markets for a number of years. The collapse of the Soviet Union embodied both the broader currents of global economic change and changes particularly important to cotton. On the broader stage, the Soviet Union epitomized the inwardoriented, centrally directed model of economic development that rose to prominence during the first half of the twentieth century. The Soviet Union and its Eastern European satellites also encompassed one of the largest cotton trading relationships between industrialized textile producers and developing country cotton exporters. The unravelling of the Soviet Union exposed Russia’s and Eastern Europe’s textile industries to global competition, and they largely collapsed, dramatically hastening the world’s steady shift of spinning away from cotton-importing countries.

The growing openness of world trade In the 1970s, when Europe and East Asia accounted for as much as 40% of world cotton spinning, as much as 46% of the world’s cotton fiber was exported before it was spun. By 2000, only 28% of the world’s cotton was spun after first crossing international borders. Spinning in China, India, Pakistan, Turkey and Brazil had displaced that of Europe and East Asia, and these countries largely supplied their own cotton. The contraction of world trade in cotton was, ironically, the product of a growing importance for world trade in general. Over the last three decades, world trade in clothing has grown significantly because the consumption of goods containing cotton still remains predominantly located in the wealthy developed countries, despite the relocation of production. Developed countries now import clothing rather than cotton as an increasingly open global economy allows countries to pursue their separate comparative advantages. The expansion of textile trade is more indicative of the broadest trends of the last few decades than is the contraction of cotton trade. Clothing trade has labored under restrictions bitterly resented by developing countries, but the general Chapter 4/page 1

Cotton Trading Manual liberalization of international goods and capital flows has been catching up on the textiles and clothing industries. This liberalization began in the 1950s as revitalized Western European economies began removing their capital controls. By 1995, five decades of multilateral trade negotiations under the aegis of the General Agreements on Tariffs and Trade (GATT) had reduced the average industrial tariff from 40% to 4%, and barriers to investment between OECD countries had largely disappeared. Even exchange rates between OECD currencies had been largely freed.

Rise and fall of government control in developing countries In sharp contrast to the relaxation of government controls and trade barriers among developed countries, in developing countries a very different trend took shape for a time. Driven by a combination of motives, governments in developing countries implemented policies that increased rather than diminished the role of government in economic decision-making. In some cases this may have been an aspect of postcolonial international politics, and in others economic control went hand in glove with local political and social control. For cotton this meant a process of nationalization that included Egypt and Syria in the 1960s, and the closure of futures exchanges and then the canalization of trade through government firms in India and Pakistan in the 1970s. Increased government economic control also meant control of international transactions, both trade and investment. During the 1970s, developing country governments took on growing debts as OPEC’s windfall earnings were recycled, a process prolonged by loose US monetary policy. Finally, in 1980, the movement towards market-based solutions reached US monetary policy, which shifted to remove the soaring inflation that was clouding the ability of prices to allocate resources. With the US Federal Reserve’s dramatic tightening, developing country governments that had relied on overvalued exchange rates to implicitly tax or subsidize chosen sectors found themselves unable to continue borrowing. To raise export earnings and regain access to international credit markets, developing countries rejoined the developed world’s shift towards market-based decision-making, freeing their trade, investment and exchange rates. By the early 1990s, after nearly a decade of struggling to reconcile decades of past policies with the new realities of international credit markets, developing countries began removing policies that protected or impeded cotton markets and trade. Mexico, where the 1980s debt crisis essentially began, unilaterally began liberalizing its trade, sought membership in GATT, and eventually achieved a free trade agreement with the United States and Canada. Brazil, another major player in the Chapter 4/page 2

Trends in the world cotton market ‘lost decade’ of the prolonged debt crisis, dropped its tariffs on cotton and clothing, becoming for a time the world’s largest cotton importer as a result. Brazil also entered into a regional trade agreement that included Argentina, which also turned its back on decades of government intervention, removing export taxes and giving up the ability of the government to generate inflation. India and Pakistan significantly reduced the roles of their state trading enterprises in cotton procurement and trade. India, although not a major debtor, nonetheless reoriented its economy in the early 1990s, accepting international investment and eliminating a number of restrictions that inhibited cotton marketing and textile production. Countries that had previously outlawed domestic cotton companies and markets to discourage ‘speculation’ began taking steps to restore them. Egypt began shifting exporting and ginning responsibilities to private companies, and steps were undertaken to revive or create cotton markets in Brazil, Turkey, India and Pakistan. Zimbabwe and Tanzania undertook significant agricultural reforms in the mid-1990s, and with the prompting of the World Bank, a variety of West African countries began permitting competition with the parastatals that had previously monopolized procurement, ginning and trade in their countries. India and Pakistan significantly diminished the roles of their state trading companies, and India was forced through the WTO’s dispute settlement process to loosen a number of import restrictions affecting textiles. The two largest cotton producers, China and the United States, will be discussed in more detail below, but from the mid-1980s on one can state that they generally shifted towards less distortionary policies. This is particularly true of China, which actually began reform earlier, but had a far, far greater distance to cover, and still does. Even more generally, the Uruguay Round Agreement strengthened the ability of the GATT, renamed WTO, to resolve trade disputes, set in motion the end of the Multi Fiber Arrangement, and all participating countries agreed to convert all non-tariff agricultural trade barriers to tariffs.

What does the future hold? As the twenty-first century gets underway, the structure of world trade looks more like it did at the start of the twentieth century than it has at anytime since 1914. By 2005, the trade restrictions of the Multi Fiber Arrangement will have withered away and membership in the WTO (which rose 50% between 1989 and 2002) may have expanded to include the world’s remaining former communist countries. A new generation of cotton importers is appearing as spinning continues to migrate to low-wage apparel producers, most recently Bangladesh and soon Vietnam. Therefore: is it safe to assume that market-based Chapter 4/page 3

Cotton Trading Manual development will be increasingly the norm? Is it safe to assume that the role of agricultural policies, government-owned companies, and international trade and financial intervention will continue to shrink? The protests associated with the WTO’s attempt to launch a new round of multilateral liberalization were perhaps indicative of the changing context that comes with a maturing process of reform. The collapse of Argentina’s reforms after about a decade and the destruction of the World Trade Center in New York illustrated that there are limits even to what appears to be sound and good-intentioned openness in an imperfect world. On the other hand, many fruitful steps toward greater market openness remain to be explored around the world. Global society’s acceptance of broad organizing principles does not change overnight, and that whatever else happens, this exploration of market orientation is likely to continue for some time.

The dominance of the US No discussion of trends in the world cotton markets is complete without an explanation of the dominant role of the United States. This is manifested in three main areas: (1) the US generally ranks second in cotton production after China; (2) the US is the world’s largest retail cotton market; and (3) the US is the world’s largest cotton exporter. A variety of factors contribute to the strength of the cotton industry in the US. These include the suitability of soil and climate, the health of the overall economy, a beneficial financial and market infrastructure and the considerable government resources that support cotton production and trade.

Diversity of US cotton production The US produces cotton in all of the States across its southern border; production extends as far north as the south-eastern corners of Missouri and Virginia. Cotton is produced in a variety of soil and climate types, resulting in a spectrum of qualities and uses. For example, producers in the arid San Joaquin Valley of California use irrigation to produce a high-quality, long-staple upland cotton used in high-end consumer textiles. This region is also a major producer, along with Arizona, of extra-long staple Pima-type cotton. In contrast, shorter-staple cottons are produced with little irrigation in Texas, especially in the High Plains area. While all cotton in the US is harvested by machine, a large proportion of Texas cotton is harvested with stripper machines, as opposed to spindle pickers. Stripper-harvested cotton includes more leaf than spindle-picked cotton, but is well suited to making coarse count yarns, such as those used in denim. The cotton grown in the South-east region and in the Mississippi Delta is a medium grade that Chapter 4/page 4

Trends in the world cotton market has traditionally been used mainly by US textile mills, which are located primarily in the Carolinas and Georgia. However, domestic mill use has declined in recent years and more South-eastern and Delta cotton is now being sold internationally.

Organization of the US cotton market According to the 1997 Census of Agriculture, there are approximately 31 500 cotton farms in the United States. US cotton farms may be individually or family owned, or have a corporate structure. Cotton producers often both own land and rent land from neighboring farms. For the 2000 crop, regional average production costs ranged from $362 per acre in the Lower Plains to $888 in the Far West. Production costs are usually financed via short-term loans from local private banks, which are repaid after harvest. Nearly 1000 cotton gins were active in ginning the 2001 US crop, many of which are co-operatively owned by producers. In general, gins apply the proceeds from the sale of cottonseed to help offset the producer’s cost of ginning. Cotton bales of about 500 pounds each are compressed into bales of universal density (UD) size either at the gin or at the warehouse. Samples are sent to the regional offices of the US Department of Agriculture’s Agricultural Marketing Service (AMS) for grading. All US bales receive a unique identification number that permits electronic tracking of bale location, weight and quality; this system allows ownership to be transferred without removing the bale from warehouse storage. US cotton is sold by producers to buyers through a variety of marketing practices. The traditional method is for producers to sell to a local buyer, who then assembles cotton for sale to large companies engaged in international cotton trade. Currently, however, a number of other marketing options are prevalent. Large producer-owned marketing cooperatives handle about one-third of the crop by pooling cotton, centralizing marketing decisions and returning profits on a share basis to their members at the end of the season. The major cotton companies also buy cotton from producers directly and some have established their own marketing pools. Producers now have the option of selling cotton over the internet in electronic trading. And some producers market their cotton directly to domestic textile mills. The cotton futures market at the New York Board of Trade (NYBOT) provides price discovery, and hedging and speculation opportunities for the US cotton industry. Futures contracts of 50 000 pounds each with delivery dates up to two years ahead are available for trading. While not all US cotton is hedged directly on the NYBOT, it is nearly all priced either directly or indirectly in relation to the New York futures contract. Premiums and discounts for different regions and qualities are reported Chapter 4/page 5

Cotton Trading Manual by the Agricultural Marketing Service for seven regional spot markets, thereby providing pricing information for the full spectrum of cotton produced in the United States.

The US cotton retail market and mill use of cotton Consumers in the US purchased textiles containing 19.3 million bales of cotton in 2001, over 20% of world consumption. On a per capita basis, consumption was 33.4 pounds. Cotton’s share of all fiber use by weight rose to just over 41%. Fiber share in the US has been boosted by the cotton research and promotion program, which is financed by producer assessments under the oversight of the US Department of Agriculture. The research and promotion budget of approximately $67 million in calendar 2002 funded projects to raise consumer consciousness about cotton’s desirability, to improve spinning and processing technology and to cut farm production costs. The program was instrumental in restoring the retail market share of cotton in clothing and home products from a low of 34% in 1974 to 60% in 2000. An increasing proportion of US cotton consumption is supplied by foreign textiles. There are about 2 000 000 active spindles on the US cotton system, which manufacture both pure and blended cotton yarn for knitted and woven fabrics. US mill use of cotton declined about onethird in 2001/02 from its recent peak in 1997/98. At the same time, cotton textile imports rose 5.0 million bale equivalents during the fouryear period. Cotton spinning has been hurt by the erosion of the domestic apparel industry, which has uncompetitive labor costs. Spinners’ loss of their apparel customer base was exacerbated by the currency depreciations that began with the 1997 Asian financial crisis. On a textile trade-weighted basis, the inflation-adjusted US exchange rate rose 18% from 1997 to 2001, 30% if trade with Mexico is excluded. On 1 January 2005, the US and other WTO member countries completed the process of phasing out non-tariff barriers to textile trade pursuant to the Uruguay Round’s Agreement on Textiles and Clothing (ATC). The implementation of the final phase of the ATC is expected to increase the access of developing textile-producing countries to the US retail market.

Evolution of US cotton farm program from the mid-1980s Prior to the 1986 crop, US cotton production was regulated through a system of support prices and limitations on planted acreage. Producers were guaranteed a minimum cotton price through a government loan program that effectively made the government the buyer of last resort; direct payments were often made in addition to the government support price. The minimum price support concept supported US prices Chapter 4/page 6

Trends in the world cotton market above world market-clearing levels during periods of world surplus and this, in turn, made the US the world’s residual cotton exporter. When surplus stocks accumulated, they were offset by larger acreage reduction programs in the subsequent year. The conceptual underpinning of the US program changed with the Food Security Act of 1985, which instituted the marketing loan program. Under this program, producers continued to receive nonrecourse loans, but the level of repayment was set based on world market prices. During the late 1980s, producers received loans in the range of 50–55 cents per pound, but loan repayment levels were set on the basis of an adjusted world price (AWP), which was the US equivalent of the prevailing world price. In years of low world prices, government subsidies made up the difference. US exports rose from an average of 5.4 million bales in the period 1981/82 to 1985/86 to an average of 6.9 million bales from 1986/87 to 1990/91, which was in part a consequence of the elimination of the minimum support price. In addition to the marketing loan, supplementary government deficiency payments were used to enhance farm income, and the system of requiring producers to reduce planted acreage in order to qualify for program benefits continued. Beginning with the 1991 crop, additional provisions were instituted to improve the competitiveness of US cotton, including the Step 2 program, which makes payments to both domestic users and exporters of cotton when US prices are above world prices. A further shift in policy occurred with the Food and Agriculture Improvement and Reform (FAIR) Act of 1996. This legislation continued the marketing loan concept, but eliminated both acreage reduction programs and deficiency payments. In their place, fixed payments tied to historical acreage and yields were instituted to de-couple payments from production. The purpose of this provision was to allow planted area to respond to relative commodity prices, rather than government support levels, and to support farm income with non-trade-distorting ‘green box’ payments, as defined by the WTO. The original fixed payments under the FAIR Act were about nine cents per pound for the 1996 crop, declining to six cents for the 2002 crop. The late 1990s saw a series of emergency measures to provide additional support to cotton and other major US commodities over and above the FAIR Act levels. This additional farm program spending was prompted by: (1) a combination of lower commodity prices stemming from the Asian financial crisis of 1998 and culminating with the economic recession of 2001; (2) a series of weather disasters, which reduced US farm income; and (3) the existence of federal budget surpluses, which eased the pressure to contain farm program spending. The combination of loans and payments to cotton farmers averaged $1.9 billion per year for the six-year period from 1996/97 to 2001/02, Chapter 4/page 7

Cotton Trading Manual reaching a peak of $3.7 billion for the 2001 crop, when government assistance slightly exceeded market returns. The Farm Security and Rural Investment Act of 2002 retains the marketing loan and competitiveness provisions that form the foundation of the US cotton marketing system. In addition, direct payments are a hybrid of the fixed payments established in 1996 and the old target price deficiency payment concept. Both types of payments are decoupled from production; that is, producers do not have to plant cotton to receive these payments. This legislation is in effect from the 2002–07 crops.

Key US cotton farm program provisions, 2002–07 Marketing loan program Once cotton has been ginned, classed and placed in a governmentcertified warehouse, its producer is eligible to receive a marketing loan at a rate of 52 cents per pound for the US ‘base quality’ of Strict Low Middling 1 and 1/16 inch, leaf grade 4, with premiums and discounts assigned to qualities other than the base. This loan may be requested until 31 May of the year subsequent to the year of production, as long as the producer retains title, and is available for a term of nine months. The loan is not required to be repaid, and if the cotton remains under loan after the end of the ten months, the US Department of Agriculture’s Commodity Credit Corporation (CCC) assumes ownership of the cotton. In addition, the CCC makes a weekly determination of the AWP, which is based on Cotton Outlook’s (Cotlook) A-index, adjusted to the US base quality and average location. If the AWP is below the 52-cent loan rate in a given week, producers repaying loans do so at the AWP level and not the original loan rate. In such cases, the government also forgoes interest and pays the monthly storage charges that have accumulated on the cotton. Producers who are shipping their cotton immediately also have the option of receiving the marketing loan differential directly without placing the cotton under loan; this payment is called a loan deficiency payment (LDP). The producer must provide proof of production and guarantee that the cotton will not be placed under CCC loan at a future date. Direct payments to producers Two types of payments are made directly to producers – a fixed payment of 6.67 cents per pound and a counter-cyclical payment (CCP), which is based on the target price level of 72.4 cents per pound. Chapter 4/page 8

Trends in the world cotton market The fixed payment is made to producers regardless of market prices; however, the CCP is equal to the difference between the target price minus the fixed payment minus the higher of the base loan rate of 52 cents per pound or the season average price received by US producers. Both of these payments are made on 85% of a predetermined historical acreage base and yield for the farm, and not on current area or production. ‘Step 2’ payments An additional payment is made to domestic mills on cotton consumed for spinning and to exporters on cotton shipped outside the US. This payment is activated when the lowest US price quoted by Cotton Outlook for the A-index exceeds the A-index average for more than four consecutive weeks, provided that the AWP is less than 134% of the base loan rate of 52 cents. The payment rate is the difference between the US price and the A-index during the fourth week of the period and is effective for the subsequent week. In addition to the above measures, the US government also subsidizes crop insurance to protect against yield and revenue losses.

Trade policies and agreements affecting cotton WTO agreements In addition to the impact of the Agreement on Textiles and Clothing (ATC) on textile trade barriers (see above), WTO provisions impact US cotton mainly through the limits on ‘amber box’ agricultural supports. In 1994, 28 WTO member countries agreed to establish ceilings for their ‘aggregate measurement of support’ (AMS) and reduce them by 20% per year to 2000. Cotton marketing loan assistance is included in the AMS by virtue of falling in the ‘amber box’ category of potentially tradedistorting measures. In the event that the AMS limit will be exceeded, the Farm Security and Rural Investment Act of 2002 authorizes the Secretary of Agriculture to take action to reduce support levels. The North American Free Trade Agreement (NAFTA) Established in 1994, NAFTA provides for reciprocal, duty-free access to markets in the United States, Canada and Mexico. NAFTA has fostered increased trade in cotton, yarn and textiles, especially between the US and Mexico. Textile imports into the US from all countries have risen substantially, but approximately one-third of the increase came from NAFTA countries. Well over half of the higher imports from NAFTA were offset by higher textile exports from the US to NAFTA countries, Chapter 4/page 9

Cotton Trading Manual mainly Mexico. The growing Mexican textile industry has absorbed increasing amounts of US-made yarn and also has at times become the US’s largest customer of raw cotton. The Caribbean Basin Trade Partnership Act (CBTPA) and the African Growth and Opportunity Act (AGOA) The CBTPA and AGOA agreements grant preferential access to the US market for textiles made with US fabric and yarn. In addition, imports of textiles from some African countries benefit from provisions that allow duty-free access for a limited quantity of apparel made in lessdeveloped countries, regardless of the source of the fabric. While over half of textile imports from the Caribbean Basin countries qualify for the preferred access due to US fabric content, most imports from AGOA countries qualify under the special regional provisions and do not contain US fabric.

US export dominance of the world cotton market During the 12-year period 1990/01 to 2001/02, US exports averaged just over 26% of world total exports, fluctuating from a low of 18% in 1998/99 to a high of 38% estimated for 2001/02. US cotton exports reached new records in 2002/03 and 2003/04 as imports from China skyrocketed. China was the largest market for US exports. The total US supply available for export has been a major factor influencing the export share since, under the marketing loan program, US cotton maintains competitiveness even when world prices fall in response to burdensome supplies. In 2001/02, the US exportable supply rose sharply with favorable crop yields and sharply declining domestic mill use. Other factors determining export share include foreign supply and demand considerations, as well as the dependability of US suppliers. US exports are shipped all over the world; in recent years, the largest buyers have been Mexico, Turkey, Indonesia, South Korea and Taiwan.

Importance of China (Mainland) China (Mainland) is the giant of the world cotton industry, producing and spinning nearly one-quarter of the world’s cotton. In addition to its importance in sheer volume, China’s cotton sector adds a dimension of unpredictability to world cotton trade. For example, China imported a substantial 390 000 tons in 1997/98, but exported a similar amount, 370 000 tons, two years later in 1999/2000. Uncertainty about China’s likely trade position stems from both the diffuse structure of China’s cotton industry, which makes it difficult to gather reliable information, and from frequent shifts in government policies affecting cotton. Chapter 4/page 10

Trends in the world cotton market Structure and history of China’s cotton industry China’s cotton is grown mainly in the Yangtze and Yellow River valleys and in the far north-western Xinjiang Autonomous Region. Cropping decisions and administration have become more decentralized in recent years, but vestiges of collective agriculture remain – in many areas, farms are still organized into production brigades with unified planting and cultivation systems. Producers base planting decisions mainly on expected prices, but local governments may still put pressure on farmers to adjust planted area. In the Xinjiang Autonomous Region, about one-third of the cotton is grown on State farms controlled by the Production and Construction Corps, a military entity. Because Xinjiang is both geographically remote and subject to political instability, the government exercises tighter control but also sometimes provides special benefits for Xinjiang’s cotton production. Cotton distribution in China has traditionally been managed by the government through the All-China Federation of Supply and Marketing Co-operatives (SMC) and its subsidiary, the Bureau of Cotton and Jute (BCJ). Prior to the reforms of September 1999, local branches of the BCJ procured the majority of China’s cotton production from farmers at prices that were fixed by the government. The BCJ controlled most of China’s ginning capacity, ginned the cotton, and sold it to mills in quantities and at prices determined by the government plan. The BCJ frequently incurred losses in carrying out its mandate, and these losses resulted either in non-performing loans from the Agricultural Development Bank or in additional funds allocated from the Ministry of Finance. The government maintained a strategic cotton reserve that absorbed much of the surplus production that accumulated during the late 1990s. Exports of cotton were made mainly through Chinatex, and other government-owned trading enterprises. China’s largest spinning mills are State-owned enterprises (SOEs), which traditionally received raw cotton allocations from the Bureau of Cotton and Jute at fixed prices according to a central government plan. These mills have access to government-backed credit, but are also responsible for an array of social services for their employees. Their heavy debt loads and social responsibilities have limited their economic efficiency and responsiveness to market signals. In addition to the SOEs, joint venture enterprises (JVEs) have been set up to encourage foreign investment; these mills tend to produce textiles for the export market. In addition to JVEs, much of China’s apparel is produced by township–village enterprises (TVEs), which tend to fall under local, rather than national government control. Throughout the mid- to late 1990s, China’s procurement prices rose in relation to world cotton prices, stimulating surplus production and demand for cheaper, imported foreign cotton. China became a signifiChapter 4/page 11

Cotton Trading Manual cant net cotton importer during the period 1994/95 to 1997/98; at the same time, the stocks and financial losses of the BCJ multiplied. For the 1998/99 season, procurement prices were reduced in all provinces, but depressed world prices undermined initiatives to make China’s cotton more competitive. The government of China liberalized procurement prices for the 1999 crop and allowed entities other than the BCJ to purchase cotton directly from farmers, after obtaining licenses to do so. In addition to the liberalization of prices and trade, the local and provincial offices of the BCJ were made responsible for all new financial losses incurred through the procurement process. The main thrust of the reforms was to allow prices to float while assigning responsibility to the local and provincial government cotton companies for any losses incurred. These reforms were largely sustained through the 2002 crop, with the exception of the Xinjiang Autonomous Region, which has maintained a procurement price floor.

Disposal of stocks in the reform period The implementation of the price reforms resulted in sharply lower production for the 1999 crop and supported higher consumption for the 1999/2000 season. The resulting shortfall enabled the government of China to begin disposing of the massive surplus stocks that had accumulated in the mid- to late 1990s. The government restricted imports and concentrated the stocks in the national government reserve, thereby absolving the local BCJ companies of the associated financial losses. It then established China National Cotton Exchange (CNCE) in Beijing to auction the cotton. During the period October 1999–September 2001, about 2.3 million tons of mostly reserve cotton from the 1993 and later crops were sold on the CNCE.

China’s entry into the WTO China became a member of the World Trade Organization in December of 2001. The terms of WTO membership require that China eliminate export subsidies and open import quotas of 819 000 tons for calendar 2002, increasing to 894 000 tons in calendar 2004. China’s initial regulations for quota administration are difficult to interpret; however, they appear to favor mills processing cotton for the textile export trade. WTO membership is likely to provide the impetus to for China’s government to continue on the path of reform. Government leaders have indicated their commitment to eliminating the government monopoly on cotton procurement and ginning by allowing private entities to perform these functions. Under the WTO provisions, foreign-owned companies will be allowed to operate in China within three years of accession, Chapter 4/page 12

Trends in the world cotton market a development that is likely to generate both greater competition and improvements in the legal and financial infrastructure for trading. WTO membership also gives China access to world textile markets nearly as preferential as that given to other developing countries. China is widely expected to be one of the world’s primary beneficiaries of the phase-out of textile quotas under the ATC. China’s textile production would therefore rise faster than in the rest of the world, and China’s cotton imports could grow. Accession to the WTO is expected to prevent China from insulating its grain and cotton farmers from world prices, but is also expected to confer greater access to export markets for fruits and vegetables. Thus, despite growing demand for cotton in China, production may not be able to keep pace as agricultural resources flow more rapidly to other commodities. See Appendix 5 for discussion of the increasing role of cotton exchanges in China.

Role of Australia, West Africa and Central Asia After China and the US, the most crucial players in world cotton trade are the rising exporters of West Africa’s Franc Zone and Australia and Central Asia, primarily Uzbekistan. As the twenty-first century gets underway, all three of these exporters produce similar volumes of cotton, about four to five million bales by Uzbekistan and the Franc Zone, and three million bales by Australia. The largest producer of these three, Uzbekistan, is also the largest consumer, so the level of exports is even more similar. What is very different are the trends in their production, with Australia rising the most rapidly – although perhaps reaching some resource constraints now – and Uzbekistan falling steadily through the 1990s. West Africa’s Franc Zone shows the most apparent promise for future growth in cotton production and exports. After stagnating in the 1970s, production rose during the 1980s, and then nearly doubled as the region’s currency was devalued significantly. This was in marked contrast to stagnant or declining production in the rest of Sub-Saharan Africa, and in part reflects the greater political and economic stability of these countries. In particular, the establishment of cotton production in the region benefited from the organization provided by the French Compagnie Française pour le Développement des Fibers Textiles (CFDT). CFDT, and the local parastatals formed in each country after independence, distributed seeds and other inputs, and handled transportation, ginning and marketing of the cotton. The Franc Zone’s yields, however, are among the lowest in the world, and have generally fallen as area has risen in the last decade. While Chapter 4/page 13

Cotton Trading Manual cotton is the major cash crop for most producers in the region, competing crops do draw inputs away from cotton. Declining soil fertility, erosion and labour availability are also factors restraining yields in some countries. The Franc Zone’s ability to bring previously uncultivated land into cotton production and improve farmers’ cultivation techniques will be key to the region’s ability to continue expanding its production and exports. It remains to be seen how rapidly the privatization of West Africa’s marketing and procurement will continue to expand. Mali, the region’s largest producer began divestment of the Compagnie Malienne pour le Développement des Textiles (CMDT). The World Bank has been actively encouraging privatization in the region, which is only just getting underway. In the very long run, SubSaharan Africa promises to be the last frontier for global apparel and textile production’s long journey in search of the lowest production costs. In contrast with West Africa, Australia’s cotton production has grown virtually without government participation, and while utilizing the most high-yielding technologically advanced techniques. Bio-engineered cotton was introduced into Australia immediately after the US, and Australian producers’ utilization of cotton and currency hedging is probably unsurpassed in the world. Australia’s yields are invariably among the world’s highest, with extensive irrigation and use of stateof-the-art techniques. However, the reliance on irrigation may constrain Australia’s ability to continue expanding output. Environmental concerns and competing water uses will probably slow expansion from its long-run 10% annual growth rate. In Uzbekistan, the government’s role in cotton production is profound, and output is declining as marketing restrictions, exchange rate manipulation and transfers of resources to other sectors of the economy reduce the incentives to produce cotton. Between 1988 and 2000, Uzbekistan’s cotton production declined 45%. On the other hand, Uzbekistan’s consumption rose 40% during that period, largely beginning in 2000 as investment in textile production grew. The economic organization of cotton production in Uzbekistan has maintained significant continuity with its origins in the centrally planned economy of the Soviet Union. This is despite the Soviet Union’s collapse and the reorientation of much of Uzbekistan’s exports away from Russia and towards the world at large. Uzbekistan’s hard currency debts may eventually force a reorientation of its cotton marketing and exchange rate policies in a direction more favorable to its cotton producers, akin to the process that occurred throughout much of the developing world during the late 1980s and early 1990s. Turkmenistan faces similar issues, and it remains to be seen how long the programs of state purchasing orders and production targets continue to govern the region. Chapter 4/page 14

Trends in the world cotton market

Conclusion There have been significant changes in the structure of world cotton trade in last few decades, but during much of that time a few things have remained constant. The four largest producers and consumers of cotton since the mid-1970s have been China, India, the United States and Pakistan. China and the US have crops well above India’s, which in turn surpasses Pakistan’s. This constellation is not likely to change – while China’s entry into the WTO is likely to result in unexpected developments, China’s productive potential is enormous. Similarly, the large and diverse resource base of US producers suggests the US will remain one of the two largest producers in the world, and therefore the largest exporter. With the end of the MFA, many are concerned that China’s vast potential in textiles holds negative implications for the textile industries of many other countries. Objective studies generally show other lowincome countries will also benefit from quota-elimination; however, China will certainly remain the world’s largest consumer of cotton fiber. Another implication of these studies is that the US is likely to relinquish its place among the top four cotton consumers, a development that is likely to bolster further its role as the world’s leading exporter. Whether China will continue as a major source of world trade and price volatility is less clear. The rough parity between China’s production and consumption, combined with its large size, has for decades forced the rest of the world alternately to absorb China’s need for large net imports or its desire to realize large net exports. China’s integration into the world economy has improved economic transparency there, and China’s WTO accession has placed limits on the use of trade policy to respond to variations in China’s production–consumption gap. China is widely expected to become a more consistent importer in future years, but some sectors of China’s cotton industry will continue to vigorously seek import constraints. Transparency will grow, particularly as the rights of foreign cotton traders in China expand, and greater transparency will ease the world’s adjustment to changes in China’s situation and outlook. More generally, market-oriented institutions and practices will continue to evolve in post-communist countries like China and Russia. Decades of economic development and integration of independent developing countries provide a further basis for expecting global policy evolution toward market-based solutions. Unexpected developments may slow or disrupt this process, but is difficult to foresee the structure of world cotton trade returning to its pre-1990 status for some time to come.

Chapter 4/page 15

5 Cotton agronomy and production Fred Gillham

Background Cultivated cottons of the world Areas of production The cotton plant

Cotton improvement Cotton agronomy Crop establishment Plant nutrients

Plant growth regulators Control of vegetative growth Harvest aid chemicals

Irrigation practices Crop protection Harvesting and initial processing Hand picking Mechanical picking Primary processing

By-products Ecological considerations National programs to limit/control cotton production vs yield as a potential ceiling on cotton production

Background Cottonseed is an important source of vegetable oil and protein but despite the value of these products, the price of cotton is based on the spinning value of the fibers that develop as elongations of the surface cells in the seed coat. Being part of the seed, they follow the same developmental pathway. The spinning value of the fiber depends on a number of interrelated characteristics, notably length, length uniformity, strength, fineness and maturity, color and trash content. The importance of quality differentiates cotton from most other field and fruit crops, in which the quality is determined by a limited number of characters that are often not measured, yield being the most important criterion. Quality has always been of prime importance in selecting varieties to produce cotton for specific end-uses. Traditionally, the major quality parameters of length, fineness, color and trash content were assessed through subjective hand stapling. Developments in textile technology have necessitated more precise and repeatable measurement of these and other fiber parameters. Quality assessment has become increasingly sophisticated with the development of high-volume testing instruments for most of the major fiber parameters. This has increased the awareness of all sectors of the cotton industry from research scientists to growers, ginners and spinners, of the importance of producing the quality of cotton desired by the spinners.

Cultivated cottons of the world There are three main groups of cultivated cottons. The first group comprizes the Extra Long Staple Egyptian, American Egyptian or Pima and Sea Island cotton belonging to the species Gossypium barbadense. The fiber in this group is long and fine with a staple length in excess of 32 mm and a micronaire value below 4.0. The second group comprizes Medium Staple American and African Upland cottons belonging to the species G. hirsutum. The fiber in this group has a staple length of about 25 to 30 mm and a micronaire value of 3.8 to 5.0. The two groups in these allotetraploid, New World species account for about 8% and 90% of the world production, respectively. The third group comprizes two Asiatic, Old World Short Staple diploid cotton species, G. herbaceum and G. arboreum, the latter being the most widely grown. The fiber of these species has a staple length of less than 25 mm and a micronaire value in excess of 6.0. They are grown commercially in India, Pakistan and parts of South-east Asia, accounting for about 2% of world production. They are also found as dooryard plants in parts of Asia and Africa (Gillham et al. 1995; Lee 1984). Chapter 5/page 1

Cotton Trading Manual Areas of production Cotton is grown in over 70 countries and is one of the most important cash crops in the world. It grows successfully on a wide range of soil types and under a range of climatic conditions. However, it likes a deep, well-drained soil, cannot stand waterlogged conditions and it is frostsensitive. About 55% of the world cotton producing areas lie between 30° and 37°N latitude. This region includes the USA and Mainland China excluding Xinjiang Uigar Autonomous Territory of Western China. The main cotton-producing areas north of this latitude account for about 16% of the world total and include Xinjiang and the former Soviet republics of Central Asia, notably Uzbekistan, with smaller areas in Greece, Bulgaria, Romania and Spain. Most of the balance of the crop is produced between 30°N and 30°S latitude, with under 10% in the southern hemisphere. In the tropics, the growing season is largely determined by the water supply and the dry season for ripening and harvesting the crop, while outside the tropics it is determined largely by temperature. The wide range of conditions under which cotton is grown spreads the supply through most of the year. The higher yield and quality of American Upland cottons resulted in the gradual replacement of Old World cottons in the spinning mills of England during the latter part of the nineteenth century and in cotton growing countries of Asia during the twentieth century. Upland cotton currently accounts for over 90% of the world production. The US was the main producer of Upland cotton during the nineteenth century and the economy of the Southern States flourished as cotton plantations expanded. However, this development was based on slave labor, leading to the Civil War. The war resulted in a sharp drop in production between 1860 and 1869, stimulating production in India and Egypt and leading to exploratory efforts to grow cotton in Australia, South Africa, the Sudan and elsewhere. The damage caused by the introduction of boll weevil in the south-eastern States in the 1890s gave further impetus to these developments. Furthermore, the colonial powers were concerned about the drain on dollar reserves caused by the importation of cotton for their textile industries, and concerted efforts were made to encourage cotton production in the colonies. The proportion of the world crop coming from the US declined from nearly 50% in the 1950s to less than 20% in the 1990s (Gillham et al. 1995).

The cotton plant The cotton plant is indeterminate so the reproductive phase may extend over several months. The blooming phase is influenced by the variety and growing conditions but normally extends over about two months. Chapter 5/page 2

Cotton agronomy and production Fruit maturation extends the reproductive phase over a further six weeks to two months. Thus, at any stage of the fruiting period, there may be fibers just starting to elongate in one boll and fibers just reaching maturity in older bolls. Consequently, the cotton plant is exposed to the predation of insect pests over a prolonged period while the impact of adverse environmental conditions may differ widely on bolls on the same plant in different stages of development. The growth and development of the cotton plant is influenced by the variety, seed quality, temperature, moisture, fertility, and disease and insect pest damage. Nonetheless, under favorable conditions, it follows clearly defined, orderly chronological and physiological patterns of growth and development. The development and implementation of management practices that will ensure the production of highyielding crops of quality cotton necessitates an understanding of these patterns. The main stem of the cotton plant produces a leaf and a branch at each node. There are two types of branch – fruiting branches or sympodia and vegetative branches or monopodia. The sympodia have a characteristic zigzag growth pattern with a fruiting point at each node, while the monopodia have a similar growth pattern to the main stem with secondary sympodia developing at each node. Normally the lower one or two nodes on the main stem do not produce a branch, the next one or two nodes produce monopodia and the rest produce sympodia. In a well-grown crop, some 65% of the crop is carried on the first fruiting position of the lower ten sympodia and over 90% on the first two fruiting positions. The monopodial crop usually accounts for an insignificant percentage of the total yield. Earliness has become a very important criterion in cotton improvement. It is influenced by the node number of the first sympodial branch, the vertical flowering interval or the interval between a flower opening on one sympodial branch and a flower opening on the succeeding sympodial branch and the horizontal flowering interval, the interval between flowers opening on the same sympodial branch. In modern varieties, the vertical flowering interval is normally about three days and the horizontal flowering interval about six days. The concept of heat unit accumulation has been developed to define more clearly the various growth stages of the plant, the boll, the seed and the fiber. Theoretically, physiological development ceases at temperatures below a physiological threshold of 60°F (16°C) and a heat unit is the number of degrees by which the daily mean temperature exceeds this temperature. Thus the accumulation of heat units comprises the daily heat units accumulated over a period of time. The number of nodes produced by the plant is not influenced to any great extent by stress but is dependent on the accumulated heat units. The internode length, however, is directly influenced by stress. Each stage Chapter 5/page 3

Cotton Trading Manual of development of the plant and boll requires a specific number of heat units, so heat unit accumulation gives a more precise estimate of physiological age than calendar days. Knowledge of the heat unit accumulation required by each stage of plant development has been used to develop simple plant mapping techniques that form management tools in determining the crop set and earliness, the maturity of the bolls, the need for additional water or fertilizer, the application of plant growth regulators and the termination of irrigation and crop protection.

Cotton improvement The variety determines the quality of cotton fiber. Fiber length, length uniformity, fineness, maturity and strength determine the spinning potential, fiber length being the predominant character that determines the end-use. However, cotton is a natural fiber and variability occurs between varieties, between fields of the same variety, within the same field of a single variety, between bolls on the same plant and even between fibers on the same seed. Variability needs to be minimized through single variety areas and ginneries since yarn properties and spinning efficiency are influenced by the extent of the fiber variability. Economic factors have driven developments in the textile machinery over the past sixty years, leading to higher speeds and increased automation in spinning machinery and in fabric manufacture. This has placed greater demands on the quality of the raw material, particularly for stronger, finer, cleaner cottons with greater uniformity and lower short fiber content. New spinning technology has also changed the emphasis on different fiber properties (Deussen 1993). Contamination with any form of foreign material is totally unacceptable and can have devastating effects on mill operation and the quality, appearance and price of yarn. In order to ensure efficient spinning operations and the production of regular quality yarn, spinners need reliable sources of raw material that deliver long runs of uniform, contamination-free cotton, in accordance with contracted delivery dates (Izawa 1994; Otto 1994). The changes in quality demanded by the spinners have to be taken into account in developing new varieties. The primary components of lint yield comprise the number of plants per unit area, the average number of bolls per plant, the average number of seeds per boll and the average weight of fiber per seed. The components of the weight of fiber per seed can be regarded as secondary components of yield and comprise the average number of fibers per seed, the average fiber length and the average weight of fiber per unit of length. The weight of fiber per unit of length is determined by the fiber perimeter (fineness) and secondary wall thickening (maturity). Thus three secondary components of yield, length, fineness and matuChapter 5/page 4

Cotton agronomy and production rity are also components of quality. Strength is a complex parameter that is not a component of but is negatively correlated with yield. Selection for increased strength without attention to yield will result in lower yields. The relationships between yield and quality impose conditions on cotton improvement, calling for concomitant selection for both yield and quality in order to achieve the desired combination of a high yield with the quality required by the market. The micronaire measures the resistance offered by a plug of cotton to the passage of air and is influenced by both fineness and maturity. Low micronaire values may result from fineness or immaturity or a combination of both, while a high micronaire value may be caused by coarseness or very mature fiber or a combination of both. Cotton length and fineness are closely correlated and largely genetically controlled while maturity is influenced more by environmental factors. Thus within a variety, the micronaire value is indicative of maturity, but this does not necessarily apply between varieties, particularly if they differ in fiber length. Forms of cotton have been domesticated for thousands of years, the earliest improvements having been made by selecting the best plants in a wild population and then selecting the best plants in existing varieties. These selections were based on observation without any scientific basis, but they gave rise to a multitude of forms that were adapted to various environments and growing conditions, and were precursors of the basic germplasm pool from which modern varieties have evolved. Undoubtedly, natural hybridization played an important role in this process, but while breeders were probably aware that hybridization was taking place, they had no scientific basis for selection. The success of selection over many generations in giving rise to a wide array of variety types suggests that there must have been considerable genetic variability in the original material. The rediscovery of Mendelian genetics in the early part of the twentieth century gave plant breeders a scientific basis for the selection process. Cotton is normally self-pollinating, so unless pollen from an outside source is introduced into the flower by insect or human intervention, the extent of reordering of the genes is strictly limited. Plant breeders widened the variability in order to develop improved varieties by cross-pollination. Hybridization followed by selection became the predominant means of improving cotton varieties. Latterly, the development of genetic engineering or biotechnology has given plant breeders an additional tool to expand genetic variability through the introduction of genetic material from related and even unrelated species. In normal hybridization programs, the chromosome complements of the two parents may be so different that fertilization is impossible, incomplete or leads to infertile offspring, or the trait desired may not be present in the variety being improved or its compatible Chapter 5/page 5

Cotton Trading Manual relatives, thus limiting the ability of the breeder to achieve the desired improvements (Trollinder et al. 1995). Biotechnology has given plant breeders a tool to overcome this problem. Successful plant improvement programs require: • • • •

clearly defined objectives adequate genetic variability appropriate instrumentation and evaluation methods time.

More breeding programs have failed as a result of poorly defined objectives than from lack of genetic variability. The objectives in cotton improvement normally include yield, lint percentage and quality. Earliness is an important selection criterion in order to minimize the exposure of the crop to the depredations of insect pests and the impact of cool late season conditions. Disease resistance and salt and drought tolerance are often included, depending on local requirements. In some breeding programs, cottonseed oil content is included to increase its value. Seedling vigor is an important criterion, particularly in regions where soil temperature is a major limiting factor determining the planting period. The breeding material must contain adequate genetic variability to facilitate improvements through selection. The program requires appropriate instrumentation and evaluation methods for both yield and quality. Finally, time is of the essence since it normally takes at least ten years from initiating a program to the release of a new variety. Price incentives can play an important role in encouraging improvements in quality since lower yields often accompany higher quality, notably strength, despite concomitant selection. Progress in developing high-yielding, high-quality varieties necessitates concomitant selection based on field assessment for yield supported by appropriate fiber and spinning tests. The development of the Fibrograph, the Micronaire, the Pressley-Strength Tester and the Stelometer for fiber testing and of microspinning technology for assessing the yarn quality of breeding lines based on small samples contributed to the progress made in improving fiber quality. HVI instrumentation was developed for commercial assessment of cotton quality and is being used by plant breeders in many countries. However, the assessment of fiber strength on HVI instruments can be misleading and needs to be used with caution, preferably complemented by instruments such as the Stelometer. Biotechnology includes everything from mutation breeding, the longestablished commercial utilization of microbes such as nitrogen-fixing rhizobia in legumes, and the relatively straightforward and inexpensive procedures of tissue culture to advanced applications of molecular biology, including genetic engineering. These techniques provide powChapter 5/page 6

Cotton agronomy and production erful tools for agricultural research in general and for variety improvement in particular. The key components of genetic engineering are the identification and isolation of suitable genes to transfer, delivery systems to introduce the desired genes into the recipient cells and expression of the new genetic information in the recipient cells. Rapid progress is being made in developing and refining techniques for genes to be transferred from one species to another and for them to express themselves in the new species. However, there are major limitations in the identification of genes that will confer agriculturally useful traits when transferred between species with appropriate molecular controls. The main lines of research are the development of insect and/or herbicide resistant, genetically transformed varieties. It is unlikely that herbicide resistant varieties will play any role in countries that rely mainly on mechanical and hand cultivation for weed control, but Bt cotton could play an important role in cotton production in many countries, particularly those with pyrethroid resistant Heliothis/Helicoverpa populations, provided the technical, financial and legal problems associated with these varieties can be resolved (Gillham et al. 1995). Several varieties have been released in the US and Australia that carry the Bt gene from Bacillus thuringiensis, enabling them to produce their own endotoxin against Lepidopterous insects. Good results have been obtained in the US in minimizing the damage caused by tobacco budworm, Heliothis virescens, but it is not as effective against cotton bollworm, Helicoverpa zea or pink bollworm, Pectinophora gossypiella. In Australia, results have been mixed and Bt cotton has proved less effective against both bollworm species, Helicoverpa armigera and H. punctigera, than it is against the cotton bollworm, H. zea, in the US. In Africa, Bt cotton is being promoted but so far, insufficient testing has been conducted to show its effectiveness against the red bollworm, Diparosis castanea and the spiny bollworm, Earias insulana. Currently, additional Bt genes are being added or ‘Pyramided’ to increase the number of endotoxins produced by the plant in order to increase the effectiveness of the Bt cotton and to delay the development of Bt resistant insect populations. Varieties have been developed with tolerance to Glyphosate (Roundup), to Bromoxynil (Buctril®) and to sulfonylurea-based herbicides (Grooms 1992). In areas where the standard cotton herbicides have been used for many years, the spectrum of weed species has changed as more resistant, previously minor species have become dominant. The herbicide resistant, transgenic cotton varieties make it possible to use over-the-top applications of herbicides that were previously unavailable for cotton, to control these persistent weeds (Wilcut 1995). Other areas where biotechnology could play a role in cotton improveChapter 5/page 7

Cotton Trading Manual ment are virus control, the development of cottons with naturally colored lint, salt tolerance and in the development of male sterility for hybrid varieties. There are also conjectures that fiber properties could be modified to more nearly meet spinning mill requirements or to introduce new properties such as a plastic core. However, so far the only successes with trangenic varieties have been in the transfer of individual genes. The technology for the transfer of blocks of genes that would be necessary to modify fiber properties have not been developed yet. Effective utilization of biotechnology is dependent on strong conventional research, in particular, a strong conventional plant breeding program. The number of varieties that will accept transformation is very limited. Thus having developed a transgenic variety, it is necessary to transfer the desired character into otherwise adapted commercial varieties. This could involve an extended period of conventional breeding. Similarly, the Bt gene is no more than an additional tool available as a component of IPM programs, meaning Bt cotton can only be successfully grown as part of an effective integrated pest management program. Varieties that produce their own endotoxins exert continuous selection pressure for resistance in the target insect population and, unless precautions are taken, resistance will develop. In laboratory feeding trials with pink bollworm, Pectinophora gossypiella, resistance began to become apparent after only three generations (Bartlett 1995). This renders not only the transgenic variety ineffective but also insecticidal sprays based on Bacillus thuringiensis. The technical problems related to prolonging the life of Bt cotton call for diligent application of other IPM strategies and of strategies specific to Bt cotton (Deaton 1995). Successful introduction of Bt cotton into the agricultural system would, therefore, depend on a region-wide approach and on active involvement of the pesticide industry, the seed companies, the research institutes, the extension agents, the crop consultants (where applicable) and the growers (Gillham et al. 1995). The cost of the technology and limitations in the research and extension services in developing countries, in particular with regard to IPM among smallholder producers, are likely to be major obstacles to the effective utilization of biotechnology in many countries in the foreseeable future.

Cotton agronomy Cotton is produced in a wide range of environments, ranging from the tropics – where there is relatively little variation in day length or temperature over the course of the season, where the number of heat units over the season is not limited and where the main criterion for selecting an appropriate planting period is the source of water and having a Chapter 5/page 8

Cotton agronomy and production dry harvesting period – to the extremes of latitude in Central Asia and China – where the day length changes considerably over the course of the season, there can be a considerable variation between day and night temperatures during the season and where available heat units are limited and crowded into a relatively short number of days. Furthermore, the scale of production varies from very large scale in Australia and the Western USA to very small scale in much of Africa and Asia. However, while agronomic practices may vary, depending on the limitations of the region and the scale of production, in all circumstances, good agronomic practices are the key to realizing the production potential.

Crop establishment One of the first problems facing a cotton grower is obtaining a uniform, healthy, vigorous plant stand. Stand failure can arise from poor seedbed preparation, low soil temperatures, excessive or deficient soil moisture, soil crusting impeding seedling emergence, seedling disease and insect pest and chemical injury arising from incorrect use of herbicides or other chemicals. However, low-quality seed is probably the major cause of poor stands since seedlings are more susceptible to adverse conditions in the seedbed and lack vigor, making them more susceptible to disease, insect pest and chemical damage. Poor-quality seed will usually only produce a satisfactory stand under very favorable conditions (Delouche 1981). Cotton is a deep-rooted crop that is sensitive to the water status of the soil and to the concentration and balance of soil gases, notably O2 and CO2. Soil compaction can impede crop development, while a plough pan or other impediments in the soil profile accelerate soil saturation following rain or irrigation. Surface drainage and land levelling help to alleviate this problem but drainage systems are also often necessary to prevent waterlogging. The practices followed in land preparation vary on different soil types and in different countries but in all cases, the objective should be to prepare a seedbed that will facilitate rapid germination and early development and permit unimpeded root development. Traditionally, clean land preparation has been emphasized to control early season weeds but no-tillage practices where weeds and crop residues are controlled with chemicals are receiving increasing attention. These practices lower production costs and by reducing the number of passages of heavy equipment over the soil, they also limit the development of compaction. In the more temperate and tropical climates, the time of planting is determined by soil moisture and soil temperature. This often permits flexibility in planting date. However, effective crop protection depends Chapter 5/page 9

Cotton Trading Manual on limiting the time of planting in order to have uniform development over large areas of cotton. In more extreme climates near the upper limits of latitude for cotton production, there is very little flexibility and cotton is often planted before the soils reach the optimum temperature. Rapid seedling development is a key component of high yields and early maturity. Seedling vigor is dependent on seed quality and is assessed from the ratio of plant height to internode length. During the blooming period, the developing boll load increases the demand on the plant for nutrients and carbohydrates. This reduces the supply available for new shoot and root growth. Thus soon after the onset of blooming, the increase in plant height and total nodes should decline as the plant moves towards cutout, the termination of active growth. At this point, most open blooms are clearly visible as they occur towards the top of the plant and the outer extremities of the fruiting branches. Where the boll retention is low, vegetative growth continues, leading to rank, vegetative plants that are difficult to manage and are very attractive to insect pests. On the other hand, a high retention of early bolls leads to early cessation of node development and growth in height. Stress owing to lack of moisture or fertility has a similar effect but boll retention is also reduced and the plants are stunted.

Plant nutrients Fertilizers play an important role in crop intensification and prevention of soil deterioration. Certain nutrient elements exert a marked influence on fruiting efficiency, the partition of vegetative and fruiting growth. A deficiency in this group, including P, K, Ca, Mg, B and Zn, limits fruit production more than it does vegetative growth. As the substrate level of these elements increases from deficient to near toxic, there is a corresponding increase in fruiting index. Four of these elements, K, Ca, Mg and B, are closely implicated in the translocation of carbohydrates and deficiencies cause them to accumulate in the leaves. Other elements have little effect on the partition of fruiting and vegetative growth. A deficiency in this group that includes N, S, Mo and Mn restricts vegetative and fruiting development to an almost equal extent, leaving the fruiting index virtually unchanged (Joham 1979, 1986). Research has shown that earliness is influenced by P, Mn, B, Zn and possibly Mg, and may also be influenced by other elements when they are brought into proper balance. Estimates indicate that for a lint yield of 480 lb/acre (543 kg/ha) the soil must deliver approximately 89 lb N, 45 lb P2O5 and 71 lb K2O per acre (100 kg, 50 kg and 80 kg per hectare, respectively). This must either be present in the soil or added as a supplement. Thus the required fertilizer rates depend on the basic soil fertility and should be established through soil analysis (Berger 1969). Chapter 5/page 10

Cotton agronomy and production N is the most widely used nutrient elements for many reasons, not least price and availability, but it should be used with caution. Excessive N in the presence of abundant moisture early in the season can lead to delayed fruit set and excessive vegetative growth, creating problems with crop protection later in the season. Nonetheless, the plant requires adequate N during the seedling stage and up to blooming since deficiencies at this stage restrict plant growth and prevent the development of an adequate plant framework to carry a good crop. Thus at least part of the N should be applied at planting and the balance at the start of flowering to give the plant adequate supplies of N for fruit development. Excessive N late in the season can lead to vegetative growth at the expense of fruit development. Cotton is highly sensitive to soil pH, the optimum range being from 6.2 to 6.5. If the pH drops below 5.5, aluminium and manganese can become toxic, damaging early plant growth. Acidity encourages seedling diseases and also inhibits the uptake of P, K, Ca and Mg, leading to reduced boll size and heavy foliage, contributing, in turn, to increased insect activity and losses through boll rots. Liming rates required to optimize pH levels vary in different soils and the only way to establish the appropriate rate is through soil analysis. Whatever the rate, lime should be applied well in advance of planting to permit time for reaction with the soil, and it should be thoroughly mixed into the soil to achieve quick results (Baird and Guthrie 1991).

Plant growth regulators Control of vegetative growth Plant growth regulators such as Mepiquat Chloride (trade name PIX®) restrict both vertical and horizontal growth and encourage early fruit set. The reduction in plant height and lateral branching may be as much as 20% to 30%. This directs the energy of the plant away from vegetative growth towards fruit development and enhances sunlight penetration into the canopy of the plant, resulting in better boll retention and development on the key first position bolls on the sympodial branches. Although the reduction in growth may reduce the total number of bolls, the boll weight is increased so there is no loss of yield. Furthermore, the reduction in vegetative growth reduces the attractiveness of the plant to insect pests and facilitates a more even distribution of pesticides in the crop canopy. The stimulation of early boll set combined with a reduction in late season losses caused by insect pests and boll rots results in an earlier, higher-yielding crop. Successful use of PGRs depends on the choice and concentration of chemical, the timing of the application(s), the plant condition at the time of application and the environmental conditions following application. Chapter 5/page 11

Cotton Trading Manual Harvest aid chemicals The abscission of the leaves occurs naturally as a result of maturity, senescence or injury. It is controlled by the hormonal balance in the plant and defoliants upset the balance, inducing abscission. The quality of cotton reaches a peak at the time of boll opening. It takes a few days to dry out and fluff up and then deterioration begins as a result of weathering. Under dry conditions, deterioration is caused by exposure to the sun and becomes noticeable after about fourteen days, but under moist conditions it does not dry out properly and deterioration begins almost immediately. Under extreme conditions of humidity, bolls may not open properly and seed cotton may become heavily infected with fungi. The use of chemicals to induce termination of both the vegetative and reproductive phases of plant development is relatively new and largely confined to mechanical harvesting. The primary objectives are to reduce the overwintering insect population and induce an earlier, more uniform crop. High rates of Ethaphon (trade name Prep) are used with success to stop terminal growth, accelerate boll opening and induce abscission of immature fruiting forms. Prep does not accelerate boll maturity but forces more developed bolls to open regardless of the stage of maturity. If applied too early, it can cause small bolls to shed and immature bolls to open, thus leading to a drop in both yield and quality. When properly applied, however, it can advance the harvest date by a week to ten days and increase the proportion of the crop harvested at the first pick. It can also force open late bolls in advance of adverse climatic conditions. There are two forms of defoliant, herbicidal and hormonal. Herbicidal defoliants injure the leaves, stimulating the synthesis of ethylene, promoting the development of the abscission zone. Sodium chlorate and Dimethipim (Harvade) are fast-acting desiccants. The former is a strong oxidizer that injures the leaf while the latter causes surface cells to lose water. DEF and Folex, both organophosphates, are slow-acting herbicides. Rates of herbicide that are excessive for the temperature cause desiccation before the ethylene can produce the abscission layer. Hormonal herbicides include Thidiazuron (Dropp®) and Ethaphon (Prep). Prep releases ethylene into the plant, stimulating the synthesis and massive release of ethylene when applied to cotton plants, leading to the formation of abscission zones in boll walls and leaf petioles and causing boll opening and leaf abscission. Prep and Dropp® rarely cause visual leaf injury, desiccation or leaf freezing. The effectiveness of defoliation is influenced by the level of N, water stress and humidity. Defoliants vary in their response to temperature and each has a critical temperature below which they are inactive. The timing of defoliant application is critical to maintain fiber quality, both Chapter 5/page 12

Cotton agronomy and production because of the influence of early defoliation on fiber maturity and the impact of late defoliation on boll rots.

Irrigation practices The cotton production of the world can be increased by irrigation, either by enabling it to be grown in arid regions where production would otherwise be impossible or in semi-arid or humid regions through supplementary irrigation under rainfed conditions. However, irrigation also has the potential to degrade the environment both on and off the farm. Cotton production can then be reduced or limited either directly as a result of the degradation of resources required for its production or indirectly through legislation or international agreements designed to prevent degradation (Gillham et al. 1995). The development of many major irrigation schemes was driven by the need to produce cotton for the textile industries of Europe and the Former Soviet Union. This includes the Sukor Barrage on the Indus River in Pakistan, the Gezira Scheme on the Nile in the Sudan, irrigation in Central Asia, western China, Egypt, Israel, Australia, the western USA and the Attaturk Dam in Turkey. World-wide, about 53% of the cotton area and 73% of the cotton produced is irrigated. Not surprisingly, where a high proportion of the crop is irrigated, average yields are higher. Globally, the average lint yield of rainfed cotton is about 391 kg/ha and of irrigated cotton about 854 kg/ha (Gillham et al. 1995). A broad band of irrigated cotton extends from Spain in the west through Greece, Egypt, the Sudan, Turkey, Israel, Syria, Iraq, Iran, northern India, Pakistan and Central Asia to China in the east. This includes Mediterranean, desert and near desert climates where cotton is fully irrigated with little or no rainfall during the growing season. This type of production also occurs in the western USA, Australia, southern Africa and Mexico. By contrast, in tropical and subtropical countries of Central and South America, Sub-Saharan Africa and South-east Asia, cotton is almost entirely rainfed. Between these extremes, cotton is grown with varying amounts of supplementary irrigation in semi-arid and humid regions (Gillham et al. 1995). The major source of irrigation water is the regulation of river flow by reservoirs with delivery systems to farms in a series of canals. Melting snow from the Tien Shan mountains in western China and from neighboring mountains in the Hindu Kush and the Pamirs is the major source of water for the important cotton-producing regions of western China and the Republics of Central Asia, a region that accounts for some 13% of the world total. Irrigation water in Pakistan and northern India also emanates from melting snow. By contrast, irrigation water supplying Egypt and Sudan comes from rain falling in the tropical areas of East Africa and the mountains of Ethiopia. In some countries, ground Chapter 5/page 13

Cotton Trading Manual water is pumped from tube wells but this is generally of less importance than water supplied in canal systems and is often only used to supplement canal water at times of high demand. During the seedling stage, the demand for water is low but it increases steadily to reach a peak during the main fruiting period. Canal systems are generally supply-driven, water being supplied on a routine basis. In large-scale production areas, many growers have on-farm storage to store water when the demand is low for use during the period of peak demand. However, in small-scale production areas, growers generally apply water when it is available regardless of the needs of the crop. Supply-driven systems have the potential for over-irrigation early in the season when supply is greater than demand and underirrigation in mid and late season when demand exceeds supply. Overirrigation early in the season promotes vegetative growth, tipping the balance between vegetative and reproductive growth in favour of vegetative growth and leading to rank plants with concomitant heavy boll shedding, reduced yields, problems with pest control, boll rot and defoliation (Gillham et al. 1995). Various forms of surface irrigation account for some 94% of the world total (Hearn 1995). Sprinkler systems follow surface irrigation in importance, with central pivot systems increasing in popularity. Drip systems are used in Israel and on a limited scale in other countries and have a place in field crop production under certain conditions of limited water supply or soil salinity, but they are more widely adapted to high-value horticultural crops.

Crop protection Cotton production is affected by insect pests and weeds in all cottonproducing countries of the world. In some areas, diseases such as Fusarium and Verticillium wilt can cause serious losses, while the leaf curl virus is serious in Pakistan and India and blue leaf disease resistance is essential in Argentina and Paraguay. Data on nematode infestations are very limited. The distribution of the root knot nematodes of cotton, Meloidogyne incognita, is limited but damage caused by ectoparasitic nematodes that are not usually present on the root is probably more extensive than realized. Crop protection in all its forms is one of the major production costs, but detailed data on crop losses worldwide are sketchy. Before World War II, most cotton was produced as a subsistence crop. This was the subsistence phase in which yields were low and there was no organized program of crop protection. The development of synthetic insecticides following 1945 revolutionized cotton production. Spectacular yield increases were achieved in traditional cottongrowing areas, and cotton production expanded into new areas that Chapter 5/page 14

Cotton agronomy and production had been considered to be unsuitable because of the incidence of insect pests (Gillham et al. 1995). However, over-reliance on insecticides resulted in new problems arising in a sequence of events that has become known as the ‘pesticide treadmill’. The second phase, known as the exploitation phase, developed. Over-reliance on chemical control led to the elimination of natural enemies and the development of insecticide resistance, resulting in a resurgence of known pests and pests that had previously been of little consequence emerging as major pests. This was followed by the crisis phase in which an increase in the frequency of pesticide applications was necessary to achieve any degree of control. The disaster phase followed when the cost of pest control rose to a level that eliminated any economic return for the crop (FAO 1984). This frequently repeated sequence of events gave rise to the integrated control phase in which there is greater awareness of the need to develop insect control strategies that recognize the need for discriminating use of insecticides at certain stages of crop development but place greater emphasis on cultural and biological control, particularly early in the season, by delaying the introduction of chemical control as long as possible. Integrated pest management (IPM) has become the key to sustainable production (Gillham et al. 1995). However, all too often, this is followed by a deterioration phase in which a new generation of farmers fail to apply the measures necessary for effective integrated control and its effectiveness declines (FAO 1984). Pest management has been defined by the Food and Agriculture Organization (FAO) as a system that, in the context of the associated environment and the population dynamics of the pest species, utilizes all suitable techniques and methods in as compatible a manner as possible to maintain the pest population at levels below those that cause economic losses. This integrates host plant resistance, biological control, cultural control and discriminating use of chemical control. Chemical control is used only when the pest population reaches a threshold above which economic losses will be experienced. At this stage, only the most appropriate chemicals are used at recommended dosage rates and adopting application methods that will ensure adequate coverage to control the pests in question (Matthews 1984). The substitution of IPM for routine spraying is intended to increase yields with lower production costs, thus increasing producer returns with reduced risk to the environment (Cochran 1985). Excessive use of synthetic pyrethroids has resulted in resistant populations of bollworms, Helicoverpa spp. developing in several countries. Pyrethroid Resistance Management depends on the implementation of all aspects of IPM. Culturally, the planting period needs to be as short as possible and agronomic practices should be applied that will give uniform crop development over large areas of cotton. Crop residues Chapter 5/page 15

Cotton Trading Manual need to be destroyed as soon as the crop is harvested to provide a cotton-free period between crops. Efficient soil preparation should be designed to reduce the number of overwintering bollworm pupae in the soil. The initiation of chemical control should be based on crop surveillance and economic thresholds that maximize the benefits of early season natural enemies. Finally, the use of pyrethroids should be restricted by rotating with other chemicals and using pyrethroids on only a single generation of the bollworm. Restrictions on the use of pyrethroids were introduced in Zimbabwe when they came on the market and have been effective in preventing resistance from developing, while a pyrethroid window in Australia introduced after resistance became a problem has extended the life of these products. Similarly, acaricide resistance has been managed in Zimbabwe through a regional acaricide rotation. The development of cotton varieties that produce their own endotoxins to control Lepidopterous insects has provided growers with an additional tool to control pests. However, the so-called Bt cotton imposes continuous selection pressure on the target pests for resistance and if this develops, selective chemicals based on Bacillus thuringiensis will also be rendered ineffective. Thus Bt cotton can only be grown as one component of an IPM program, and measures are necessary to reduce the chances of resistance developing. This includes planting a set percentage of refugia or alternative host plants that may be normal cotton where the pests can feed and develop without any selection pressure for Bt resistance. These insects would dilute any resistant population developing on the Bt plants. Surveillance should be intensified so that any resistant specimens can be detected and alternative methods of control applied. Economic thresholds may need to be adjusted to ensure that the endotoxin has a chance to take effect before any decision is taken on introducing chemical control measures. Most countries rely on cultural weed control through hand cultivation on at least two or three occasions, such as after irrigation or rain to open up the soil and to control newly germinating weeds. Mechanical cultivation normally takes care of weeds between rows but not between plants in the row. Delayed weeding leads to strong competition between the weeds and the young crop seedlings for light, water and nutrients, frequently resulting in elongated internodes, leggy, weak plants and loss of bottom-fruiting bodies, promoting vegetative growth and reduced yields (Gillham et al. 1995). Hand cultivation is a laborintensive operation and this presents problems in many countries. Competition for labor between crops often results in late weeding of cotton with an associated decline in yield and quality. Chemical weed control is fairly widely practiced but mainly on larger farms. Herbicides fall into three main categories: pre-emergent incorChapter 5/page 16

Cotton agronomy and production porated herbicides that are applied before or during the final stages of land preparation: pre-emergent herbicides that are applied at the time of planting without incorporation; and post-emergent herbicides that are applied mainly with directional sprayers to control weeds in the rows. In the past, cotton has been sensitive to most over-the-top herbicides that are applied over the growing crop. The widespread use of herbicides has given rise to a shift in the spectrum of weed species, with minor weed species that were resistant to the herbicides being used sometimes becoming major problems. The development of herbicideresistant varieties through biotechnology has opened the way for over-the-top products to be used on cotton to control these problem weeds.

Harvesting and initial processing Hand picking Cotton is hand-picked in most developing countries. Seed cotton is ready for picking when it has dried and fluffed out and begins to deteriorate as a result of weathering about seven days after opening. Hand picking should commence as soon as an average of three or four bolls per plant are open to minimize weathering. Picking efficiency depends on training, boll weight, plant structure, size and yield. Pickers should be trained to separate clean, undamaged seed cotton from stained or waste seed cotton so that grading can commence with picking. However, in many countries, picking is carried out in the early morning and seed cotton is then spread out to dry, and separation into different grades is carried out in the shade in the afternoon. This is more timeconsuming than grading during picking and also exposes seed cotton to contamination.

Mechanical picking Cotton is entirely mechanically picked in the USA, Australia and Israel, with variable degrees of mechanization in several countries in Central Asia, the Middle East and Mediterranean region, Latin America and southern Africa. There are three main types of picker: the American spindle picker, which has vertical picker bars and horizontal spindles and is relatively selective in picking only open bolls, thus facilitating multiple picks; the cotton stripper, used mainly in Texas, which strips everything from the plant; and the Uzbekistan picker, which has vertical spindles and is more or less intermediate between the other two. Strippers and vertical spindle pickers are cheaper and lighter than horizontal spindle pickers and are easier to maintain, but seed cotton picked with horizontal spindles has a lower waste content than seed Chapter 5/page 17

Cotton Trading Manual cotton picked with vertical spindles, while strippers produce the highest waste content of seed cotton.

Primary processing Various forms of storage and transportation systems are used for delivering seed cotton to the ginnery and for storage prior to primary processing or ginning, the separation of the fiber from the seed. Most developing countries use some form of container such as woolpacks, gunny bags or squares of cloth. Wagons are widely used but are increasingly being replacing by modules in countries where cotton is mechanically picked. In many countries, storage at the ginnery is in seed cotton sheds but it is also stored in large stacks of the seed cotton containers or in 400–600 metric tonne heaps. Protection from weathering and contamination is of prime importance and the moisture content of seed cotton has to be below 10% if it is to be stored for an extended period. There are two forms of ginning, the roller gin and the saw gin. The roller gin is gentler on the seed cotton than the saw gin and is the only form of ginning used for long-staple Egyptian and Pima cotton. The basic principles of the two systems have hardly changed since they were invented but the capacity has increased and ancillary equipment has been developed to cope with changes in harvesting methods. The basic components of a ginning system consist of a feeding system, the gin stand, a condenser and a bale press. This is the sum total of equipment in many ginneries in developing countries where cotton is hand-picked and, in many cases, the feeding system is by hand. The move towards mechanical harvesting resulted in an increase in trash content and a rapid increase in the delivery rate of seed cotton to the ginnery. Gin stand capacities were increased by using bigger saws, increasing the peripheral speed of the saws and increasing the number of saws. It was also necessary to develop various types of seed cotton cleaner and moisture control systems to optimize the moisture content of the seed cotton for cleaning and for ginning. Seed cotton is easier to clean at a low moisture content but this can lead to increased fiber breakage. Efficient ginning requires a moisture content of 6.5% to 8.0% for Upland cotton and 5.0% to 6.0% for Egyptian/Pima cotton. Seed cotton cleaners do not remove all the trash from the cotton so lint cleaning became necessary to achieve high grades, a major price determiner. However, increased cleaning resulted in increased fiber damage and, in particular, increased lint cleaning resulted in a significant increase in short fiber content, the impact of which was transferred to a decline in spinning efficiency and yarn quality. The ancillary equipment required in a ginnery depends on the location and the amount of trash expected in seed cotton to be ginned. In Chapter 5/page 18

Cotton agronomy and production the USA, it is estimated that hand-picked cotton contains about 48 kg, spindle-picked cotton about 98 kg and stripper-picked cotton about 336 kg of foreign matter per 217 kg bale of cotton (about 620 kg seed cotton). The basic modern ginning system for ginning hand-picked cotton may comprise a feed system with feed control, cylinder cleaner, tower dryer, extractor feeder, gin stand, condenser and press. Table 5.1 outlines the equipment that is likely to be required to gin cotton harvested by different means. The introduction of mechanical picking is not merely a matter of picking the crop with a machine but is part of an overall farming system going all the way from land preparation to ginning. All crop production practices including land preparation, the use of high-quality seed, crop establishment and crop production and protection practices must be geared towards producing compact plants and uniform opening. The seed cotton storage and transportation system must be able to handle the amount of cotton picked each day. The ginnery and its ancillary equipment must be specifically designed for the type of picking machine being used. Finally, weed control is critical early in the season

Table 5.1 Equipment needed for ginning cotton harvested by different means Hand-picked

Spindle-picked

Stripper-picked

Feed system Feed control Cylinder cleaner Tower dryer Extractor feeder Gin stand

Feed system Rock and green boll trap Feed control Tower dryer Cylinder cleaner Stick and green leaf machine Tower dryer

Feed system Rock and green boll trap Air-line cleaner Feed control Tower dryer Cylinder cleaner

Condenser Press

Cylinder cleaner Cylinder cleaner a Extractor feeder Gin stand Saw-cylinder lint cleaner Saw-cylinder lint cleaner Condenser Press

Stick and green leaf machine Tower dryer Cylinder cleaner Stick and green leaf machine Stick and green leaf machinea Extractor feeder Gin stand Saw-cylinder lint cleaner Saw-cylinder lint cleaner Condenser Press

a. Optional equipment dependent on location and amount of foreign matter expected

Chapter 5/page 19

Cotton Trading Manual to prevent competition that could affect the uniformity of the crop and late in the season to ensure that the crop is free of weed seeds. Contamination in any form causes the textile industry serious problems. The commonest forms of contamination in hand-picked cotton are strands of polypropylene fiber from picking bags and pieces of jute, raffia and other material used to close the seed cotton container for delivery to the ginnery. Other contaminants such as human hair can get into the seed cotton when it is spread out to dry. The commonest contaminants in machine-picked seed cotton are grease and shards of rubber from poorly set doffer pads on the picker. Contaminants may also emanate from bale-wrapping material, particularly when the wrapping is applied direct to the lint before being tied and then cut to remove the classing samples. Any form of fibrous contaminant can behave like cotton fiber, passing through the cleaning systems in the ginnery and in the spinning mill and becoming spun into the yarn. This can then be woven or knitted into the fabric, causing it to be downgraded or rejected.

By-products Cotton is an oilseed crop that is grown for its fiber, an outgrowth from the seed epidermis. Cottonseed constitutes about 65% of the seed cotton and contains about 17% oil and 24% protein. In addition to the cotton fibers that are removed during ginning, the seeds produce short fuzz known as linters that remain on the seed after ginning. Linters are normally mechanically removed from the seed as the first stage of oil extraction and form the raw material for a range of products (see Fig. 5.1). A number of countries depend heavily on cottonseed as a major source of their vegetable oil requirements and extract it from the seed by crushing or by solvent extraction methods. The absence of organized trading facilities for cottonseed is an important factor affecting production economics. The oil is semi-unsaturated and is used for cooking, soap making and other purposes. During oil extraction, the meat of the embryo is converted into protein-rich oil-cake, a valuable source of protein for stock feed and other purposes.

Ecological considerations The distribution of water in surface irrigation schemes is often irregular because of poor land levelling. This contributes to excessive use of water, rising water tables and salinity. Data on crop water requirements based on evaporative demand and soil water-holding capacity required to evaluate how much of the available water is used by the plant in evapotranspiration, the agronomic water use efficiency, ie the yield per Chapter 5/page 20

MEATS

CAKE AND MEAL

FLOUR

Bread, cakes and confectionery

STOCK FEED

Beef and dairy cattle, sheep, horses, mules, poultry and hogs

FERTILIZER CRUDE OIL

REFINED OIL

FOOTS

Salad and cooking oil, mayonnaise, salad dressing, shortening, margarine, mellorine and packing oil

SOAP GLYCERINE

Explosives, pharmaceuticals, food preparations and cosmetics

LIVESTOCK FEED FATTY ACID Rubber, plastics, insecticides, fungicides, metallic soaps, waterproofing, leather, paper and textiles HULLS

STOCK FEED FERTILIZER

Beef and dairy cattle, sheep, horses and mules Mulch and soil conditioner

OIL DRILLING MUD

LINTERS

BRAN

Livestock feed

FIBER

Pulp – same uses as linters

FURFURAL

Synthetic rubber, petroleum refining and plastics

PULP

VISCOSE

RAYON

Air hose, industrial fabrics

CELLULOSE ESTERS AND ETHERS CELLULOSE NITRATE CELLULOSE ACETATE

YARN

Clothing, household fabrics

PLASTICS

Automotive upholstery, electrical equipment, toiletware, pens and pencils

FILMS – X-RAY AND PHOTOGRAPHIC PAPERS

Writing, filter and absorbent

ABSORBENT COTTON MEDICAL SUPPLIES YARNS

Lamp and candlewicks, twine, rugs and mops

FELTS FOR:

Automotive upholstery, pads, cushions, furniture upholstery, comforters and mattresses

5.1 Cottonseed utilization (source: National Cottonseed Producers Association Inc, 1950).

Chapter 5/page 21

Cotton Trading Manual volumetric unit of water applied, and the risks of salinity and rising water tables are often lacking, precluding meaningful comparisons between countries and regions of water use efficiency (Gillham et al. 1995). Cotton production is not sustainable if it depletes or degrades nonrenewable resources, either those used in cotton production or those affected by cotton production. All irrigation schemes have the potential for environmental degradation through rising water tables, salinity and draw down of water flowing into wetlands lower down the river system (Gillham et al. 1995). Pump schemes have also run into problems by excessive draw-down of aquifers. The potential can be minimized through land levelling, scheduling irrigation applications on the basis of available soil moisture and crop water requirements, recycling taildrain water and well-maintained, efficient drainage systems. Regulatory authorities on pesticides have been concerned with the toxicity of the product and possible hazards to users. In some countries, appropriate safety precautions have to be taken under Health and Safety legislation, but in many countries the climate is not conducive to wearing protective clothing so deaths have occurred following the use of toxic products (Matthews 1984). Lists of approved products for the control of particular pests, weeds or diseases are available in many countries. These data should become more widely available through the internet. In the USA, legislation on agro-chemicals is administered by the Environmental Protection Agency while the Committee of Experts on Pesticides, established by the Council of Europe, is concerned with the health risks associated with the use of pesticides and publishes recommendations for use by authorities involved in their registration (Matthews 1984). As the license period of the older, more toxic insecticides expires, they become readily available, often at prices well below newer, more selective and environmentally friendly chemicals. However, increasing attention is being paid to the development and selection of chemicals that are less hazardous to the environment and more active against the target species than against non-target species. Thus the selection of the most appropriate pesticide to apply in a pest management situation is not simply a matter of choosing the cheapest and most easily obtainable product from an approved list but is based on the efficacy of the product and its environmental impact, with economic factors playing a secondary role (Matthews 1984). Pesticides need to be registered for use in specific circumstances and their distribution needs regulation to prevent the indiscriminate use of undesirable products. Application technology is as important as the choice of the most appropriate pesticide. The rate of application of the active ingredient in a pesticide should be regulated by the leaf area to be covered rather than the soil surface area being sprayed. Furthermore, the application technology should minimize spray drift and ensure that most of the pesChapter 5/page 22

Cotton agronomy and production ticide reaches the target area in a form that will be effective against the target pest. The costs of environmental degradation arising from agricultural activity such as irrigation and the use of pesticides has been described as the cryptic cost of production. This cost can be very high, eg the drying up of the Aral Sea. However, the cryptic cost of production that is not taken into account in assessing the economic value of cropping systems is considered as part of the cost of production. An agricultural system is only fully sustainable if the cryptic cost is zero. This cost needs to be taken into account so that necessary funds can be provided to reverse any degradation that may be taking place.

National programs to limit/control cotton production vs yield as a potential ceiling on cotton production Farm income depends on the cost of production, yield levels and the farmgate price of outputs. However, high farmgate prices are no guarantee of high farm income because high returns are dependent on high yields resulting from high levels of input and, in general, price inflation causes the rise in cost of inputs to be higher than the rise in farmgate prices. Farmers face both price and production risk – price risk resulting from price volatility and inelastic demand for farm produce, and production risk from the nature of agricultural production. This is reflected in the large changes in the volume of farm output and widely fluctuating commodity prices and farm incomes (Eisa et al. 1993). Cotton is an important source of foreign exchange, seasonal employment and rural cash flow in virtually all countries where it is produced. In all countries except Argentina, Australia, Brazil, Israel, Mexico and the US, the farmgate price for seed cotton was declared in advance of the marketing season and in all countries except Australia, the US and the large operations in Guatemala, seed cotton was graded on delivery to the purchase point to establish the price to the grower. Ideally, payment was made with minimal delay (Eisa et al. 1993). Farmers in all countries received some form of subsidy or preferential allocation of inputs such as seed, fertilizer, pesticides or irrigation water. These interventions provided growers with an assured market at a set or minimum price, thus isolating them from price volatility. Furthermore, single-variety areas and ginneries ensured regularity of quality. Government organizations were responsible for cotton improvement and the production and distribution of planting seed of approved varieties. Although market information was not readily available to farmers Chapter 5/page 23

Cotton Trading Manual in developing countries and cotton prices played little role in planning future acreage or reinforce incentives to increase production or improve quality, government interventions ensured the regularity of supply and quality needed by the spinners. With the passage of the GATT, the governments of all countries are being pressured into divesting their involvement in cotton and privatizing cotton marketing. However, some 73 countries produce cotton but only five – China, India, Pakistan, the US and Uzbekistan – account for over 70% of world production, and when Turkey, Brazil, Argentina and Australia are added, this exceeds 80%. Thus about 65 countries are competing for less than 20% of the market. Government interventions totally isolated growers from the risk of price volatility while subsidies on inputs provided a degree of protection against production risk. Privatization has left growers fully exposed to both production and price risk, and unless some form of risk management can be developed, particularly for smallholders, privatization could result in some countries ceasing the production of cotton (Gillham 1998). This could have farreaching economic consequences. Since the mid-1950s, the area planted to cotton has ranged between 30 and 35 million hectares, the increase in production from 7.8 to 19.1 million metric tons having resulted mainly from an increase in average yield from 222 to 584 kg/ha. The need to produce more food is likely to lead to a decline in the area planted to cotton over the next decade. Thus cotton production prospects for the next decade will be intertwined with yield improvement and production intensification rather then area expansion. This will depend on variety improvement through conventional and unconventional breeding technology, combined with improved production technology resulting from ongoing research. Price incentives will influence the implementation of improved technology but the transfer of technology is not easy and is not always effective, particularly in smallholder production (Eisa et al. 1993; Gillham et al. 1995). For a number of years, there has been increasing pressure on land to increase food production. This has resulted in a stagnation or decline in the area planted to cotton. Consequently, the increase in cotton production has been due mainly to increased yields. The introduction of genetically modified, insect resistant BT cotton is given the most credit for this increase, mainly in China and, to a lesser extent, in India. Other contributing factors have been more favourable monsoons in the last few years in India, boll weevil eradication, BT cotton and improved production practices such as minimum till or no till in the USA and the move to a more productive region in Mato Grosso in Brazil. Increased competition between food and cash crops is likely to continue so there is likely to be a continued stagnation or decline in the area planted to cotton and other cash crops. The maintenance or any increase in cotton production, therefore, will continue to depend mainly on yield improvement. Chapter 5/page 24

6 Cotton consumption Cotton Incorporated

Cotton cultivation and consumption over the years Components of cotton consumption Raw cotton consumption: factors and trends End-user consumption

Current advances and promising technology Promotion efforts around the world Summary

Throughout the ages, cotton has been the fiber of choice for apparel worn throughout the world. Its endearing qualities of comfort, ease of care and breathability have helped ensure its popularity in apparel with people across cultures and throughout the centuries. Remnants of spun cotton yarn have been discovered dating back to at least 3500 BC, reflecting keen interest over many years in producing a comfortable yet utilitarian fiber for domestic use. Since then, cotton’s popularity has grown, as production and consumption have spread to six continents and have climbed to reach record levels (ICAC 2005). Over time, as its use has increased to the record levels seen in the early twenty-first century, cotton has experienced fundamental shifts in the markets for its consumption. These changes include increasing market presence in traditional apparel and textile uses, shifts to new, expanding alternative markets beyond traditional uses in apparel, geographic shifts over time in production and consumption, and improving methods to process and utilize cotton from production through to end-user. As markets for cotton and other textiles have fluctuated over time, cotton’s position has remained strong and the future for cotton consumption around the world appears bright.

Cotton cultivation and consumption over the years Archaeologists and botanists are unsure of exactly where or when cotton cultivation began. Early cotton fabrics have been discovered throughout the world in regions including Mexico, pre-Inca Peru, China, the United States and India dating prior to 2500 BC. International trade in cotton textiles began as early as 450 BC, when Greek historians Herodotus and Arrian described traders selling lustrous, colorfully dyed Indian cotton fabrics along the Red Sea (Roche 1994). Beginning during the Renaissance, Western Europe, particularly England and France, specialized in spinning cotton fibers, then knitting and weaving the yarns into elaborate fabrics. Early Spanish explorers to the New World discovered that cotton was particularly well suited to the semitropical climate and soil in Florida. Prior to the development of the cotton gin by Eli Whitney in the US in 1793, harvested cotton lint had to be separated from cottonseed by hand. Development and refinement of Whitney’s gin, along with advancements in spinning, knitting and weaving machinery, allowed for cotton to be processed more quickly and efficiently, contributing to increased use of cotton worldwide. Once reserved exclusively for the rich, as cotton textiles and apparel became cheaper and easier to manufacture and produce in bulk, cotton’s popularity with the masses soared. Since then, cotton production and consumption have spread to six continents, accounting for approximately 25 million metric tons annually. Chapter 6/page 1

Cotton Trading Manual 30

Millions of metric tons

25 20 15 10 5 Production

Consumption

19 61 19 63 19 65 19 67 19 69 19 71 19 73 19 75 19 77 19 79 19 81 19 83 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 20 05

0

6.1

World markets for cotton continue to flourish.

As the world’s per capita income and spending have gradually risen during the twentieth century, consumers’ spending on textiles and apparel has risen in step. Cotton, a dominant fiber in apparel production, enjoyed dramatic increases in consumption during the twentieth century to meet this growing demand (Fig. 6.1). As other fibers, particularly man-made fibers such as polyester, have entered the market, cotton’s dominant share around the world has been challenged. Through aggressive research and promotional efforts in several countries, cotton has faced down rising market share from other fibers. However, in other, primarily developing national markets, cotton’s faltering market share illustrates the challenge for global cotton consumption. To expand market share further it will be critical to expose consumers in these markets to the qualities and benefits of cotton textiles and apparel over other fibers.

Components of cotton consumption Lint cotton generally is consumed throughout the world in one of three ways: as apparel, as home furnishings, or for industrial uses (NCC 2004). The largest component of cotton consumption, apparel, is perhaps the oldest, best-known and most widely recognized use of the fiber. Cotton apparel ranges from underwear to coats, shirts and saris to pants and socks. Household furnishings, another strong market Chapter 6/page 2

Cotton consumption for cotton, includes products ranging from bedspreads to window trimmings to toweling. The third category, industrial and nonwovens uses, accounts for the remainder of global cotton consumption and includes products ranging from automotive headliners to pulp and paper products to disposable wipes. Traditionally underutilized in previous years, cotton’s share of this burgeoning textile category has made gains recently as increased attention has been focused on alternative uses for cotton. In studying the consumption of cotton, a distinction must be made between raw fiber consumption and final consumer end-uses of cotton products. While the two types of data may be used in a complementary manner, raw consumption measures fiber demand at the beginning of the textile chain (consumption by manufacturers and mills), while consumer demand measures demand for final textile products at the end of the textile pipeline. Raw cotton consumption is a measure of the usage in textile mills or industrial plants of cotton in its natural form. Consumer demand, or apparent consumption, may be defined as the sum of a region’s wholesale cotton textile production and its net trade (imports minus exports), ignoring stocks held in inventory (Toyne et al. 1984). Although raw cotton fiber consumption measures are useful in studying consumption trends, many analysts also like to consider the second approach, measuring final-product consumption data or consumer expenditure data, in order to gain insight into both raw and finished consumption patterns. Differentiating between the two measures yields insight into global textile consumption patterns witnessed over the last several decades.

Raw cotton consumption: factors and trends Global shifts in textile and apparel activity began to occur in the early twentieth century as less-developed nations throughout the world began to establish and promote domestic textile and apparel industries and their exports in order to stimulate economic development. During the last several decades, there has been a marked shift in the pattern of textile and apparel consumption, and therefore raw cotton consumption, around the globe, forcing fundamental changes in how we view the world (Dickerson 1999). At the turn of the twentieth century, Britain accounted for 70% of the world’s textile trade. World textile production increased by about 90% between 1900 and 1937, and significant changes in where production would occur began during this era. After the Depression began in 1929, challenges to the dominant positions of the textile and apparel industries in the industrialized countries set the stage for what would follow for much of the century. Japan’s economic development from the 1920s through the 1950s paralleled earlier patterns in the United States and certain European countries Chapter 6/page 3

Cotton Trading Manual by relying heavily on textile production to lead the industrialization process. By 1933, Japan had become the primary exporter of cotton textile products in the world. Japan’s textile competitiveness was seriously affected, however, by World War II; more than three quarters of its textile production capacity was destroyed. After the war, the US and British industries expanded vigorously, while the textile and apparel sectors in several other countries rebuilt their production facilities. By 1947, the US textile and apparel industries enjoyed an impressive trade surplus and began to consider the surplus as normal. Consequently, US manufacturers willingly supported efforts to help Japan rebuild its industry. The struggling nation depended heavily on textile production for rebuilding its economy, and by the 1950s Japan again became a major contender for global cotton textile markets. In the 1950s and 1960s, other developing nations began to pattern their economic development strategies on those of the industrialized countries. These newly emerging countries hoped that similar industrialization would permit them to become important forces in world markets and would bring to their economies some of the prosperity they observed, particularly in the US and Western Europe. Textile production was a natural first industry for developing countries to choose. Then and now, the textile and apparel complex provided an easy entry for new producer nations. Simple apparel/textile production required relatively little capital and technology – resources in limited supply in developing countries. Portions of the industry are quite labor intensive, and emerging nations usually have an abundance of low-cost labor. Such countries usually have large populations in need of jobs to help the nation earn foreign exchange and improve the local standard of living. In addition, unskilled workers are able to assume simple production jobs in the textile and apparel complex with little training. Following Japan’s example, a number of less-developed nations began to produce and export cotton products destined for the export market. By the 1960s and 1970s, the ‘Asian Dragons’ of Hong Kong, South Korea, Taiwan, and Singapore began to increase production and exports of textiles and apparel to developed nations, through low labor and production costs, capacious quotas, and successful export strategies. As the industries matured in these countries by the 1980s, quota limitations and higher labor and production costs there caused production to shift again to several countries in Southeast Asia, China, and the Indian Subcontinent. Although worldwide textile and apparel production experienced a healthy growth rate from the 1950s through the 1990s, production in developing countries grew more rapidly. As a result, the developing countries found primarily in Asia, Oceania, and the Middle East enjoyed a larger share of total world raw cotton consumption, while developed nations in Europe, Japan, and the US experienced dwindling shares (Fig. 6.2). Chapter 6/page 4

Cotton consumption

Share of world mill use

100% 80% 60% 40%

Asia Europe Western Hemisphere Oceania & Middle East Africa

20%

19

61 19 65 19 69 19 73 19 77 19 81 19 85 19 89 19 93 19 97 20 01 20 05

0%

6.2

Cotton consumption migrates east.

The number of nations producing for the international textile and apparel markets has multiplied many times over since the 1950s, as has the level of world trade in cotton textiles and apparel, reaching an estimated $334 billion in 1999 (TIL 2001). The less-developed countries’ share of world exports increased from about 10% in 1955 to 58% in 1996. By the 1990s, Asia began to emerge as the leading apparelproducing region in the world. After harvesting, raw cotton is ginned to separate the cotton lint from cottonseed and extraneous matter. Once ginned and baled, the cotton lint may begin the process of being transformed into a final product. Consumption of cotton throughout the world typically begins at textile mills, where raw cotton lint is processed, or spun, into cotton yarn. During most of the last 50 years, cotton spinning capacity has increased as the number of ring spindles, open-end rotors, and air-jet spindles have climbed. At the same time, improved technologies have yielded faster and more efficient spinning systems around the world, allowing more production with fewer machines and even fewer workers. Similar to the eastward migration in raw cotton consumption noted earlier, measuring the world share of aggregate ring spinning capacity of cotton yarn shows a similar migration to Asia over the last several decades (Fig. 6.3) (ITMF n.d.). Once cotton is spun into yarn, the fiber may be woven or knit into fabric for use in apparel, home fabrics, or other textile uses. Similar to spinning capacity shifting to Asia, an increasing share of global weaving capacity is migrating to Asia as well. Although imports accounted for only about 2% of the US textile market by 1955, domestic manufacturers became increasingly concerned over the threat from exporting countries. Similarly, by 1958, Chapter 6/page 5

Cotton Trading Manual

100%

Millions of ring spindles in place

80% Asia & Oceania Europe America, South America, North Africa

60%

40%

20%

6.3

20 03

20 01

97

95

19 99

19

19

91

93 19

19

19 89

19 87

19 85

19 83

0%

Global shift in spinning capacity.

British textile and apparel producers became alarmed that their country, which had launched the Industrial Revolution with textiles, was importing more cotton cloth than it was exporting. These events set the stage for similar shifts that would occur in the decades that followed. As competition for world markets increased in the middle to late 1950s, early efforts began in both the United States and Europe to stem the flow of textile products from low-wage countries into the developed countries’ markets. Although problems associated with global textile trade began to seem difficult in that era, the 1950s were a mere prelude to the growing clash between exporting and importing nations. As the number of textile-producing nations grew, the competition for market access became increasingly intense. Further, at a time when the number of producer nations increased, end-user textile and apparel consumption slowed in the major markets – those of the developed countries. As a result of the increased competition and the perceived threat of imports, textile and apparel manufacturers in the more industrialized, developed nations began to demand trade policies to protect domestic markets. Growth in the number of textile and apparel producers for the world market led to a growing production capacity that exceeded demand. As a result, global competition grew more intense and difficult. As textile producers in developed countries attempted to protect their markets from imports from the low-wage developing countries, bilateral countryby-country trade policies emerged. Later, multilateral global textile trade policies developed in an attempt to mediate the problems associated Chapter 6/page 6

Cotton consumption with the worldwide surplus. Import restrictions including tariffs and quotas were implemented against exporters, prompting retaliatory restrictions from others. An amalgam of restrictive, convoluted trade policies with complicated rules and high tariffs throughout the world after World War II prompted the formation of the General Agreement on Tariffs and Trade (GATT) in 1947. The primary goal of GATT was to liberalize trade – that is, to free trade from the web of restraints that had evolved. From the time of its establishment to the 1960s, GATT made remarkable progress toward liberalizing trade by reducing or eliminating prior restrictions. By 1973, it became clear that a new multilateral framework was required to solve textile trade problems that had arisen since the implementation of GATT. Called the Multifiber Arrangement (MFA), the new agreement, signed by 50 countries, aimed to include trade liberalization for products made from manufactured fibers and wool – extending beyond original provisions limited to only cotton. The original MFA was a general framework under which bilateral agreements between countries would occur, providing the ‘specifics’ of ‘managing’ textile and apparel trade. Over the next 22 years, the MFA promulgation would go through various transformations in an attempt to satisfy the interests between exporting and importing countries. It was, however, a series of agreements with which few participants were satisfied because, as a compromise, it gave none of the players all the provisions desired. By 1993, during the Uruguay Round negotiations, MFA participants agreed on a transitional instrument to provide the guidelines to integrate textiles and apparel into mainstream rules. Called the Agreement on Textiles and Clothing (ATC), this sweeping legislation aimed to progressively integrate textile and apparel products over a ten-year period into a four-step quota phase-out that culminated with the full removal of applicable quotas for WTO-member nations on January 1, 2005. Under terms of the ATC, each importing country chose the quota categories that would be integrated at each of the four stages. Categories to be integrated had to encompass products from diverse groups, including yarns, fabrics, made-up textile products, and apparel. This watershed agreement has only recently come to full fruition, and early signs indicate a surge in Chinese textile and apparel exports to several foreign markets. This surge marks a landmark shift in textile trade and is likely to remain an evolving and contentious issue worldwide for several years. With the introduction and development of man-made fibers, the share of cotton in total global fiber consumption has steadily declined over the last half century (FAO n.d.). During the early 1950s, cotton accounted for over 80% of global fiber consumption, but that share had declined to roughly 40% by 2002 (Brock 2005). As a result, though world fiber consumption increased more than threefold, from 16 million metric tons in 1960 to 60 million metric tons by 2000, cotton Chapter 6/page 7

Cotton Trading Manual

70,000

Thousands of metric tons

60,000

MMF (Noncellulosic)

50,000

MMF (Cellulosic)

40,000

Other natural fibers

30,000

Wool

20,000

Cotton

10,000 0 1950

1960

1970

1980

1990

2000

6.4 Increasing presence of synthetic fibers in world fiber production.

consumption during the same period grew by only 142%, from 10 million metric tons to 19 million metric tons (Fig. 6.4). Man-made fibers have enjoyed increased market share for several reasons. The significant improvement in quality over earlier synthetic fibers has made man-made fibers a more viable substitute for cotton fibers. Also, the development of new man-made fiber textile markets can create new demand for fibers. The introduction of new products such as coated or waterproofed fabric and new industrial uses generate consumption in markets that were not previously available for cotton, thereby contributing to expanded markets for man-made fibers.

End-user consumption As noted earlier, there is a distinct difference between raw textile consumption and end-user consumption, or consumer demand. This endof-stage demand for textile and apparel products is the leading force in determining the levels of production and employment seen earlier in the global textile pipeline, as demand for final end-use products of apparel, home furnishings and textile products affects the demand for intermediate inputs of fibers, yarns and fabrics. Changes in consumption levels can have a widespread impact on the global textile complex, as a drop in consumption leads to a ripple effect backward through the production chain. A decline in apparel demand reduces fabric demand; this is followed by similar reductions in yarn and cotton fiber demand. Evidence shows that even as developed countries have experienced a declining share of raw cotton consumption over the last half century, on a per capita basis developed countries still account for the lion’s share of cotton end-user consumption (FAO 2003). For example, in Chapter 6/page 8

Cotton consumption 2000, while world consumption of cotton was estimated at 3.4 kg per person (Fig. 6.5), developed countries’ per capita final product consumption was pegged at 8.7 kg. Conversely, developing countries’ consumption per person was estimated at only 2.0 kg. Understandably, a strong positive correlation exists between per capita income levels and per capita end-product cotton consumption. Per capita income, population, and economic growth are three primary factors affecting consumers’ expenditures on cotton textile and apparel products. But beyond these three exogenous variables, consumer affinity can lead to higher cotton consumption. If consumers desire and seek out cotton textile and apparel products in lieu of other fibers, cotton demand can grow at a faster pace than determined solely by expanding incomes, populations, and economic growth. In addition to consumption of cotton lint, cottonseed has proven to be an invaluable byproduct in the production and consumption of cotton fiber. After separation and extraction from lint at the gin, cottonseed may be processed into linters, hulls, oil and cake meal. Linters are used in the production of rayon, or can be used in manufacturing diverse products ranging from mattresses to explosives to photographic film. Cotton hulls are a cost-effective component in livestock feed for nonruminant animals or for other industrial products, including heating fuel for furnace boilers. Cottonseed oil can be processed into cooking oil and margarine, or used in products ranging from cosmetics to plywood glue. Cottonseed meal, containing a high concentration of protein, is used primarily as feed for livestock, swine and poultry. The diverse and growing list of uses for cotton reflects society’s affinity for consuming a natural, plentiful, and widely dispersed product with a long history of functionality and a bright future for continued strong consumption.

Current advances and promising technology By the end of the twentieth century, advancements in information technology had enabled the world cotton industry to produce and consume cotton more efficiently, saving time and money, while ultimately lowering costs to the consumer. Advancements ranging from precision agriculture on the farm through electronic data interfacing at the checkout register all contribute to expanding markets for cotton. Additionally, the growing influence of the Internet has benefited cotton consumption by giving rise to quicker, cheaper, more efficient utilization of resources, including the use of e-mail, electronic marketing of cotton, and online procurement, logistics, and improved supply chain management. Ubiquitous e-mail allows people and firms involved in the cotton trade to communicate ideas and share data cheaply and instantaneously with Chapter 6/page 9

Cotton Trading Manual

US Japan Developed countries EU World Latin America Developing countries China India Africa 0

2

4

6

8

10

12

14

16

Kilograms per year

6.5

Per capita cotton consumption in selected regions, 2000.

others across town or around the world. Advancements in harvesting and ginning technology contribute to cheaper and more efficient production processes, lowering costs to consumers, and contributing to increased consumption of cotton. Advancements in marketing technology have given birth to several online, neutral cotton-trading platforms in recent years, allowing buyers and sellers the opportunity to interact in a virtual international marketplace, regardless of size or location of operation. The increasing volumes of online futures and options hedgers and speculators will contribute to increased transparency and efficiency in trading and insure risk and price protection to producers. Online procurement and supply chain management strategies are set to revolutionize how cotton-consuming textile mills, manufacturers, importers and retailers manage inventory and production, saving time, money, and resources. A collaborative project in the United States called DAMA (Demand Activated Manufacturing Architecture) is developing technological advances to help the US industry remain competitive against global rivals. The project speeds communications within the entire textile and apparel pipeline through a computer-based information system. Through advanced electronic marketing, companies can identify, compare, and buy and sell resources, products, and services in support of innovative business partnerships. DAMA technologies will permit better forecasting, inventory management, sourcing, and point-of-sale analysis for the domestic industry. Being able to Chapter 6/page 10

Cotton consumption access and exploit detailed and up-to-date information on textile suppliers, including their capacity to provide specific products in specific delivery periods, will be critical for the competitive future of segments of the US textile and apparel industry (DAMA website). Firms utilizing similar technologies are able to communicate and transact business in ways unimaginable to many just a decade ago. These firms are able to harness the most valuable commodity – knowledge – and utilize it in ways that lower costs and inventories, shorten response times, accelerate production, and increase sales, ultimately promoting the markets for increased cotton consumption. One of the most important technological advancements to benefit the cotton textile industry in the last 30 years is the development of automated cotton classing. Cotton fibers, like any naturally grown product, develop with differing measures of quality according to growing conditions, location, seed variety, and farming methods. These quality attributes include fiber length, strength, color, fiber fineness (or micronaire), and collateral debris or trash collected while harvesting the cotton. These attributes can affect the quality of the final manufactured product. High volume instrumentation (HVI) machines have been developed to objectively test cotton samples to determine the specific quality characteristics for each particular bale. By being able to do so, the market attains several goals: Firstly, mills, merchants, and producers are able to price cotton more accurately according to a schedule of premiums and discounts. Cotton with less attractive quality measurements than the market demands will trade at a discount, while cotton with highly desirable qualities may trade for a premium in the marketplace. Secondly, by utilizing HVI data mills can acquire only the needed mix of bales, optimize inventories, and select the best mixes of cottons to yield the most consistent yarn production. More specifically, mills can order bales within a specific range for each quality variable, thereby enabling mills to use only quality grades best suited for their particular consumption needs, while smoothing out the variance in distribution within a production run for each quality characteristic, ensuring higher mill productivity, more consistent uniformity, and better performance of the end product. To complement the HVI technology, the US cotton industry developed Engineered Fiber Selection (EFS®) cotton fiber management software that allows users to quickly and efficiently utilize large amounts of individual HVI bale data (CI website). These data can be used by cotton consuming textile mills to acquire and process cotton more efficiently. Mills can use the software to properly select optimal cotton mixes that perform as efficiently as possible on today’s high-speed automated textile equipment. Producers and ginners can use the software to determine their most profitable production, ginning, and marketing practices, and therefore gain a critical edge in the marketplace. Chapter 6/page 11

Cotton Trading Manual As globalization and textile competition have increased around the world, more manufacturers are competing for the same textile and apparel customer. In this environment of tight margins and shifting manufacturing strategies, textile consumers continue to search for comparative advantages over their competitors. Lower-cost labor and increased penetration of imports from lesser-developed countries have undoubtedly affected the domestic textile industries in more-developed countries. In response to the increased competition and faltering margins, many in developed-country textile industries have begun adopting agile manufacturing strategies to remain viable: streamlining production, shortening replenishment times to retailers, and improving responsiveness in order to remain economically viable, increase sales and ultimately increase consumption of raw textile materials, including cotton. During economic slumps such as those of the early 1980s, 1990s, and 2000s, all segments of the textile and apparel industry became more proficient at careful inventory management. Since manufacturers and retailers often borrow to finance production or inventory for forthcoming seasons, periods of high interest rates such as those in the early 1980s caused exorbitant carrying charges. As retailers and manufacturers alike experienced losses associated with the excessive inventories and high interest rates, companies at all levels became sensitive to the need for more careful inventory management. In the textile and apparel sector, overproduction and forced liquidation of apparel fabrics taught mill managers to be more sensitive and skilled in scheduling production. Textile manufacturers learned to work more closely with apparel manufacturers, wholesalers and retailers to better gauge consumer demand. Difficulties experienced by the textile complex encouraged both textile and apparel manufacturers to focus on a stronger marketing orientation. Faced with declining sales and tighter margins, manufacturers have become much more sensitive to the importance of responding to consumers’ needs and desires through improved marketing efforts. Although consumer demand influences the production chain in almost any industry, the consumer’s impact on both upstream and downstream segments is amplified in the textile and apparel pipeline. The whimsical nature of fashion trends and the seasonal characteristics of many of apparel products mean that excessive inventory from one season can seldom be held for a following season. In the increasingly interconnected, competitive and globalized world of textile and apparel trade, the capability of a firm to compete increasingly depends on the manufacturer’s ability to manage operations according to the logistics of time and flow of product, reducing both time to market and the costs and opportunity costs of holding inventory. Maintaining this fine balance between risk and cost entails seeking out and implementing efforts aimed at agile manufacturing. Strategies Chapter 6/page 12

Cotton consumption utilizing technology including electronic data interfaces along with Point of Sale technology along the textile and apparel pipeline could effectively minimize inventory, indicate the correct type and volume of production, and shorten response times to downstream wholesalers or retailers. Business theories such as Quick Response, Just-in-Time inventory management and Total Quality Management are being implemented in textile and apparel industries to utilize comparative advantages manufacturers may have over their competitors. Providing product and service to customers faster, cheaper and more efficiently requires a growing degree of integration among business enterprises within and across industries. Channel integration and utilization of technologies are driving the current industrial transformation in textile and apparel production around the globe and will continue to do so in the period ahead.

Promotion efforts around the world Several countries involved in cotton production, consumption or trade have organizations devoted to increasing markets for cotton. These organizations are charged with increasing markets for domestic cotton through a combination of efforts, including education, research, promotion, and governmental policy lobbying. For example, Cotton Australia, formed in 1972, strives to promote demand for Australian cotton. The organization accomplishes this goal through conducting market research, implementing promotional activities, and lobbying for policies beneficial to the domestic cotton industry. Several other similar promotional organizations are found in Japan, India, Egypt, Germany, Poland, the United States and Australia. To help cotton maintain its dominant share of total world textile usage, several organizations work to promote demand for and profitability of cotton through a variety of individual and collaborative efforts. Worldwide collaborative cotton promotion activities are directed primarily through the International Forum for Cotton Promotion, or IFCP. Formed in 2000, the principal objective of the IFCP is to encourage and facilitate national market development programs, organized by associations and commercial organizations in individual countries and funded from domestic resources. The Forum is achieving this objective by serving as a clearinghouse for the exchange of proven ideas and strategies to be implemented by national organizations, and by facilitating the establishment and expansion of national demand enhancement efforts (IFCP website). Member governments anticipate that the International Forum for Cotton Promotion may serve as an example of how cooperation within the cotton industry can rapidly translate into programs to address challenges and improve worldwide demand for cotton (ICAC 2001a). Chapter 6/page 13

Cotton Trading Manual One of the oldest organizations in the world devoted to fostering a healthy world cotton economy is the International Cotton Advisory Committee, or ICAC. By raising awareness, providing information, and serving as a catalyst for cooperative action on issues of international significance, the ICAC serves as a clearinghouse for technical information about cotton and cotton textiles and serves as an objective forum for discussion of cotton matters of international significance. Composed of 43 member nations throughout the globe, the ICAC works to promote cotton on a worldwide basis. One of the oldest groups involved in efforts to promote cotton is the United States’ National Cotton Council (NCC), based in Memphis, Tennessee (Jacobson and Smith 2001). The NCC began operations in 1939 to insure the ability of all US cotton industry segments to compete effectively and profitably in the raw cotton, oilseed and USmanufactured product markets at home and abroad. The NCC serves as the central forum for consensus-building among US producers, ginners, warehousers, merchants, cottonseed crushers, cooperatives and textile manufacturers. The organization is the unifying force in working with the US government to ensure that cotton’s interests are considered (NCC website). In 1970, in response to calls for more aggressive marketing of and research into cotton, a division of the NCC called the Cotton Producers Institute separated from the Council to form a new research and promotion arm for US cotton producers called Cotton Incorporated. The mission statement of the organization is to increase the demand for and profitability of cotton through research and promotion. Cotton Incorporated utilizes a ‘push/pull’ approach to build demand for cotton products and influence product development decisions. The company’s objective, to improve the demand and profitability of cotton, can be achieved at several different points in the cotton textile and apparel pipeline, from producer to consumer. Company programs and activities target these ‘points of influence’ in an effort to build demand for cotton. The ‘push/pull’ approach involves working from both directions in the pipeline, driving consumer demand for cotton products and working with manufacturers and retailers to increase cotton usage by offering new and innovative cotton products to consumers. The organization employs a staff with technical expertise in fields including agricultural research, fiber processing, fabric development and textile chemistry research to ‘push’ adoption of novel technologies to producers and manufacturers for producing cotton and processing cotton products more effectively, efficiently and profitably. At the same time, Cotton Incorporated’s emphasis on strong, effective advertising, consumer marketing and public relations programs is a fundamental tenet of its ‘pull’ strategy to build demand by influencing consumers. This combined strategy has proven effective in the US market, where cotton’s Chapter 6/page 14

Cotton consumption share of the retail market has risen steadily from its 1975 nadir of 34% to over 60% 30 years later. Cotton Incorporated and the international division of the National Cotton Council, called Cotton Council International, have recently engaged in a collaborative international cotton promotion program called the Cotton Gold Alliance program. The program is targeted at developing nations with large middle and upper income populations who are ready and able to afford cotton’s natural benefits. The program aims to involve the full chain of cotton processing, from mill to apparel manufacturer to brand to retailer – with the ultimate objective being increased stimulation of cotton demand at the consumer level in these developing markets.

Summary Demand for cotton has increased throughout the world during the twentieth and early twenty-first century to unprecedented levels. As cotton consumption has grown over the years, its use in textile mills has expanded to over 80 countries on six continents. In several developed countries around the world, cotton is the single best selling fiber in the retail market. Cotton consumption has experienced a fundamental shift in geography, as a greater proportion of raw cotton consumption has migrated east to Asia, particularly to China and the Indian Subcontinent. Per capita end-use of cotton products, strongly influenced by per capita income, has mushroomed to record levels in developed countries, yet remains flat in many developing nations where real per capita incomes are stagnant. During the last 50 years rising consumption of cotton has been hampered by the advent, development and progressive refinements of various man-made fibers, which have eaten into market share once dominated by cotton. Future vibrant growth of cotton consumption around the world relies on expansion of successful promotional efforts similar to initiatives already in place in many markets touting the desirable qualities inherent in natural fiber. Reaching and educating an increasingly globalized manufacturer, retailer and end consumer on the enviable attributes of cotton that other fibers may strive to mimic are the imperative goals set before all in the world cotton industry to ensure a viable future for the fiber and fabric of all our lives.

Chapter 6/page 15

Part 3 The physical trade

7 Cotton as an industrial raw material Dean Ethridge

Major uses of cotton Major determinants of cotton’s market value Fundamental requirements for spinning staple fibers Impact of spinning technology on fiber requirements Additional fiber property measurements needed Compensating technology

Blending cotton with other fibers Conclusion

Cotton is one of the most exotic commercial crops in the world. Genetically it is a woody perennial plant with indeterminate fruiting, yet it is grown predominantly as an annual crop and the growth/harvest period is increasingly compressed. It has a valuable oilseed by-product, but the reason for growing it is to provide an industrial raw material in the form of fiber. The dominant use of cotton fibers is to make yarns, which are then generally either woven or knitted into fabrics for many different applications. Nevertheless, it is remarkable how varied are the uses of cotton and the processes applied to the fibers. Many of the less famous, niche uses for cotton do not require the fiber properties that are so important in yarn and fabric formation – length, strength, fineness, color, trash, etc. Some of these uses rely primarily on the fact that cotton is the purest form of cellulose found in nature – about 94% pure in the form of ginned lint and about 99% pure after the lint has been cleaned and scoured. Examples include the following: • Both historically and currently, the highest-quality smokeless powders for munitions and explosives are achieved by using cotton linters as a catalyst. (Linters are very short fibers, most of which remain on the seeds after ginning.) • Linters have long been used in the manufacture of products as diverse as rayon, photographic film and fingernail polish. • In recent years, the cattle feeding industry in the US has begun offering a premium price for cottonseed that has not been delinted; this is because the linters provide roughage that facilitates the digestion of the oilseeds. • Paper products, made by chemically breaking the molecular bonds of cellulose then forming them into paper, most often use wood pulp as the raw material. But cotton may readily be used as the source of cellulose. Cotton is generally used in the higher-quality paper products. A notable example of its use in high-quality paper is the paper currencies produced by government treasuries. The peculiar molecular and crystalline structures of cotton fibers make them a versatile raw material for diverse, non-fabric products that provide comfort, non-polluting decomposition or non-allergenic environments. Examples include the following: • Cotton balls and cotton swabs are well-known applications that rely on the comfort and absorptive capabilities of clean, raw cotton fibers. • The absorptive and biodegradable properties of raw cotton make it a widely used medium for absorbing damaging liquid spills (eg oil, solvents, etc). Chapter 7/page 1

Cotton Trading Manual • Cotton is still widely used as padding and batting for added comfort in household and automotive products. • With special treatments to impart resistance to fire and to microbial damage, cotton is used for household insulation, both as loose fibers that are ‘blown’ into walls and roofs and as needle-woven or thermalbonded mats that are laid down, wrapped around or used to line walls, ceilings and air ducts. These foregoing examples may be characterized in two ways. Either (1) they are specialized, low-volume, niche applications or (2) they are applications that rely on low-priced sources of cotton fibers. Cost may not be very important for the cotton used in US currency, but most other papers made with cotton rely on waste fibers for the raw material. Cotton used in padding and batting will probably not even be virgin fibers; rather, it may be ‘reclaimed’ fibers – most often obtained by destroying fabrics back to a state of loose fibers (a process called ‘garneting’).

Major uses of cotton The uses of cotton characterized above provide the foundation for substantial economic activity across the world. But cotton’s status as the world’s dominant natural fiber does not depend on them. Rather, this status depends on the widespread use of cotton in woven and knitted fabrics to make textiles for apparel, home furnishings and industrial uses. From time immemorial, the intrinsic characteristics of cotton have made it appropriate for apparel and for those home furnishings that involve significant human contact, such as towels, washcloths, bed coverings, rugs, etc. These characteristics include softness, absorbency, non-allergenic, cooling to the touch, breathability, abrasion resistance and ease of dyeing. Cotton has also been widely used in industrial applications over the centuries; however, the advent of man-made fibers in the midtwentieth century marked a decline in cotton’s competitiveness for these purposes. The wide variety of characteristics needed for diverse industrial uses includes high strength, extreme abrasion resistance, rigidity, elongation, thermo-plasticity, flame resistance, mildew resistance, non-permeability elasticity and electric conductivity. Highly specialized man-made fibers have increasingly dominated in industrial applications – and especially in the more industrialized economies of the world. Evidence on cotton’s dominance in the three major end-use categories is available for the US in the National Cotton Council of America’s annual publication Cotton Counts Its Customers, which Chapter 7/page 2

Cotton as an industrial raw material quantifies the cotton consumed in final uses by US manufacturers. This reveals that in the year 2000 cotton had a 68% share of apparel, a 25% share of home furnishings and a 12% share of industrial uses.

Major determinants of cotton’s market value The fiber properties determining the prices paid for cotton – the properties targeted by cotton plant breeders, fostered by cotton farmers and pursued by cotton merchants – are generally those that determine the fiber’s use-value in the manufacturing processes of spinning, weaving, knitting and dyeing/finishing. However, an evaluation of those fiber property measurements that are dominant in global marketing systems reveals that spinning performance has been de facto targeted by these measurements. Yarn spinners constitute the segment of the traditional textile manufacturing industry that actually buys the ginned cotton fibers; therefore, it should not be surprising that this segment’s vested interests have dominated initiatives in the measurement of cotton fiber properties. Additionally, yarn spinners’ success generally depends on serving the yarn needs of fabric manufacturers, so the spinners cannot ignore those fiber properties that become important further down the processing chain.

Fundamental requirements for spinning staple fibers All existing short-staple fiber spinning technologies (which are still commonly referred to as ‘cotton systems’) involve opening, cleaning and blending of the raw fibers, then carding the fibers into an untwisted, cord-like bundle of parallel fibers called a sliver. These slivers are typically treated further to improve the evenness and orientation of the fibers (the drawing process). In ring spinning they are condensed down to a smaller, slightly twisted package (called roving) in order to allow placement of the package on the spinning frame. In the spinning technologies of open-end rotor spinning and air-jet spinning the sliver is fed directly into the spinning positions. In all cases, the objective at the spinning machine is to twist a bundle of fibers into a continuous yarn of specified size. As illustrated in Fig. 7.1, many individual fibers must overlap one another as they are twisted together so as to produce a sturdy, cohesive yarn surface. The twist factor must be adequate to produce a yarn with sufficient self-locking compression to hold together when the yarn is stretched. The fibers overlap in a staggered way and they stay together because of a positive, static inter-fiber friction. Thus, it is imperative that the number of individual fibers in the yarn ‘bundle’ be Chapter 7/page 3

Cotton Trading Manual

Self-locking compression when yarn is extended

Fibers overlap in a staggered way, with positive,static inter-fiber friction

7.1

Sturdy, cohesive surface

Principles of staple fiber spinning (source: ETH, Zürich).

large enough to overcome inherent weakness resulting from fiber ends that are present throughout the yarn. Holding all other variables equal, we may make the following statements: • The longer the individual fibers, the smaller the number of fibers needed in a cross-section of the yarn to produce a yarn of specified strength. • The stronger the individual fibers, the smaller the number of fibers needed in a cross-section of the yarn to produce a yarn of specified strength. • The finer the individual fibers (i.e. the smaller the fiber perimeters), the larger the number of fibers that will fit into the cross-section of a specified yarn size. Therefore, in order to make a very fine cotton yarn it is necessary to use cotton fibers that are long, strong and fine. These are the three characteristics or properties of cotton fibers that most fundamentally define value to spinners. While ‘color’ designations and measures of waste content may significantly impact the market price of cotton, these are not concerned primarily with the inherent fiber properties. Rather, they primarily treat the issues of external fiber damage and contamination. (They also provide the opportunity for much of the creative grouping and sorting of cottons by participants in the marketing system, in order to sell the various lots of cotton more advantageously.) Chapter 7/page 4

Cotton as an industrial raw material It is not an accident that the most expensive cotton fibers in the world are those to which the designation ‘extra long staple’ (ELS) is applied; these include the Pima and Sea Island cottons produced in the Western Hemisphere and the Giza cottons produced in Egypt. All of them are also fibers with remarkably small perimeters. To this day, it is unproven that the strengths of the individual fibers of these ELS cottons are significantly different from individual fiber strengths of most other cottons. The combination of length and fineness is apparently the foundation of their spinning value. The issue of strength, like other fiber properties, is confused by the techniques used in measuring such properties. In fact, the only reliable measurements of fiber strength are ‘bundle measurements’. Thus, it is still not possible to test the strengths of individual cotton fibers adequately. Strength can be tested by breaking fiber bundles, whether the bundles are a group of loose fibers or are twisted into a yarn. As yarns become coarser (thicker) the dilemmas caused by length, strength and fineness decrease. It is possible to get an adequate number of fibers into the cross-section of a coarse yarn with shorter, coarser fibers. The prices for such fibers are significantly below prices for the long, fine fibers. Therefore, unless constrained by government regulations or trade barriers, yarn spinners will seek to buy lower-priced fibers that are adequate to make the yarns they are producing. For example, the yarns produced to make denim jeans are coarse yarns, and spinners around the world emphasize the discounted cottons to use in making denim yarns.

Impact of spinning technology on fiber requirements The use-values of cotton in spinning have become much more dynamic during the last thirty or more years, following the advent of two new spinning technologies and a new innovation in an old technology. For the first seventy years of the twentieth century ring spinning was the dominant technology. As shown in Fig. 7.2, the essence of the ring spinning process is the controlled drafting and twisting of the fibers into yarn, with the fibers never losing contact with one another. A limiting factor in the manufacturing efficiency of ring spinning is that the yarn package (on the bobbin) is an inseparable part of the spinning process; therefore, bobbin shapes and sizes are limited by the requirements of spinning geometries and bobbin yarns have to be rewound onto larger yarn packages before they are ready for further use in textile manufacturing. Ring spinning geometries also put an upper limit on the revolutions per minute (rpm) that a ring spindle can make, which sets an upper limit for throughput. In the early 1970s open-end rotor spinning entered the commercial arena (Fig. 7.3) and over the next 25 years became the equal of ring Chapter 7/page 5

Cotton Trading Manual Fiber supply (roving) Roving

Yarn

Spinning triangle

Drafting system

Spindle

Thread guide

Bobbin

Yarn balloon

Ring

Close-up view of yarn formation

Traveler

Spindle drive tape Spindle

7.2

Diagram of ring spinning (source: International Textile Center).

spinning in terms of volumes of yarns produced. The yarn is formed through the natural twisting motion created by a grooved rotor that turns very rapidly (generally between 70 000 and 140 000 rpm, depending on the size of yarn being produced). It is referred to as an ‘open-end’ technology because the end of each fiber becomes unconnected to other fibers (thus, its end is ‘open’) before it is incorporated into the yarn structure. The yarn is withdrawn from the rotor as it is formed and wound up onto a yarn package that is suitable for further use in textile manufacturing processes. During the 1980s air-jet spinning technology entered the commercial arena, but has only slowly penetrated the yarn spinning industry. A diagram of the dominant air-jet spinning process, Murata Vortex Spinning (MVS), is given in Fig. 7.4. Some versions of air-jet spinning qualify as ‘open-end’ technologies, but the preferred method now actually drafts the slivers before the yarn is formed with a precisely controlled vortex of compressed air. Precision control of the air pressures and flows is absolutely necessary and non-fiber content of any kind is likely to disrupt these. Therefore, air-jet spinning requires very clean fibers. Furthermore, the fibers in the sliver fed into the air-jet drafting section must be very evenly distributed and parallel; the cotton used is generally combed to remove most of the shortest fibers before the sliver is taken to the spinning machine. Like rotor spinning, air-jet technology Chapter 7/page 6

Cotton as an industrial raw material er Fib

Close-up view of yarn formation

Yarn

Fib e

r

Peel point

Navel Rotor

rn

Ya

Fiber

Comber roll

Cleaning port

7.3

Trash

Feed roll

Sli

ve

r

Diagram of rotor spinning (source: International Textile Center).

allows winding of the yarn onto a finished yarn package directly out of the spinning position. A summary explanation of the productivity relationships between these spinning technologies is assisted by the illustrative information in Table 7.1. A rotor spin box enables about a ten-fold increase in yarn produced per minute versus a ring spindle. An air-jet spinning position results in another 60% increase over a rotor spin box. (These approximations are based on a yarn size of 18–20 Ne, which is a size that may be commercially spun by all three of these technologies.) The least costly technology per pound of yarn produced, however, is rotor spinning. Air-jet spinning cost is about 15% higher, while ring spinning cost is about 25% higher than rotor spinning. The implications of these data are moderated somewhat by the fact that more ring spindles can be put within a given floor space than can rotor spin boxes, with air-jet spinning positions requiring still more space. In addition to the greater Chapter 7/page 7

Cotton Trading Manual Sliver

Drafting section

Take-up shaft/roll

Close-up view of yarn formation

Yarn clearing

Yarn Fiber Package winding Yarn extraction

Fiber inlet Spindle Jet

7.4 Diagram of air-jet spinning (source: International Textile Center).

Table 7.1 Productivity indicators a Spinning technology

Meters/minute of yarn produced

Relative cost/lb of yarn produced

Ring Rotor Air-jet

25 250 400

125% 100% 115%

a Based on one spinning position producing 18–20 Ne yarn

Chapter 7/page 8

Cotton as an industrial raw material % Cotton use by weight 30%

Both systems 25% 20%

Rotor spinning Ring spinning

15% 10% 5% 0% <5

Coarse

7.5

5-10

11-15

16-20

21-25

26-30

31-35

36-40

41-45

Yarn count (Ne)

46-50

>50

Fine

Yarn count percentages spun in the US.

throughput, the lower cost of rotor spinning is due in part to the elimination of back-processes necessary to prepare the yarn for the spinning machine, as well as the elimination of winding yarns onto packages after spinning. Ring spinning still sets the standard for yarn quality, especially in terms of yarn strength and ‘hand’ (a term used to indicate pleasantness to the touch). Rotor spinning produces a yarn that is somewhat weaker and harsher to the touch. Air-jet spinning produces a yarn that is significantly weaker for medium-sized yarns, but its strength compares more favorably with ring spinning for the fine yarns. Air-jet spinning accounts for a small percentage of total spinning capacity in the world, and almost all of it is devoted to fine yarn sizes. Most of the capacity is split between ring and rotor spinning. Figure 7.5 illustrates how in the US rotor spinning dominates the coarse yarns and ring spinning dominates the fine yarns, while both systems are commonly used for the medium yarns (between 16 and 35 Ne). In the late 1990s a potentially important innovation in the old ring spinning technology was introduced. This is called ‘compact spinning’ because it involves the precision use of negative air pressure to compact the fibers into a tight bundle just before they are twisted to make the yarn. Compact spinning effectively eliminates the ‘spinning triangle’ that had until then always been associated with ring spinning (see close-up view of yarn formation in Fig. 7.2). This enables a nearly perfect orientation of fibers just before they are twisted into yarns, which results in a much more ‘organized’ yarn structure. Indeed, as ring spinning has been the historic standard for yarn quality, compact ring spinning is expected to set a new, higher standard for comparison. As the market shares of each spinning technology evolve, the market’s valuation of fiber properties also changes. This is because each technology requires different mixes of properties for optimum perChapter 7/page 9

Cotton Trading Manual Table 7.2 Relative importance of fiber properties by spinning systems Rank

Ring spinning

Rotor spinning

Air-jet spinning

1 2 3 4

Length Strength Fineness

Strength Length Fineness Cleanliness

Length Cleanliness Fineness Strength

formance. A simplistic explanation is provided by a ranking of fiber properties as in Table 7.2. The consensus for ring spinning is that fiber length is most important, followed by strength and then fineness. For rotor spinning fiber strength is ranked first, followed by length and fineness, then the cleanliness (lack of leaf, waste and other contaminants) has to be added. For air-jet spinning length is again ranked first, but cleanliness comes next because this spinning system cannot handle contaminants of any kind. Fineness is ranked third is and fiber strength comes in fourth.

Additional fiber property measurements needed There are several more fiber properties that are important in determining cotton’s use-value in spinning; however, the inability to measure them cost-effectively prevents the marketing system from pricing them efficiently. Indeed, even fineness is not efficiently priced because the only measure available in commerce that gives an indication about it is the micronaire value, which cannot distinguish between fineness and maturity. Thus, a coarse, immature fiber may give the same micronaire value as a fine, mature fiber. It is to be hoped that measurement technology will soon be commercialized that provides a cost-effective measure of both fineness and maturity. The length measurement available in the marketing system is evolved from the age-old technique of ‘pulling the staple’ by hand and observing the ‘dominant’ length of the fibers. As it is done now by high-speed instruments, it has come to be called the ‘upper-half mean length’. But cotton fibers have a non-uniform distribution of their lengths, which is undoubtedly very important in determining spinning values. This length distribution is determined by genetics of the cotton plant, but it may also be changed by poor ginning of the cotton. For any given ‘staple length’ of cotton, the more uniform its length distribution, the better it will perform on any of the existing spinning technologies. That being said, the rotor spinning system compensates Chapter 7/page 10

Cotton as an industrial raw material best for the presence of ‘short fibers’ in the cotton, while the air-jet spinning system does the worst job with them. In fact, the current generation of air-jet technology, Murata Vortex Spinning (MVS), incorporates a vacuum around the base of the spindle to remove short fibers as the yarn is formed. Awareness is growing about the importance of measuring the length distribution of cotton fibers. There are laboratory instruments available that enable useful measurements and they have proven their value for predicting spinning performance and yarn quality. What is needed, however, is a high-speed measurement of the length distribution that can be confidently used to guide the spinning industry in selecting and pricing the cotton it buys. The need for separate measurements of fineness and maturity is enhanced by the fact that they also become important in the later stages of textile manufacturing. The industry is generally aware that micronaire is an important measurement for preventing uneven dyeing of yarns or fabrics. Thus, having variable micronaire values in the mix of fibers used to make yarns is known to result in streaks and in shading differences (often referred to as ‘barre’). In fact, however, variations in either fineness or maturity may cause these problems, so micronaire values cannot be adequate to avoid all of them. Contamination and fibrous defects of any kind may cause poor spinning performance and degraded yarn quality. A type of contamination that has become critical since the early 1980s is stickiness, which is caused by deposition of insect sugars on cotton bolls. Even if contaminants are not critical to the successful formation of yarns, they can become critical at subsequent stages in textile manufacturing – in fabric formation, and in dyeing and finishing. These include contamination with ‘pepper trash’, and seedcoat fragments. The same may be said of fibrous defects like neps and white specks. The degree of the problems caused is often not determined until the fabric is made and the dyeing and finishing is done. At these junctures in the manufacturing process almost all the cost has been expended; therefore, the loss that must be endured is very large. The result is that yarn spinners who are selling to fabric manufacturers making textile products that are ‘sensitive’ to such contaminants and fibrous defects will exclude fibers that are even suspected of having them.

Compensating technology The general trend of machinery development for textile manufacturing has been toward higher speeds and greater throughput of raw materials. This is true for yarn formation, fabric formation and finishing processes. As a result, in many cases these manufacturing processes have tended to become more stressful – more demanding – on the raw Chapter 7/page 11

Cotton Trading Manual materials used. It is understandable that emphasis has been put on making the raw materials (the fibers and yarns) more capable of withstanding these stresses. The ‘mantra’ has become that cotton fibers must become increasingly longer, stronger and finer. Yet the mantra of longer, stronger and finer is not universally true. As hinted at above, rotor spinning provides an example of technological change that compensates for disadvantages of some cotton fibers; in particular, it works well with the medium- and shortstaple cottons. Indeed, the ideal cotton (from the standpoint of costeffectiveness) for rotor spinning may be characterized as short (rather than long), strong and fine. It is noteworthy that further increases in the productivity of rotor spinning machines would probably involve further decreases in the circumference of rotors, which would in turn require a renewed emphasis on getting shorter cotton fibers to run on them. This is because the longer fibers would lap the entire circumference of the rotors and cause failure of the spinning process. Another example of compensating technology is provided by the aforementioned innovation known as compact spinning. The greatly improved orientation of the fibers, through elimination of the spinning triangle, results in a more complete utilization of the length available in every cotton fiber. Therefore, while the driving motivation for development of compact spinning was to achieve very high-quality yarns, a side effect of the technology is to enable the use of shorter fibers to get a quality of yarn that was previously possible only with longer fibers. In previous years, increased throughput for carding machines was achieved primarily by feeding the cotton faster through it. This inevitably put more stress on the fibers, thereby creating more short fibers and neps. And in the case of carding, the longer the fibers, the greater the tendency to damage the length distribution and get elevated levels of neps whenever the carding machine is speeded up. However, the latest innovation in high-speed carding has been to widen the cylinders and flats that operate on the fibers, thereby alleviating the need to speed up the machines in order to get greater throughputs. The point of the foregoing examples is that technological change in spinning need not always result in relentlessly increasing the demands made on cotton fiber properties. Those who are responsible for enhancing the use-value of cotton must be alert to opportunities in two major areas: (1) improvement in the properties of cotton fibers and (2) compensation for cotton fibers’ properties through new textile manufacturing technologies. Those involved in cotton merchandising and in buying cotton for textile mills should strive to be knowledgeable about the technological changes, in order to do a better job of matching the cottons with the needs of the different technologies. Chapter 7/page 12

Cotton as an industrial raw material

Blending cotton with other fibers Cotton is blended with a wide variety of natural and man-made fibers. This may be done at the raw fiber level before spinning occurs, either at the opening line (where fibers are intimately blended when they exit the carding machines) or at the drawing machines (where slivers of cotton fibers are combined with slivers of other staple fibers) – or at both places in the process. Blending may also be done at the weaving/knitting level, where cotton yarns may be put together with other spun or filament yarns. Blending cotton with other fibers may be done to reduce costs, but it may also be done to achieve desirable characteristics in the textile products. In fact, most of the blends require additional processing at the dyeing and finishing stages, which adds cost to the end product. For example, blending cotton with polyester requires that different dyes be used for each fiber, and the dyeing of polyester is generally more expensive than for cotton. Fabric characteristics that may be sought when blending cotton with other fibers include wrinkle resistance, elasticity, luster, drape, etc. The objective is generally either to (1) achieve a different look than is possible with 100% cotton but retain the comfort of cotton or (2) achieve a different performance criterion but retain the look and feel of cotton. If 100% cotton yarns are blended in weaving or knitting with yarns made of other fibers, then the fiber properties required of the cotton will probably not change very much. This is because the performance required of the cotton yarns in fabric formation and finishing stages will probably be about the same as if the fabric were made of 100% cotton. In cases of intimate blending (at opening and carding) or blending at the drawing machines, the fiber property requirements of cotton may be significantly altered from the requirements for 100% cotton. If cotton fibers are required to provide the strength for the yarns, then long, strong and fine cotton fibers may be needed. If, however, the other fibers will provide the strength, then short and/or coarse cotton fibers may be adequate. In either case, it would be necessary to control the fineness/maturity properties of the cotton fibers sufficiently to prevent problems in dyeing and finishing.

Conclusion While cotton is one of the most exotic row crops grown in the world, the cellulose-based fiber provided by it must be understood and managed as an industrial raw material. Its economic value is determined primarily by its utility in the spinning, weaving and knitting of textile products. Cotton both serves and is served by the textile manuChapter 7/page 13

Cotton Trading Manual facturing technology prevailing in the world. The challenge is to advance both cotton’s ability to serve the technology and the technology’s ability to serve cotton. Meeting this challenge will require a knowledgeable marketing sector with people who are sensitive to the issues of matching the fiber properties of cotton with the pertinent textile technology.

Chapter 7/page 14

8 Cotton quality Anton Schenek

Physical characteristics and properties of cotton Introduction to cotton quality Repeatability and reproducibility of test results Round tests for practical results and measurements Laboratory conditions Properties of cotton General properties Cotton single-fiber growing conditions and maturity Product quality versus fiber quality Yarn spinning systems and demand for fiber quality Ring spinning and compact spinning Open end rotor spinning Air jet spinning Nonwovens production and demand for fiber quality Linters quality Cotton fiber quality demands for classing and HVI measurement Micronaire HVI – Length (staple length) HVI – Uniformity Index HVI – Strength HVI – Color HVI – Trash Fiber quality demands for future classing and selected measurements Moisture content Short fiber content Elongation CIE – Color Future instrument color grade Trash identification by size, shape, trash color and type (extraneous matter) Neps, seed coat fragments Stickiness Maturity

Fineness Gutknecht-correlation Additional cotton fiber quality problems Contamination Chemical residues Microbiological infestations Green fiber spots Colored cotton fiber spots Selected traditional laboratory tests Pressley-strength (psi) Stelometer-strength Comb-sorter length array Fibrograph

Varieties and types of cotton Cotton-producing countries and regions Cotton varieties Cotton breeding and resulting changes of quality parameters Genetically engineered cotton: Bt cotton Cotton breeding time schedule Important species Breeding influence on properties Yield Staple length Strength Elongation Micronaire Description of cotton types

Impact of production and ginning conditions on quality Impact of cotton production on quality Seed selection Soil and nutrition Water supply Weather conditions Pests and disease control Insect control Weed control Harvesting Defoliants Definitions of organic and other agricultural practices Storage and module averaging Impact of cotton ginning on quality

Ginning principles Seed cotton feeding system Drying Seed cotton cleaning Lint cleaning Bale pressing Bale wrapping Sampling procedure Storage and transportation Variation from bale to bale and within bales

Contamination Cotton contamination types Fabrics String Organic matter Inorganic matter Oily substances/chemicals Stickiness Seed coat fragments

Classing and grading Classing and grading principles Sampling for traditional classing Classification of American Pima cotton Typical classing systems of selected cotton-producing countries Universal Cotton Standards (USDA–Upland cotton) Egyptian Standards (long staple and extra-long staple cotton) Pakistan Cotton Standards Uzbek Upland Cotton Standards Paraguayan Cotton Standards Peruvian Cotton – Peru Tanguis Standards Turkish Cotton Standards HVI-classing (USDA) HVI-classing procedure Repeatability and reliability of HVI-instrument determinations HVI-calibration ITMF HVI-User Guide and USDA Guidelines for HVI-testing HVI-Bremen Roundtests and USDA Round Trials

Acknowledgments

Physical characteristics and properties of cotton Introduction to cotton quality What is cotton quality? According to one commentator, ‘Cotton quality means that your customer comes back to buy again, and not the cotton bales.’ The trading rules of the Bremen Cotton Exchange, for example, allow for the rejection of bales of inferior quality and sending them back to the shipper. Determination of cotton quality, either by classing or by instrument testing, is necessary in order to reach an agreement between buyer and seller. In this sense, modern cotton testing by means of HVI supplements classing is the continuation of classing by another means. Classing by eye and hand remains the basis of quality determination in most cotton-producing countries. Reliability and repeatability of cotton measurements in any part of the world, yielding data that can be transferred by internet to the customer, has become the necessary basis of cotton quality data for trade and industry. An interesting prediction of trends in the classing and testing of cotton to the year 2020 is given in Table 8.1 (see Shofner and Shofner 2000; Shofner et al. 2002). The elaboration of instrumental measurements in the table offers a pointer to the future basis of cotton quality determination. Repeatability and reproducibility of test results The growing cotton plant constantly produces new cells. In the typical growth pattern the emerging first leaves ripen, open bolls develop at the bottom, with closed green bolls in the median part of the plant and flowers at the top. The same plant thus has different boll-growing conditions, resulting in different fiber quality stages. There will be also quality differences from plant to plant, field to field, region to region, country to country and season to season. All measurements of fiber properties done on bale samples will therefore result in varying test results, leading to mean values of a test series and natural deviations from those mean values. Each test result is an expression of a mean value and its possible variations. Understanding how to ‘read’ the ranges in common test variations is the basis of the day-to-day cotton business. Lab-to-lab ‘reproducibility’ indicates the percentage of test results obtained within permitted tolerances. The term ‘accuracy’ refers to how well an instrument measures a certain property in relation to its ‘true value’. The true value is determined by repeated specific round trials Chapter 8/page 1

Cotton Trading Manual Table 8.1 Timeline of classing and instrument measurements –1965

–1980

2000

2020

Human ‘measurements’ – Classing Grade Grade Color Grade Extraneous Extraneous Leaf Grade matter matter Preparation Preparation Preparation Staple Staple Instrumental measurements Micronaire

Micronaire Length UHM UI Strength Tenacity Color Rd, +b (Fiber + Trash) HVI Color Grade Trash % Area

Micronaire Length UHM UI SFC Strength Tenacity Elongation Color CIE (Fiber only) Instrument Color Grade Trash % Area Size, Shape, Color, Type (Extr. matter) Moisture content Neps, Seed coat fragments Maturity/Fineness Stickiness

Source: Shofner 2000

as used to fix values for calibration cottons. The term ‘precision’ refers to the ability of an instrument to produce the same measurement result time after time (USDA–AMS 1999). Round tests for practical results and measurements Round tests or round trials are the series of tests made by different laboratories on samples from identical, well-blended cotton. Comparing these results makes it possible to analyze variations in test procedures, the influences of materials and instruments, and the influence of operators (Hadwich 1969; Bremer Rundteste n.d.). Chapter 8/page 2

Cotton quality If there are sufficient participating laboratories, such a round test gives statistically sound data to determine lab-to-lab variations and to get close to the true mean value of all test results. Examples are the Bremen Roundtests and the USDA Roundtests, where for properties such as micronaire more than 100 laboratories contribute by sending back test results. Lab-to-lab variation can be expressed by the mean value of all tests performed and relevant standard deviation, or by the calculated coefficient of variation CV (L). If the CV (L) between results is lower than 5% from such a round trial with enough participating laboratories (>20 is recommended), the test method may be acceptable for industrial application, according to the ITMF Committee on Cotton Testing Methods (Schenek 2002). Round tests are performed to check the method, to determine calibration cottons and to control the daily work of test laboratories. Laboratory conditions Atmospheric conditions influence the measurements of cotton fiber properties, especially strength and fineness. A difference of 2% in moisture may result in one gram per tex difference of strength. Therefore, the temperature of laboratories for testing (eg HVI) should be maintained at a standard 70° Fahrenheit (21° Celsius) +/- 1° and relative humidity maintained at 65% at that temperature +/- 2%. Cotton samples have to be conditioned to bring the moisture content to equilibrium with the approved atmospheric conditions, starting from the dry side of the sample. In passive conditioning, the samples must normally be exposed for 48 hours in trays with perforated bases to allow free circulation of air. In active conditioning, a rapid conditioning unit is used by which air at the approved atmospheric conditions is drawn through the sample until equilibrium is reached. The time may be reduced to 15 minutes. Conditioned cotton samples will have moisture content between 6.75 and 8.25% (dryweight basis) (USDA–AMS 1999).

Properties of cotton General properties Cotton has a number of unique properties for clothing and textile processing. It: • • • • •

has high tensile strength (18–35 g/tex) has medium elongation range (6–9%) is stronger in wet condition than dry (10 to 15% more) withstands water boiling processes (up to 90°C) withstands many washing processes Chapter 8/page 3

Cotton Trading Manual • has good resistance to caustic soda • swells in caustic soda, giving cotton higher tensile strength and lustre (mercerization) • has medium to high humidity absorption (7–11% at 65% at 20°C; up to 21% at 100% at 20°C) • is easy to dye with different color types and bleaches well • has medium resistance to acids. Cotton single-fiber growing conditions and maturity If we examine a single fiber and its growing process, it delivers the characteristics that will be responsible for its quality (Basra 1999; Hequet n.d.; Ramey 1982; Lord and Heap 1981). On the seed of the cotton plant, there are two forms of epidermis cells, the lint and the fuzz. The lint fibers start to grow on the day of flowering or the following day. The fuzzy hairs or linters start growing on the fifth or sixth day after flowering until the tenth or eleventh day. Both hair types start to develop as thin, round, tubular structures of living cells filled with a nucleus and protoplasm. Cellulosic chain molecules or macromolecules are produced from which five combine to form the first fibrillar structure, yielding fibrilles and later the fiber. The growing process includes the forming of crystallite structures out of the liquid into extremely long molecular chains of 2000 to 3000 or more monomers, which accounts for the extraordinary strength of cotton fibers. The period of lengthening of the lint fiber takes some 20 days, depending on variety and growing conditions; in bad, cold weather conditions it will take up to 30 days. The final length of the fiber may be 1000 to 3000 times the diameter, in the range of 10 to 50 mm. The thin outer wall is called the primary wall, which later becomes the outer layer of the lint fiber, with a thickness of 0.1 to 0.2 micrometers. Then, as the fiber ceases to increase in length, for a period of 20 to 30 days, a new layer of the secondary wall is formed until three to four days before the boll opens. The layers are formed day to day, depending on environmental variables, including sunshine, temperature, nutrition, water supply, insect infestation, pests etc., similarly to the yearly rings of trees, but in this case daily rings. The orientation structure of crystallites and fibrillous structures at a spiral angle of 20 to 45 degrees to the long axis of the fibers change daily. Together they constitute a solid compound structure, which gives the cotton fibers their strength and strain stabilty. The secondary cells, growing towards the center of the fibers, do not completely fill the space occupied by the fibers, leaving the characteristic ‘lumen’, the hollow space in the cotton fibers. From the beginning of the fiber-growing period, the cross section of Chapter 8/page 4

Cotton quality the fiber is circular, and remains in that form until the boll opens. The diameter is nearly constant in the middle portion, slightly tapered to the base and more tapered to the fiber tip. The diameter of the fiber and consequently the perimeter of the fiber is specific to the species and is constant for the same seed. The wall thickness, like the length, depends on the species, but is also related to the growing conditions of the cotton plant. The wall thickness is generally related to so-called ‘maturity’. If growing conditions are favorable, most of the fibers have thick walls and are termed ‘mature’. If the growing conditions are poor, many fibers have only thin walls and are termed ‘immature’. If the growing conditions are very bad, the growing sequence of the fiber may stop at the end of or before the lengthening period, and the fiber remains with only an outer wall, the cuticle, and the secondary wall will not develop. These are known as ‘dead fibers’. The percentage of mature fibers gives the ‘maturity’. Every cotton sample will contain a mix of mature, immature and dead fibers. Dead fibers do not take up color during dyeing processes, form neps and become the source of ‘white specks’ on woven fabrics, as seen on blue jeans. Immature fibers also take up less color and may form neps. After the opening of the boll water is lost, the cells die and the protoplasm of the lumen dries, leaving the hollow lumen of the dry fiber. As a resut of the drying process, mature fibers typically have a kidneyshaped cross section. Dead fibers form thin plates and immature fibers can have variable bent shapes. Very mature fibers are nearly round. The drying process also develops typical fiber convolutions owing to the crossing points of different growing structure orientations from day to day. Another characteristic of the cotton fiber is the crimp. During the lengthening growth period of the fibers in the capsule, they bend in groups and form sharp angles. Most of the mature fibers on a seed have a similar length, but according to their natural growth distribution some at the ‘chalazal’ end of the seed are longer, but immature. This explains the typical fiber length distribution of a cotton sample.

Product quality versus fiber quality New technologies have altered and continue to change the structure and the strategies of the textile industry (Deussen and Knecht 1995; Schenek 1984). The cotton processing industry has continued to adopt many new developments, which enabled the considerable recent growth in cotton consumption. Among these were new spinning technologies such as open end rotor spinning, air jet spinning with the new vortex spinning system, enabling easier cotton processing at Chapter 8/page 5

Cotton Trading Manual ultimate production speeds, new compact spinning and automation. Other developments making weaving much more productive have included shuttleless weaving, air jet weaving and the new multiphase weaving technology. New developments in technology with resulting higher production speeds continue to change cotton processing quality demands.

Yarn spinning systems and demand for fiber quality Cotton fibers from fine species (long staples) are long and strong, so cotton can be used to produce the finest staple yarns (industrial processing 4 tex, metric count Nm 250, English cotton count close to Ne C 150; finest yarns 2 tex, metric count Nm 500, English cotton count close to Ne C 300). Ring spinning and compact spinning Fiber length, strength and fineness are the key parameters. The ring spinning system, which is also the basis for compact spinning, depends on excellent fiber length and uniformity of length, since short fibers are troublesome in roller drafting systems. Strength of fiber is the basis of yarn strength, as for fiber elongation. If fiber strength is higher, the resulting yarn will be stronger, when the specific yarn strength is at a level of about half the amount of the specific fiber strength. Trash and seed-coat fragments are of importance too, as total cleaning is never possible and some of these particles remain in the yarn, especially in the cheaper carded yarns, where they cause yarn defects like neps. As ring spinning has been the traditional and most important spinning system, and the other mentioned systems are relatively new, traditional classing has been based on ring spinning demands. New spinning technolgies imply necessary changes in cotton classing in the future (Table 8.2). Open end rotor spinning For rotor spinning, the most important fiber property is strength, with the fibers under stress during the yarn-forming process in the spinning rotor. With a poorer yarn structure compared to ring yarn, the fiber-toyarn strength ratio is lower for rotor yarns. A minimum of 90 to 100 fibers is necessary, compared to 50 for ring spun yarns, which prioritizes finer fibers. Length itself is of lower importance, but uniformity of length is necessary. Other important factors are cleanliness, lower trash content and fewer neps and seed coat fragments. Chapter 8/page 6

Cotton quality Table 8.2 Importance of fiber properties for different yarn spinning systems Ring spinning (and Compact spinning) 1. Length/Length uniformity 2. Strength 3. Cleanliness 4. Fineness 5. Short fiber content Open end rotor spinning 1. Strength 2. Fineness 3. Length/Length uniformity 4. Cleanliness Air jet spinning (and Vortex spinning) 1. Fineness 2. Cleanliness 3. Strength 4. Length/Length uniformity 5. Friction/Surface properties

Air jet spinning For air jet spinning, length and length uniformity are again very important, because roller drafting systems are used, as in ring spinning systems, but at higher speeds. More significant is the fact that 10 to 15% of the fasciating fibers have to hold the parallel yarn core together. Cleanliness is of the highest importance, as the air nozzles may build up dust deposits and air streams can be disturbed by trash particles (Deussen and Knecht 1995; Ghorashi 2000; Wulfhorst and Külter n.d; Schenek 1984; Klein n.d.). The following cotton fiber properties are important for different yarn spinning systems (see Table 8.2): • • • • •

length, length uniformity and short fiber content strength and elongation fineness and maturity (micronaire and maturity or fineness) cleanliness (neps, seed coat fragments, trash, dust, foreign matter) surface properties (friction/wax content, honeydew etc, dust, chemical residues) • structure and crimp (shape, bending properties, convolutions, compression behavior, crimp). Other important parameters are not yet or still only partially included in cotton classing. USDA–AMS states (1999): USDA classification currently consists of determinations of fiber length, length uniformity, strength, micronaire, color, preparation, Chapter 8/page 7

Cotton Trading Manual leaf, and extranous matter. Research and development for the technology to rapidly measure other important fiber characteristics, such as maturity, stickiness, and short fiber content, continues. Nonwovens production and demand for fiber quality Nonwovens production has shown remarkable growth in recent years. In Europe and in the US, the conventional spun yarn sector has stagnated while nonwovens production has continued to expand. Cotton is used in small amounts for nonwovens made of staple fibers, but more than 98% of nonwovens are man-made fibers (MMF). Reasons for the popularity of MMF are uniformity of fibers, cleanliness and consistent production quality, resulting in better product quality. Important fiber properties for nonwovens made of staple fibers include: • • • • • • • • • • • • • • • •

fiber length and uniformity fineness and uniformity of fineness crimp surface structure shape/cross section cleanliness density/specific weight strength elasticity, elongation, modulus bending behavior temperature stability water absorbency and swelling behavior stability against acids and alkalis light and oxidation stability stability against microbes electrostatic behavior.

Linters quality Linters, the fuzz of the seed, is used for producing pure cellulosic products such as film, skin for sausages, medicine tablet coverings, special papers including share certificates and dollar notes, lacquers and many other products, such as dynamite. Important quality parameters are: • • • •

cellulosic content visual grade, cleanliness, color linters fiber length (first cut, second cut) polymerization grade (average number of monomers in polymer chain) • bacterial and thermal damage. Chapter 8/page 8

Cotton quality Grading is according to standards similar to the cotton lint standards; linters trading is also similar to cotton trading. Linters of second cut quality have the following typical constituents: cellulosic 73%, water 8%, fatty matter and waxes 2%, pectines 1%, proteins 2%, ash content (anorganics) 2%, sand and foreign matter 1%, seed coats 11% (Temming, Grunert and Huckfeldt 1972). First cut linters contain longer linters fibers and are of better quality than second cut. Mill run linters are linters from a one-stage delintering process. Motes are linters separated together with trash, which when cleaned again may be used for low-grade products. Throughs are unusable trash parts of the delintering process. Linters are pressed into bales, from low density (250 kg/cubic meter) to high density (500 kg/cubic meter).

Cotton fiber quality demands for classing and HVI measurement Micronaire

Definition ‘Micronaire’ is an arbitrary unit and lacks a precise engineering definition. An airflow instrument is used to measure the air permeability or resistance to airflow through a plug of cotton of a constant mass of cotton fibers compressed to a fixed volume. It is measured on an arbitrary scale developed and maintained by USDA (Heap 2000, 2002; Lord and Heap 1981; Ramey 1982; Steadman 1997). Micronaire measurement gives an indication of fiber fineness and maturity as well as additional surface properties. Theoretically, the airflow resistance of a given cotton should be strongly related to the inverse square of the average fiber specfic surface (surface area per unit volume); this has been confirmed by experiment. In principle, coarse fibers would have a high air permeability, high micronaire value, while fine fibers would result in a low air permeability, low micronaire value.

HVI-testing micronaire For HVI measurements, 10 g of cotton is measured into a chamber of fixed dimensions. The chamber is closed and compressed air passed through the cotton sample. The amount of air flowing through the sample in a fixed time is measured and gives the ‘micronaire value’. An instrument scale, defined by USDA calibration cottons from low to high, delivers the micronaire value.

General measurement Micronaire-testing has been standardized by ASTM as D1448-90, BSI 3181, ISO 2403 and other national standards. Most micronaire instruChapter 8/page 9

Cotton Trading Manual ments measure the rate of airflow when pressure drop is held constant, but some measure the pressure drop at a constant rate of airflow. In either case, the result is converted to a micronaire reading, either by means of a calibrated scale on the instrument or by a suitable conversion formula, or by integrated software. Historically, the inventors of micronaire instruments measured gravimetrically the cotton fineness, based on cotton mass in micrograms per inch of fiber length and used these values as a basic scale. Calculating the mean fiber fineness of a cotton sample in decitex (dtex) by the formula: micronaire value divided by 2.54 goes back to the described determination. Commonly micronaire is given without dimensions.

Range of test values The range of international cotton species is from about 2.5 to 8, the usual range of Upland cottons being from 3.5 to 5.5. An ideal range of micronaire for Upland cottons has been defined by USDA as ‘premium range’ from 3.7 (USDA code 37) to 4.2 (USDA code 42). Micronaire values (USDA–AMS 1999): under 3.0 4.0 5.0 above

– – –

2.9 3.9 4.9 5.9 6.0

very fine fine medium light coarse coarse

Reproducibility and possible testing tolerances Micronaire values of cotton are influenced during the growing period by environmental conditions including water supply, temperature, sunlight times, plant nutrients and extremes in plant or boll population. Micronaire variation from bale to bale, within a production lot or even within a bale indicates variation of other quality parameters and predetermines the variations of processing parameters and fabrics. By referring to international round trials such as the Bremen Roundtest over a period of more than three decades, Hadwich and Schenek (1985) established that micronaire gave the best test results. Differences of 0.1 units may be measured by lab-to-lab reproducibility, 76% of results being within tolerance (USDA 1997 crop). Accuracy is at +/- 0.150 at a precision of +/- 1.000 units. Testing tolerances for arbitration at +/- 0.3 micronaire units are used for Bremen Cotton Exchange Arbitration.

Chapter 8/page 10

Cotton quality HVI – Length (staple length)

Definition Length in cotton trade and industry was defined in early days as ‘classers length’ or ‘staple’ or ‘staple length’. The staple is pulled manually by classers or trained persons and represents the typical length of a sample of cotton fibers, based on the characteristic fiber length distribution of cotton. The staple length is then compared to cotton length standards. Long staple cottons are necessary to produce fine cotton yarns. Staple is internationally reported in 1/16th of an inch; in China, Russia and some other countries it is reported in millimetres (mm).

HVI-testing length HVI length is defined as the average length of the longer half of all cotton fibers of a given sample (= upper half mean length, UHM). It is reported in either 100th or 32th of an inch. The basis of HVI length measurement is the span length distribution measurement of a clamped fiber sample, from which UHM is calculated. It is measured by passing a beard of parallel fibers through a sensing point. The beard is formed when fibers from a sample of cotton are grasped by a clamp, then combed and brushed to straighten and make the fibers parallel (USDA–AMS 1999).

General measurement The fiber length distribution or fiber length array, either measured manually or by modern single fiber length measurement (e.g. AFIS), giving length distribution by number, is the basis of length measurements. Other possibilities are the traditional comb sorter methods (SuterWebb, Johannsen-Zweigle, Balls-Sorter, Shukov-tester etc), which deliver length distribution by weight, or automated comb-sorter like Almeter, which delivers length distribution by cross section (close to number-distribution). Fiber length distribution may give mean length, coefficient of variation of length (uniformity), upper half mean length (‘upper quartile length’), short fiber content and longest fibers (Grignet 1979; Steadman 1997; Wulfhorst and Külter n.d.). Span length methods may deliver calculated upper half mean length, mean length, uniformity index, 2.5% span length, 50% span length, uniformity ratio, floating fiber index and short fiber index (SFI) (Steadman 1997).

Chapter 8/page 11

Cotton Trading Manual Table 8.3 Upland length conversion chart (USDA) Inches

32nds

Inches

32nds

0.79 & shorter 0.80–0.85 0.86–0.89 0.90–0.92 0.93–0.95 0.96–0.98 0.99–1.01 1.02–1.04 1.05–1.07 1.08–1.10

24 26 28 29 30 31 32 33 34 35

1.11–1.13 1.14–1.17 1.18–1.20 1.21–1.23 1.24–1.26 1.27–1.29 1.30–1.32 1.33–1.35 1.36 & longer

36 37 38 39 40 41 42 43 44 & longer

Range of test values For Upland cotton, the HVI-length ranges from 0.79 inch and shorter (24/32nds and longer) to 1.36 inch and longer (44/32nds and longer) (Table 8.3). International short staple cottons may be shorter than one inch, and extra-long cottons may be longer than 44/32nds inch. According to El Attal (1986), there are the following length classes for cotton species: short staple, medium to short staple, medium staple, medium to long staple, long staple and extra-long staple.

Reproducibility and possible testing tolerances For HVI-testing reproducibilty of staple lengths is in the range of half 32th of an inch. Length differences may be measured at permitted tolerances of 0.02 inches by a lab-to-lab reproducibility of 78% of all results within these limits. Accuracy is at +/- 0.018% at a precision of +/- 0.012 inches. Length testing is in the same range of exactness as micronaire measurements or better. For classers’ determination reproducibility is in the range of 1/32th of an inch. HVI – Uniformity Index

Definition The Uniformity Index is defined as the ratio between the mean length and the upper half mean length of the fibers, and is expressed as a percentage. If all the fibers of a sample were of the same length, the mean length and the upper half mean length would be the same, and the uniformity index would be 100. As there is a natural variation of Chapter 8/page 12

Cotton quality length, the Uniformity Index will be always less than 100, typically in the range of 77 to 85 for Upland cottons (USDA–AMS 1999).

HVI-testing Uniformity Index Measurement according to length determination.

General measurement Commonly length differences can be determined as a coefficient of variation, expressed as standard deviation divided by the mean value multiplied by 100%.

Range of test values For Upland cottons, USDA gives the following ranges: Degree of uniformity HVI Length Uniformity Index (%) Very High High Intermediate Low Very Low

Above 85 83–85 80–82 77–79 Below 77

Reproducibility and possible testing tolerances Cotton with a lower Uniformity Index may have a higher amount of short fibers, resulting in processing problems, unevenness and higher hairiness of yarns. Length uniformity can be measured at a lab-to-lab reproducibility of 1.0%, where 84% of all results were within these limits. Accuracy is at +/- 1.200% at a precision of +/- 0.800%. HVI – Strength

Definition Cotton fiber strength is measured in grams per tex (g/tex). A tex unit is equal to the weight in grams per kilometer of fibers (or yarns). Gram is the mass unit and gramforce the force unit used in the US. The strength of fibers is reported in grams (force) required to break a bundle of cotton fibers of the size of one tex fineness.

HVI-testing strength HVI instruments are used to determine cotton fiber strength. For HVI measurements, strength measurements are made on the same fiber beard (fiber bundle) that is used for measuring fiber length. The fiber Chapter 8/page 13

Cotton Trading Manual beard is clamped between two sets of jaws 1/8 inch apart. The force required to break the fibers is determined, the amount of fibers calculated and the resulting strength in gram per tex reported.

General measurement Traditional means of measuring fiber strength were Pressley and Stelometer instruments, which are still in use in some countries (see page 25).

Range of test values The following range is given by USDA–AMS (1999) for Upland cottons: Degree of strength

HVI – Strength (grams per tex)

Very Strong Strong Average Intermediate Weak

31 and above 29–30 26–28 24–25 23 and below

Reproducibility and possible testing tolerances As the weight of the sample cannot be determined directly, exact calibration of the HVI instrument and defined humidity and temperature conditions are essential to achieve correct strength results. The strength of cotton is predetermined by the species. Pima cottons are usually stronger than Upland cottons. Strength is difficult to measure, but HVI strength is more reliable than traditional strength testing. Lab-to-lab reproducibility is in the range of 1.5 gram/tex of 74% of results being within limits. Accuracy is at +/- 1.5 gram/tex and precision at +/- 1.0 gram/tex. HVI – Color

Definition For HVI instruments, color is defined by the degree of reflectance (Rd) and the yellowness (+ b) of the cotton sample. Reflectance indicates how bright or dull a sample is; yellowness indicates the degree of color pigmentation. As cotton color is typically natural white to yellow, it is not the true color but only the yellowness (+ b) that is measured.

HVI-testing color A three-digit color code is used for HVI. The color code is determined by locating the point at which the Rd and + b values intersect on the Chapter 8/page 14

Cotton quality 4

5

6

7

8

9

1 2 GM SM 3 M

80

12

13

11

16

17

18

LT. SP. 12

SPOTTED

22

41

13

32

23

42

70

TINGED

33

51 Rd (% Reflectance)

15

WHITE

31

5 LM

14

21

4 SLM

Light

11

10

24

6 SGO

Y.S.

43 52

34

25

61 53 60

7 GO

44 35

62 54

63

71

Dark

82

50

85 81

84

83

40 Decreasing yellowness

+b

Increasing yellowness

8.1 HVI color grades for American Upland cotton (source: USDA–AMS).

Nickerson-Hunter cotton colorimeter diagram for Upland cotton (Fig. 8.1) or for Pima cotton (Fig. 8.2).

General measurement The color of cotton is determined in classing by visual comparison with cotton standards. For measurement, the Nickerson-Hunter colorimeter has long been used for classing. In the future color may also be Chapter 8/page 15

Cotton Trading Manual

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

80

Light

1 2 3 70

Rd (% Reflectance)

4

5

6

Dark

60

50

40 Decreasing yellowness

8.2

Hunter’s +b

Increasing yellowness

Color chart for American Pima cotton (source: USDA–AMS).

determined by CIE color measurements, used in dyeing control (Hequet n.d.).

Range of test values There are 25 official color grades for American Upland cotton, plus five categories of below-grade color (Tables 8.4, 8.5). USDA maintains physical standards for 15 of the color grades. The others are descriptive standards. Chapter 8/page 16

Cotton quality Table 8.4 White color grades of US Upland cotton (USDA) Good Middling Strict Middling Middling Strict Low Middling Low Middling Strict Good Ordinary Good Ordinary Below Grade

(GM) (SM)** (M) (SLM) (LM) (SGO) (GO)

11* 21* 31* 41* 51* 61* 71* 81

* Physical standards available. Below grade descriptive only. ** Short Term (SM) according to Upland Color Chart

Table 8.5 Other color grades of US Upland cotton (USDA) Light

Spotted

Spotted

Tinged

Yellow Stained

GM SM M SLM LM SGO GO Below Grade

12 22 32 42 52 62 —

13 23* 33* 43* 53* 63* —

— 24 34* 44* 54* — —

— 25 35 — — — —

82

83

84

85

* Physical standards available All others descriptive

Reproducibility and possible testing tolerances The color of cotton fibers can be affected by rainfall, frost, insects, pests and fungi as well by bacteria; cotton fibers may also be stained by contact with soil, grass, leaf and foreign matter contaminations. Lab-to-lab reproducibility of color Rd is 1.0 units, color + b at 0.5 units. Accuracy is at +/- 1.000 units for color Rd and 0.500 units for color + b. Precision is at 0.700 units for color Rd and 0.300 units for color + b. HVI – Trash

Definition Trash is the non-lint material in cotton, such as leaf and bark, bract stems and other parts of the plant. Trash is generally included in cotton Chapter 8/page 17

Cotton Trading Manual classing grade, like color, determined by classer’s eye and compared to cotton standards.

HVI-testing trash Trash is measured in two ways: first, by scanning the surface of a cotton sample with a video camera, the percentage of the surface area occupied by trash particles can be calculated; second, the classer’s leaf grade is a visual estimate of the amount of cotton plant leaf particles in cotton. There are seven leaf grades, designated as leaf grades 1 to 7, and all are represented by physical standards. In addition, there is a below-grade, which is descriptive.

General measurement Trash particles can be separated manually or mechanically by instruments (Shirley Analyser, Trash Separator, MDTA, AFIS, FQT and others), and trash content may be given as weight percentage (gravimetrically). Trash measurements are used in the textile industry but not for classing (Steadman 1997; Shofner and Shofner 2000; Shofner et al. 2002; Mor 1998, 2000; Stuhlfauth 2002).

Range of test values The range of average trash values for US Upland cottons is 0.12 to 1.21% (Table 8.6).

Reproducibility and possible testing tolerances HVI-Trash units of 0.1% area by lab-to-lab measurements give a reproducibility of 80% of values within limits. Accuracy is at +/- 0.100% and precision is at +/- 0.040%.

Table 8.6 Relationship of HVI trash measurement to classer’s leaf grade (US Upland cotton) Trash measurement (4-year average) (% area)

Classer’s leaf grade

0.12 0.20 0.33 0.50 0.68 0.92 1.21

1 2 3 4 5 6 7

Chapter 8/page 18

Cotton quality Fiber quality demands for future classing and selected measurements Moisture content This data product is particularily important for gin-based classing, which may increase in importance in the future. Exact testing needs moisture control (eg strength). Moisture content is water weight relative to the dry weight of the cotton (Shofner and Shofner 2000; Shofner et al. 2002). Short fiber content Short fiber content of cotton is commonly defined as fibers shorter than 0.5 inch or 12.7 mm. Short fibers contribute to yarn irregularities, lower yarn strength and increased hairiness. To produce fine and regular cotton yarns, combing out of short fibers (along with neps and impurities) is necessary. Short fiber content may be measured by AFIS instruments (although CV (L) of lab-to-lab round tests is still at a range of 10 to 15%) (Schenek et al. 1998; Schleth 2000; Shofner et al. n.d.).

AFIS measurements Fiber length distributions have been established in research by manual measurement of single fibers. The true mean fiber length can be calculated as the sum of all lengths divided by the number of fibers. The true short fiber content can be determined as percentage of fibers shorter than 1/8th inch (12.7 mm). As single fiber measurement is very tedious and time-consuming, it is not used for industrial purposes. Comb-sorter methods were developed to overcome that problem and were common in the industry until about 1970, but reproducibility of results was insufficient for trade purposes and methods were still too slow (3 to 4 hours) (Shofner et al. n.d.). Starting around 1980, Dr F. Shofner developed the AFIS System (Advanced Fiber Information System), which is marketed by Zellweger Uster Knoxville (Shofner et al. n.d.; Schleth 2000; Ghorashi 2000). By this method, a fiber length array similar to a single fiber length distribution is determined. An aeromechanical separator individualizes a tuft or sliver of fibers and separates them from the trash and dust. Individual fibers and neps are transported by a high-velocity airstream to an electro-optical highspeed sensor and measured by a near-infrared ribbon beam. A second sensor measures trash and dust particles. The basic AFIS outputs for length distribution are as follows: mean length, CV (coefficient of variation) of length and short fiber content Chapter 8/page 19

Cotton Trading Manual by number. Mean length, CV of length, upper half mean length and short fiber content by weight are calculated. In industry, AFIS is mainly used for nep testing in slivers and raw cotton samples. Trash and dust distribution measurements are possible. Future possibilities may include maturity. For trade purposes, however, AFIS is still too slow; quicker instruments are being developed and field trials are progressing. Elongation Elongation may be measured on single fibers, as applied to man-made fibers, but many individual fibers have to be measured. Results of single fiber elongation measurement may range from 4 to 25% in a sample (Steadman 1997; Shofner et al. 2002). Instruments to measure single fiber strength and elongation are available, but these are too slow for commercial application (eg Textest Fafegraph). Elongation may also be measured on bundles, eg by HVI instruments, but here precision is low. The HVI mean elongation for typical cottons may range from 5 to 10%. Measurements for research purposes can be made by the manual Stelometer Instrument. But as the length basis for elongation determination is very small (distance length for elongation 1/8 inch = 3.2 mm) an elongation of 10% would mean an elongation of 0.32 mm, which is very difficult to measure mechanically. The same is true for HVI instruments. So bundle elongation measurement results are relatively poor. CIE – Color There are three essential elements involved in color response measurements: a sensor, such as the eye or a photo detector; light; and an object. Any variation in any of these elements (eg the quality of light, the health of the eye, the quality of the photo detector or the size, shape and texture of the object) will alter the color response (Hequet n.d.). The color of an object can be described in three dimensions: • the predominant color or hue: whether the perceived color is red, purple, green, yellow etc. • the degree of lightness, darkness or greyness. This ranges from white, through grey and down to black, and is directly related to light reflection • the color intensity, saturation or chroma: whether the color is weak, greyish, strong etc. Color instruments using photoelectric cells and light filters have been developed to simulate the way the eye perceives color in daylight and then display the light intensity from the sample in numeric terms. Different ‘true’ color measurement principles are known, the common Chapter 8/page 20

Cotton quality system being CIELAB color measurement (CIE), which measures L (lightness or reflectance) expressed on a ‘y’ scale, a (red–green component), expressed on an ‘x’ scale, and b (yellow–blue component), expressed on a ‘z’ scale in three-dimensional color. Numbers produced from these scales give the exact color value of cotton, for example. CIE measurement, already used for wool and for printing, may have applications in cotton classing in the future. Future instrument color grade CIE color measurement on lint only may be used for determination of color grade. Systems are under investigation. Trash identification by size, shape, trash color and type (extraneous matter) Optical determination of different trash particles by image analysis systems and usage of true color meaurement systems will soon be possible (Mor 1998, 2000; Shofner et al. 2002). Neps, seed coat fragments Neps are visible entanglements of fibers in the size range of about 1 mm diameter, which cannot be separated to single fibers. Neps may be formed directly by ginning or by mechanical opening and cleaning processes. Traditional nep testing was done by hand by means of magnifying glasses and special lights; for slivers special testers are available. Modern nep testing is possible by AFIS, but this is too slow for commercial HVI testing. New systems are being developed, and the Fiber Quality Tester (FQT) by Lintronics, for example, is able to measure neps and seed coat fragments in cotton as well as stickiness (Mor 1998; Shofner et al. n.d.). The basic data product is neps per gram. Seed coat fragments are parts of the seeds, destroyed in ginning or cleaning, with adhering lint fibers, which makes it difficult to separate seed coat fragments from lint. Stickiness Stickiness on cotton lint (see below on contamination) can be caused by secretions from insects (honeydew) or natural plant sugars resulting from nectaries on the cotton plant or cellulose precursors in the cotton boll. Other reasons include occasional seed oil or other oily contaminations and in some cases fungi and bacteria. Most sticky problems are related to insect honeydew contamination on cotton lint. Chapter 8/page 21

Cotton Trading Manual Insect honeydew is most often caused by aphids, whiteflies and mealy bugs, all members of the insect order Homoptera (Perkins 1983; Watson 2002). These insects ingest plant juices, extract proteins and other nutrients from them and then expel excess sugars in the form of honeydew. These sticky liquid droplets fall on the lint and may cause severe stickiness problems in the yarn manufacturing process. Insect honeydew is not evenly distributed in cotton and may consist of different sugar types. At the field level, insect infestation may reduce yield or even destroy the complete harvest. Natural sugars are produced by leaf and floral nectaries on the cotton plant as well as sugars present on fibers from newly opened bolls. Stickiness caused by natural sugars is evenly distributed and usually disappears on storage. Stickiness accumulating over a period of days in a mill may cause sufficient build-up that even machine destruction is possible. ITMF-recommended measurement of stickiness is the Manual Thermodetection device, according to CEN–Standard Proposition CEN/TC 248. Automatic systems for determination of cotton fiber stickiness are being developed and tested. An automatic thermodetection plate device (H2SD–CIRAD) and an automatic thermodetection rotating drum device (FCT-Lintronics) are under examination, and standards for testing have been worked out in Europe (CEN/TC 248). As stickiness is commonly unevenly distributed, repeatability of results is poor and an important issue (Schenek 2002). Maturity Maturity is the degree of fiber wall development. It may be expressed as either relative wall area or relative wall thickness. Relative wall area is the cross-sectional area of the fiber (excluding lumen) divided by the area of a circle having the same perimeter as the fiber. Relative wall thickness is twice the average wall thickness divided by the diameter of a circle having the same perimeter as the fiber. Maturity ratio is defined for maturity measurement and has no units (Heap 2000, 2002; Lord and Heap 1981; Ramey 1982; Steadman 1997). The IIC-Shirley Fineness/Maturity Tester (FMT) is the ITMFrecommended test method, working on the principle of a double compression airflow instrument. Standards are ISO and ASTM D38181979. Fineness Fineness may be defined in two ways: gravimetric or biological (Heap 2002). Gravimetric fineness is synonymous with linear density or mass per unit length. It is given the symbol H (hair weight) and Chapter 8/page 22

Cotton quality Fineness Hs (mtex)

%

150 170 190 210 230

Percent maturity (PM)

250 270 290

Gutknecht-correlation 3.0

4.0

5.0

6.0 Micronaire

8.3

Gutknecht-correlation diagram.

has the unit decitex or militex (1 unit decitex means 1 gram fibers at a length of 10 000 metres). Biological fineness expresses the intrinsic thickness of the fiber, independent of the mass, in terms of its perimeter (or the diameter of the equivalent circle). Units are usually micrometers. Standard methods of gravimetric fineness (ISO 1973–1996, ASTM 1769, BS 2016-1973) rely on weighing a known number of fibers from various length groups of the fiber array. Measurement of biological fineness is made by determining the fiber perimeter (P) from direct microscopical measurements on transverse sections of fiber bundles. Automatic image analyzing systems are commonly in use. Direct fineness measurement is too slow for industrial application. Gutknecht-correlation As air permeability is dependent on the surface, outside structure, dimensions and bending properties of fibers, micronaire values include both fineness and maturity. A low-micronaire cotton can be either immature or fine, while a high-micronaire cotton can be coarse or mature. Chapter 8/page 23

Cotton Trading Manual The relationship between fineness and maturity has been examined by various researchers, and a correlation established by J Gutknecht and co-workers at CIRAD, Montpellier, France (Fig. 8.3) (Gutknecht 1982). This allows the determination of fineness, if micronaire and maturity are known. If the species is known to be a particular variety, for the same species grown from year to year in the same region, low-micronaire cotton would be immature and high-micronaire cotton would be mature.

Additional cotton fiber quality problems Contamination Cotton contamination means foreign matter other than non-lint plant parts, such as fabric, string, organic and inorganic matter, oily subtances and sticky residues on cotton, such as honeydew (Strolz 1999, 2001). Colored contamination parts can be detected by the foreign fiber detection systems of modern yarn clearers, if big enough. It is still nearly impossible to detect undyed or light yellow dyed polypropylene and polyethylene films and fibrillous parts of such materials (Table 8.6). Complete detection is impossible, so contamination has to be prevented on the cotton fields and during harvesting. Chemical residues Chemical residues may accumulate from insecticides, pesticides and herbicides as well as from other treatments, such as defoliation, and from residues in the soil. So, for example, DDT, prohibited for decades, can still be found in cottons produced on infested soils. The cotton plant may take up these residues and, as not needed for the growing process, will deposit most of them in the outside cuticula wax layer of the fibers. Washing off these residues is possible (and is usually done in textile processing), and modern measurements allow the detection of these residues. The Bremen Cotton Exchange regularily publishes information on these tests (http://www.baumwollboerse.de). Microbiological infestations (bacterial attack, Cavitoma infestation, Mexicali) Bacterial attack to cotton plants is a common form of infestation. The same is true for fungi. Pesticides are used to reduce bacterial impacts on cotton plants. Nevertheless in bad, damp and rainy weather conditions after boll opening and at late harvesting dates, bacterial infestaChapter 8/page 24

Cotton quality tion of cotton fibers may occur. Bacteria may affect the fibers, reducing their stability and strength. When bacteria remain on the dried fibers, under certain conditions of warmth and humidity, they may even develop in the bales long after storage and eventually destroy the cotton. Microbiological infestation can be detected by the ‘Cavitoma test’, developed at ITT (Institute of Textile Technology), Raleigh, N.C. Special chemicals are sprayed onto the cotton and color changes indicate bacterial deposits. Other detection methods include use of UV lamps, where for example the ‘Mexicali’ fungi attack can be seen as bright green to yellow spots. Green fiber spots Green fibers may eventually occur in cotton through genetic changes or other biological changes in the plant. Green fibers, as with naturally colored fibers, are very difficult to bleach out without destruction of the fibers and consequently the fabric. Colored cotton fiber spots In recent years, naturally colored fibers have been bred, reviving a practice known to the Incas in Peru at the time of the Spanish conquest of South America. Breeding and production in the US have been promoted by Sally Fox and others, while in Israel, Turkey, Uzbekistan and India natural green, brown and red cottons are grown and used for special fabric production. It is also known for colored cotton to be found in white cotton (Wulfhorst and Külter n.d.). The dyeing behavior of these colored cottons will differ from white cotton.

Selected traditional laboratory tests Historically, the first cotton tests in laboratories were made in Germany and in the USA around 1920, starting with comb-sorter length measurements, (e.g. Johannsen–Zweigle Comb Sorter, Reutlingen) as length was most important for spinning, followed by fineness measurements and fiber strength determinations. The airflow principle developed for micronaire measurement is still in use today and the bundle strength principle, the ‘Pressley Tester’, was developed around 1930. After 1950, these measurements, cheap, quick and easy to apply at that time, were used worldwide in addition to cotton classing. Pressley-strength (psi) For measurement of Pressley-strength, bundles of cotton fibers are used. The test, designed for cotton testing in the fields, was quickly Chapter 8/page 25

Cotton Trading Manual adopted by the industry and cotton trade, as it was found to be both practical and reliable. A cotton sample is hand-combed and the fibers are paralleled in the form of a flat ribbon. This is then placed in a set of special breaking clamps with no space between the jaws (O-gauge). Protruding fibers are squeezed off so that the clamps contain a cotton bundle of fibers of the same length. The Pressley instrument consists of a pivoted balance beam. The beam is slightly inclined. A free-rolling heavy weight is released to run down the inclined balance beam far enough to break the fibers held in the clamps at the other end of the beam. When the bundle breaks, the force required can be read off the beam to the nearest tenth of a pound. The two broken parts of the bundle are weighed (in milligrams) on a sensitive balance (Hequet n.d.) The results are expressed as Pressley Index (P I, strength index) as follows: PI = breaking load (pounds) divided by bundle weight (mg). The ‘Pressley-strength’ is given in psi (pounds per square inch) values, expressed as follows: Pressley-strength = 10.81118 ¥ PI - 0.12 The following ranges of values were used and are still in use in some developing countries and in international trade (Hadwich 1967; Steadman 1997): Pressley Index (P I)

Pressley-strength (0-gauge)

Cotton rating

8.8 and above 8.0–8.8 7.1–7.9 6.1–7.0 6.0 and below

95 000 and above 86 000–95 000 76 000–85 000 66 000–75 000 65 000 and below

very strong strong average weak very weak

Some Egyptian long staple cottons have recorded Pressley-strength values up to 110 000. Limitations include the inability to determine elongation and weak places in the fibers. Pressley-strength is in process of being replaced by HVI–strength. The two measurements are not directly comparable as the principles are very different, and there is no linear correlation. Stelometer-strength The Stelometer was developed to include elongation and yield a betterdefined strength (g/tex or calculated cN/tex) of cotton. The same Chapter 8/page 26

Cotton quality clamps are used as for the Pressley test, but for gauge length a distance of 1/8 inch (3.2 mm) was introduced, to improve correlation of these test values to yarn strength (Hadwich 1967; Steadman 1997). The clamps containing the fiber bundle are inserted into slots in a fixed beam and pendulum beam. The pendulum beam is released and the specimen is broken. The load necessary to break the fiber bundle is read off directly on a scale from 2 to 7 kg. A second scale graded from 0 to 40% allows an elongation reading. The Stelometer is a basic measurement for cotton, giving strength related to fiber bundle mass. Though different from HVI in breaking speed and number of fibers measured, it might be considered as a comparable basic measurement, but test results do differ from HVIstrength values. The Stelometer is used as a basic tenacity measurement for wool and defined by IWTO Test Standard 32-82 (IWTO = International Wool Trade Organization). Comb-sorter length array Comb-sorter methods to measure fiber length distribution consist of one or two beds of parallel rows of pointed needles. Many instrument types have been in use in industry, including Suter-Webb, JohannsenZweigle, Zellweger, Shukov and Balls-Sorter. The fibers in a sample are parallelized through the combs, and arrayed according to length. The different-length groups are weighed. The resulting fiber length distribution is therefore according to weight (Fig. 8.4). The following parameters can be calculated: Upper half mean length (UHM) (= upper quartile length, exceeded by 25% (by weight) of the fibers = classer’s staple length); mean length (ML); coefficient of length variation, CV (L); short fiber content (= SFC, percentage of fibers shorter than 0.5 inch, 12.7 mm). Length values are commonly calculated by number. Another partially automated system, known as Almeter, was developed in Belgium and is still in use for wool fiber length measurement (Grignet 1979; Steadman 1997). For cotton, these measurements are no longer used as they are time-consuming, dependent on operator ability and not easily comparable from lab to lab. Fibrograph The principle of the fibrograph, developed by Hertel in Knoxville in 1940, is still used for HVI-length testing. A prepared test specimen of cotton fibers is clamped by special combs. The clamped fibers are combed at their free end and then scanned by light – the variation of Chapter 8/page 27

Cotton Trading Manual 60 mm 50

Staple by fiber weight

60 mm 40

40 Fiber length

Frequency of weight

30

L¢ g = 22.6 mm 20

20 10 0 0

10

20

30

40

50

60

70

80

90

10 20 % 30

% 100

Cummulative frequency 60 mm 50

Frequency of 60 cross-section

Staple by fiber cross-section

mm 40

Fiber length

40 30

20

20 10 0

0

10

8.4

20

30

40 50 60 Cummulative frequency

70

80

90

% 100

10 20 % 30

Cotton comb sorter length array.

density of the different length groups of clamped fibers (= span length) is recorded in a special type of length frequency curve, called the Fibrogram. From these data UHM length and mean length may be calculated. A later instrument, the Digital Fibrograph, used the span length principle to measure 2.5% span length (= classer’s staple length) and 50% span length. In general fibrograph measurement has been replaced in the industry by HVI-length measurement (Steadman 1997).

Varieties and types of cotton Cotton-producing countries and regions Cotton is produced in about 60 countries worldwide on a planting area in the range of 32 million hectares (320 000 square km, 80 million acres). The growing area is limited by climatic conditions, and ranges from South Africa, Argentina and Australia in the southern hemisphere to Uzbekistan and Kazakhstan in the northern hemisphere. Moderate to warm temperatures, with sunny weather and night temperatures of no less than 10 to 14°C during the fiber-growing period and no frosts, enough water and nutrition for the plant and fiber development are necessary to produce high-quality cottons. Insect infestation and pests as well as weeds can damage the growing process and affect the cotton quality negatively or even destroy the crop before harvesting. Chapter 8/page 28

Cotton quality The amount of cotton produced worldwide ranges between 19 and 23 million tons per year, or approximately 87 to 92 million bales (standard bale 480 lb) (Bremen Cotton Exchange 2002; Schenek 2000). Due to growing consumption it may continue to rise slowly.

Cotton varieties The term ‘variety’ is mainly used in the sense in which cotton growers use it, as compared to botanical varieties, which differ from regular species by one or more definite and permanent hereditary characteristics. The cotton varieties listed in ‘variety tables’, such as those published by the Bremen Cotton Exchange, are not always distinguishable by such definite marks, although the apparent differences may be much more striking, as for example big-bolled, vigor in growing, earliness, large-leaved or low-growing. Different agricultural varieties are known as ‘strains’. These are not entirely uniform and do not breed true to type in all cases. Genetically, they are of hybrid constitution, and various reversions and combinations of ancestral characters appear in actual generations. The cotton plant belongs to the plant family Malvaceae, or mallow family, containing 39 genera and some 300 species. The genus Gossypium L. consists of annual or perennial herbs, shrubs or rarely trees, but usually grown annually for cotton production (Gutknecht 1986; Stead 1981). More than 37 Gossypium species are known, most of which are wild, but for commercial purposes four cultivated species (Gossypium hirsutum, G. barbadense, G. arboreum and G. herbaceum) are the basis of world cotton production. The first group of cultivated cottons belongs to the so-called old species or cottons of the Old World or Asiatic species. G. arboreum and G. herbaceum are diploid species, with a genome A including 13 chromosomes (2n = 26 chromosomes). The Chinese species G. nangking belongs to the same group. These cottons have been grown for thousands of years. Cottonseed residue in early human dwellings found in Pakistan dates back to around 7000 BC. These species produce cottons with short staple length, often less than 1 inch, with greater diameter (20 to 25 mm) and mostly of high maturity. Fibers can be very coarse, up to extremes of Micronaire 8.0 for Pakistani Desi cottons. Cotton species of these types are still planted in Pakistan and India. The second group of cultivated cottons belongs to new cottons or cottons of the New World or American species. G. hirsutum and G. barbadense, the important ones, are tetraploid species, combining genomes A and D, with 26 chromosomes (2n = 52 chromosomes). In the same group are the species G. peruvianum, G. purpurascens and Chapter 8/page 29

Cotton Trading Manual G. brasiliense. These new cottons have also been in human use for thousands of years, with cotton textile remnants found in Mexico, for example, dating back to about 5800 BC. The New World species must be biologically younger, as they have double the number of chromosomes compared to the old species. G. barbadense cottons can be traced back to the West Indies, Central and South America, probably Peru, and are known today as Long- and Extra Long-staple cottons, Egyptian cottons and the US Pima cottons both having the same origins. Long-staple cottons have finer fibers with smaller diameters (10 to 15 micrometers), are the strongest cottons known (up to 40 g/tex) and have staple lengths from 1 1/8th inch (36/32 inch) to 1.5 inch (48/32 inch) and more. Worldwide these cottons constitute 5 to 8% of all cottons. G. hirsutum has become the most succesful cotton species (Fig. 8.5). It is not known in the wild, but is widely distributed in cultivation all over the world. Nearly all of the American Upland varieties belong to this species. Its ancestors include G. mexicanum torado, from Mexico. Today, probably more than 85% of all cottons used for commercial cotton production are G. hirsutum species. Worldwide there are about 460 varieties used for commercial cotton production, most of them Upland species. In the USA, more than 75 varieties are planted, in India about 38, in Pakistan about 30, in China about 17 and in Uzbekistan about 16.

Cotton breeding and resulting changes of quality parameters Traditional cotton breeding uses three different principles. These are selection, searching out and propagating from certain outstanding plants; hybridization, the essential part of which is crossing different races; and acclimatization, which consists of transferring strains or

Upland G. hirsutum

G. nangking Sea island

G. barbadense Pima G. brasiliense

8.5

G. herbaceum Giza G. arboreum

Distribution of main cotton species.

Chapter 8/page 30

Cotton quality varieties from one region to another and growing them in the new habitat. From the beginning of the twentieth century the application of Mendel’s laws of heredity to plant breeding in agriculture, and use of synthetic fertilizers, have resulted in enormous gains in production. Genetically engineered cotton: Bt cotton The second big step in breeding was the industrial introduction of gene transformation technology beginning around 1990, based on the DNA analysis of Watson and Crick in 1954. New modified varieties already introduced into the cotton market include the Bt cottons, in which genes taken from the soil bacterium Bacillus thuringiensis were inserted into the cotton genome. The primary objective is insect control and reduced pesticide usage, along with herbicide resistance. Breeding of higheryielding or superior fiber properties might be the next targets of genetic research. According to cotton breeders, genetic engineering of cotton is just beginning. Cotton breeding time schedule The time from breeding to commercial planting of seeds is still six to seven years at least and usually up to ten years. Half of the time is necessary for breeding and selection, the remainder for seed multiplication. As cotton deteriorates in seven to ten years, a new variety has to be selected while the previous variety is being grown. Important species US Pima cotton was bred on the basis of Egyptian cotton seed. Egyptian cottons can be traced back to G. barbadense cottons from South America, Sea Island cottons, which were introduced into Egypt by a French engineer, Jumel, who began breeding experiments in 1820. Yuma is a variety of Egyptian Mitafifi (Afifi) cotton, bred by the USDA in Arizona. The Pima variety originated from a single stalk selection made in a field of Yuma cotton by USDA cotton breeders at Sacaton, Arizona, in 1910. Pima later became the basis of Californian San Joaquin Valley (SJV–Pima) cottons and was brought back to Egypt for cross-breeding to become the ancestor of today’s Giza cottons. The Acala variety was developed from seed imported in 1906 from Acala, in the state of Chiapas in southern Mexico, and grown by Dr DA Sounders in 1911 from the original field in Waco, Texas. Successful breeding, especially in the US, in USDA and private breeding stations such as Stoneville, Mississippi, and many others, Chapter 8/page 31

Cotton Trading Manual resulted in robust cotton types, most of them so-called ‘Upland cottons’, typified by high fiber content (yield) and strong fibers with medium or even medium to long staple length. Upland cottons are grown successfully in Australia, West Africa, Mexico, Central and South America, Pakistan, Europe; even the Former Soviet cottons, now known as Central Asian cottons, can be traced back to Upland cottons. In many cases the names of varieties (eg Stoneville 506, Deltapine DP 5415) in many cotton-growing countries indicate the wide spread of Upland cottons. Breeding influence on properties Breeding of course includes breeding of insect, pest and weed resistance, low temperature and early frost resistance and many other environmental conditions that have a bearing on cotton quality. Yield A critical factor for the cotton producer is the yield, the amount of fibers per hectare or acre, as he is paid by weight. Average worldwide yield is constantly growing: taking one recent twenty-year span, from 442 kg/hectare in the season 1981/82 season to no less than 624 kg/ha in the season 2001/02 season. Higher yields are possible, ranging from 726 kg/ha in Uzbekistan to 1559 kg/ha in Australia in the 2001/02 season (Bremen Cotton Exchange data). Breeding has made it possible to raise the lint yield from about 30% in 1950 to more than 40% today. Staple length Development of staple length by breeding and other effects is well supported by evidence. In the US, in 1928 the mean staple length of 14 million bales was 15/16th inch (30/32 inch). In 1984, for nearly the same amount of comparable cotton bales, the mean staple length was 11/16th inch (34/32 inch) (Fig. 8.6). In a similar way the percentage of long and medium to long staple cottons has increased, not only in the US but also worldwide. Temperature, water stress, lack of nutrients and breakage later in the gin can affect length negatively. Strength It was possible to develop stronger fibers by breeding. From West Africa it was reported that strength of cotton could be raised in 20 years from about 16 to 20 g/tex to 18 to 23 g/tex. Today that level is 20 to Chapter 8/page 32

Cotton quality Staple length 1/32 inch 34

33

32

31

30 1930

8.6

1950

1970

1990

Staple length 1/32 inch, 1930–90.

25 g/tex, measured by Stelometer. Long staple cottons (Egyptian or or Pima type) can have a strength of 35 g/tex and more. Elongation Fiber elongation has reduced to 5 to 6% from 7 to 9%. Elongation will become more important in the future and is being introduced into breeding programs. Micronaire Micronaire is dominated by the variety or species itself, but also by growing conditions. Long staple cottons usually have lower micronaire values (3.5 to 4.0), while medium staple cottons of Upland types show higher values (4.0 to 5.0). With the same varieties planted from year to year in the same region, micronaire values indicate more different maturity levels than fineness, which is more species-dependent. Coarser fibers give more yield, therefore cotton production has seen a trend to slightly higher micronaire values in recent years.

Description of cotton types A cotton ‘description’ is the combination of country of origin and name of growth or seed variety. A cotton ‘type’ is a physical cotton sample at the size of a bale sample, which represents a special cotton variety, a certain cotton breed grown in a specific region or country. The cotton Chapter 8/page 33

Cotton Trading Manual type is identified and used as physical example for a cotton lot or several lots, which a cotton shipper wants to sell to his customer, eg a certain spinning mill. Given the name of the sample, the cotton variety, the grade, color and staple length, micronaire limits or strength limits and the weight of the cotton to be shipped, and the price, a contract may be fixed by both parties based on that cotton type. In cases of quality differences of shipped cotton, the quality of the bales will be compared by an arbitration procedure against the cotton type that was the basis of the contract. This is the procedure of the traditional cotton trade, even though HVI measurements are more and more used in contracts and new ways of internet business may change the reliance on types. It might well be possible that measurements and high-resolution sample pictures sent digitally will be used in businessto-business trade or even to the final customer, or between buyer and seller with long-term business associations (Shofner and Shofner 2000; Shofner et al. 2002).

Impact of production and ginning conditions on quality Impact of cotton production on quality In many countries today cotton growing is a highly technical industry, requiring large investments, particularly for fertilizer, irrigation water and pest control. Insect pests are probably the major impediment, and because their control is so expensive as well as critical to profitable cotton growing, optimized usage of insecticides, pesticides and herbicides – so-called integrated pest management – in addition to water management, is obvious (PC Jones n.d.; Beltwide Cotton Conferences). There are also special market niches for organic cottons or naturally colored cottons, produced without chemical feritilizers and other chemicals, but mostly resulting in lower yields and poorer fiber quality. Primary factors affecting growth and development of cotton plant and fibers are variety, soil conditions, climate, humidity, solar radiation and temperature, wind and water supply, rain-grown or irrigated.

Seed selection Seed selection is the most important contribution to maintenance of excellent cotton quality and to reduction of variety deterioration. In some cotton-producing countries, for example, Egypt, cotton seed is controlled by the government in order to maintain quality. The selected variety dominates both fiber quality and yield. Chapter 8/page 34

Cotton quality Soil and nutrition Soil fertility and or additional nutrition is the basis of effective cotton production. With proper handling, soils retain their richness and continue to yield well. Elements that are scarce in the soil must be supplied in the form of manures or artificial fertilizers. Recommended nutrients include: phosphorus, potassium, magnesium, calcium, boron, zinc, manganese, iron, copper and sulphur. Too much of these minerals can have negative effects on fiber quality. In Brazil, for example, too much iron in the soil may result in red-colored fibers, which cannot be bleached out or in catalytic defects during dyeing processes. Growth enhancers are used widely. Nitrogen–phosphorus enhances maturity, increases yield, develops the plant root system and helps to overcome adverse conditions. Too much nitrogen causes the plant to grow too tall and to fruit later, reducing fiber quality.

Water supply (irrigated, rain-grown) The peak of water requirement is during blooming at an average rate of 0.3 to 0.4 inches of water daily. Lack of water negatively affects strength and elongation of fibers and micronaire values. Water supply can be from rain or by irrigation. Cotton from irrigated land production will deliver the finest quality (Arizona, New Mexico, California and Australia, for example). Negative effects from irrigation can include a build-up of high salt concentrations in the soil, resulting in infertility and soil erosion. Desertification in cotton-growing areas of Central Africa is an increasing problem. The question of water supply and mounting water costs (eg in California) will be a critical issue for future cotton production in many cotton-growing areas.

Weather conditions Under favorable weather conditions, the cotton plant follows a systematic growth path, with a well-defined and consistent development and physiological pattern (PC Jones n.d.). In addition to a reliable and sufficient water supply, cotton needs enough sufficient sun and accumulated heat units for optimum growth. Night-time temperatures should not be below 10 to 14°C. Dry weather conditions after the growth of the fibers are necessary for drying and keeping fibers dry until harvesting to avoid microbacterial attacks. Bad weather conditions, such as rain before harvesting, lead to bacterial attacks resulting in fiber destruction and color changes. Chapter 8/page 35

Cotton Trading Manual Pests and disease control Commercial-scale pests that reduce fiber quality include Fusarium wilt, Verticilium wilt, Cotton root knot and Bacterial blight. Fusarium wilt (Fusarium vasinfectum Atk.) is a cotton disease commonly known as ‘black heart’ and is caused by fungi from infected soils entering the roots. The disease causes a stunting or dwarfing of the main plant stem, and the yellowing spreads into the leaves, which fall prematurely. Yield is reduced considerably and fiber quality goes down. Verticilium wilt (Verticilium albo-atrum Reinke and Berth.) is similar to fusarium, but not so harmful. Cotton root knot (Heterodera radiciola, Greef, Muell.) is caused by nematodes, small worms that enter the roots of cotton plants, multiply and cause swellings. Bacterial blight or Angular leaf spot (Pseudomonas malvacearum EFS) attacks the leaves and bolls, particularly in rainy weather. Other diseases are boll rot, mildew, leaf spot, rust and damping-off caused by fungi. Bacterial and fungi attacks can also be traced on lint fibers in cotton bales, as for example the ‘Mexicali Effect’, which can be seen under UV light as bright green to yellow infestations.

Insect control The most notorious insect pest of cotton is the Boll weevil (Anthonomus grandis Boh.), which first entered the US from Mexico in about 1890. The Boll weevil can destroy entire cotton crops or cause severe damage to fiber quality. Control by insecticides is possible if application is systematic and timely. The Pink bollworm (Pectinophora gossypiella Sound.) destroys bolls and parts of the plants and is also very destructive for cotton production. The Cotton aphid (Aphis gossypii Glov.) destroys the young leaves of cotton plants, disturbs the growing process and reduces fiber quality. Another important problem for cotton processing is the so-called ‘honeydew’, resulting from sticky insect sugar exudates and excrement on the fiber surface. Similar problems can be caused by White fly (Bemisia tabaci Genn.). Insects from other crops and neighboring fields can also attack cotton and reduce fiber quality. Insect infestation reduces fiber strength and length and maturity. Continuous insect control is therefore a necessary part of agricultural production control.

Chapter 8/page 36

Cotton quality Weed control Weeds rob surrounding plants of water and nutrition. Herbicides are used for weed control but can injure the cotton plant. Modern weed control has been facilitated by genetically engineered cotton varieties with enhanced herbicide resistance. Harvesting The cotton plant characteristically matures with open bolls at the bottom of the plant, green bolls in the middle and flowers on the top, all at the same time. By hand picking it is possible to harvest the open bolls only and to return for the rest later, harvesting perhaps two or three times. In India, Pakistan, Central and South Africa hand picking remains the usual harvesting technique. Machine picking, which is necessary in industrial countries, is made possible by spindle-picking harvesting machines that allow selection of more or less open bolls and repicking. But non-lint material is harvested too. If stripper-type harvesting machines are used, all the bolls, whether mature or not, are harvested, including all remaining leaves, parts of the stalk etc. This method is practiced in north-west Texas owing to the short growing season. Cotton quality depends on the harvesting methods used. Given the same cotton variety, hand picking would allow the best cotton fiber quality, as is proven in West Africa. Machine picking by spindle picker generally delivers cotton of normal to good quality, whereas stripper harvesting of the same cotton results in a cotton of lower quality, especially in terms of variation in maturity. Defoliants In the US, especially in areas where stripper-harvesting is used, the cotton plant is defoliated before harvest. Defoliation kills the leaves and causes them to drop off. Once the leaves are destroyed, plant growth stops. The purpose of defoliation is to reduce the amount of trash entering the gin and thus delivering a better grade. Defoliation reduces the food supply to insects, thus stickiness, and lowers the seed cotton moisture before ginning, enabling easier cleaning during ginning. Definitions of organic and other agricultural practices The primary goal of organic agriculture is ‘to optimize the health and productivity of interdependent communities of soil life, plants, animals

Chapter 8/page 37

Cotton Trading Manual and people’ (Organic Trade Organization, OTA). However, organic agricultural practices cannot ensure that products are completely free of residues. Specific methods are used to minimize pollution from air, soil and water (Tobler and Schaerer 2002). To produce organic cotton according to the laws of the Texas Department of Agriculture the land has to remain fallow for three years, without any crops, chemical fertilizers, pesticides, insecticides etc. ‘Integrated Pest Management’ is a strategy that focuses on long-term prevention or suppression of pest problems with minimum impact on human health, the environment and non-target organisms. Practices include application of less harmful pesticides, biological control and adoption of agricultural practices to avoid pests. ‘Conservation Tillage Production’ practices leave most of the previous crop residue (from harvest or a winter cover crop) on the soil surface to provide mulch for the soil, increase water infiltration rates and decrease wind and water erosion compared to conventional methods of seedbed preparation.

Storage and module averaging Storage of seed cotton can result in reduced cotton fiber quality if, for example, humidity is too high and bacteria or other microbes develop on the cotton. USDA research in 1972 showed that storage of seed cotton at certain conditions is possible without damage. A density of 12 pounds per cubic foot and less than 8 to 10% moisture content allows one month of storage without quality problems. This finding led to the development of module-building on the fields and transportation of complete modules to the gin. Storage of seed cotton is necessary, as not all the harvested cotton can be ginned at the same time and later harvesting would result in reduced cotton quality. There is also an additional advantage in the blending of seed cotton by building up modules. Module averaging allows for more even distribution of cotton in the bales and better processing stability, but is only possible for large-scale cotton production areas. Open stores (go-downs) or mountain stores are the most common storage systems in developing countries with low rainfall. Stored seed cotton is in some cases used for manual blending, for example, the Farfalla system used for long staple cotton in Egypt and in Sudan. Warehousing is expensive but commonly used in Europe and some Central Asian cotton-producing countries. Trailers are still in use for transportation and short-term storage, if smaller areas have to be harvested. Chapter 8/page 38

Cotton quality Impact of cotton ginning on quality After cotton variety and growing conditions, ginning is the next important factor for cotton quality to be considered. Bad ginning conditions will reduce the fiber quality, while optimum ginning conditions will maintain it (PC Jones n.d.). New measurement principles used during ginning, such as the ‘Intelli-Gin’ from Zellweger-Uster Inc. (Ghorashi 2000) and the ‘GinWizzard’ from Schaffner Technologies (Shofner and Shofner 2000; Shofner et al. 2002), can optimize quality control during ginning and adaptation of ginning machinery conditions. Quality control at the gin, sampling of every bale produced and online measurement of quality parameters are already the basis of HVI classing and will underlie internet cotton trading into the future.

Ginning principles The two ginning principles used widely in industry are saw ginning and roller ginning. Roller ginning is applied for long and extra-long staple cottons; saw ginning is used for medium staple and short staple cottons.

Saw ginning A typical two-stand ginning system of 25–32 bales per hour capacity would have the following steps for spindle-harvested cotton: module feeding system, input control, tower drier, incline cleaner, stick machine, tower drier, incline cleaner, impact cleaner, gin feeder, gin, lint cleaner, output control, battery condenser, bale press, sampling and wrapping. Seed cotton is fed into the gin where a roller creates a seed cotton roll in the roll box. As this roll rotates and presses against a wall of ribs through which saws are protruding, individual fibers are pulled from the seed. The spacing between each saw and rib is such that seed cannot pass through. The ginned seed is discharged at the bottom of the stand and the lint transported to the lint cleaners or to the bale press. Cotton fibers can withstand the forces applied during ginning, but fiber shortening is inevitable. Increased cylinder speeds can damage seed cotton, and poorly maintained gins lead to higher short fiber contents, seed coat fragments and fiber neps. Trash may be destroyed and pepper trash may be found in overginned cotton. Saw-ginned cotton has a totally different appearance from roller-ginned cotton: it looks fluffy, cleaner and has a more regular surface. Chapter 8/page 39

Cotton Trading Manual Roller ginning Roller gins are used for ginning long staple and extra-long staple cottons, in developing countries such as India and Pakistan and elsewhere. Old-type reciprocating knife roller gin stands (capacity 50 to 80 pounds lint per hour and stand) are still used for medium and short staple cottons too. Roller ginning is gentle to lint, and seed separation for long staple cottons is easier. Modern roller ginning technolgy uses a rotary knife roller gin stand (capacity 600 to 700 pounds lint per hour and stand). The rotary knife roller gin separates lint from seed by using frictional forces between a moving roller and a fixed stationary knife surface. Maintenance of knifes, knife-to-roller distances and speed control are essential for good ginning. Overginning will produce fiber knots, which can be seen in bale cotton and are difficult to process in the mill or lead to fiber destruction. Roller-ginned cotton is irregular in appearance, and can be characterized as striped and knotty. Seed cotton feeding system Seed cotton feeding is usually by suction from trailers, bringing the seed cotton from the fields to the gin. In developing countries in Africa and Asia cotton is transported manually and still partially hand-fed to old gins. In the US and Australia, modules of seed cotton are built on the fields, transported by trucks to the gin and directly fed into the gin. Drying Drying of seed cotton is necessary to clean seed cotton and to ensure a smooth ginning operation. Seed cotton moisture of 7% at the gin roll box is recommended. Tower driers are used to dry the seed cotton, which has higher humidity content when brought direct from the fields. Too low a moisture decreases fiber strength and increases fiber breakage and numbers of short fibers. Higher moisture will reduce gin and cleaning efficiency, lower the grade and even break gin saws through roller stickiness. In some cases conditioners are applied to the seed cotton to support ginning and cleaning. Conditioners remain on the lint that is pressed into bales (Griffin and Lalor 1984). Seed cotton cleaning Modern gins have several stages of intensive seed cotton cleaning. Cylinder cleaners employ a series of beater cylinders, concave screens and grid bars to separate trash as broken leaf, dirt, small sticks and Chapter 8/page 40

Cotton quality stems from the seed cotton. Seed cotton cleaning gives a better cotton grade, but overcleaning and extreme speeds will produce pepper trash and fiber neps, which are difficult to separate from lint cotton in the mill later. Lint cleaning Lint cleaning is an additional mechanical cleaning process applied to lint cotton after ginning. Lint cleaners were developed when machine harvesting progressed to higher speeds, which produced more trash in ginned lint. Lint cleaners were designed to remove leaf, motes, grass and bark left by pre-cleaners. Lint cleaning at the beginning gives a better cotton grade, but overused it destroys fibers, gives higher short fiber content and may lead to neppiness in lint cotton. Trash may be transformed to pepper trash and dust, disturbing spinning processes and giving poorer fabric quality. Bale pressing Before baling, moisture is usually added back to the lint allowing for easier bale compaction. After pressing, the bales are tied with 6, 8 or 9 ties per bale. Ties are normally flat metal bands or hot-cold rolled wire. Sampling and covering is applied afterwards. The following bale sizes are used in the US: Flat Standard Universal High Density

55 55 55 55

¥ ¥ ¥ ¥

28 ¥ 36–48 inches 20–21 ¥ 30–36 20–21 ¥ 26–30 20 ¥ 28

15 lb/cubic ft 22 21 28

The international ISO recommendations (ISO 8115) for cotton bale size adapted to standard container size (40 ft/12 m) are as follows: Length

Width

Height

Density

1060 mm 1400 mm

530 mm 530 mm

780–950 mm (ideal 815 mm) 700–900 mm (ideal 740 mm)

360–450 kg /cubic m

Bale sizes in different cotton-producing countries vary substantially, as many different bale presses from different dates are still in use. Bale weight may vary from 50 kg in China to 380 kg in Egypt and differ greatly in size and density. Bale wrapping Traditional jute/hessian is still used for bale wrapping in many countries, while polypropylene wrapping has spread the US and is now Chapter 8/page 41

Cotton Trading Manual widespread. The problem with polypropylene is its different dyeing behavior as compared to cotton, if parts of the wrapping are contaminated in the bale, which may occur by sampling or transportation damage. Some countries therefore use undyed cotton fabrics for bale wrapping. Sampling procedure Sampling for cotton quality determination (HVI) and classing is done directly after baling or by shippers, forwarders, trade representatives and customers at seaports or destination locations. Commonly two samples of 200–300 grams are taken. The samples are identified by bale numbers, weight, gin and other original information printed as a ‘green card’ or similar identification systems, including computerreadable barcodes or numbering systems. Storage and transportation Bales are stored in warehouses or sometimes on open spaces and transported in containers or on open trucks to their destination. Container sea transportation has become increasingly important. Variation from bale to bale and within bales Cotton quality may vary from bale to bale in a lot and within the bales. Nevertheless the bale sample is taken by the cotton trade and industry to represent statistically the quality of that uniquely identified bale. The premise is that statistical variation is similar within a bale and within the bales of a lot of designated origin, gin or production area from a specific harvest time. This is particularly true for large production areas, with large fields of cotton of the same quality harvested at the same time. Measurement of the quality of each bale therefore will deliver a good ‘picture’ of a certain cotton lot. If only some few bales are represented and measured, eg every tenth bale, the quality of the information is poorer. Smaller fields and greater quality differences from field to field give rise to higher variation of quality parameters of a lot. The same would be true for re-pressed bales from different origins. In that case, the bale sample may differ totally from the mean of the whole bale. No HVI instrument is able to detect such differences, and only visual appraisal of the bale itself will clarify the situation. In these cases, arbitration by sworn classers is necessary for the trade, cotton exchanges and customers.

Chapter 8/page 42

Cotton quality

Contamination Cotton contamination types Foreign matter, stickiness and seed coat fragments in raw cotton continue to be among the most serious problems affecting the cotton spinning industry worldwide. Various kinds of foreign matter, known as ‘contamination’, have always been found in cotton bales. While spinning was a laborintensive process and opening and blending of bales was by hand, foreign matter could usually be eliminated manually. Following extensive modernization of textile processing in recent years, the opening and blending processes are increasingly performed by machines. The trend towards automation in textile manufacturing is not limited to any particular geographical area and will gain further momentum in years to come.

Table 8.7 Sources of contamination (selected examples, Dr Strolz, ITMF Zürich) All countries/All growths Source of contamination

Number of samples: 1501 Degree of contamination (%) Non-existent/ Moderate Serious insignificant

1 Fabrics made of 2 3 4 5 Strings made of 6 7 8 9 Organic matter 10 Inorganic matter 11 12 13 Oily substances/ chemicals 14 15 16 Average of 1–16

Stickiness

woven plastic 80 plastic film 84 jute/hessian 75 cotton 76 woven plastic 75 plastic film 78 jute/hessian 70 cotton 75 leaves, feathers, paper, 61 leather, etc sand/dust 70 rust 82 metal/wire 84 grease/oil 77

14 11 17 19 17 16 19 19 29

6 5 8 5 8 6 11 6 10

23 14 12 18

7 4 4 5

rubber stamp color tar

5 11 3 15

1 3 1 6

No (%)

Yes (%)

80

20

94 86 96 79

Seed coat fragments

No (%)

Yes (%)

62

38

Chapter 8/page 43

Cotton Trading Manual The International Textile Manufacturers Federation has for many years organized a biennial survey on cotton contamination, which is published periodically (ITMF Secretariat, Am Schanzengraben 29, Postfach, CH 8039 Zürich, Switzerland. Detailed information is available at http://www.itmf.org). For each cotton description, participating companies are asked to indicate whether they had used that particular description and if they had found any contamination in their cotton (Strolz 1999, 2001).

Fabrics Fabric contaminants include woven plastic, plastic film and jute/ hessian, in the form of bale wrapping materials or material left on the fields, especially colored cotton woven fabrics, distributed during the growing period by land pollution or during picking time by workers/ pickers on the fields.

String String may be made of woven plastic, plastic film, jute/hessian or cotton, and in much the same way as fabrics string material from handpicking bags left in the fields may be a contaminant.

Organic matter Organic matter includes leaves, feathers, paper, leather and other residues of land pollution, or trash left on the roads and on the fields, which may be distributed by wind and harvested by machinery.

Inorganic matter Inorganic matter includes sand, dust, rust, metal and wire. Sand and dust has many sources and is collected during harvesting by machinery, particularly by strippers but also in lower amounts by spindle pickers. A second source of dust is storms or hurricanes, bringing fine dust over large distances to the open cotton bolls, where it sticks to the fibers. It is mostly invisible to the human eye but results in heavy damage to machinery during spinning or knitting (needle damage), for example. Rust can come from metallic wires and can lead to severe damage of fabrics during dyeing processes, through catalytic reaction with chemicals used for dyeing and finishing. Metal/wire can be from the machinery, from wrapping and from the fields. Chapter 8/page 44

Cotton quality Oily substances/chemicals Grease and oil, rubber, stamp color and tar are among the oily or chemical contaminants of cotton. Grease and oil mostly results from harvesting machinery, e.g. if too much spindle grease is used. Rubber may come from rubber parts of the machines. Stamp color is from bale stamping, where color stains the cotton. Tar can find its way into the cotton during transportation over hot roads.

Stickiness (honeydew, etc) Stickiness remains a very severe problem for many cotton-growing areas. It is irregular, occurring when insect infestation runs out of control, but it is widespread. In 2001, for example, the ITMF survey reported that 18% of all the samples revealed the presence of stickiness. The highest occurrences of stickiness in that year were reported from Sudan (Acala and Barakat), Brazil (North), Israel (Pima) and the Central African Republic. On the other hand, no stickiness in that year was reported from South-Eastern USA, China (Xinjiang), Pakistan (AmSeed AFZAL), Tanzania and Zimbabwe.

Seed coat fragments Seed coat fragments are parts of the destroyed seed to which fibers are still attached. As these seed coat fragments are very difficult to separate from lint during cleaning in the mill, their presence can lead to higher ends down during spinning, lower efficiency during weaving preparation and weaving itself, and the yarn produced shows neppiness and irregularities. There are various sources of unwanted seed coat fragments in cotton, including cotton varieties with lower seed stability, immaturity effects owing to inferior growing conditions and, most of all, ginning problems, such as running the ginning machinery too fast, poor servicing and old machines in bad condition.

Classing and grading Classing and grading principles In traditional cotton marketing, most sales of cotton lots are made on the basis of a cotton sample or so-called ‘type of cotton’. Types are named and offered to the customers, described in contracts and form the basis of the worldwide cotton business. Cotton of different varieties and origins varies greatly in length, strength and character, and different lots of one variety vary in respect of color and amounts of trash and foreign matter. Before cotton can be Chapter 8/page 45

Cotton Trading Manual marketed, the different kinds of cotton quality must be named and designated in such a way that the seller can describe the kind of cotton he has to offer and the buyer may understand what is offered and be able to determine the market value of cotton of such a quality. This need for a standardized system for use in cotton marketing brought into existence the art of ‘cotton classing’. Any system of cotton classing or grading must take into account many qualities of cotton being produced in a specific region or country, and it has to express in some way the quality of that cotton description. Grade or classification group, color, preparation and staple length are the main parameters of classing systems. These parameters are traditionally determined by a trained and experienced person, the ‘classer’, who determines by eye the amount of leaf fragments, trash, impurities, color and preparation, and by hand in pulling the staple and testing staple length. Part of the classification process is the comparison with ‘standards’, physical cotton samples prepared as ‘grade boxes’, which represent the defined grade or quality class. Another aspect is comparison with length standards, using cotton samples of defined staple lengths. During the development of classing systems over many centuries, additional measurements have been introduced, such as the comparison of pulled classer’s staples on rulers with an integrated inch-length scale and later the measurement of length by instruments. Instrument measurement has always been a part of cotton classing and has become the sole basis of cotton classing in some countries (eg HVI in the US). The leading cotton-producing regions or countries have their own classification systems, defined for the specific properties of their own cotton. The best-known classification is the Universal Cotton Standards system developed in the USA for the national and international trading of US cotton. It was initiated in 1907 in Atlanta, Georgia with the recommendation for ‘the establishment of uniform cotton standards to eliminate price differences between markets, provide a means of settling disputes, make the farmer more cognizant of the value of his product . . .’. Also well known is the Egyptian Classification System for long staple and extra-long staple Egyptian cottons. Some systems included unique measurements, such as the former Soviet cotton classing system, now partially replaced in Central Asian countries by traditional classing or HVI measurements. Sampling for traditional classing Classing is done by means of cotton samples in the range of 100–300 grams, taken from every bale. Thus the bale sample represents the quality of that defined cotton bale. Chapter 8/page 46

Cotton quality Every sample, taken from a specific bale after bale pressing in the gin or later, is identified by a specific bale number, indicating production source, gin and relevant data such as bale weight and instrument measurements.

Color grade Color grade is determined by classers, by eye or in many cases by instruments called colorimeters. In the US determination of color is done by HVI instruments, based on the Nickerson-Hunter Colorimeter. The USDA–AMS states (1999): There are 25 official color grades for US Upland cotton, plus five categories of below grade color. USDA maintains physical standards for 15 color grades. The others are descriptive standards.

Leaf grade The USDA–AMS (1999) says: The classer’s leaf grade is a visual estimate of the amount of cotton plant leaf particles in the cotton. There are seven leaf grades, designated as leaf grade ‘1’ through ‘7’, and all are represented by physical standards. In addition, there is a ‘below grade’ designation which is descriptive. Leaf content is affected by plant variety, and harvesting methods and conditions. The amount of leaf remaining in the lint after ginning depends on that present in the cotton prior to ginning, and on the type and amount of cleaning and drying equipment used. Even with the most careful harvesting and ginning methods a small amount of leaf remains in the cotton lint.

Preparation ‘Preparation’ is a term used to describe the degree of smoothness or roughness with which the lint is ginned. Various methods of harvesting, handling and ginning cotton produce differences in roughness or smoothness of preparation that are sometimes very apparent.

Extraneous matter ‘Extraneous matter’ is any substance in the cotton other than fiber or leaf. Examples of extranous matter are bark, grass, spindle twist, seedcoat fragments, dust and oil. The kind of extranous matter and indication of the amount (light or heavy) are noted by the classer on the classification document. Chapter 8/page 47

Cotton Trading Manual Staple length Staple length is determined in 32nds of an inch, 16th of an inch or half an inch (the USDA uses 32nds or 100ths of an inch as its length scale). An experienced classer is able to judge the length of a staple by distinct sampling, parallelizing and drawing out the representative length of the fibers, the ‘staple’, which is compared to staple standards. The international cotton trade still uses 16th, quarter and half an inch for cotton staple length. Length classes in the US are determined by HVI instruments. Classification of American Pima cotton The USDA–AMS (1999) states: There are six official grades (‘1’ through ‘6’) for American Pima cotton, all represented by physical standards, plus below grade, which is descriptive. A different chart is used to convert American Pima fiber length from 32nds to 100ths of an inch. Classification procedures for American Pima cotton are similar to those for American Upland cotton, including the instrument measurements. Different grade standards are used because the color of American Pima cotton is a deeper yellow than that of Upland. Also, the ginning process for American Pima cotton (roller-ginned) is not the same as for Upland.

Typical classing systems of selected cotton-producing countries Universal Cotton Standards (USDA–Upland cotton) The Universal Cotton Standards Agreement, the US-classing system, established by the USDA, is used not only for US cotton in international trade, but also for cottons produced in Mexico and Central America, Australia and West Africa (USDA–AMS 1999; Griffith 2000). The basic grades are: Good Middling Strict Middling Middling Strict Low Middling Low Middling Strict Good Ordinary Good Ordinary See also Tables 8.4 and 8.5 above. Chapter 8/page 48

Cotton quality Egyptian standards (long staple and extra-long staple cotton) In Egypt, the country with the most famous cotton worldwide, a special long staple classification system was developed, incoporating seven grades. Arbitration of Egyptian cotton is restricted to the Cotton Testing General Organization (CATGO) based in Alexandria, Egypt. The following grades and standards are used: 1. 2. 3. 4. 5. 6. 7.

Extra Fully Good Good Fully Good Fair Good Fair Fully Fair Fair

EX FG G FGF GF FF F

There are also additional intermediate descriptive classes between these, eg Good to Fully Good Fair. Referring to staple length, the following classes are used, according to Dr Sorrady, Faculty of Cotton Science, Alexandria, and Hassan A El-Attal (El-Attal 1986): 46 and longer 45 44 43 42 41 40 39 38 37 36 35 34 and shorter

1 1 1 1 1 1 1 1 1 1 1 1 1

7/16 13/32 3/8 11/32 5/16 9/32 1/2 7/32 3/16 5/32 3/32 1/16 1/32

inch inch inch inch inch inch inch inch inch inch inch inch inch

Extra long

Long Medium long

Medium

Pakistan Cotton Standards The official Pakistan Cotton Standards Institute (PCSI) gives six standards (1990): Grades 1. 2. 3. 4. 5. 6.

Super One Two Three Four Five Chapter 8/page 49

Cotton Trading Manual The following length classes are typical: 1 1 1 1 1

1/8 3/32 1/16 1/32

inch inch inch inch inch inch inch

31/32 15/16

Uzbek Upland Cotton Standards Grades

Color Grades Oliy

Yakshi

Urta Oddiy

Iflos

Birinchi Ikkinchi Uchinchi Turtinchi Besinchi

Paraguayan Cotton Standards The official Paraguayan standards of 1990 give these grades: 1. 2. 3. 4. 5. 6. 7.

Grado Grado Grado Grado Grado Grado Grado

1 2 3 4 5 6 7

Staple length classes are: 1 1 1 1 1

1/8 3/32 1/16 1/32

Peruvian Cotton – Peru Tanguis Standards Grades: Standard Standard Standard Standard Standard Standard

1 2 2 1/2 3 3 1/2 4

Chapter 8/page 50

inch inch inch inch inch

Cotton quality Standard 5 Standard 6 Standard 7

Staple length classes: 1 2 3 4 5 6

1 1 1 1 1 1

5/32 1/4 3/16 1/8 3/32 1/16

inch inch inch inch inch inch

Turkish Cotton Standards Regions: Ege roller-ginned, Cucurova r.g., Upland saw-ginned. Grades: 1 Extra 2 Grade I 3 Grade II 4 Grade III

Color changes: light spotted. Staple length: 1 1 1 1 1 31/32

1/8 3/32 1/16 1/32 inch

inch inch inch inch inch

HVI-classing (USDA) USDA cotton classification is based on HVI measurements: fiber length (Upper Half Mean, UHM, length, inch) length uniformity (Uniformity Index, UI, %) fiber strength (HVI-strength, g/tex) micronaire (HVI-micronaire, units) color (HVI Color, Rd, + b, units) trash (HVI trash area, %)

Leaf grade (preparation and extraneous matter is determined by classers): Leaf Grade 1 to 7. In the USA, the transition from Classer to HVI Color Grade has proceeded smoothly, the 2000/01 classing season being the first to officially utilize HVI Color Grades for Upland Cotton Color Classification.

Chapter 8/page 51

Cotton Trading Manual The classer’s role was reduced to classifying leaf and extranous matter only (i.e. Trash and Leaf Grades), the Classer’s Color Grade being eliminated. Separate classification of Color and Leaf Grade for Pima cotton came into effect from July 2001. HVI Color Grade reproducibility between classing offices and quality assurance was about 75%. Rd and + b reproducibility (tolerance 1.0 for Rd and 0.5 for + b) reached an all-time high of 95% of results within tolerances for both indices. The development of HVI Leaf Grades for Classification is underway, in addition to the possible use of photographic HVI trash standards to replace the present physical cotton standards mounted under glass (Hunter 2002; ITMF Bremen 2002; USDA–AMS 1999).

HVI-classing procedure USDA operates 12 cotton-classing facilities across the US cotton belt. At the gin, cotton fibers are separated from the seed, cleaned to remove plant residue and other foreign material, and pressed into bales of about 500 pounds (220 kg). A sample of at least 4 ounces (115 grams) is taken from each side of the bale by a licenced sampling agent, and the 8 oz (230 g) sample is delivered by the agent or designated hauler to the USDA classing facility in the area. Upon arrival at the classing facility, samples are conditioned to bring the moisture content to specified ranges before the classing process begins. Cotton classification data are available to the producers and their authorized agents and subsequent owners of the cotton, merchants and manufacturers. Repeatability and reliability of HVI-instrument determinations Laboratory-to-laboratory reproducibility is more difficult to achieve than within-lab or same-instrument reproducibility, because of the problems of maintaining identical test conditions. The following list (USDA–AMS 1999) gives lab-to-lab reproducibilty of 1997 classing results:

Micronaire Length Length uniformity Strength Color Rd Color + b Trash

Chapter 8/page 52

Limits

% of results within limit

0.1 units 0.02 inches 1.0 percent 1.5 gram per tex 1.0 units 0,5 units 0.1 percent area

76 74 84 74 88 91 80

Cotton quality HVI-calibration Calibration is an important basis of repeatable results. HVI instruments are calibrated for length, length uniformity, micronaire and strength by using calibration cottons. Tiles are used to calibrate color and trash measurements. HVI Calibration Cottons are prepared by USDA and can be ordered from the following address: Cotton Program, AMS, USDA, 3275 Appling Road, Memphis, TN 38133 or online at: http://www.ams.usda.gov/cotton/ Cottons used for instrument calibration must pass rigorous screening procedures, including special round trials. Benchmark cotton bales are retested within the program to check references. In addition to calibration, samples of known value are tested on HVI instruments used in USDA classing facilities several times in every eight-hour shift. If the test value deviates from the known value more than specified tolerances limits, corrective action is taken. ITMF HVI-User Guide and USDA Guidelines for HVI-testing In order to supply correct HVI data on a worldwide basis and enable correct measurements, specific HVI guidelines have been published. The ITMF HVI User Guide was established by Dr L Hunter, A Heap, J Knowlton, Dr P Sasser, H Ghorashi and A Schleth (ITMF Committee on Cotton Testing Methods, ITMF Secretariat, Postfach, Zürich, Switzerland or online at: http://www.itmf-secretariat.org). The USDA Guidelines for HVI Testing give similar recommendations and can be ordered from: Cotton Program, AMS, USDA, 3275 Appling Road, Memphis, TN 38133 or online at: http://www.ams. usda.gov/cotton/ HVI Bremen Roundests and USDA Round Trials Within-laboratory variations of test results and lab-to-lab variations are inevitable. There are natural sources of variation such as climatic differences, especially humidity; instrumental differences caused by variable machine tolerances and temperature variation; sample preparation differences caused by persons or instruments; and quality variations in each cotton sample. To achieve reliable test results, it is not sufficient to repeat the testing as often as possible. Repeated tests on the same cotton deliver a socalled ‘laboratory mean value’, which would not necessarily be the ‘true’ value of that material. Only international, controlled round tests with a statistically significant number of participating laboratories (recommendation > 20) can achieve a mean testing value close to the ‘true value’, including all possible variation sources. Regular cotton round tests or Chapter 8/page 53

Cotton Trading Manual round trials are organized by the Bremen Fiber Institute (Bremer Rundtest) and by USDA–AMS Memphis. Repeated round tests over a period of many years on the same cotton have shown practically the same mean values (Hadwich 1969; Hadwich and Schenek 1985). The coefficient of variation of test results lab-to-lab (CV (L)) is therefore a good indicator for the quality of test methods. The ITMF Committee on Cotton Testing Methods considers testing methods as acceptable for application in trade and industry if the CV (L) from round tests is 5% or lower. Results by the Bremen Roundtests gave CV (L) for micronaire over many years in the range of 1.3 to 4.4% (mean 2.7%). The CV (L) within cotton bales from different origins was in the range of 1.7 to 6.5%, when small samples (5 g) have been taken and in the range of 1.2 to 2.9%, when common samples (200 g) were taken from the bales. Roller-ginned cottons showed a higher variation than saw-ginned. Average Inter-laboratory variations CV (L) for HVI in Bremen and USDA round trials were reported by Hunter (2002) and Schneider (2002). Participating laboratories averaged from 20 to 59 participants in the period 1991 to 2001: Micronaire Length Uniformity Index Strength Color Rd Color + b

CV (L) (UHML)

3.3–4.0 1.5–2.1 1.1–2.2

5.0–6.4 1.6–2.2 3.9–5.1

At the end of 2001 there were some 1436 HVI systems in place in 70 countries, roughly one-third being in East Asia and one-third in the USA. More than 95% of installations are in the name of Zellweger Uster Inc. (Motion Control Inc., Spinlab Inc.), who own patent rights on the term HVI. New systems for high-volume testing of cotton, such as Premier Technologies (eg ART) India, Schaffner Technologies Inc. (STI RapidTester), USA and Lintronics (FQT–FIBRO-LAB), Israel are appearing on the market. Some of the newly developed systems can test for the traditional HVI-measured properties, plus neps, seed coat fragments, stickiness and maturity as well as additional color parameters (separately from trash and other contaminants) (Hunter 2002).

Acknowledgments This chapter was made possible by the substantial support and contribution of USDA–AMS Memphis and Washington, DC, especially Mrs Chapter 8/page 54

Cotton quality Norma McDill, for permission to use USDA charts and information. Essential assistance was also given by Eric Hequet, International Textile Center, Lubbock and by Peter Jones, Zellweger Uster Inc., Knoxville. Special thanks go to the Bremen Cotton Exchange (Bremer Baumwollbörse), Mr W Neumann and co-workers; the Bremen Fiber Institute (Faserinstitut Bremen e. V), Mr T Schneider and co-workers; and the International Textile Manufacturers Federation (ITMF), Dr H Strolz and staff for their support. The Roundtest data was made possible through the lifetime work of Dr Fritz Hadwich, former Director of the Bremen Fiber Institute, to whom I wish to express personal thanks. To many other persons who contributed information, tables and diagrams and are not individually named here I would also like to acknowledge help and support.

Chapter 8/page 55

9 Cotton pricing Don Ethridge, Darren Hudson and Sukant Misra

Factors affecting cotton prices Market fundamentals Cotton demand Cotton supply Price determination Macroeconomics Cost of production Cotton pricing policies Subsidies Taxes Policy evolution Quality

Cotton pricing arrangements Impact of quality measurement Types of arrangements Spot markets Futures markets Forward contracts Marketing pools

Sources of price information and price predictions Current price data Cotlook Indices Futures market prices Daily Spot Cotton Quotations Historical data

Summary and conclusions

Cotton pricing in the market can be viewed as taking place on two levels. On the most basic level, pricing occurs in each instance in which a buy/sell transaction takes place. When this happens, a price is established such that it meets the criteria of both the buyer and the seller. On another, more aggregated level, each of the individual transactions that takes place plays a role in establishing a broader perspective of price across an entire market. These prices can be viewed as aggregations, or averages, of all of the individual transactions that occur across the defined market. For example, a transaction that takes place on a given day between a merchant in Memphis, Tennessee, USA and a cotton producer in the US Mid-south production region on a given day for a specified price constitutes one price of the thousands that may have taken place in that same region on that day; it is also one price for the US in that year. On an individual transaction level, the agreed price is a market price. The average of all of the transaction prices that take place is the market price for the specified market. As we discuss prices, it is important to distinguish which of these levels we are addressing. But, as the above illustration suggests, they are linked. As the individual transactions go together to give the overall market picture, the overall market situation affects the individual transactions. No buyer wants to pay more than necessary for the cotton needed, and no seller wants to sell for less than is obtainable. Consequently, each relies on market information about what is going on in the market in general to help guide their decisions. All of the participants know that what is occurring in the market constrains what they can likely obtain (buy or sell) in the market. Therefore, market information – information about the general levels of prices – is very important to all buyers and sellers in a market. That information helps markets work efficiently. We can therefore make a distinction between price determination and price discovery. Price determination is what markets do, albeit through the actions of many individual buyers and sellers. Markets, through the more-or-less simultaneous actions of numerous buyers and sellers, determine a general level of prices. Except in the cases in which there is only one buyer or seller, or a small number of buyers or sellers acting in unison, individuals do not set the level of prices that exist in a market. This is done by the market itself, or when the market is not allowed to function by reason of government action or the control of a monopolistic buyer or seller, it may be done by dictate. Price information is what each buyer/seller in a market needs to know in order to make the best buying/selling decisions. Price discovery is the process of individuals within a market finding or knowing the general or average level of prices, then proceeding to ascertain a valid price for a given transaction – a given amount of cotton of a given quality in a given Chapter 9/page 1

Cotton Trading Manual location at a specified point in time. This chapter addresses the topics of both price discovery and price determination of cotton.

Factors affecting cotton prices Understanding the factors that determine the general or average level of prices and factors that influence price for a given transaction is important to the cotton price discovery process discussed in the previous section. Market price of cotton is determined by a complex interaction of factors that influence demand for and supply of cotton, both domestically and globally. Price for a given transaction, in addition to being influenced by the general or average market price, is further influenced by a diverse and complex set of quality characteristics embodied in cotton. This section discusses the factors that affect cotton prices – both the general price level and price for a given transaction.

Market fundamentals Market fundamentals refer to the general interaction of supply and demand forces. For clarity, we should note that supply and demand are not quantities, but rather relationships between prices that sellers/buyers would be willing to offer/accept for various quantities under a set of conditions in a market at a given time. The interaction of supply and demand results in the observed prices and quantities traded in a given market. Cotton demand Although textile mills are typically the ultimate buyers of cotton lint, it should be understood that cotton lint is an industrial material, an input into textile production, and eventually is used in consumer apparel, household furnishings and an array of industrial goods. Thus, the value textile mills place on cotton is governed by the behavior/demand of the final consumers of cotton (the buyers of various textile products in the market), by the contributions of the fiber to the production of products and by the prices and substitutability of other fibers. Demand is defined as the various amounts of a product/commodity (cotton) that consumers are willing and able to buy at various prices. The demand for cotton is driven by (derived from) the markets for the products that cotton fiber is used to manufacture. In general, there are many factors that influence the level of consumer demand for textiles, and thus that of cotton. Aside from the price of the textile product produced with cotton, prices of substitute and complementary goods also affect the demand for cotton – availability of relatively cheaper polyester apparel would reduce consumer demand for cotton apparel. The Chapter 9/page 2

Cotton pricing level of consumer income also affects the level of consumer demand; people will purchase more cotton products as their incomes rise. Increases in population may also lead to an increase in demand for the product under consideration. Fashion trends and such types of consumer preferences are yet another set of important factors that influence demand. A shift of consumer preference away from cotton apparel in India or the USA or China, for example, could have considerable impact on the global aggregate demand for cotton. Cotton supply Producers or agribusinesses are the suppliers of cotton to the market. Though cotton producers’ decisions involving how much cotton to produce or supply to the market rests heavily on the level of demand and price of cotton, it is also greatly influenced by cost factors such as availability and prices of inputs. Costs of production also depend on the technical efficiency of the production process, with efficiency measured as output per unit of input. Other factors that could influence supply of cotton are growing conditions (climate, crop diseases, etc.) and/or an improvement in technology (new crop variety that increases yield per acre). A reduction in relative prices and/or profitability of other agricultural products could also cause producers to increase cotton production and supply. Changes in institutional constraints such as subsidies can influence supply of cotton – amounts offered for sale at each price. Price determination Interaction between the market demand for cotton and the supply of cotton determines the market price. Left alone, without governments’ interference, the market will arrive at an equilibrium price – a price at which the quantity demanded by all consumers equals the quantity supplied by all producers, with no shortages or surpluses in the market. In reality, the prices we observe the markets generating are not purely market prices because governments have implemented policies that affect the behavior of the markets. Some of the policies are those that have some impact on supply and/or demand within a country, in which case the effects are likely to spill over into world markets. Alternatively, trade policies – those designed to affect commerce between countries – always spill over into international markets. As a practical matter, interference with markets is so prominent that we can rarely discern what the true market price, without interference, would have been. But these facts do not mitigate the fact that traders still face the problem of discovering market prices, even if they are altered by the actions of governments. The upshot is that the needs for price discovChapter 9/page 3

Cotton Trading Manual ery remain critical to all those active in the market, but government interference makes it more difficult to anticipate future movements because discretionary actions of governments are less predictable than the behavior of unencumbered markets. Macroeconomics The macroeconomic environment and policies of economies around the world affect agricultural markets like cotton in many different ways. The following subsection discusses agricultural policies specific to cotton and their influence on cotton prices. We should note, in conjunction with the above explanation, that macroeconomic linkages to agriculture also affect these markets. Generally, macroeconomic policies influence farm prices through changes in taxes and government spending (fiscal policy) and the money supply (monetary policy). Expansionary monetary policy, such as the Federal Reserve lowering the discount rate, makes more money available for agricultural credit and loans at lower interest rates. This reduces debt-servicing costs for agriculture, but may result in higher input prices by increasing farmers’ demands for inputs. Monetary policies also influence the amount of international trade in agricultural commodities. The depreciated value of a nation’s currency increases the foreign demand for a commodity produced in that nation, and conversely, exports of agricultural commodities decrease when the value of the currency appreciates. Expansionary fiscal policy, such as higher government expenditures or lower taxes, may temporarily increase aggregate demand, prices, income and interest rates. However, with a higher interest rate, domestic investment expenditures would eventually decline and domestic aggregate demand will fall. Expansionary fiscal policy can also result in appreciated value of the currency, resulting in further decline in aggregate demand. A central point here is that microeconomic impacts from macroeconomic policies are unavoidable. In fact, the primary purpose of this discussion is to emphasize that macroeconomic monetary and fiscal policies influence every sector of an economy, including agriculture and the cotton industry. Changes in these policies affect consumption and investment decisions, as well as cotton prices, production costs and producer income. Cost of production One of the fundamental components of supply relationships is the cost of producing cotton. Other factors being equal, the greater the cost of producing a kilogram of cotton lint, the higher the price must be for the grower to maintain a viable business operation. The cost per kg of lint Chapter 9/page 4

Cotton pricing can be determined as the cost of producing a hectare of cotton less the revenue from seed divided by the number of kg of lint produced from the hectare. The cost per hectare includes all of the input costs – machinery operations, seed, fertilizer, herbicides, insecticides, labor, land costs, harvesting and ginning. These costs may be subdivided into two groups: variable costs and fixed costs. Variable costs are those that typically vary as output per hectare (yield) varies, and may include seed, fuel, chemicals, labor, etc. Land costs may be variable if, e.g. land costs are under a share-lease arrangement. Fixed costs are those that are incurred independent of the quantity of production and include items such as ownership costs of land, depreciation on equipment, certain land taxes, etc. The reason for separating these types of costs is because they each have different implications for the level of production, and ultimately market supplies. Growers must in the short run cover at least their variable costs to cover their cash-flow requirements of the enterprise. In the long run, they must be able to obtain prices that cover all (variable and fixed) costs; otherwise, they eventually deplete their capital stock and cannot finance its replacement. The only other alternative is to receive a subsidy to make up the difference between costs and revenues. There are great variations in production costs, both spatially and temporally. The temporal variations are usually associated with environmental fluctuations – weather patterns, insect infestations, etc. Geographical differences are driven by factors such as soil fertility, rainfall and/or irrigation conditions, production technologies, management systems and levels of government input subsides. Estimates of variable and total costs per kg of lint for selected countries are shown in Table 9.1. The purpose is to illustrate the variability of costs. However, comparisons should be made very cautiously. The data are assembled by the International Cotton Advisory Committee (ICAC) via surveys, and numbers are reported without normalizing across countries. Different countries treat some costs differently, use different systems of cost accounting and subsidize production inputs differently. Additionally, no adjustments are made for the differences in average quality of lint, packaging or marketing services across countries, all of which affect the value of the lint. Note also that all cost values are reported in US $ units, calculated on the basis of exchange rates, themselves quite variable.

Cotton pricing policies Government intervention into the cotton sectors of various economies is pervasive. Historically, cotton (and textiles) were important to the industrialization of the developed economies, and as such, still wield Chapter 9/page 5

Cotton Trading Manual Table 9.1 Production costs per kg of lint, by country, 2000 Country

Variable cost

Argentina Australia Bolivia Brazil Bulgaria China Egypt India Pakistan Sudan Syria Thailand Turkey USA

0.845 0.645 0.973 0.948 1.491 0.669 n.a. 1.089 1.073 2.423 1.677 1.247 1.099 1.241

Total cost

$US/kg 1.075 1.109 0.996 0.954 1.567 0.716 1.894 1.236 1.230 1.785 1.833 1.272 1.334 1.841

Source: International Cotton Advisory Committee, Survey of the Cost Of Production of Raw Cotton, Washington, DC, September 2001

considerable political power in those countries. For developing economies, cotton and textiles have been a burgeoning source of industrial employment considered vital to political stability as well as economic development. Government intervention has implications for cotton price, both domestically and globally. This section describes, in a general sense, the types of policies that have impacts on the cotton price. We can effectively segregate policies into two general classifications: subsidies versus taxes and direct versus indirect policies. The intersection of these types of policy instruments can be viewed in a matrix (see Table 9.2), with examples of policy approaches included within the cells. Direct subsidies are subsidies that are applied directly to the price of the product, either domestic or export, or subsidies on inputs. Indirect subsidies are targeted towards items other than product price, but can have price impacts. Direct taxation is a levy against the product itself or acts as a tax on the product (quotas). Indirect taxes are not on the product, but have price effects. The following sections discuss these different possibilities in more detail. Subsidies Direct production subsidies are payments made directly to producers on the basis of production, price, or both. Because these payments are Chapter 9/page 6

Cotton pricing Table 9.2 Combinations of policies that affect cotton price Intervention Direct

Indirect

Subsidy

US target price (pre-1996 and again since 2002); US countercyclical payments (since 2002); input subsidies; export subsidies

Tax incentives and rebates; US de-coupled direct payments (since 1996); conservation payments; import restrictions/quotas

Tax

Export tax (Pakistan pre-1995); export quotas (Turkey); energy tax

Income tax; high interest rates; strong currency

tied to the level of production, they influence the amount of cotton that is produced by these producers. An increase in the level of subsidies increases the level of production, other things equal. Assuming that demand has remained unchanged, this decreases the price of cotton. That is, if we increase the amount of cotton on the market as a result of a policy without increasing demand, the price of cotton will be lower. Other policies that have similar effects are input subsidies. Examples of these are in Pakistan, where irrigation water is subsidized, which increases the use of irrigation water and increases cotton production. Thus, the production subsidy has much the same effect as a direct production subsidy in that it directly subsidizes the production of cotton, which, other things equal, will decrease the price. Finally, export subsidies can directly affect cotton price. By providing financial incentives for moving cotton on to world markets, an export subsidy can decrease world price if the exporting country is a large enough force in the world market (Hudson and Ethridge 2001). The magnitude of these effects is uncertain, but the use of export subsidies has created considerable controversy. Indirect subsidization is also prevalent. A prime example is the market transition payments included in the US Federal Agricultural Improvement and Reform (FAIR) Act of 1996. In this program, farmers were provided with income support payments that were not tied to production. These so-called ‘de-coupled’ payments are not supposed to influence production decisions. However, in 2001, the US Department of Agriculture declared that these transition payments did, in fact, influence planting decisions, and thus have an impact on price (US Department of Agriculture 2001). Another area of some controversy is conservation subsidies, which are used to promote practices that conserve natural resources. These Chapter 9/page 7

Cotton Trading Manual policies are also not supposed to affect production, and hence price. However, there has been recent criticism of these ‘green payment’ programs as affecting production, and therefore prices too (Sumner 2001). Finally, import restrictions such as taxes or quotas also affect price. For example, the US utilizes an import quota on cotton. Because this shields the US price from world price, it allows the US price to drift above the world price. This fact puts US exporters and textile manufacturers at a disadvantage in the world market. In recent years, this effect has been offset by the use of an export and use subsidy called the ‘Step 2 Competitiveness Provision’. In summary, subsidies are pervasive. These subsidies are intended to support incomes of a domestic group and/or confer competitive advantages on domestic producers. However, they alter the market’s ability to guide production and therefore have effects on prices. Many countries use subsidies of various kinds, and there is a vast array of types of subsidies and combinations of subsidies being practiced. Each impacts domestic, and therefore world, price to some degree. Taxes Although much less frequently used, taxes can also have impacts on prices. A primary example is that of pre-1995 Pakistan’s use of an export tax (Hudson and Ethridge 2000). The tax on exports reduced the incentive to export cotton, increasing the availability of cotton within Pakistan, and thereby decreasing the price. A different, but effective technique is the export quota, which Turkey has employed (Hudson 1997). The quota serves the same basic purpose as the tax and has the same outcome, although the income distribution impacts may be different. An example of an indirect tax, although not formally labeled as such, is the mandated system of marketing of cotton production, such as has been practiced in Egypt, for example. This system works as follows. Farmers are required to use a portion of their land to produce cotton, but the cotton may be legally sold only to a government-controlled group, which pays a below-market price for the cotton (then sells it and makes a profit). Thus, the penalty to the farmer is effectively the same as a tax, with the inevitable result being reduced production (through lower yield) and higher market prices (because supply was reduced). Finally, taxation of energy reduces the use of inputs (e.g. fuel, fertilizer, irrigation pumping, etc) and, therefore, cotton production. Other things equal, the reduction in output will increase cotton price. Other macroeconomic policies such as income taxes, high interest rates and a strong currency all have indirect effects on cotton price as well.

Chapter 9/page 8

Cotton pricing Policy evolution Cotton policy continues to evolve and change. Generally speaking, each generation of policy tends to become more complex and abstract in attempts to navigate the myriad trade agreements, political sophistication of interest groups and government budget concerns. Perhaps of greater concern, however, is the connection between cotton and textiles. US policy has traditionally focused on the cotton sector, with little regard for the textile sector. The ‘Competitiveness Provisions’ of the 1990 Farm Bill were the first real recognition of the impact of cotton policy on the US textile sector. In contrast, policies such as the export tax used in Pakistan prior to 1995 were designed specifically to exploit this linkage. This difference in perspective has led to significantly divergent policy objectives across countries. However, it appears that most policy is converging on at least a recognition of the linkage between cotton and textiles, and that forces that affect the textile industry also impact the cotton fiber industry, and vice versa.

Quality The price determination process discussed above is important because an understanding of how supply and demand, and the forces that shift them, influence current and future market prices of cotton is critical to making decisions by market participants. Equally important is the price discovery process – the process by which buyers and sellers ascertain a transaction price for a given amount of cotton of a given quality in a given location at a specified point in time. When markets are operating efficiently, the difference between the general or average level of price and a transaction price should reflect the costs associated with the time (the cost of storage), place (the cost of transportation) and form (the cost of processing) dimensions of the product. In the case of cotton, this situation is somewhat more complex than with many commodities because cotton is so highly differentiable or heterogeneous – buyers and sellers distinguish between lots of cotton by virtue of the qualities embodied in them. Therefore, the quality attributes that make up the cotton must also be taken into account when addressing transaction prices. Cotton embodies a diverse set of quality characteristics that influence its use value in manufacturing textile products. Later in this chapter, effects of the accuracy and reliability of quality measurement on market prices are discussed. In this section, we focus on the impact of cotton quality characteristics on market transactions assuming the existence of a standardized grading system such as exists in the USA.

Chapter 9/page 9

Cotton Trading Manual In the USA, the cotton industry recognizes and provides objective measurement of eight or nine official cotton quality attributes, depending on how one counts them: fiber strength, fiber length, length uniformity, micronaire, leaf content, color (Rd or yellowness, and + b or grayness), extraneous matter content and preparation. Because of the availability of these standardized quality grades, cotton buyers reveal their preference (demand) for attributes in the market based on their use value in manufacturing textile products and relative availability of the needed attributes. Producers, then, attempt to supply cotton that contains these attributes, which gives rise to ‘pseudo markets’ for each of the cotton quality attributes. These markets are not directly observable, which emphasizes the importance of traders having a price information system provided by an objective independent third party, which provides reliable current information about how the markets are differentiating prices on the basis of the quality attributes – i.e. what the market premiums and discounts are for differences in quality attributes. In these pseudo markets, demand for and supply of quality characteristics establish prices for each of the quality characteristics, though not explicitly observed by industry participants. Cotton prices vary with the level of each quality attribute of the cotton being traded in the market. In the USA, the standard practice is that a base price is recognized for a certain fixed combination of attributes defined as base qualities (color grade 41, staple 34, leaf grade 4, micronaire 3.5–4.9 and strength 27–28 grams/tex). The transaction price for a given lot of cotton containing quality deviating from the base quality is then seen as premiums and/or discounts based on perceived values of the quality characteristics. See also Chapter 8 above.

Cotton pricing arrangements This section focuses on the different types of pricing arrangements or types of transactions found in the cotton market around the world. The manner in which a transaction is carried out is influenced by the type of quality measurement used. Before describing the types of pricing arrangements, the impact of quality measurement on market transactions is addressed.

Impact of quality measurement Cotton quality is a fundamental element in price determination because (1) quality heterogeneity is so prevalent in cotton and (2) combinations of quality attributes have a known effect on its use value in manufacturing textile products. The accuracy and reliability of quality measurement also affects the manner in which a transaction is carried out. Chapter 9/page 10

Cotton pricing Consider the evolution of cotton grading in the USA as a historical example. In the early part of the twentieth century, US cotton was traded in centralized spot markets. Samples were brought to a central location where merchants inspected the samples and made bids on the lots of cotton. The development of a widely accepted, standardized grading system, evolving to the eventual adoption of HVI grading many years later, allowed merchants to make bids on lots of cotton based on the standardized quality grades, and not having to view the samples. This transition eliminated the need for centralized spot markets and led to remote, and eventually electronic, trading. The point of this digression is that the pricing arrangements observed in different countries are to some degree related to the sophistication and reliability of the grading system. The more sophisticated and/or reliable the grading system, generally speaking, the less reliant a country is on centralized spot trading. This reduces the transaction costs associated with the buying and selling activities, usually making marketing more efficient. Thus, the grading system affects the type of market transactions. There are very divergent systems of quality determination (grading) in use across cotton-producing countries. The most sophisticated, precise and reliable is the High Volume Instrument (HVI) grading practiced in the US. In that grading and marketing system, farmers own the cotton lint until it has been ginned and graded (it is not marketed until the quality is known), then it is sold. At the other end of the spectrum, in several countries in Africa (e.g. Ethiopia), cotton undergoes only visual inspection, which produces much less accurate and reliable information about the fiber. Additionally, farmers sell seed cotton before it is ginned and graded. The impacts of the different systems of grading are that the more reliable the grading system, the greater the value of the cotton, other things equal, because users have better information with which to make more effective/efficient use of the fiber. This value will reflect itself in market prices.

Types of arrangements Pricing arrangements can be effectively divided into four general categories: spot markets, futures markets, forward contracts, and pooling arrangements. This section will discuss each of these in turn. Spot markets Spot markets are the oldest and most commonly used pricing arrangement for cotton. In one sense, it is not a pricing arrangement at all. Rather, the pricing arrangement is determined ‘on the spot’, or when Chapter 9/page 11

Cotton Trading Manual the ownership of the cotton changes hands. For example, the farmer takes samples to market. Merchants view the samples and make bids on the lot of cotton. If the farmer accepts, the terms of the agreement are established there, or ‘on the spot’. The ownership of the cotton changes hands and money is exchanged. These spot markets range in sophistication from open-air cotton procurement bazaars in rural India, to open outcry floor exchanges in Turkey, to the Telcot (now The SEAM) all-electronic spot market in the US (Ethridge 1978). No matter the method of trading, the outcome in terms of a pricing arrangement is generally the same. Producers sell cotton after it is harvested in a market to merchants who offer immediate payment and delivery. Futures markets Futures markets trade contracts for future delivery of a commodity – they do not, in a strict sense, trade the commodity. However, because of the way contract conditions are specified, there is a direct connection between the contract prices and the commodity prices. The most prominent futures market in the world for cotton is the New York Futures Exchange (NYFE), described below. For more explanation of futures markets, there are numerous books that explain their operation, e.g. Hull 1997. See also Part 4 below. The NYFE is an open-outcry market. Traders, who represent clients, bid on sales and purchases of contracts on the floor of the Exchange. Contracts are for a standardized, specific quality for a specified quantity delivered at specified locations at a specific time. A cotton futures contract in New York is for 50 000 pounds of Strict Low Middling cotton, 34/32nds inch staple, 3.5–4.9 micronaire. The standard delivery dates are March, May, July, October and December for as much as two years into the future. For example, the December contract is for delivery of cotton during the month of December for the contract price. Most cotton traded on the futures exchange never changes hands (contracts are rarely delivered against). This is because positions are liquidated before contract maturity. For example, if you sold a cotton contract (50 000 pounds of cotton) for December delivery on the exchange in May and then bought a December delivery contract in September, you would no longer have an open position in the market. Thus, even though you sold cotton in May, you are no longer obligated to deliver that cotton because you have purchased an offsetting amount of cotton in the market. For this reason, the futures market is more often treated as a means of price discovery (discussed later) than as a direct market pricing arrangement. However, because of the relationship between the price movements in the futures market and price movements in cash markets, traders use futures markets for price risk manChapter 9/page 12

Cotton pricing agement – to ensure against the effects of adverse market price movements through time. The mechanism that makes futures markets useful for price risk management (hedging) is the fact that the actual commodity can be delivered to fulfill the conditions of the contract. This ‘threat’ of delivery is what forces the cash price and the futures contract price to converge at the delivery date/location. If the two prices do not converge, with differences allowed for location and quality, the cotton is delivered against the contract; the simpler solution is to have offsetting transactions without having to handle the actual commodity. A somewhat more complicated form of futures market trading is for options. An option is the purchase or sale of the right to buy or sell a futures contract at a set price. Rather than explain how these work, the reader is referred to futures trading books (e.g. Hull 1997). Suffice to say that the use of options for cotton traders is that it allows them to establish an effective price floor or ceiling (allowing for location, quality and other basis differences) for the cotton they are selling or buying. Options purchasers and sellers pay a fee (price) for that price insurance. Forward contracts There are a variety of forward contracts available to traders and producers. The different forward contracts typically differ in the method in which the price is determined, but all have a set of similar characteristics. Forward contracts typically specify a quality or range of qualities that are acceptable to the buyer, time of delivery and location of delivery. Other specifications may be method of delivery, type of packaging, amount of ginning or other processing, etc. These general characteristics are typically seen in most forward contracts. A forward contract, by definition, is a method for the producer to sell his crop (and the merchant to purchase that crop) before the crop is harvested (and, in many cases, before the crop is planted). The advantage of the forward contract for the producer is that it allows him to have knowledge of who his buyer will be and what price will be paid before the harvest of the crop. For the merchant, the forward contract allows him to have knowledge of how much cotton he will be purchasing and at what price so that he can better plan sales to mills. In cases where the forward contract is negotiated before the crop is planted, the contract may actually provide the producer more access to production credit because the sales price is certain, and thus net revenue is more certain. Forward contracts may also be established between merchants/shippers and textile manufacturers. There are two basic types of forward contract – cash and basis. The cash (sometimes called a fixed price) contract is the most basic form Chapter 9/page 13

Cotton Trading Manual of a forward contract. The contract specifically identifies a fixed price that is to be paid to the producer by the buyer. This price can only be altered by provisions in the contract or at the agreement of the seller, and is thus called a fixed price contract. This type of contract offers the highest degree of certainty to both buyer and seller about the eventual price of the cotton in the contract. It, however, offers little flexibility to either the buyer or seller to alter the contract price if market conditions change. A basis contract, by contrast, fixes the price differential between the futures price for the cotton and cash price in the local market. Thus, basis contracts operate in conjunction with futures markets. For example, assume that a producer makes a contract with the buyer to sell his cotton at 200 points (100 points = 1 US cent) below the December New York futures price for cotton on a given day, with the producer having the right to ‘call’ or ‘fix’ the futures price when he chooses. On the day of the contract, the price of cotton for December delivery on the New York Futures Exchange was 72 US cents per pound. Thus, the merchant would pay the producer 70 US cents per pound for the cotton (72 US cents minus 2 US cents basis) if the producer elected to fix the price on that date. Alternatively, the producer might elect to wait (if he thinks the futures price will rise). If he waited a month and the December futures price had risen to 74 cents, he could call the price on that day, making his cash price 72 cents. Thus, even though the price was not fixed in the beginning of the contract, the relationship between the local cash price and the futures price (called the basis) was fixed. For producers who are willing to take on a greater risk of price changes, the basis contract allows them to increase their contract price if the market price goes up. However, if the market price goes down, their contract price goes down as well. Merchants typically use call contracts, sometimes simultaneously with farmers and textile mills, to lock in their basis, which is, in effect, their profit margin. Marketing pools Another popular market pricing arrangement, especially in the US, is the marketing pool. In this arrangement, producers act together, pooling their cotton into larger lots. Typically, a professional trader or organization manages the marketing of the pool’s cotton. This trader uses the size of the marketing pool to negotiate higher prices for cotton than if individual producers had marketed the cotton themselves. Farmers are typically offered a below-market, up-front cash distribution based on the amount of cotton placed in the pool. Then, as the cotton is sold to merchants and shippers or textile mills, the net proceeds of the sales are distributed back to the farmers. The main advantage of the marketing pool is the size of the pool, which offsets the market power of large Chapter 9/page 14

Cotton pricing buyers. This form of marketing has gained popularity in the US, and accounts for as much as 60% of cotton marketings in the country.

Sources of price information and price predictions It is useful to separate information on prices from information about factors that affect prices. We know that cotton prices are affected by all of the factors that affect the supply or the demand for cotton. Demand for cotton (the relationship between the price of cotton and the consumption of cotton) is affected by individuals’ and countries’ income levels and rates of growth, prices of synthetic fibers, values of textile products and similar variables. Data sources for these types of variables include the statistical reporting offices of various governments and of international organizations such as the United Nations, the International Monetary Fund, Food and Agriculture Organization, the International Cotton Advisory Committee, the World Bank, etc. The supply of cotton (the relationship between the price of cotton and the quantities offered for sale) is affected by weather, individual government policies, production input costs, transportation costs, storage costs and other factors. Sources of data on these variables include the same sources as for demand-related data, plus various statistical reporting government agencies in individual countries. Sources of information on estimated (projected) production and consumption of cotton, which take many of these other variables into account, that are widely used and watched include country government statistical reports, such as those of the US Department of Agriculture and the International Cotton Advisory Committee (ICAC). Projections of production, consumption and the changes in stocks of cotton lead to expectations of how prices will move over time and are therefore the source of interest in these estimates on the part of the cotton trade. Information about prices themselves is somewhat more limited, although closely related to movements in production, consumption and stocks. We can separate price information into two types: information about historical prices, including prices and price movements up until the present, and projections or expectations about future prices. Major sources of these types of price information are discussed below, with current price data addressed first.

Current price data There are numerous sources of local or regional price information in markets around the world. The Bremen Cotton Exchange, for example, Chapter 9/page 15

Cotton Trading Manual provides price quotations and the Izmir Mercantile Exchange posts monthly average prices for cotton traded on the exchange. All of these price information sources are important to traders in those markets for price discovery. However, in most cases the markets covered by these reports are limited geographically or in the quantifies of cotton traded. On a more comprehensive scale, current price information, e.g. information on today’s or yesterday’s or this week’s prices, is available from primarily three sources: Cotlook Ltd, based in Liverpool, England, which collects prices from various countries; the New York Futures Exchange (formerly the Cotton Exchange), for futures market prices; and the Daily Spot Cotton Quotations, published daily by the Agricultural Marketing Service, US Department of Agriculture. These three price series are briefly described below. Cotlook Indices The Cotlook A and B Indices are widely regarded barometers of international price movement for cottons used to spin medium and coarse count yarns. These constitute the broadest-based and most consistent of price data across countries that currently exists. They have been in existence since 1966 and are compiled and published each day by Cotlook Ltd of Liverpool, England, an independent private company whose staff have no trading interest in cotton. Cotlook Ltd gathers and collates information from around the world about the prices at which cotton from various origins is offered to spinning mills and establishes its assessment of the representative price (including cost, insurance and freight to North European ports) for each growth. The indices and their constituent prices are provided to clients through a range of services, namely Cotlook Cifquotes, Cotlook Priscope and Cotlook Daily reports, as well as the weekly Cotton Outlook magazine. The Cotlook A Index is a Middling 1–3/32” quality, and cottons from 16 countries or growing areas of the world are eligible constituents, namely Uzbekistan, West Africa, Greece, Australia, Syria, US California-Arizona, US Memphis Territory, Paraguay, Turkey, Mexico, Tanzania, China, Pakistan, India, Spain and Brazil. The day’s index is the simple average of the cheapest five growths. The Cotlook B Index aims to reflect the value of cotton used by the spinner of coarser count yarns and the eligible constituents comprise eight ‘lower quality’ groups of cotton from Pakistan, US Orleans/Texas, Uzbekistan, Brazil, Turkey, Argentina, India and China. The B Index itself is the average of the cheapest three (rounded to the nearest five cent points). Since the 1970s, the Cotlook indices have been used in numerous ways by governments and private enterprises. The US Department of Chapter 9/page 16

Cotton pricing Agriculture first used the A Index as a means of calculating the commodity loan rate for Upland cotton and subsequently adopted it as the basis for calculating the US Adjusted World Price, as well as aspects of the three-step competitiveness provisions of the Upland marketing loan program. Elsewhere, the European Union uses the Cotlook A Index to determine price support levels for seed cotton in Greece and Spain, the two member countries that produce cotton. The index is used elsewhere as both a guide for domestic cotton programs and as a tool in cotton marketing. A large proportion of Central Asian output, for instance, has been sold to export markets by reference to the A Index since the early 1990s. However, it is important to note that the quotations on which the Cotlook prices are based are not necessarily market-based prices; in fact, most of the price quotations are affected by a government trading authority except for those from the US and Australia. Futures market prices Cotton futures prices from the New York Futures Exchange are widely disseminated in the US and are accessible from most cotton market centers throughout the world. Current trading can be followed online through any of a number of market news services (e.g. Data Transmission Network, headquartered in Omaha, Nebraska, USA; www.dtn.com). Many market news and consulting groups report New York Futures Prices, including charting and analysis, as part of their daily activities, e.g. Cotlook, the US Department of Agriculture (although not on a real-time basis), Calcot, Ltd, a cooperative marketing association in the western US, reports them, and the Jernigan Group in Memphis, Tennessee. The daily reporting of these prices typically includes the opening bids, closing bids, average, highs and lows for the day. New York Futures prices are for a standardized quality, and they represent the market consensus of expected future prices for that quality at the designated future times and places specified in the contracts. It is important to note that they reflect the consensus on future, not current, prices, although there tends to be a positive, but not perfect, correlation in the movements of future expectations and current cash prices. Also, the New York Futures prices are a more direct reflection of prices in the USA than in other countries, but they are also used in many other countries because their movements are highly correlated with international prices. Traders in other countries may use the market for hedging, even though there remains a greater basis risk when used for non-US growths. There are futures exchanges for cotton in some other countries (e.g. Turkey), but none are as widely/heavily used as the New York Exchange. Chapter 9/page 17

Cotton Trading Manual Daily Spot Cotton Quotations Neither of the data series discussed above provides information about market price differentials based on the quality of cotton. The most accessible data on quality differentials is the Daily Spot Cotton Quotations (DSCQ), published by the Agricultural Marketing Service, US Department of Agriculture. These quotations are intended to represent the range of market prices across the entire quality spectrum of cotton for each of the major production regions in the US (Southeast, North Delta, South Delta, East Texas/Oklahoma, West Texas, Desert Southwest, Far West). They are constructed and reported so as to report a base price (the price for color grade 41, leaf grade 4, staple 34, micronaire 3.5–4.9, strength 27 and 28, length uniformity 80, free of grass, bark and other foreign materials), reported in cents per pound, then the differences from that base for all other qualities, reported in points per pound (100 points = one cent). The DSCQ is not built from a statistical sample of the market; it represents the market reporters’ judgements and relies on market intelligence. Consequently, its accuracy or reliability is not known. Many US farmers appear to assume that the price differentials reported in the DSCQ generally represent what is happening in the marketplace, although few merchants assume that it is valid for price discovery. By law, the DSCQ was developed to serve as the price differential tool for settlement of quality differences on deliveries of contracts (i.e. when the cotton delivered against a forward contract or on a futures contract actual delivery is not exactly as specified in the contract). Although it was not initially proposed as a spot market price discovery mechanism, over time some market participants have grown to expect that function of it. However, the existing evidence suggests that it is not valid for price discovery (Hudson, Ethridge and Brown 1996). But nothing like the DSCQ exists anywhere else in the world. Price data, and some price-quality differentials, are available from private and quasi-public (cooperative) sources in some countries. However, this information is usually published only sporadically and infrequently at best, and therefore limited in its usefulness for price discovery. Available information on price differentials does not typically reflect market differentials. In most cases they are either administered by a government group or an association of merchants. Overall, the present state of affairs is that information for discovery of current and future general price levels is much more reliable than information about price differences as influenced by quality variations in cottons. Market participants are thus left with more uncertainty regarding price discovery than if cotton lint were a more homogeneous commodity.

Chapter 9/page 18

Cotton pricing Historical data The International Cotton Advisory Committee (ICAC) collects and compiles data on cotton prices for all member countries that report prices. These price data are either approximations of market average prices for countries using a market system or prices as dictated by a government agency or quasi-government organization as the case may be. In most cases, the reported prices are intended to represent a farm-level (producer) price, but in some cases may represent prices further into the market channel. Consistency in what the prices represent is not always well defined, and cross-country comparisons are problematic. The US provides perhaps the most thorough and complete historical data on cotton prices of any of the major cotton-producing and exporting countries. The National Agricultural Statistics Service of the US Department of Agriculture collects and reports average prices received by farmers, by month, by state in the US. These data are collected using statistical sampling procedures; only average prices are reported. These prices are averages across all qualities, and the average is affected by the mix of quality attributes for the cotton; that is, the prices reported are not for a standardized quality. While the US has the most extensive price reporting on cotton, many countries engage in statistical reporting of prices in varying degrees of completeness.

Summary and conclusions Cotton prices in the various regional and country markets are increasingly influenced by markets on a global scale. While most countries continue to insulate their markets from external forces, the gradual lowering of trade barriers in both cotton fiber and textile markets is making each country’s cotton markets more exposed to forces at work with trading partners. These facts lead to more variable prices in many regional markets, thus making price discovery more important, and making accurate, reliable and timely price information more critical to efficient market functioning. Successful trading in cotton markets requires an understanding of the markets on several different levels. That is, traders in the various markets require price information on several levels in order to engage in price discovery. On one hand, traders need an understanding of the various general forces at work that move the entire global and national levels of prices up and down – the market fundamentals. These include general knowledge of consumer income changes, particularly for some countries and/or regional consumption trends, production shifts worldwide and in major producing countries, competition from man-made

Chapter 9/page 19

Cotton Trading Manual fibers, and macroeconomic forces and policy changes in tradingpartner countries. Most active traders use an array of economic news and market intelligence sources to shape their expectations and strategies with respect to these general market movements. As part of this perspective, traders need to have understanding of the different marketing systems. The different systems used for marketing cotton affect the process of price determination, and traders must understand those processes. On another level, traders must understand the national, regional and local markets in which they are trading. These markets are affected by specific things such as national policies and programs, transportation and other location factors, local crop conditions, and specific fiber needs of manufacturers in these markets. Markets at these levels, and the prices within them, are certainly affected by the larger (global?) markets and in turn may have some impact on the larger markets, but they may, and often do, deviate because of more local forces. Price discovery on these levels necessitates a more specific set of information needs on the part of traders. On still another more disaggregated level, traders must engage in price discovery for a vast array of cotton fiber quality. This is the aspect of trading in cotton that differentiates it from most other commodities – the extremely complex set of quality attributes that are relevant to efficient use in manufacturing and producing useful products. The value of fiber can easily vary by 50% based on its combinations of quality attributes alone. Because of this fact, for markets to be efficient price discovery essentially requires both (1) a reliable means of buyers and sellers knowing the quality of cotton and (2) having timely and accurate market price differences based on quality. Most countries’ marketing systems make at least some effort to provide for the first element, although some do much better than others. However, few countries are doing well with the second element. This absence of reliable price information based on quality differences presents traders with higher risk levels in price discovery and causes markets to operate less efficiently. The most critical point for traders is that price information is essential. Buyers and sellers should find sources of information on all levels – global, national, regional, local – that affect price determination and price discovery for their situations, practices and locations. Obtaining that information requires time and other resources, but market participants cannot afford to be without it.

Chapter 9/page 20

Part 4 Derivatives

10 The New York Board of Trade® The New York Cotton Exchange®*

Futures and options contracts The Certificate System The Clearing House Development of the NYCE® The current cotton contract and futures market The Cotton No 2 Futures Contract Hedging

Conclusion Appendix Cotton No 2sm Futures Contract Options Contract on Cotton No 2sm Futures Cotton No 2sm Options on Futures Spreads

* The New York Board of Trade® wishes to acknowledge that material for this chapter on cotton futures was drawn from P M Magness (1999) and J Baffes and I Kaltsas (2002) with permission of the respective authors.

On 20 July 1870, 106 cotton merchants and brokers signed an agreement to support plans for an organized marketplace where some sense of order could be brought to the business of buying, selling and (most important) pricing of cotton. The result – the New York Cotton Exchange® (NYCE®) – officially opened for business on 10 September 1870. Today the New York Cotton Exchange, now merged with the Coffee, Sugar & Cocoa Exchange, Inc (CSCE) to become the New York Board of Trade® (NYBOT®), holds the distinction of being the oldest commodity exchange in New York. It is also the longest-running cotton exchange in terms of continuous operation (more than 130 years) in the world.1 Price risk has always been a central characteristic of the cotton industry. The need for transparent and effective price discovery and price risk transfer has made cotton futures and options critical risk management tools for all those who grow, trade and mill cotton as well as to those involved in the manufacturing and selling of cotton goods, and the NYBOT remains a premier marketplace for cotton futures and options and the central pricing mechanism for the cotton industry internationally. Appendix 4 provides a more detailed account of the history and development of the NYCE/NYBOT and of other cotton futures exchanges around the world. This chapter looks at the structure and workings of the New York Board of Trade cotton futures and options marketplace.

Futures and options contracts Futures contracts, descending from forward contracts, have remained basically unchanged in form and function since the founding of the first futures exchanges. Forward contracts are cash market transactions that establish the terms for the actual ownership transfer of the physical cotton at a specific delivery date. The terms of the contract are unique to the parties involved. The forward contract became possible as information transfer accelerated in speed. A futures contract, however, differs primarily from a forward contract in that it is standardized and, while it has a delivery component, it does not exist primarily to facilitate physical delivery. A futures contract is a standardized agreement to purchase or sell a fixed quantity of a commodity at a predetermined price, with settlement to take place at a future date. The only negotiable element of the contract is the price. The trading of cotton futures, therefore, involves 1

Magness, P M, A speech on the history of cotton, delivered to the Southern Cotton Shippers Association in Memphis, TN, on 23 April 1999. Chapter 10/page 1

Cotton Trading Manual pricing cotton. Unlike forward contracts, delivery of futures contracts seldom takes place; the difference between the agreed and spot price at the time of contract expiration is typically settled through a cash transaction. An option on a futures contract grants the right, but not the obligation, to buy (call option) or sell (put option) a futures contract on the commodity at a prearranged price (the ‘strike price’). For this contract, the buyer or seller of the option has to pay a price at the time of contracting which is called the ‘premium.’ In effect, an option contract provides a kind of price insurance. Although the institutions and the governing rules and regulations behind the contracts evolved considerably over time, the concepts behind futures and options contracts and the purposes they serve remain largely unchanged. Futures markets are created to serve cash market needs and therefore seek to reflect cash market conditions. The exchange’s capability to adapt contracts and trading procedures in response to changing industry practices and conditions accounts for its long-term survival and its continuing ability to serve the underlying industry.

The Certificate System In 1887, the NYCE implemented the Certificate System. Under the system, a certificate stipulating the grades of cotton became good for delivery, passing from hand to hand like a stock certificate. This became the standard for recording and guaranteeing the quality of a specific bale of cotton, a measure necessary to ensure the validity of the futures contract as a benchmark for pricing. The United States Department of Agriculture (USDA) is the source of grading cotton for certification in the US. The certificate functions as a kind of ‘currency’ that facilitates the trading of cotton futures. The current NYBOT Cotton No. 2sm Contract for 50 000 lb of cotton of a specified minimum standard and grade represents approximately 100 bales of cotton (each bale 500 lb). In the case of delivery, the certificate for each bale of cotton would have to satisfy the contract’s minimum standards. The evolution of the Certificate System illustrates how the exchange can change its procedures and practices while maintaining the essential concepts of its primary functions. Today the Certificate System still serves its original purpose, but the development of the electronic warehouse receipt (EWR) system has allowed the assignment of ownership of a bale of cotton to move from a cumbersome manual exchange of paper to a completely electronic transfer and record of the transaction. With ever-increasing globalization, the ability to transfer ownership Chapter 10/page 2

The New York Board of Trade instantaneously via electronic means ranks with the development of the steamship and the transatlantic cable in terms of the movement of critical market information.

The Clearing House The New York Clearing Corporation (NYCC) or ‘Clearing Corporation’ is the designated clearing house for the Board of Trade of the City of New York, Inc. (NYBOT®). The NYCC was originally organized in 1915 as the New York Cotton Exchange Clearing Association and later became the Commodity Clearing Corporation. Although a NYBOT subsidiary, the NYCC has its own separate membership, board of directors, elected officers and operating staff. The Clearing Corporation provides clearing services and financial stability for its clearing members. The development of the Clearing Corporation adds a crucial advantage to futures trading. The clearing house removes counter party credit risks and performs two major functions: (1) reconciliation and clearing of all futures and options transactions made on the Exchange, and (2) assuring the financial integrity of such transactions. Through its system of financial safeguards and transaction guarantees, the NYCC protects the interests of the trading public, members of the Exchange and the clearing members of the Clearing Corporation. The Liverpool Exchange had established the first model of the clearing house in 1874. The New York Clearing Corporation assures contract performance through stringent financial requirements and NYCC member position limits.

Development of the NYCE® The great depression of the 1930s obviously affected all markets in the US. In 1933, cotton reached its lowest historical futures price of 4.91 cents/lb (see Fig. 10.1). In 1930, the NYCE founded the Wool Associates of the New York Cotton Exchange, Inc. and started trading in Wool Top futures on 18 May 1931. In 1941, a new contract providing for the delivery of wool in the grease was inaugurated. Neither contract has survived. The expansion of the NYCE reflected a growing cotton trade until about 1950, when the role of government in agricultural commodity industries again became a serious issue. In 1967, the US government modified its Farm Programs and the NYCE introduced the Cotton No. 2 Contract (basis 1 1/16th inch). This marked the beginning of the return of the NYCE to prominence in the cotton futures market. The 1973 commodity price boom and Chapter 10/page 3

Cotton Trading Manual 120

1864 High-190c 1865 High-120c

110 100

NY Spot Average 1791–1799 NY Spot Range 1800 –1960 NY Futures 1961– Present

90 80 70 60 50 40 30 20 10

*2001 prices through 4/2/02.

01 * 20

81

91

19

19

61

71 19

51

19

19

31

21

19 41

19

11

01

19

19

18 91

19

18 81

61

18 71

18

18 51

31

21

18 41

18

18

18 11

91 17

18 01

0

10.1 Cotton spot and futures prices in New York, 1791–2001.

subsequent withdrawal of the CCC from commodity markets contributed to the renewal of NYCE trading volume, which by 1975 had reached an annual average of half a million contracts (see footnote 1). The regulatory framework for the commodity futures markets also changed during this period. In 1974, the Commodity Exchange Act established the Commodity Futures Trading Commission (CFTC) as the US government agency overseeing the futures marketplace. While a consistent regulatory framework added more safeguards to the futures industry, government controls on cotton cash market forces had a profoundly negative impact on the effective function of the cotton futures market. The necessary conditions for the creation of a futures market include competitive buying and selling interests and the presence of price risk. Because of the threat to its survival, in 1966, the NYCE formed the Citrus Associates of the New York Cotton Exchange, Inc. and trading in frozen concentrated orange juice (FCOJ) futures began. This represented the first agricultural futures market to trade a processed commodity. The development of this market again demonstrated the elements of creating futures markets: sufficient price volatility, enough market participants to create price competition, a commodity that could be quantified and standardized in deliverable form, and support of the underlying industry for a price discovery mechanism. In July 1977 the NYCE relocated to the World Trade Center along with three other independent New York commodity exchanges. For the first time ever, the major New York commodity exchanges shared a trading floor. Chapter 10/page 4

The New York Board of Trade While at the World Trade Center, the NYCE again expanded its product line. After a half-century ban on agricultural options, the NYCE started trading options on cotton futures on 30 October 1984. The Coffee, Sugar & Cocoa Exchange, Inc. (CSCE) had reintroduced options on agricultural futures (Sugarsm No 11) in 1982. Options added greater strategic flexibility for risk managers and created new opportunities for speculators. The NYBOT cotton options market has become one of the most active of all the traditional agricultural commodity markets. The options capability gives hedgers a form of price insurance with which they can establish a price floor or ceiling without completely sacrificing upside potential should the cash market move in a favorable direction. With futures, hedgers are essentially locking in a price and sacrificing flexibility for the security of a predetermined net price for the commodity. With both capabilities, risk managers have a much wider variety of tools to help them achieve their price goals. With risk management becoming a factor in other market areas, in 1984, the NYCE entered the financial futures and options arena by creating the FINEX® division and launching USDX® futures on 20 November of that year. Several successful financial futures and options products were subsequently introduced over the next several years. The NYCE then further expanded by purchasing the New York Futures Exchange (NYFE) in 1993, thus adding markets based on key stock index and commodity benchmarks. In 1994, cotton established a new volume record of more than 4.6 million contracts. In 1995, cotton traded for over one dollar per pound for the first time since the Civil War (see Fig. 10.1). In 1998, two significant events further altered the shape and size of the NYCE. In June, the NYCE joined with the CSCE to form the New York Board of Trade® (NYBOT®). At that time, the two exchanges committed to a six-year merger process, with NYBOT as the parent company, at the end of which they would merge into one exchange. In the same year, two of the four exchanges sharing space at 4 World Trade Center (the New York Mercantile Exchange – NYMEX and the Commodities Exchange – COMEX) moved to their own new building in downtown Manhattan. The ability of the NYCE to develop and sustain crucial futures and options markets through world wars, economic crises, technological revolutions, as well as natural and man-made disasters was never more apparent than with the tragic events of 11 September 2001. On that day, the course of NYCE’s history shifted again with the destruction of the exchanges’ entire World Trade Center headquarters including trading floor, back offices and primary data centre. Because the CSCE had created and maintained a unique backup facility in Queens, NY following the bombing of the World Trade Center in 1993, the Chapter 10/page 5

Cotton Trading Manual NYBOT exchanges were the first New York exchanges to reopen floor trading on 17 September. The NYBOT operated from its backup site for two years until September 2003, when it moved into new headquarters in Lower Manhattan.

The current cotton contract and futures market In spite of all of the changes in the cash market, the New York cotton futures market today still serves the same primary functions – price discovery, risk transfer and price dissemination – that it did in 1870. Even with the pace of globalization of the cotton trade, the NYBOT is considered the most important cotton futures trading center in the world, and the world still prices its cotton at a premium or discount to the Cotton No. 2 Futures Contract traded in New York. Since 1997, for example, while the overall number of cotton futures and options traded has declined in response to a variety of supply and demand conditions, the New York Cotton Exchange/New York Board of Trade share of the futures market had increased to over 90% of the total by the end of 2001 (see Fig. 10.2). The stability and continuity of the futures market function is based on the standardization of the contracts to reflect cash market conditions and practices. The NYBOT continuously monitors the performance of its markets and the changing cash market conditions.

1 800 000 1 600 000

Contract volume

1 400 000 1 200 000 1 000 000 800 000 600 000 400 000 200 000

NYBOT

Central Japan Comm Exch

Chubu Comm Exch

Osaka Merc Exch

Note: BM&F and MGE trade nominal volume (not shown).

10.2 Cotton contract volumes, 1997–2001. Chapter 10/page 6

4Q01

3Q01

2Q01

1Q01

4Q00

3Q00

2Q00

1Q00

4Q99

3Q99

2Q99

1Q99

4Q98

3Q98

2Q98

1Q98

4Q97

3Q97

2Q97

1Q97

0

Tokyo Comm Exch

The New York Board of Trade Adjustments have been and will continue to be made to the contract as cash market conditions, crop characteristics and industry practices demand. For example, the fiber standards in the contract were upgraded in the recent past. The exchange’s contract committee is charged with maintaining the integrity of the contract. Proposals for new contracts are also considered and evaluated for potential introduction to the market.

The Cotton No. 2 Futures Contract The unique characteristics of cotton as a plant are reflected in the complexity of grading standards of the Cotton No. 2 Futures Contract, the specifications of which are given in the Appendix to this chapter. While the 50 000 lb contract has an established size of about 100 bales (with each bale about 500 lb of cotton), each bale has its own class and grade. The primary cotton classing components are color, length, micronaire and strength. Micronaire is a reading of the coarseness of the fiber measured by its resistance to air passage. Strength is quoted in ‘grams per tex’. Regarding color, the contract permits delivery of only ‘white’ grades of ‘good middling to low middling’ and light spotted grades of ‘good middling to middling’. The basic fiber length is 1 1/16 inch with a minimum of 1 1/32 inch at commercial discount and a maximum of 1 3/32 at a premium. Any longer staple does not carry a higher premium. Industry standards and practices have led to specification changes periodically. The minimum grade of cotton deliverable against the NYCE contract was raised to Low Middling from Good Ordinary in 1920. A contract permitting Southern delivery was introduced in 1929. In 1939 the basis of the cotton contract was changed from 7/8 inch to 15/16 inch and raised again in 1953 to 1 inch. Trading in the Cotton No. 2 contract with a 1 1/16 inch basis was introduced in 1967. In 1974, the basis grade was changed from Middling 1 1/16 inch to Strict Low Middling 1 1/16 inch. Most recently the NYCE has adjusted the contract specifications to reflect industry practices, beginning with the May 2003 Cotton No. 2 Contract: increasing the minimum strength requirement to 25 grams per tex (from the previous minimum of 22); allowing for price differentials should the US Department of Agriculture (USDA) commence quoting price differentials for cotton with a micronaire level of 4.8 or 4.9 (currently, micronaire readings of 3.5 to 4.9 are allowed with no premiums or discounts); establishing a new ‘age of cotton’ discount applied to cotton delivered on and after 1 January of the second calendar year following the cotton’s year of growth. In spite of a wide range of global cotton pricing and practices, the cotton industry uses the Cotton No. 2 Futures Contract as its primary Chapter 10/page 7

Cotton Trading Manual tool to hedge the purchase or sale price of cotton. Hedging is possible because the cotton futures and the cash market have a strong relationship. While the relationship is not constant, the two markets generally move in tandem over time.

Hedging To establish a successful hedge, the industry user in cotton (as in other agricultural commodities) must calculate a historical basis for the product trading in the local cash market. The basis figure represents the difference between the hedger’s local cotton cash price and the applicable Cotton No. 2 Futures Contract price. That difference may widen or narrow over time. This basis risk cannot be transferred to the futures market. In addition, since the abolition of the gold standard in 1973, all cotton futures contracts, with the exception of India, have been traded in US$ (see footnote 1). Hedging or speculation in cotton futures in any other currency involves unpredictable exchange rates and adds one more element of pricing uncertainty. Currency risk therefore becomes a factor in calculating basis risk. The presence of basis risk, however, does not negate the importance of hedging with futures and options. Historically, the overall price risk exposure exceeds basis risk. When the cost of raw materials for a mill owner, for example, generally ranges from 50 to 80% of total costs, the importance of a hedging plan becomes apparent. The New York Board of Trade cotton futures and options markets provide a number of useful hedging tools and strategies as well as investment opportunities. The historic NYBOT exchanges, dedicated to maintaining and enhancing an essential role in the marketplace, combine technology and tradition to meet the demands of a changing global cotton industry. The successful cotton hedger with a clear risk management plan and specific price goals can utilize a variable mix of futures, options on futures and forward contracts to protect and even enhance the bottom line (see Chapter 11).

Conclusion Throughout history cotton stands as a primary example of the power and influence of a single commodity on the political, economic and social lives of all the citizens of the world.2 Competitive success in the global marketplace in the cotton industry or in most other sectors

2

Baffes J & Kaltsas I, Cotton Futures Exchanges: Their Past, Their Present, and Their Future, Washington DC, 2002.

Chapter 10/page 8

The New York Board of Trade increasingly depends upon full access to all the available economic tools, particularly in the area of risk management. The NYBOT stands at the center of those efforts to maintain and broaden access to those tools and increase their efficiency. The New York Board of Trade® (NYBOT®), New York’s original futures exchange, represents the proud legacy of two historic commodity markets – the Coffee, Sugar & Cocoa Exchange (CSCE) and the New York Cotton Exchange (NYCE). The NYBOT provides reliability, integrity and security in one global marketplace for futures and options on cocoa, coffee, cotton, ethanol, frozen concentrated orange juice (FCOJ), pulp, sugar and twenty-nine currency pairs. Financial contracts are listed for Russell Equity Indexes, NYSE Composite Index®, Reuters/Jefferies CRB Index and U.S. Dollar Index®. The Exchange also provides innovative services on the internet including its exclusive eCOPS® electronic commodity delivery and documentation platform for the coffee industry and NYBOTlive, a direct real-time market data service. For more information, see to www.nybotlive.com or www.nybotlive.com

Chapter 10/page 9

Cotton Trading Manual

Appendix Cotton No. 2 Futures Contract Contract specifications are current as of Sept. 2, 2003 and may be subject to change. Verify information with your broker.

Trading Unit 50 000 lbs. net weight (approximately 100 bales) Trading Hours 10:30 am to 2:15 pm; closing period commences at 2:14 pm Price Quotation Cents and hundredths of a cent per pound Trading Months Current month plus one or more of the next 23 succeeding months. Active trading months: March, May, July, October, December. Ticker Symbol CT Minimum Fluctuation 1/100 of a cent (one ‘point’) per pound below 95 cents per pound. 5/100 of a cent (or five ‘points’) per pound at prices of 95 cents per pound or higher.* N.B.: Spreads may always trade and be quoted in one point increments, regardless of price levels. Chapter 10/page 10

Last Trading Day: Seventeen business days from end of spot month. First Notice Day: Five business days from end of preceding month. Daily Price Limits: 3 cents above or below previous day’s settlement price. However, if any contract months settles at or above $1.10 per pound, all contract months will trade with 4 cent price limits. Should no month settle at or above $1.10 per pound, price limits stay (or revert) to 3 cents per lb. Spot month – no limit on or after first notice day. Position Limits: Delivery Month 300 contracts Any other month 2500 contracts All months combined 3500 contracts Futures & options have a combined limit in futures equivalents. Contact the Exchange for more information. Basic Grade Quality: Strict Low Middling Stape Length: 1 2/32nd inch. Contact the Exchange for more information and other specifications. Point Value: $5.00 Delivery Points: Galveston, TX; Houston, TX; New Orleans, LA; Memphis, TN; Greenville/Spartanburg, S.C.

The New York Board of Trade Options Contract on Cotton No. 2 Futures Contract specifications are current as of Sept. 2, 2003 and may be subject to change. Verify information with your broker. Confers to buyer the right to buy (in the case of a call) or sell (in the case of a put) one Cotton No. 2 futures contract

Trading Unit One New York Cotton Exchange Cotton No. 2 futures contract.

Last Trading Day The last Friday which precedes first notice day for the underlying future by at least five business days.

Trading Hours See cotton futures

Expiration Date/Time Until 5 p.m. (NY time) on any trading day including last trading day. Automatic exercise at one tick or more in-the-money at expiration on last trading day.

Price Quotation Prices quoted in cents and hundredths of a cent. Trading Months Mar, May, Juy, Oct & Decr. The nearest ten delivery months will be available for trading. Example: In Aug 1999, the Oct 1999, Dec 1999, Mar 2000, May 2000, July 2000, Oct 2000, Dec 2000, Mar 2001, May 2001 & Jul 2001 contracts will be available for trading. Ticker Symbol CT

Daily Price Limits: None Strike Price Increments: 1 cent increments Minimum Price Fluctuation: 1/100 of a cent. Point Value: $5.00 Position Limits: See Cotton Futures specifications for combined Futures/Options Limits. Contact the Exchange for more information and other specifications.

Minimum Fluctuation Prices quoted in cents and hundredths of a cent.

Chapter 10/page 11

Cotton Trading Manual Cotton No. 2sm Options on Futures Spreads 10/20/04 Contract specifications may be subject to change. Verify information with your broker.

Strike Price Intervals Every 25 points; on first day, open at the money strikes, plus 3 up and 3 down. Additional strikes listed upon demand.

Contract Months 1. Month Series: Each of the first four listed months paired with consecutive listed months; 2. Month Series: Each of the first three listed months paired with the 2nd listed month forward from that listed month; 3. Month Series: Each of the first two listed months paired with the 3rd listed month forward from that listed month; 4. Month Series: The first listed month paired with the 4th listed month; 5. Month (Annual) Series: Each of the first five listed months paired with the 5th listed month forward from that month.

Price Quotation Premiums priced in cents per pound, to 2 decimal places. 200 points = $0.02 per pound, or $1000 per contract.

Minimum Tick 1 point, or $5.00 per contract.

Listing Cycle Five Series listed at all times: the 1 Month, 2 Month, 3 Month, 4 Month and 5 Month Series. Contracts or Pairs Permitted (16 pairs) H1K1 K1N1 N1V1 H1N1 K1V1 N1Z1 H1V1 K1Z1 N1H2 H1Z1 K1H2 N1K2 H1H2 K1K2 N1N2 (Total of 25 pairs)

V1Z1 V1H2 V1K2 V1N2 V1V2

Z1H2 Z1K2 Z1N2 Z1V2 Z1Z2

Listing Cycle • On theoretical first trading day of January 1, 2005, contract months would be: CT1 H5, CT2 H5, CT3 H5, CT4 H5, CT5 H5, CT1 K5, Chapter 10/page 12

The New York Board of Trade

•

•

•

•

CT2 K5, CT3 K5, CT5 K5, CT1 N5, CT2 N5, CT5 N5, CT1 V5, CT5 V5, CT5 Z5 (15 contracts) Following the expiration of the March options, listed months would be: CT1 K5, CT2 K5, CT3 K5, CT4 K5, CT5 K5, CT1 N5, CT2 N5, CT3 N5, CT5 N5, CT1 V5, CT2 V5, CT5 V5, CT1 Z5, CT5 Z5, CT5 H6 (15 contracts) Following the expiration of the May options, listed months would be: CT1 N5, CT2 N5, CT3 N5, CT4 N5, CT5 N5, CT1 V5, CT2 V5, CT3 V5, CT5 V5, CT1 Z5, CT2 Z5, CT5 Z5, CT1 H6, CT5 H6, CT5 K6 (15 contracts) Following the expiration of the July options, listed months would be: CT1 V5, CT2 V5, CT3 V5, CT4 V5, CT5 V5, CT1 Z5, CT2 Z5, CT3 Z5, CT5 Z5, CT1 H6, CT2 H6, CT5 H6, CT1 K6, CT5 K6, CT5 N6 (15 contracts) Following the expiration of the October options, listed months would be: CT1 Z5, CT2 Z5, CT3 Z5, CT4 Z5, CT5 Z5, CT1 H6, CT2 H6, CT3 H6, CT5 H6, CT1 K6, CT2 K6, CT5 K6, CT1 N6, CT5 N6, CT5 V6 (15 contracts)

Chapter 10/page 13

11 Cotton futures and options as hedging tools Herman S. Kohlmeyer Jr

Origins of trading Why hedge? Options Who hedges? Merchants Mills Farmers The purchase of put options The purchase of call options

Summary

The literature on hedging is an extensive one. Some fifty years after trading began in the late nineteenth century, academics were drawn to the challenge of explaining the relationship of futures and cash prices. We are all still trying to puzzle it out. The first group of English economists who turned to the subject developed the theory of normal backwardation, a term rarely used in the US trade, but which refers to the gradually increasing discounts that distant futures contracts sell relative to the nearest contract. John Maynard Keynes, in a 1923 article, advanced the theory of how a speculator could profit from what he observed to be a downward bias estimate of final expiration values. He reasserted this argument in his famous Treatise on Money in 1930, though without any empirical evidence. Keynes’ hypothesis was tested by Holbrook Working in his article, ‘Financial Results of Speculative Holding of Wheat’. Working had a distinguished career as an agricultural economist, and is certainly the father of all American studies on the futures markets. His involvement with futures markets began with his appointment as an economist of the Food Research Institute at Stanford University. The Institute, founded in 1921, began a project to study the world wheat economy and its relationship to American agriculture. The Wheat Studies, which the Institute began publishing in 1924, eventually ran to 20 volumes. Working incorporated the theory of the price of storage to explain the relationship between futures and cash prices, the same area of concern about which Keynes wrote. Working expanded his work to encompass how the level of commodity stocks affected the differences between various futures prices. His studies, extended over a period of more than 30 years, form the core of all efforts to understand the markets. The seminal work was expanded by a large group of disciples, particularly Roger Gray, into some of the major American universities and ‘think tanks’. All this early work concentrated on variables that we take for granted today: costs of storage, interest rates, opportunity costs, risk premiums, speculative activity or the lack of it, stocks of commodities or the lack of them, and characteristics of thinly traded markets. Sadly, however, the language of the academic literature became increasingly expressed in mathematics, making the study of the modern body of work a daunting endeavor to the traditional entrant into the business. Almost all the literature in the field since the writings of Keynes and Working, including even those of Paul Samuelson, is far too technical and specialized to be digested, much less understood, by the general cotton population. But at least there is a considerable list of studies devoted to the area that is of a more general nature and can be easily understood by those in the business. Chapter 11/page 1

Cotton Trading Manual Holbrook Working has left us with a corps of studies that remain a particular pleasure to read even now, especially so in that his work is illustrated with tables and graphs but is void of all the mathematical formulas that are beyond the grasp of most. Written over a period of 40 years, the works show his efforts in trying to make sense of carrying charges, speculative activities of scalpers and other day traders, the effect of liquidity, and the anticipatory nature of futures, to name just a few subjects. All these seem to make sense to us today, but Working shows the difficulty with which academia struggled to understand just what was going on in the pits. It remains a mystery to most people. Most of the books on the commodities markets that clog bookstores have a common theme. They are ‘how to’ books, telling the reader how to make money in the markets. Hidden in between advice of that nature and the more esoteric works of the academy is a smaller body of literature that attempts to explain how the markets can be used in the conduct of business. That, after all, is their purpose. The first entry on any list devoted to the cotton market is the classic Cotton Goes to Market, written by Alston Hill Garside in 1935, and sadly long out of print. Garside, the economist of the New York Cotton Exchange, designed his lengthy work to instruct both the novice and the curious exactly how to hedge. The book, read today, lacks the veneer of sophistication that one would expect from current authors, but it is successful in what it attempts to achieve. Garside takes the reader by the hand, step by step, and ploughs through the hedging process in great detail. Of the very many books written for the commodity trade, none is better than the two-volume work by Jack D. Schwager. Published in 1995 and 1996 and entitled very plainly, Fundamental Analysis and Technical Analysis, they are the ne plus ultra on this subject. Even though composed by a mathematician, he has written it in plain English. When the subject of commodities is brought up in polite society, the first word generally associated with it is ‘speculation’. The subject of hedging would be well down the list. In fairness, the urge to speculate is a much greater human trait than that of hedging, which some would say is no urge at all. The history of speculation has been the subject of countless books, which are much more interesting than books on hedging. After all, the saga of the South Sea Bubble, which blew up in 1720, is a keystone to any work on speculation, and it is just a matter of debate whether what happened in Holland a hundred years earlier with tulip bulbs is a bigger story than what happened in Paris and London with land in the New World. Needless to say, Europe was consumed by a passion for speculation in both Chapter 11/page 2

Cotton futures and options as hedging tools the seventeenth and eighteenth centuries. Only in the last few years might it be said that those sagas have finally been eclipsed by the recent dot.com bubble and bust in the stockmarket. Though Europe had much to teach Americans about speculation, that instinct travelled well to our shores. On a much more prosaic level, and closer to home, the story is well known of JP Morgan’s speculation in the gold market beginning in the early days of the Civil War, when he was in his early twenties. His initial venture found him accumulating gold in New York and then shipping it to London, creating a temporary shortage in the US and driving up prices, all to the great distress of his father. The great Morgan, who single-handedly stemmed the tide of the Panic of 1907 and who was by far the dominant banker of his day, obviously had the instincts of a major speculator in his early career, one that he never entirely shed. The cotton market has always been better known by the men who speculated in it than by those who were hedgers. There is a veritable pantheon of names that we could list, and none stands out more than that of Nicholas Biddle. Easily the most prominent financier of his day, Biddle was appointed to the board of the Bank of the United States by President Monroe and became its president in 1823. He was a pioneer in the belief of the need for a central bank to provide stability for the currency and to curb inflation. During the Panic of 1837, Biddle began to buy enormous amounts of cotton on behalf of his private bank, the successor to the failed Second Bank of the United States. Biddle teamed up with the New Orleans cotton merchant, Vincent Nolte, who found both additional financing for the venture and composed very bullish market letters in support of Biddle’s venture. Although their projection of smaller crops was correct, they failed to anticipate a failure in the wheat crop in both England and America. As wheat prices soared, cotton consumption dropped, much as it has in current times in response to higher energy prices. The corner failed, Nolte went to debtors’ prison, and Biddle’s already reduced reputation was dealt another blow. Since then, there have been many people who have lined up to follow Biddle in efforts to corner the cotton market. It often seems as if the more colossal the failure, the more noble the character. Clearly these captains of industry had no interest in hedging. Major homes in Memphis and New Orleans are still identified as the residences of men who tried to corner the market. It was considered every bit as honorable a venture as breaking the bank at Monte Carlo. The US government ultimately came to disagree with that point of view, passing laws in the early 1930s limiting the amount of any particular futures market than an individual can own. Yet schemes are still hatched, both by professional speculators and by those in the business. Chapter 11/page 3

Cotton Trading Manual

Origins of trading Critics of the futures markets would have you believe that they are just tools for speculation. As history shows, no one needed a futures market for that sort of activity. These markets were organized for a single reason: to hedge. The American trade had one particular issue to deal with. After the end of the Civil War, cotton production started to recover its health. By 1870, it had reached the 4 million-bale level, close to that of the peak years before the war. Almost three-quarters of that cotton was exported, most of it going to the English mills in Lancashire, the balance being spun by mills in New England. Cotton was shipped mostly from Savannah to the port of New York, where the decision was made whether it would be sold to the American mills or overseas. Steamers took as much as six weeks to make the Atlantic crossing, and the English mills were only willing to pay the market price at the time of the arrival of the cotton. Sellers, of course, wanted to nail down the price at the time the cotton was shipped. In an effort to provide a mechanism for merchants on both sides of the ocean to establish their price before putting the cotton on a boat, as well as to enable mill customers to take advantage of market levels when they wanted to, 106 cotton merchants and brokers in New York formed an association on 20 July 1870 to provide a mechanism for pricing cotton. The first trade took place a month later. The New York Cotton Exchange, before it merged with the Coffee, Sugar & Cocoa Exchange to form the New York Board of Trade in 1998, was the oldest commodity exchange in New York. It is also the only cotton futures market remaining in the world, although, as seen elsewhere in this manual, there have been similar institutions in New Orleans, Liverpool, Bremen, Le Havre, Alexandria, São Paulo, Bombay and Osaka, as well as a cotton ring on the Board of Trade in Chicago. The Alexandria market is credited with being the first cotton futures exchange. It was organized in 1861, with informal futures trading a part of business even earlier than that. All these exchanges were formed in the major cotton trading centres of the world, an obvious indication that the health of the trade required such a method of managing risk. The success of the New York market inspired a similar development in New Orleans, which was the major center of commerce in the South. A group of cotton merchants, the same number as in New York, organized in New Orleans on 6 February 1871, and began trading on 20 February, handling 1600 bales that first day. Trading closely paralleled New York and enjoyed great health down to World War II. Following the suspension of trading because of price controls that were established at the start of the Korean War, the exchange fell victim to modern commercial practices. Put simply, improved communications no longer Chapter 11/page 4

Cotton futures and options as hedging tools let the Southern cotton trade find it easier to reach New Orleans than New York, and neither did regional loyalties make good business sense. The virtue of a single concentrated exchange became obvious. The duplicate facilities in New Orleans no longer served a purpose. The single market in New York continues to serve the international cotton trade, in the view of the author, in a more efficient and effective manner than if a variety of regional exchanges existed. Orders from all parts of the world flow into this market. It is not at all unusual that a buyer from Turkey would meet a seller from Australia, that a seller from the Ivory Coast would meet a buyer from Japan. All parties of the trade benefit from this concentration of interests. In a similar fashion to cotton, the grain trade also began to search for a way to hedge its price risks after the Civil War. The shipment of corn involved a number of those risks. In particular, it was common practice to hold corn past the harvest period through spring and often into early summer so that it could dry thoroughly before shelling and shipping. Dealers began to hit on the arrangement of ‘time contracts’ or ‘to arrive contracts’, those becoming the forerunners of modern futures contracts. The handling of wheat involved similar risks, especially since substantial stocks were accumulated during the winter when navigation on the Great Lakes was shut down. The Board of Trade was established in Chicago in 1848, twelve years after the establishment of the St Louis Merchants Exchange. These exchanges provided a place for merchants to meet, to exchange information and to arrive, through private negotiation, at various contracts for particular amounts of corn and wheat to arrive at selected times. The first futures contract probably took place in 1875, though records are not as precise as those in New York. Hedging in wheat became common by 1880.

Why hedge? Why hedge, indeed? Isn’t it odd that the question is still asked? Isn’t it strange that we still find ourselves suggesting reasons that producers and consumers of commodities hedge? It isn’t, after all, a new idea. That is why some space has been given to the discussion of speculation, which was alive and well long before futures markets were established. And that is why some space has been given to the history of the beginning of our markets, to demonstrate that they were formed to provide a platform for hedging. A second very important feature, price discovery, developed along with the maturation of the market. Price discovery has been an essential feature for all sectors of the trade, but the farmer has been the biggest beneficiary, since he was the most in the dark. That was demonstrated as recently as the early 1980s, when a futures market Chapter 11/page 5

Cotton Trading Manual was established in New Orleans for rice. Up to that time, producers in most areas only knew what one or two buyers in their own county were willing to pay. All of a sudden, the market told them what was going on, enabling them to market their crop at competitive prices. Modern communications have now brought daily prices to all the inner recesses of Third World producers. Now, if they would only hedge! Although the futures markets were organized as a mechanism for hedging, they became a much greater platform for speculation. Since one might argue that the very nature of his business makes both the merchant and the farmer a speculator, perhaps the speculative nature of the futures markets was inevitable. Holbrook Working, as late as 1962, wrote ‘Although they [the futures markets] rather early won recognition as useful for hedging, their hedging use was treated as a fortunate by-product.’ It took years and years of research by both private and government economists to convince themselves that the futures markets were not only a legitimate tool for hedging but were actually used for that purpose by the trade. All sorts of anecdotal evidence from the trade had to be fleshed out with statistics of open interest and the like before academia would accept the obvious. At long last, the economics fraternity became willing to embrace the concept, as Working wrote, that the futures markets depend on hedging for their existence. For the handler of the commodity, whether he is called a dealer, merchant, trader, shipper or exporter, there is scarcely no way to remain in business in this modern environment without hedging against price risks. That was not always the case, of course, and before the establishment of futures markets, there was no simple method of hedging. Just as JP Morgan’s father’s bank was a bold dealer in gold, happy to force the market higher when it was to its advantage, so were all dealers in agricultural commodities speculators to a greater or lesser degree. But that is much the exception now. As a footnote, even today, a shipper who is long one growth of cotton can offset it with a sale of another growth, but that is becoming a less common technique. While there is no law other than that of common sense that requires a merchant to hedge his stocks or his forward commitments, the major enterprises simply cannot obtain bank financing to run their businesses if price risk is not avoided. With the increasingly narrow profit margins a consequence of more aggressive competition, better communications and an almost non-stop flow of information, an unexpected price movement would not only eliminate a year’s profits, it would eliminate the business. Traditional merchants today stand ready to buy crops when they are for sale and to sell commodities to their customers when the customers find the price attractive. The simultaneous purchase and sale of comChapter 11/page 6

Cotton futures and options as hedging tools modities at a profitable level has become increasing rare, so that the merchant always stands ready to sell futures when his farmer customers wish to sell their crops, and to buy futures when his commercial customers are ready to buy. Within the cotton trade, farmers and mills are equally resistant to the use of the futures market to hedge their price risks. In neither instance is the use of the market essential to their financial health. But in neither instance is the path to the market difficult to find. True, that path is littered with many corpses. That is not the fault of the market, but simply the fault of the victims.

Options The introduction of options on commodity futures came in 1984, with the first trade in cotton taking place on Halloween Day. An option on an underlying futures contract, much like an option on an individual stock, was not a new concept, but it was a bit of a dirty word in this industry. Option trading on commodity futures was a largely unregulated business with a modest turnover in the 1920s and 1930s, focused mostly on overnight risks in cotton and wheat. In a trade that pitted customers against dealers, the dealers mostly sellers, the customers mostly buyers, resistance began to build as public losses inevitably mounted. When dealers reneged on their obligations in a rare instance of a large victory for the customers, the protests finally reached boiling point, and Congress was obliged to outlaw the use of options for commodities in the mid-1930s. That was never the fate of options on stocks. The increasing public and professional participation in the stockmarket after World War II brought option trading to the fore. With interest swelling, input from the academic arena fuelled the fire and cloaked the industry with a great veneer of respectability. This was climaxed by the work of Robert Merton and Myron Scholes, who jointly received the Nobel Prize in Economics in 1997 for their research on a derivative pricing formula. This work on options, published in the early 1970s, did not materialize overnight. Fisher Black had started working at the same time to create a valuation model for stock warrants, calculating a derivative to measure how the discount rate of a warrant varies with time and the price of the stock. Scholes then joined Black to produce an accurate option pricing model in 1973, known ever since as the Black–Scholes model. It made its appearance just prior to the listing of stock options on the major stock exchanges. Even this work was built on what had come before. Going back to the dim past, options were traded by ancient merchants in the Mediterranean sea trade against outgoing shipments, with one party having Chapter 11/page 7

Cotton Trading Manual the right but not the obligation to do something. So we might say that there is nothing new going on here. The Black–Scholes formula uses fairly daunting mathematics to calculate the value of an option, taking into consideration the current stock price, the time until the option expires, the option strike price, the volatility of the underlying instrument and the interest rate. However, the use of the formula became child’s play to market participants, thanks to inexpensive, palm-sized, hand-held computers. With the formula directing investors and traders alike, dressing prices with a high degree of predictability, transactions in securities options markets ballooned. As trading progressed, we began to see an avalanche of books on the subject that were directed to traders and the general public, rather than to academics. Not until 1980 was a book finally called the bible of the industry, Lawrence McMillan’s Options as a Strategic Investment. But it took over ten years from the debut of listed options on securities for options to make their appearance in US agricultural futures markets. That was in part a result of the poor taste left by trading in the 1930s as well as the conservatism of the regulators at the Commodity Futures Trading Commission. In retrospect, there was an even more important piece of the puzzle that was missing: the lack of support by major farm organizations on behalf of their membership. It must be said that they failed to see what a tool these options are, and many still fail to understand them. The initiative to develop and to list commodity futures was undertaken by the merchant communities of the various commodities trades rather than by representatives of the farmers. They now have the potential to be the farmers’ best friend.

Who hedges? Who hedges indeed? Of course, every merchant does, or should, in one form or another. Those in the merchant community who don’t hedge don’t stay in business. Unpredictable markets are the mortal foes of all the participants, and they regularly bring down merchants who do battle with them.

Merchants Of the three sectors of the cotton trade – the farmer, the merchant and the mill – the practice of the merchant is the most simple and most universally followed. Since the merchant transactions are rarely accomplished simultaneously, back-to-back, so to speak, the merchant must buy futures as a hedge against his sales and he must sell futures as Chapter 11/page 8

Cotton futures and options as hedging tools a hedge against his purchases. Those are classic transactions, nice and simple. The merchant, of course, intends to sell his cotton to his mills for more than he paid his producer, or, in reverse order, to buy cotton from his producer for less than he initially sold it to his mills. Merchandising profits are traditionally generated by changes in the basis, ie in the relationship of the price of cotton to the underlying futures market: precisely the subject that puzzled and consumed academics for so many years. Unfavorable changes in the basis simply cannot be hedged, and this is the major risk the merchant must accept in conducting business. But in terms of the pure and unpredictable price movement of the commodity, the use of futures eliminates that risk.

Mills There is absolutely no need for the cotton-consuming portion of the trade to hedge. In a classic, by-the-book transaction by a spinning mill, the mill buys its cotton for whatever the price is at the time. That is the end of the business. Especially in the American trade, most of the cotton is purchased in a modification of that practice that involves two separate stages. The mill first identifies the basis that is acceptable to it. As an example, should a particular style of cotton traditionally trade at a premium of 300 points over the futures contract, the mill nails down that style of cotton at that particular basis for the desirable delivery times. That particular transaction is the most time-consuming of all trades for the mills. It establishes, by contract, four essential variables for the mill, and, in truth, many more than that, since the style of the cotton involves almost limitless combinations of grade, staple, color, micronaire and trash content. The one element the transaction does not establish is the one that is the most important: the price of the cotton. Changes in basis may vary from ten to fifty points over a short period of time, and rarely more than a few hundred points over the length of a season. Changes in style are well regulated by custom, with only the weather dictating that certain types of cotton cannot be produced in a season. However, changes in price can vary enormously in that time. The reason that the decision to fix the price of the cotton becomes a secondary issue with much of the American mill trade must be laid to one fact: it is almost entirely unpredictable, and the decision-making process is distasteful. Therefore, the nuts and bolts of the business are first attended to. The trigger-pulling to actually fix the price is then left to chance, black magic or good luck. The most traditional hedging activity of the mills, should they use the markets, casts them as buyers of futures against their forward sales of Chapter 11/page 9

Cotton Trading Manual products. If, as an example, a mill were to sell cloth a year ahead and at a profitable price, the mill could purchase futures to offset the sale. In truth, though, the same protection can be taken by the purchase of cotton from merchants, who would themselves turn to the futures market to manage the price exposure. The decision whether to use the markets as a hedge has long been a matter of style for each company. The choice is complicated by the capital demands on the mills in order to finance the use of the markets, as well as by various accounting and tax considerations. Although there are no studies on the subject, certainly well less than a quarter of all ‘hedgeable’ transactions involve direct activity by the mills. Since option trading started in 1984, a variety of strategies have been employed by a modest percentage of the mill trade. Many of those transactions cannot be considered to be hedges in the classic sense. What seems to attract some organizations, much as a flame attracts a moth, is the sale of put options. The sale generates a credit for the customer, which is a very pleasing event, as money flows into the account from the sale of the option. The option places an obligation on the mill to price cotton at the strike price should the market drop below the strike, but that seems an acceptable risk, since the price is always lower than the market at the time of the transaction. As an example, on 19 April 2002, with December futures about to close at 39.66, a mill could have been attracted to selling puts at a strike price of 37. The transaction would have earned a premium of 300 points, or $15 a bale, and it would have given the mill an obligation to purchase cotton at a price of 37¢, provided futures fell below that level. However, the option to initiate that transaction is completely up to the owner of the put. The seller has no ability to cause the transaction to be made, and is at the mercy of the owner throughout the entire life of the contract. Two weeks after the trade with the 37¢ strike option in the above example, December futures were down to the 37¢ level, and traded there for four days. After that, the market rallied. The mill, which probably would have been pleased to price cotton at the 37¢ level, was deterred from doing so because the owner of the put had no motivation to exercise his option at that particular time. The premium remained with the customer, but the ability to take advantage of the cheaper prices most likely eluded him. Even more to the disadvantage of the mill, if he is a particularly aggressive user of the strategy of selling puts, should the market sink considerably further than he anticipated, he has a great deal more highpriced contracts than he would like to have, with the only reward a few cents’ worth of premiums. Should the market not work lower, and prices advance further than anticipated, the customer is often blinded to that potential because of Chapter 11/page 10

Cotton futures and options as hedging tools his ongoing obligation to accept cotton should prices again reverse themselves. A prudent rule for mills, as well as for all users of the markets, is that they should never be sellers of options, whether they be puts or calls. There are only two uses of options for the mill that can be considered appropriate hedges: the purchase of call options and the purchase of put options. Neither instance is widely used by the mill trade, for one simple reason: it costs money. Of course, so does insurance, but that has been used for several hundred years. Perhaps we will need to see several hundred years of option trading before the purchase of options is widely accepted. The use of call options, giving the customer the right to acquire cotton at the strike he selects, can be used at both market peaks and bottoms, as well as everywhere in between. Even at historically high prices, when fears of further gains are the most extreme, the purchase of call options will cost the mill the premium, but it will give him the time to wait in hopes of a subsequent decline of the market. As an example, in 1998, December futures traded as high as 78¢ in June, as the prospect of a small crop and good business generated considerable hope for much higher prices. For reasons that were surely not so clear at that time, the enthusiasm quickly came to an end, and prices declined all the way to 60¢ by the end of the year. With call options bought as insurance, the customer could have been become comfortable waiting for the newly developed bear market to get into full swing. The opposite tack is easier to undertake, the purchase of call options at around market lows. Of course, the trick is to establish what that low actually is, or will be. Towards the end of 1999, December 2000 futures traded as low as 54¢, but there were signs that negative pressure from foreign growths was coming to an end. Customers may have not been comfortable in extending price coverage past traditional levels, but the additional purchase of call options would give price protection for a modest cost that could be quantified. Mills traditionally withdraw from the purchase of options at what appear to be low levels, feeling that if the levels are that low that they should be willing to fix the price in a traditional way. During all of 2001, December futures could have been considered cheap. After all, the average price of futures over the previous twentyfive years had been approximately 70¢, and the year started off with December futures at 63¢. Prices got cheaper and cheaper all year long. December had dropped to 60¢ by the end of January, to 50¢ in late March, to 40¢ by mid-August, and below 30¢ in late October. By all standards, the price was cheap all year long. Mills that purchased call options all the way down, for an average of 3¢ or so, could be said to have wasted that Chapter 11/page 11

Cotton Trading Manual premium at every instance, but they also had the opportunity to actually fix the price at much lower levels. The purchase of puts is a classic variation on the use of insurance, giving the buyer price protection should the markets go lower rather than higher. If a mill were to purchase puts each time he purchased cotton, his cost would be increased by the cost of the option, but he would be gaining valuable insurance in the case of a major decline. In a sophisticated variation of this strategy, Wal-Mart has frequently required that its suppliers of cotton products attach a put option to their contracts. In this manner, the company is able to benefit from unanticipated lower prices, thereby keeping its ability to remain aggressively competitive with its pricing structure in the stores. There are almost as many combinations and permutations of option strategies for mills as there are different staples and grades of cotton. One such strategy that always has its adherents is call the ‘three-way’. This strategy involves the purchase of a call option at about the current market level, the sale of a call option at a somewhat higher level, say 6 to 10 cents up, with the sale of the option reducing the cost of the purchase of the option. The price of this call spread is then reduced further by the sale of a put option at a lower strike. For instance, as of this writing, December futures are worth 43.18, the December 44¢ call option is worth 3.14, the 50¢ call 1.33, the 39¢ put worth 1.66. The purchase of the 44¢ call, matched by the sale of the 50¢ call and the 39¢ put, would only cost 15 points. The opportunity to get something for nothing is almost too good to pass up, and the strategy will always have a following. However, it belongs more to the speculative community than to an industrial organization that has the responsibility for pricing its raw material with only modest price exposure. In other words, the customer should follow the old adage, ‘Keep it simple.’

Farmers The major question the cotton farmer must face is when to sell his crop. The secondary question, how, is another matter. One old-time rule of thumb, simple and unsophisticated at first glance, has proven to make good sense over the many years of cotton production: ‘Sell one-third at planting time, another third at harvest, the last third in the spring.’ That rule says a lot. Don’t try to price the entire crop at one time. Get started early. Sell more when it’s harvested and you know what you have. Hold some for a possible rally into the spring. Without testing the formula, no one would doubt that it works. Prices march up and down in time with the seasons for very good

Chapter 11/page 12

Cotton futures and options as hedging tools reasons. Of all the influences on commodity price trends, the time of the year remains the principal one. Certainly the worst time to sell the crop is at harvest, when prices generally make their seasonal lows because of the concentration of that selling. Different markets have different dynamics. In the US, the wheat market generally begins its advance around the Fourth of July, after the completion of the harvest. The soybean and corn markets generally begin their advances after the completion of harvest in the fall, though the traditional spring rallies in soybeans have been muted of late by the large South American soybean crops. The consideration of this price pattern is of paramount concern to any farmer trying to get better than an average price for his crop. The grower has many choices of how to sell or hedge his crop. To our rule of never selling options short we would add another ironclad rule: a farmer should never sell futures short. The purpose of this statement, which flies in the face of traditional advice, is to point out that the financing of the short sale of futures becomes a backbreaking task when the market makes a considerable advance. Almost all individual farmers, as well as mid-sized corporate entities, are ill-equipped to fund the margins that are required if prices advance significantly after the hedge is placed and before the cotton can be sold and the hedge retired. Cotton farmers all over the world should be students of their market. An important part of that education is to be aware of price patterns. The patterns that are important are not the ones that are found in chart books, such as head-and-shoulder formations and rounding tops and bottoms. Instead, they are the performance of prices that are largely influenced by seasonal considerations. The behavior of the market is not so easily predicted, but knowing what has happened in the past is critical in trying to plan for the future. The purchase of put options When a typical farmer in the American Mid-South territory works on his budget at the beginning of the season, he can calculate in precise terms the cost of his inputs: spraying, ginning, fertilizers, fungicides, herbicides and insecticides, and seed, along with the cost of labor, fuel and capital. There is even a calculation for insurance against catastrophic weather events. The one element he usually leaves out is the cost of insurance against catastrophic price activity. In fairness, the US price support system makes that insurance unnecessary, but that will not always be the case. It certainly is not the case for some percentage of world cotton growers who lack any safety net.

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Cotton Trading Manual That Mid-South grower can conservatively anticipate producing a bale and a half to the acre. At the time of planting, he can usually purchase an ‘at-the-money’ put option for a cost of four cents. In other words, if the December futures contract is trading at fifty cents, the option to ‘put’ or sell his cotton at the planting-time price would cost about $2000 per hundred bales. Protection for the bale-and-a-half he expects to raise would thus amount to $30 an acre, an increase to his budget of about five percent. The cost would be slightly less than what he would expect to pay for his herbicides. It is true that he can’t have a successful crop without the herbicides, but he may not be able to have a successful financial experience without the puts. Modern futures trading can be said to have started in 1973, when the market woke up after years of slumber and surged up to the famous 99¢ mark. Down through 2004, in the time between the planting of the seed and the harvest of the cotton, the market went down thirteen times, was unchanged once and rose seventeen times. In the 1970s, beginning with 1973, the market advanced five of the next seven years, but the two bear markets in 1974 and 1977 were expensive. In the 1980s, prices generally trended higher during the growing season, with the price movement still volatile, averaging 14¢ from start to finish. Six of those seasons saw higher prices from planting time to harvest time, with nine out of ten enjoying movements of over 10¢. Put options would have more than paid for themselves in 1981, 1982 and 1984. In the 1990s, price movements were not as volatile, thanks to a gradual building of stocks around the world. Only half of that decade saw a price movement of 10¢ or more, with the average for the decade being only 8¢. Prices trended lower in half those years, with doubledigit declines in 1992, 1996 and 1999. This century started out with a sleeper season, with prices advancing irregularly some 4¢. The next year, 2001, saw prices decline almost without interruption until October, when futures recorded the lowest price in over thirty-odd years: 28.20. What made risk management that much more difficult is that futures at planting time were the lowest since 1975. except for the never-to-be-repeated 1986 year. Indicative of how persistent the trends are in the cotton market, in the period 1973–2004 prices recorded either their highs or their lows during the growing season 18 out of 31 times in the last quarter of the year and 13 times in the month of November and the few days of trading in December. The summertime price spikes that are normal events in both the corn and soybean markets are not nearly as frequent in the cotton market. Fire insurance is something you never expect to use. Crop price insurance is something you know you will be able to use, but the cost is a stumbling block. Yet it would have been valuable in more than oneChapter 11/page 14

Cotton futures and options as hedging tools third of the seasons from 1973 to 2004. In addition, owning the put option doesn’t keep the grower from selling his cotton if he wishes. As a footnote, the grower can control the expense of the option purchase program by liquidating the put should its value sink to half the purchase price. In other words, the initial cost of $30 per acre can be reduced to about half that amount, the theory being that if the option is declining in cost, it is because the market is increasing in value, making the option less necessary to the grower. Particularly if he sells his crop during the growing season, the option should then be sold. The purchase of call options The reverse strategy can be employed at harvest time, when the grower knows the size of his crop. An increasingly greater percentage of the cotton crop is being sold ahead of its harvest, especially as a larger number of growers become aware of markets and trends. However, especially in years of low prices at harvest, a greater than normal amount of the crop around the world is usually not sold. The cotton farmer has the same instinct as the soybean farmer, and in the US is often the same person. Holding cotton for a possible spring rally is an enticing prospect. With farmers always optimistic about prices, it appears as if a post-harvest rally is a sure thing. However, in the past thirty years, that phenomenon occurred only fifteen times. The most famous market move, of course, was the rally up to $1.15 in the spring of 1995. That proved to be the most expensive market performance in cotton price history. In the first place, almost no one participated during the final few months of the rally. The market only went that high because almost all the grower cotton had been sold. The most conspicuous effect of the record price was an increase in world planting the next year of 11% and an increase in the world crop of 8%. Because of larger crops and the build-up in stocks following the season of dollar cotton, the market enjoyed a post-harvest rally only twice from 1995 to 2004, with only one advance significant: the near30¢ rally in 2003 that followed the million bale sale to China. By contrast, five of the years that experienced lower markets produced losses in double digits, averaging 20¢ each season. It was not always that way. In fact, the 1995 rally proved to be the climax of a wonderful winning streak. Beginning in the spring of 1986, prices mounted rallies in eight of ten years. The negative two years produced nominal losses, less than 5¢ apiece. Of the eight years with rising post-harvest prices, six were in double digits, with four of them scoring advances of better than 20¢, averaging 42%. That, of course, is what a grower lives for. But participating in higher prices carries a cost. Remembering the glory days, the grower is just Chapter 11/page 15

Cotton Trading Manual as likely to be ensnared by declining prices. Navigating through this morass is always difficult, but the use of options makes it considerably less painful. Suppose the same grower who purchased put options on his cotton at planting time now purchases call options at harvest time and then markets his crop. The same $30 per acre cost would have been a successful investment in about one-third of the past thirty years. By selling the crop at harvest time, the grower would have avoided eight seasons of subsequent double-digit declines. He would have the use of the proceeds of the crop as early as possible, and would not incur any storage charges. The cost of the option is really nominal for the benefit it provides.

Summary There’s nothing new about the use of the cotton market in the last one hundred years except for one important new tool: options. There are limitless combinations that can be used in both futures and in options. We have not tried to dwell on anything but the basics. The purchase of options should be an important tool in risk management, and the premium for the option should be looked at the same way as the cost of insurance. But it is not only a way to avoid a catastrophe, a fire or a theft. It’s an intelligent method to increase the rewards of growing cotton.

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12 Over-the-counter derivatives Nigel Scott

Features of the global cotton markets and their impact on OTC derivatives Supply Quality Market risk

A typical risk management problem in raw cotton Greek Box 4 cotton purchased from a Greek ginner by a merchant

How OTC instruments work in practice Hedging with cotton swaps Cotton swaps dissected Cotton options

OTC and exchange-traded instruments compared Historical development of exchange-traded and OTC markets Exchange-traded or OTC? Cross-currency swaps and options Term structure extension

Potential difficulties with OTC instruments Liquidity Credit Contrarian risk

Postscript: risk management using OTC instruments in the developing world

As we have seen in the last two chapters, there is a range of exchangetraded instruments available to agricultural businesses that wish to manage their market price risk. However, exchange-traded instruments sometimes fail to meet all of these businesses’ needs: • The commodities underlying the exchange-traded contracts may not always be identical, in terms of location, quality or origin, to the commodities of interest to the businesses concerned. • The structures of the exchange-traded contracts may not always be appropriate for the companies seeking protection. For example, an Australian cotton producer who is broadly satisfied with NYCE futures and options as hedging instruments may require AU$denominated rather than US$-denominated price protection to reflect his AU$ cost structure. • Exchange-traded contracts typically require cash payments upfront for initial margin and variation margin, whereas in the agribusiness world cash may not always be available. All these drawbacks could be remedied by moving away from exchange-traded instruments to over-the-counter (OTC) instruments. OTC instruments are individually negotiated, cash-settled contracts agreed between two parties with specific terms reflecting both parties’ needs and desires. Their terms could be identical to those of exchangetraded instruments but need not necessarily be so. For example, the two parties could agree an OTC instrument linked to the price of New York futures as translated to Australian dollars at the prevailing AU$–US$ exchange rate.

Features of the global cotton markets and their impact on OTC derivatives The production, shipping and sale of cotton is incredibly diverse. With a large number of origins, qualities, grades and delivery locations, cotton prices vary considerably from place to place, origin to origin and quality to quality. As a result of these numerous characteristics and the large numbers of combinations of these characteristics that determine cotton prices, prices observed for cotton can vary enormously. For example, a highmicronaire, high-grade piece of cotton FOT Ex Gin Azerbaijan varies considerably in value from a piece of SJV cotton FOB the West Coast of the US. All of these variations have a very real impact on the ability for a market participant to perfectly hedge an open cotton position in a highly variable underlying market. Chapter 12/page 1

Cotton Trading Manual The trading of cotton by producers, traders and consumers is mainly done through spot or forward, fixed-price, physical contracts. Bespoke in nature, and, by definition, off-exchange, these contracts are the primary method of hedging cotton contractual commitments. Should a contract or position be entered into where no equal and opposite contract exists or can be entered into, principals have few possibilities of matching off their liabilities. In order to understand the hedging requirements of a cotton market participant, a complete understanding of the problems and concerns regarding physical cotton contracts is vital. The derivative utilized must of course perfectly mirror the market movements of the underlying, but additionally must be appropriately flexible to mirror the underlying contracting issues associated with physical cotton. Some of the main issues impacting the physical trade of raw cotton are described below.

Supply The responsibility of the deliverer or shipper is that they deliver or ship on time, in the right quantity at the right point of delivery. The term ‘delivered’ is often regarded as synonymous with cost, insurance and freight (CIF) in the international cargo trade. Generally, the seller’s risks are greater in a delivered transaction because the buyer pays on the basis of delivered or landed quality/quantity, depending on the terms of the trade or requirements of the mill. Risk and title are borne by the seller until such time as the cotton passes from seller to buyer. The impact of non-delivery or non-receipt of the cotton impacts both the buyer’s and seller’s positions, which has a knock-on effect on the derivatives either party has contracted. An example would be tenor – the delay of physical delivery could require the derivative to be rolled back a commensurate period of time.

Quality Quality problems include cotton being the incorrect origin or grade, or other quality parameters such as micronaire, staple and a series of strength parameters. There could be evidence of extraneous matter within the lint bale, or potential contamination through the use of inappropriate packaging, overageing or moisture retention. There could be damage to the wrapping and thus potentially damage to the lint through discoloration, etc. Variation in quality has basis implications for the derivative hedge – for example, if the hedge is for Strict Low Middling 1.1/16, but the underlying is Good Middling 1.1/8, the hedger is exposed to basis risk. Chapter 12/page 2

Over-the-counter derivatives Market risk The risk of loss in value, owing to adverse movements in price of cotton on a spot or forward basis, is commonly referred to as market risk. This is the main subject of this chapter. But market movements also have the potential to create credit risk in the form of wilful contract default if the market moves sufficiently to give the counterparty an incentive to default on the trade and to seek a new trading partner at a new price. This kind of default can of course turn a derivative hedge position that perfectly matches, or is opposite to a physical position, into an outright speculative position. In this case a hedge would have to be immediately ‘unwound’, or else a flatprice position would remain, exposing the counterparty to market risk. The best way of explaining how all of these risks affect a cotton transaction is to take an example.

A typical risk management problem in raw cotton Greek Box 4 cotton purchased from a Greek ginner by a merchant In June, a merchant purchases 500 bales of Greek Box 4 cotton at US$0.70/lb for delivery free on truck (FOT) ex gin for October delivery, ie four months after trade date. The merchant takes on the obligation to make payment for the 500 bales in four months’ time to the ginner, against receipt of the cotton by his chosen haulier. He is exposed to the following risks: • The supplier not delivering the requisite grade or the specified quantity at the contract stipulated date. • The haulier not being able to transport the cotton from the gin to the port. • The overall market price of cotton falling between June and October, with the result that he sells the cotton to its eventual consumer at a loss to his purchase price. • The specific market price of Greek Box 4 at the consuming markets falling between June and October, even if the cotton market in general is stable, again resulting in the merchant taking a loss when the cotton is finally sold. • Forex risk, if not a dollar-denominated trade or company. The first of these risks should properly be considered as credit or counterparty risk and is discussed in Chapter 18 of this book. The last two are market risks, which can be hedged only by market transactions, either in the physical market or in derivatives. Chapter 12/page 3

Cotton Trading Manual Cotton Risk

A – Physical hedge

Mill

B – Derivative hedge

Trader

Exchange-traded

Futures

Options on futures

C – Over-the-counter (OTC)

Swaps

Options

12.1 The choices facing a cotton trader.

A physical hedge would simply take the form of a contract for the sale of the physical cotton for October shipment. The merchant could contract this hedge with another trader or, perhaps, with the end-user, a mill. In this case he would run credit risk on both of his transactions: if market prices rose then his seller might have an incentive not to deliver, and if market prices fell then his buyer might decide not to pay (see Fig. 12.1 for the range of choices facing a cotton trader). Why might the merchant decide to hedge his market price risk via a derivative rather than via a physical contract? • Speed: to hedge a physical position in the quickest possible time • Confidentiality: he may not wish to betray his position to the rest of the physical market • Liquidity: the physical market may be unattractively priced, or simply not bid or offered in volume, whereas the derivative market may be the opposite • Flexibility: in order to finesse the logistics until the last moment on a trade flow, and potentially maximize profit. • Price: to take advantage of an arbitrage between the physical market and the derivative markets • Credit risk management: the physical forward carries credit risk, which he may prefer to take with a derivative house – which will typically be a well-rated bank, an exchange or a major trader – than with a local physical trader who may have no scruples about disChapter 12/page 4

Over-the-counter derivatives claiming the trade if prices fall and it becomes attractive for him to do so. By trading a derivative, the merchant is effectively separating his physical ownership of the cotton from his economic risk. He retains the physical ownership, control over logistics and the choice of physical counterparty at the conclusion of the transaction. However, he trades away the economic price risk associated with this physical ownership. How this works in practice is described in the next section.

How OTC instruments work in practice Hedging with cotton swaps If the merchant decided to trade away his price risk via an OTC derivative, the simplest instrument for him to use would be a swap. A cotton price swap is a forward price agreement between two counterparties who agree to settle the difference between: • a fixed price, established on trade date by mutual consent; and • a floating price index published by an independent third party, whose value will be examined at the end of the transaction on ‘fixing date’. Settlement would normally be made a few business days after fixing date. The term ‘swap’ is used because settling the difference between two price indices is analogous to ‘swapping’ the prices. One party pays one index (or a fixed amount) and in exchange the other party pays another index. In practice, settlement is always made net by whichever party owes the larger amount. The swap is called a ‘derivative’ because it is a contract whose value is derived from the third party, independent price source. The swap is unlikely to reference the physical bales of Greek Box 4 traded by the merchant, FOT ex-gin or delivered to the port, but will instead reference an independent publicly quoted index, such as perhaps the Cotlook A Index, which is the nearest widely traded index to Greek Box 4 and can be found in various publications such as the Financial Times. Because the merchant is ‘long’ cotton from his physical trade, he would wish to ‘short’ the derivative, in other words to notionally sell cotton at a fixed price. He might therefore contract as follows: • To receive a fixed price of US$0.70/lb on a notional quantity of 500 bales • To pay the A Index on the same notional quantity. Chapter 12/page 5

Cotton Trading Manual 90 80 70 60 50 40 30 20 Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

12.2 Cotlook A and New York Futures, 2000–2005, an example of basis risk (source: Bloomberg).

If the index rises over US$0.70/lb then he would anticipate that he would make a market-related gain on the physical sale of his cotton but pay away the difference via the derivative. If the index falls below US$0.70/lb then the opposite would take place. In either situation he hopes that if the reference index correlates to the physical, his general price risk is minimized. Of course, the merchant has no guarantee that the price he achieves when making his physical sale will equate to the A Index price when the swap matures. This difference between the real physical market and the index is known as ‘basis risk’ (see Fig. 12.2). Basis risk is simply the risk of loss owing to imperfect correlations between the derivative and the physical price. Traditionally, when derivatives were confined to exchange products, basis was described solely as the differential that exists at any time between the cash, or spot, price of a given cotton and the price of the nearest futures contract for the same or a related cotton. Today we may redefine basis to be the differential that exists at any time between the cash, or spot, price of a Chapter 12/page 6

Over-the-counter derivatives given cotton and the price of the nearest derivatives (OTC or exchangebased) contract for the same or a related cotton. Basis may reflect different time periods, product forms, qualities or locations. It should be noted that with the multiplicity of qualities of different commodities, basis risk can generally not be completely removed. However, it can be significantly reduced through the choice of an appropriately narrowly defined index. However, there is always a trade-off between basis risk and liquidity – more broadly defined indices are of interest to more traders and are therefore more liquid, but in turn carry more basis risk, if it is not exactly the same index that represents the physical goods traded. This trade-off is a key difference between the exchange-traded and the OTC derivative markets – the exchange typically being more liquid in the nearby maturities but with an underlying that carries considerable basis risk versus any particular physical piece of cotton other than one deliverable into the contract. Basis risk can be completely removed in instances where the index used to reference the derivative is a perfect match for the physical cotton traded. Traditionally countries such as Uzbekistan, Turkemenistan, Greece and Spain have traded physical cotton based on fixation of various indices. The US Government program is of course also effectively trading cotton based on an index, the AWP, which is of course derived from the A Index. Interestingly, there is a lower threshold of volume required to ensure that an OTC market succeeds than the higher volume required to ensure that an exchange-based market succeeds. This is often because the type of trades that occur on an exchange follow smallsized, very frequent hedging patterns, while an OTC market in soft commodities is typified by infrequent or intermittent, large notional transactions. The former can sustain the costs involved in an exchange, if the small trades are done in sufficient volume. If not, the futures market fails. Frequently, the research performed that identifies the need for a futures market is justified – it is perhaps the daily volume, or pattern of trades, that is overestimated, resulting in the failure of an exchange-based market. It is the underlying, true rationale for a market that is often then picked up by an OTC market maker. The resulting OTC market formed can be successful where the futures market failed. An example of the trade-off between basis risk and liquidity was seen in the cotton swaps markets. The NYBOT futures market based on the A Index had failed as a result of lack of liquidity required to support an exchange-based product, and a series of OTC markets were formed in 1998, in West African, Greek, Step 2 and the A Index. All the markets had legitimate basis and market requirements for a derivative. However, only one out of the four markets survived, because of liquidity challenges. The cotton swaps market remains an interesting Chapter 12/page 7

Cotton Trading Manual example of a swaps market experiencing some measure of success, following a futures market failure. This has been seen in the fertilizer and the freight swaps markets (FFAs) as well. In the final analysis, the merchant’s profit margin must also depend on his skill in managing the logistics and his ability to negotiate with his two physical counterparties around the general market price. No amount of derivative financial engineering can replace these skills and abilities.

Cotton swaps dissected Characteristics to be specified in a swap agreement are the following: • Which type of index or fixed price is to be received by each counterparty. The main indices used in cotton price swaps are the settlement prices of cotton futures or independent, published reference prices. Every day cotton prices are quoted on publicly available systems – namely, Reuters and Bloomberg – and newspapers, for example the Financial Times. • The maturity of the swap, which would generally be from three months to five years. • The frequency of the fixings, which can either replicate the first notice day of a future’s strip or can be monthly, quarterly or annually. The example above was designed to hedge a single physical transaction and had only one fixing date, but a merchant with continuing supply over a number of months, or a processor with continual purchases over a number of months or years might wish to trade a swap with multiple fixing days to match his business profile. • The averaging method, if averaging is required. Many agricultural businesses are more exposed to the average price of their cotton over a period of days or months than to any particular price on a single fixing date. Averaging is therefore common in cotton swaps and is one of the key advantages of OTC products as compared with exchange-traded ones. • The level of the fixed price, determined at the outset of the transaction depending upon market conditions and the characteristics of the underlying transaction, which is effectively the level at which the counterparties notionally ‘buy’ or ‘sell’ cotton via the swap. • The notional quantity to which the prices are applied, which might be quoted in MT, bales, bushels, lb or in ‘futures contract’ equivalents. If the transaction has multiple fixings, the notional quantity may vary between fixing dates, in accordance with a schedule, which would be mutually agreed at the start of the transaction. The seasonal nature of agricultural production means that some kind of notional quantity schedule is a common feature of cotton swap contracts, and the ability to tailor-make fixing dates and amounts per Chapter 12/page 8

Over-the-counter derivatives fixing is another key benefit of OTC as opposed to exchange-traded contracts. • The currency in which settlement is to be made and the exchange rate. Some agricultural businesses will wish to receive a fixed price in their domestic currency in order to hedge their domestic production costs. In this case their counterparty may have to trade a foreign-exchange-rate hedge as well as a cotton hedge in order to secure their positions. • Upfront fee: If the swap is struck at market prices no upfront fee would be payable. However, an off-market cotton swap may require a fee payable at some point before maturity in order to bring its economic value back to fair value. This will depend on the mark to market price of the swap when no independent price for the date in question is available. The cancellation of a cotton price swap remains possible throughout the transaction’s lifetime, by transacting an identical but opposite swap. The replacement cost of this swap will be dependent on the market conditions prevailing at the date of cancellation. In practice, banking counterparties prefer to transact cotton swaps under the master agreement of the International Swaps and Derivatives Association (ISDA), which has standard definitions for cotton swaps. However, other documents are used as well. The credit and documentation implications of using or not using ISDA are discussed in Chapters 16 and 18, which cover documentation and contracts.

Cotton options In the example above, the profits and losses on the cotton swap balanced almost exactly – basis risk excluded – against the profits and losses on the merchant’s physical trade. What if the merchant wished to have the best of both worlds: to receive protection from his derivative if prices fell but to avoid paying away when prices rose? In this case he would purchase a cotton put option: if prices fell his effective selling price would be flat because his derivative gains and physical losses would net to zero, while if prices rose his effective selling price would rise too. Characteristics to be specified in an option agreement include all the characteristics required in a swap agreement (see Chapter 11) as well as the following: • Which counterparty is the buyer of the cotton price option and which one is the seller? • The premium amount, which is always paid by the buyer to the seller, and the premium settlement date, which is usually a few business days after trade date. Chapter 12/page 9

Cotton Trading Manual • The style of the option, which may be European if it can only be exercised at maturity or American if it can be exercised before maturity. For cotton, NYCE exchange-traded options are American. • The expiry date or dates, which replace the fixing dates in the swap contract. • The option strike, which is determined at the outset of the transaction and corresponds to the fixed price of the swap.

OTC and exchange-traded instruments compared Historical development of exchange-traded and OTC markets Cotton markets of today originated from simple farming markets and they vary in their level of freedom. This disparity in origin has a direct impact on the requirement for a hedging program – in an environment of a controlled or semi-controlled market there is arguably little need for hedging for any subsidized or protected parties. Interestingly, though, subsidized markets can, through the reference of the subsidy, provide additional or new ways of hedging an overall total return for trader, producer or consumer. For example, the US Farm Program provides such possibilities when combined with hedging instruments. The Cotton Brokers’ Association was formed in the beginning of the nineteenth century, which approximately coincided with the initiation of trading cotton futures in Chicago on the CBOT. The first cotton contract was traded in 1865 and was based on the Liverpool Cotton Exchange price of physical contracts. A migration ultimately occurred to New York, where the NYBOT and then the NYCE traded exchange-based futures and then options contracts. At the same time, contracts on grains and other agricultural products gained in volume and popularity. It is not within the remit of this chapter to discuss exchange-based instruments at length, but it is important to grasp the choices facing a holder of a physical position as to the hedge he or she employs for an opposite physical position. The choice of which derivative to use is up to the market counterpart, who should make an informed decision based on the underlying physical position held and the characteristics of the hedging instruments available. Exchange-based derivatives are designed to appeal to the widest possible audience to achieve reasonable liquidity, so they are homogeneous in nature. In order to encourage the maximum number of transactions they are traded in one location for a specified number of hours. Information about the exchange, market information and prices is published on the internet, with a slight delay, and in real time from Chapter 12/page 10

Over-the-counter derivatives international service providers. This ensures global availability to the knowledge of this market, and allows price discovery to take place. But with this liquidity and price transparency has come a cost, namely that futures contract specifications have been designed, broadly speaking, for domestic US counterparties to hedge the majority of their risk, but not for other global counterparties with different qualities, origins and locations. Globally, the US futures exchanges have allowed only a section of market participants to hedge all of their risk. This has meant that counterparties have retained exposure to basis risk and, in some instances, the hedged risk has been largely offset or even exceeded by the additional risk introduced by the basis between the exchangetraded product and the physical cotton being hedged. This is clearly not a result that users would have desired when entering a derivative contract to hedge a physical commitment. An Indonesian purchaser of cotton who is a multi-origin purchaser of cotton could hedge his short position through physical contracts, but, if he was unable to do this, may purchase futures on the NYCE. In this case, he may actually end up purchasing cotton from Australia or Zimbabwe, or a variety of other origins, so he is well and truly exposed to basis risk. As a result of efforts to reduce basis risk in other commodities, mainly oil components, some OTC commodity swap markets began to develop in the 1980s. Next to be traded as OTC contracts were swaps in freight. Then, in the 1990s, soft-commodity OTC contracts began to be traded. These markets were based on the concept of a contract for difference. Derivative markets were cash-settled and derived their price reference from the price of a physical commodity against which market participants are trying to hedge their risk. Interestingly, while swaps were traded in traditional exchange-based markets, there were other, slightly more exotic, commodity underlyings traded, albeit in tiny volumes: for example, corn gluten feed pellets, CIF A/R (Amsterdam/Rotterdam). This was a natural progression for grain traders, used to trading ‘string’ contracts, as they effectively had been trading ‘paper’ markets anyway: there was little chance in a string contract of actually being the recipient of the cargo unless so desired. Soft commodity swaps form a small part of the overall financial OTC swaps markets, whose outstanding notional amounts are currently estimated to be valued at in excess of US$83 trillion.

Exchange-traded or OTC? How would a market participant decide whether to use exchange-traded or OTC derivative products to hedge his price risk? Table 12.1 outlines the key features of cotton derivative contracts in general and illustrates how they are reflected in exchange-traded and OTC products. Chapter 12/page 11

Cotton Trading Manual Table 12.1 Cotton derivative contracts for exchange-traded and OTC products Feature

Exchange-traded

OTC

Price transparency Counterparty risk Liquidity

Excellent Practically none Excellent for near months, can be difficult for longer maturities Can be a barrier for a successful exchange market if insufficient daily volume

Poor Significant Less liquid than the exchanges in the near months, more flexible otherwise Can be successful with smaller weekly volumes than an exchange market

Accounting, booking Very transparent require and valuation valuation systems Cashflows and margin calls

Require derivative-specific knowlege, systems skills accounting, MTM Initial and variation margin Can be adjusted to match required, can cause major perfectly with cashflows liquidity problems for hedger of underlying physical if timing of margin calls on business hedge fails to match cash received on core cotton transactions

Underlying price indices

Typically US-based

Any index in the world can be used provided it is calculated by a reliable independent third party

Tailoring

None possible other than selection of contract type, contract month and number of contracts to trade

Complete flexibility over quantity, maturity, settlement formula, averaging, foreign exchange components of the settlement index, etc

Brokerage

Small and transparent

Can be significant, and extent of bid–offer spread not always obvious to the end-user.

Cost-effectiveness overall

Excellent on brokerage, but client may end up buying more protection than he needs in some cases, e.g. options

Can be cheaper if tailored structure is a better match with client needs

It is clear from Table 12.1 that they key benefits of the OTC products as against the exchange-traded ones are related to tailoring and specialization. A few examples, which illustrate these features, are discussed in more detail in the rest of this section. There are pros and cons to all hedging mechanisms, whether physical or derivative-based. Both sets of derivatives (exchange and OTC) must be looked at by market players as simply tools in the tool kit to complement their Chapter 12/page 12

Over-the-counter derivatives Price obtained by merchant sales price

Floating price of cotton

Net price achieved

Pay-off from put option

Strike level of put

Market price

12.3 The protection afforded by the option means that the net income from the physical cotton and the put option will have a minimum of the strike level of the put minus the premium paid. There is no limit to the upside amount received, should the market price exceed the strike price – this will actually equate to the physical price minus the premium.

physical cotton activities – there is no ‘quick fix’ or panacea to all the risks involved in trading raw cotton (Fig. 12.3).

Cross-currency swaps and options Most exchange-traded derivatives are priced in US$. But, with an OTC transaction, a bank can quote a producer (in the client’s time zone) a fixed price in the producer’s own currency. For example, he might quote AU$500 per bale FOB Brisbane on 5000 tonnes of cotton with an expiry in May one year hence. This will automatically be closed at the nominated benchmark yielding an AU$ profit or loss. Otherwise, the producer would have had to trade futures on the New York Cotton Exchange, if there was a market maker prepared to quote this far forwards for this volume, and then transact separately the equivalent amount of foreign exchange, closing out the futures and foreign exchange separately to realize gains and/or losses. A reasonably sophisticated Australian producer with 24-hour futures and foreign exchange trading capability would possibly be able to do the simultaneous foreign exchange and cotton trades himself, if the exchange had sufficient liquidity this far out on the curve. But an OTC market maker could also quote an option struck at the same fixed price in AU$. For the producer to replicate this himself would require Chapter 12/page 13

Cotton Trading Manual continual night-time (in the Australian time zone) access to both the cotton and the foreign exchange markets as he adjusted his hedges. If he wanted to trade a very large volume, he may simply not be able to trade on the exchange at all. This level of operational activity would probably cost an ordinary producer more than any potential saving from using exchange-traded rather than OTC markets. The cross-currency cotton option, which is relatively easy to price and hedge, thus provides a powerful demonstration of added value that can be obtained from OTC market makers.

Term structure extension A term structure extension swap consists of the provision of a cotton price swap beyond the term of the futures market between a fixed-price payer and a floating-price receiver. The fixed price is calculated by the bank and, at each fixing of the floating reference price, the level established is compared to this fixed price. This product is designed for producers and consumers who are seeking to guarantee the price of a future unpriced physical sale or purchase beyond the term of the futures market, and of course does not involve the physical sale or purchase of physical cotton. So swaps can be structured for periods of time significantly beyond where exchangetraded products stop trading, and this is the other particular area where swaps have developed. Banks make prices to cotton clients for tenors far in advance of traded months on futures or options exchanges. The Australian and Asian markets have been particularly focused on these products, an indication of the combination of the sophistication of the investors, the longer-term view of markets held by the participants therein and the lack of subsidies that forces producers’ minds to focus on longer-dated price protection strategies. In the previous example, an OTC market maker could quote a swap based on cotton prices in AU$ three years hence, and could quote for a greater volume, or a longer tenor (term extension) than currently traded on the exchange (Fig. 12.4). The producer could not replicate this himself. If he wanted a long tenor, or to trade a very large volume, he may simply not be able to trade on the exchange at all. As examples of recent activity (circa 2003–4) in soft commodity swaps markets, since the turn of this century, coffee roasters have locked in long-term (3–5 year) low forward prices of coffee, textile mills have locked in long-term (2-year) low prices of cotton, sugar producers and consumers have locked in long-term (2–3 year) prices of a very volatile sugar market, and cocoa producers have locked in long-term (3-year) high forward prices of cocoa. In summary, an OTC product applied properly can take some market or basis risk away from the grower, trader or consumer that is inherent Chapter 12/page 14

Over-the-counter derivatives

Price

Structure extension Existing futures markets

Date 1 yr

2 yr

3 yr

12.4 A classic term extension.

in futures products. These risks are transferred to the provider of the OTC product. Exchange-traded futures will not disappear. In fact, the gradual takeup of OTC products adds to the liquidity of futures markets as they provide an ultimate clearing mechanism. The NYBOT has fully understood this and encouraged swaps use through Exchange For Swaps (EFS), whereby swaps positions can be migrated on to the board. It is possible, however, that over time the OTC product may become the product of choice by producers or consumers in some markets, liquidity and regulatory environment permitting. Any prediction is dangerous, and must be subject to all sorts of outside factors such as issues of domestic US subsidy, etc. Cost is clearly a driving force for change – OTC products allow the customer, who is often unable to pay up large sums, to pay only for the protection he really needs. In some cases this cost saving can be significant over exchange-based products for example, in the case of options. If transacted through an institution that is providing credit already, such as a bank, OTC products do not necessarily require daily margining, potentially until the ability to pay the cash flow arrives (for instance, a producer sells his crop).

Potential difficulties with OTC instruments Liquidity A market is said to be ‘liquid’ when it has a high level of trading activity and open interest. Liquidity risk is the risk of loss through inability Chapter 12/page 15

Cotton Trading Manual to sell a derivative at a reasonable price and volume in a timely manner. The cotton swaps market suffers from liquidity problems, which arise when market players utilize the market intermittently for large volumes. This is in contrast to the futures markets, where small regular transactions are executed by a wide range of players on a daily basis. Open interest is thus immediately visible. Liquidity risk has remained high throughout the life of the soft commodity swaps markets. This has been exacerbated by some overly complex derivatives sold to some corporations – in certain parts of the world this has diminished the reputation of OTC derivatives in markets such as sugar. Liquidity risk should be clearly explained by the seller of derivative products, and this should be clearly understood by the ‘clients’. The Financial Services Authority in the UK, which governs (from a regulatory perspective) UK providers of soft commodity derivatives, has distinguished itself from other regulatory bodies globally in actively policing this aspect of capacity of counterparts to trade. This body should afford a high level of comfort to counterparts who transact with UK banking institutions.

Credit Credit issues are addressed elsewhere, but it should be mentioned at this point that credit availability is one of the key drawbacks of the OTC derivative markets. Because of the provision of initial and variation margin, credit losses in the exchange-traded market are practically unknown. But credit losses in the OTC market are possible and could cause serious damage if they occurred. As cotton markets tend to be more volatile than other financial markets, and counterparty credit quality tends to be lower, credit is a more dangerous issue in cotton markets than in other OTC derivative markets. Credit problems can of course be reduced for market participants if they trade with a company that is well rated – preferably AA or above. And the credit risk of cotton derivatives should be seen in the context of the poor credit quality of many cotton players: it may be preferable for a cotton merchant to trade long-dated price risk with a bank or OTC market maker, even one rated below AA, than to trade long-dated physical with a producer, unless the producer could come up with a letter of credit or bank guarantee. However, this could cause relational difficulties and would require a more to floating physical purchases. This is the reason, historically, that OTC swaps markets have evolved to banks and financial institutions that possess a good credit rating, even in commodities like energy, where trade counterparts are large entities.

Chapter 12/page 16

Over-the-counter derivatives Contrarian risk The seasonal nature of the world’s cotton production, along with the function of buyers’ and sellers’ buying and selling habits, dictates the level of contrarian risk. An Ivorian cotton producer is always technically long, a mill and integrated textile manufacturer is always technically short. Thus, contrarian risk naturally exists. The diversity of the global market – where commodities are produced in dozens of countries and traded in many more, with the ensuing variety of seasonal requirements – ensures, in theory at least, a natural spread of continuous contrarian risk.

Postscript: risk management using OTC instruments in the developing world The majority of cotton producers in developing countries are, in general, unable to access derivative markets at all: • the minimum size of contracts traded on organized exchanges may exceed the annual quantity of production of individual small and medium-sized producers • small producers often lack knowledge of derivatives • sellers of such instruments are often unwilling to engage with a new and unfamiliar customer base of small-scale producers, characterized by high transaction costs, diminished access to credit and increased performance risk. They therefore suffer disproportionately from the effects of market price volatility and, as a result, are unable to access the credit resources they need to invest in and improve their operations and manage their risk more professionally. One approach to mitigating the impact of price volatility on these small developing country farmers is to give them preferential access to risk management instruments available otherwise through international markets. Some local hedging markets may also be good candidates for use of risk management, such as Argentina, Brazil, Hungary, India, Malaysia and South Africa. In 1999, the World Bank – with support from the EU, and governments of the Netherlands and Switzerland, and in collaboration with other international organizations and private-sector representatives – started a project called the International Task Force (ITF) to make price risk management instruments available to farmers in the developing world, particularly the small ones, through cooperaChapter 12/page 17

Cotton Trading Manual tives, producer organizations, banks and rural financial institutions, and traders. The role of the World Bank is that of a facilitator, providing technical assistance and capacity building to farmers and intermediary institutions that link farmers to risk management markets. Hedging transactions are carried out strictly on commercial terms and are transacted directly between the local intermediary and an OTC market maker in soft commodity price risk management instruments. In 2002, the project entered into the implementation phase, and several soft commodity hedging transactions have now been concluded involving local producer organizations in Nicaragua, Tanzania and Uganda, and OTC market makers (one major international bank, Rabobank International, and one major trade house, Volcafe) in Europe and the USA. These pilot transactions in coffee assisted 250 farmers in Nicaragua, about 450 farmers in Uganda and a few thousand farmers in the case of Tanzania. It is clear, from anecdotal evidence in the trial transactions, that, in the future, price hedging via the international derivative markets will become a more regular feature of agriculture in developing countries and that this, in turn, will free up access to credit, to investment and to growth for farmers in these countries.

Chapter 12/page 18

13 Technical trading H Rogers Varner Jr

Combining technical and fundamental aspects Candlestick theory Stars Counts to new highs and lows

Traditional methods Five-point signal The cowboy wiggle Gann Elliott Volume and open interest

The open Reasonable risk, or trip to the casino? Much left out . . . Conclusion

The broad spectrum of what is commonly referred to as ‘technical analysis’ includes far too many techniques of analysis to cover in this chapter, so the focus will be on the alternatives that seem to work most of the time. There is nothing in ‘technical analysis’ that is foolproof and works 100% of the time, and if it existed, it would soon have all of the traders following in lock-step style. Technical analysis of cotton can of course be taken as a general view, when studying all commodity futures markets, as cotton can be seen to exhibit normal or routine patterns that are common for other markets. Pure technicians treat cotton as any other market, and eschew particular aspects. However, taking cotton as a pure numbers game, when only price and reaction matter, could result in an economic debacle, one full of margin calls, losses and worse. So before we get into the details of working with technical analysis and making use of myriad systems, we must first describe what is peculiar only to cotton. Consider the US Department of Agriculture, micro-managed by 535 politicians, each competing for votes as they design and create a farm program destined more to keep them in office than to provide any useful benefit to the producers, consumers or traders of cotton. What does technical analysis lead us to conclude about the specifics of this situation in respect of cotton? Owing to the massive price support provided by the US government, the cotton market has often reacted violently and counter to normal supply/demand or technical reasons. And, owing to these support mechanisms, the open interest level of cotton futures – a key technical feature – has been greatly affected and altered. First, a brief discussion of the ‘loan’ program must be understood, as it is this price support that greatly affects, and diminishes, overall open interest. Open interest, being the total number of futures contracts outstanding, depends greatly on farmer participation in order to lay off risk. However, the American farmer, producer of about 20% of the world’s cotton, does not take nearly the futures position when the market price is below the official government loan rate. For years, the benchmark loan rate has been roughly 52 cents for standard strict-low middling cotton, inch and 3/16, with normal parameters for strength and other qualities. If the market price falls below this level, 20% of the world’s production therefore has much less reason to use futures for hedges and risk protection. Even though this cotton does eventually come out from under the government’s ‘protection’, its marketing and hedging with the futures contracts is much less extensive than what would have taken place had market price been above the loan price. By removing a quarter of the world’s production from having to use futures and options as a risk layoff, the overall open interest level of cotton decreases substantially during these low price periods. To illustrate how greatly the US government loan program affects futures open interest, traders may want to refer to the great bull market Chapter 13/page 1

Cotton Trading Manual of 1995, when futures moved to their highest level ever (‘spot’ or ‘cash’ prices traded higher, during the Civil War, 1861–65). Open interest during this bull market got as high as 95 000 contracts and remained high as long as the price was well above the government loan price. However, in 2001, prices broke to a multi-year low, trading as low as 28 cents on spot futures, and 20 cents on spot US price. Open interest responded in kind, losing approximately half of its peak total, bottoming at around 45 000 contracts. Therefore, a trader of cotton using technical tools such as open interest totals and changes must be aware of this market-distorting program instituted by the US government. The US government has affected technical analysis and aspects during other periods of cotton trading, and we will discuss a couple of major events that took place with huge price implications. In 1986, the government responded to a huge build-up in ending stocks by deciding to implement a system whereby cotton was protected, but not carried indefinitely by the government. This idea became known as ‘Inventory Protection Program’, and resulted in a large carryout from the previous year to be made instantly available at the beginning of the new crop year. Thus, two crops were for sale at the same time, sending prices to a multi-decade low. In order to ‘protect’ or otherwise insulate the owner of the old crop stocks, the government decided to continue to pay a protected price for the old crop, right up to day one of the beginning of new crop. Cotton futures responded to this by having the July 1986 futures going off the board at expiration at around 65 cents, while the next spot month, the October, was trading at around 30 cents. Something this bizarre would befuddle a pure technical trader, as when plotting a continuous chart a gap of over 35 cents would appear, so that he could make little sense of the situation. One only needs to view quickly the chart of cotton futures in 1986 to see what a strange and drastic distortion the government bestowed upon this market. In another example of US government intrusion upon cotton technical analysis, look at what happened in the summer of 1998. At this time, there was in effect an export subsidy program commonly called ‘Step 2’. The export subsidy had a complicated set of triggering mechanisms, but a great unintended consequence arrived that summer, as politicians refused (for reasons unknown) to fund the program past the 1985–86 marketing year end. And, by capping the monies allocated at a specific level, the program forced many merchants to sell and ship cotton much faster than they would have done in normal marketing periods. With the money running out quickly, it became a furious game to buy, then sell, then ship the cotton, in order to collect the growing subsidy. Market price reacted by moving from around 60 cents to over 83 cents within a few weeks. Certainly, a technician may have enjoyed this move had he been on the right side, and reacted quickly and prudently. However, many technicians following old and ‘proven’ methods may have got Chapter 13/page 2

Technical trading

8500

7500

6500

5500

4500

Jun-02

Jul-99

Oct-98

2500

Oct-95

3500

13.1 Continuous spot cotton futures, 1995–2002.

themselves caught in a brutal price change because they were unaware or, worse, refused to acknowledge, that once again a government program had serious implications for the price of cotton. There are, of course, other government programs in other countries that do affect the price of cotton, but in much smaller ways. Some of the pure technical traders often eschew knowing of these, and argue that whatever the US government does with cotton is instantly and efficiently priced in the futures market. The three examples above prove them wrong and decidedly so. This government intrusion can double, or cut in half the price of cotton. A savvy technical trader will at least be aware of its presence; to ignore such a powerful influence is to ignore the elephant in the living room. You may not want to deal with it, but it is there and can affect the cotton futures market greatly. See Fig. 13.1.

Combining technical and fundamental aspects Some die-hard technical traders are loath even to admit that they consider fundamental events, much less know that they exist. They put all their energy into the wizardry of mastering technical happenings such as moving averages, momentum, timing, overlapping prices, zigzags and other sophisticated works. No doubt these are all useful tools, and Chapter 13/page 3

Cotton Trading Manual they do work, sometimes spectacularly, but in practice the pure technician may often be blinded by upcoming major moves in a market, or be unaware that a major price turn is at hand. They have followed a trend dutifully and resolutely, often adding and ‘pyramiding’ their positions into glorious profits, only to give back much of what was earned when the market’s behavior changes. A sideways trend can be worked nicely by a technical trader, realizing limits on both sides of the market. But he is often caught with his guard down and positions loaded, when the market breaks through this price band on a looming fundamental event. The same can be said when price is at historical extremes, when the pure technical trader has his positions and profits loaded for more. He often gets blindsided by sudden price reversals, whereas the plodding fundamental analyst saw correctly macro changes in production and usage. A successful trading strategy may well be one that uses fundamental analysis for broad price parameters, and technical analysis to assist with entries, exits, timing, adding or decreasing positions, and use of options. Thus, neither type analysis gets the full credit – or full blame – when the market does make instant and dramatic moves. A fundamental analyst knows something about a break-even price of cotton for farmers, and realizes that prices much under that level stifle production. Thus, the fundamental trader may become excited about an impending supply shortage long before the technical trader is aware of a price trend change. However, technical traders often can ‘stay the course’ much longer than some fundamental traders, as some events unfold during and after price change, not revealing themselves to an analyst reading a report two months after the fact. A technician may not know, or care, that a major drought occurred to alter supply, but he may position himself in the market much more aptly than the fundamental trader, sticking with the trend, and the drought, until both had reached their conclusions. A good case can be made for the technical trader during the bear market of 2000–01. Reading reports of fundamental analysis during this time, one noted growing demand and tight carryouts. However, market price broke on future prospects of a record large crop, one that was unforeseen to most of the market at the time. Technical traders who followed the trends were ahead of and with the price change well before fundamental analysis caught up. The trend in this market was relentless, hardly having a counter-rally of any consequence during a nearly year-long decline into historical low levels. Technicians were delirious with profits, and fundamental analysts were too often buying at each ‘historically cheap’ price level. However, it was perhaps the fundamentalists who did identify changes that affected supply and demand, when the price had traded down to a three-decade low. The trader who used technical analysis to identify and stay with the trend, along with fundaChapter 13/page 4

Technical trading mental work that showed a major price reversal was at hand, did better than either of the purists set.

Candlestick theory The British were explorers, trendsetters and adventurers of a class the world had never seen before. Having the world-class navy enabled them to export their way of government and capitalism all over the world. When they came to India, they brought many things to the subcontinent, but the merchants and traders of tea were exposed to something new and revolutionary to their old methods. It was here in India that the western world was first exposed to the technical system known today as ‘candlestick’ theory, whereby the Indians taught the English methods they had learned from other places in the Orient, mainly Japan. English tea traders quickly absorbed this ancient technique, and having a worldwide system of trading in commodities, the system spread into all markets. Today, the most complicated and highly technical quote and computer systems routinely include this charting method along with others. Japanese candlestick experts can be found in all nations among all peoples, and it is a method many use to get a quick, clear assessment of price possibilities. Does this system work with cotton futures? Like all other technical indicators, candlesticks can be used but cannot be guaranteed for all market turns and targets. The benefits are many, but so are the traps and pitfalls that happen so often, especially to those who refuse to accept inefficiencies of some markets as regards 24-hour trading vs day charts only, or light volume and erratic sessions where price became influenced unduly to large orders or lapses in time. However, candlestick theory can be most useful in trying to determine key price reversals and major highs and lows. Trying to make this section ‘cottonspecific’, let us illustrate how well cotton adhered to the centuries-old system the Japanese formulated, then taught to the Indians, who then tutored the English, who then introduced it to the world.

Stars Using a strict definition gleaned from the textbook Japanese Candlestick Charting Techniques by Steve Nison, an evening star is described as a reversal signal, named because the evening planet Venus appears prior to twilight at the end of day. This pattern comes at the end of an uptrend, and is made on three days. The first day is a long real body, the body being contained in price between open and close, and the second day is the star of the pattern. This day will have an opening and closing nearly the same, with a long shadow on either side of the body, those points defined by the daily low and high. The third day comChapter 13/page 5

Cotton Trading Manual

60

55

50

45

40

35

Apr

Jul

Oct

2002

Apr

13.2 Cotton futures, July 2002.

pletes this bearish signal, as the real body is below the value of the previous day’s open/close, often creating a gap, or as the Japanese refer to this price jump, a window. The star thus stands out by itself, hinting that the current price move has ended. The example shown in Fig. 13.2 is that of the July 2002 contract, whereby an evening star was made in late November of 2001 at 4150. This star was preceded by a positive move of roughly 1000 points, and the star contained all upward attempts for six months. It is the dominant technical pattern on the chart, one that correctly and accurately told the candlestick trader that an important price reversal was at hand. A bullish price reversal would have the opposite qualities described above, and is called a morning star because it is the planet Mercury, sometimes called the morning star, that foretells sunrise. Once again, cotton proves that it is does honor these signals, as a key price reversal and intermediate low was made on the July 2002 futures contract in early May 2002. Price had moved from above 4100 in March 2002, to slide just below 3300 in May. One can see the opposite parameters of the evening star made on successive days of 6, 7 and 8 May, as the morning star bullish reversal was constructed on these days. The market reacted sharply upward thereafter, posting a quick 700-tick gain. Once again, the candlestick theorist was forewarned that a key event had taken place, and he was able to take advantage of a powerful move. Chapter 13/page 6

Technical trading There are many other candlestick chart patterns and signals, some known in their old-world colorful names as dark-cloud cover, engulfing pattern, hammer, hanging man, piercing pattern, harami, tweezer, two crows, dumpling top, fry pan bottom, tasuki, white soldier, rickshaw man and so on. Studying this theory can take many months, but several textbooks are on the market to help traders quickly get a grasp on how to recognize these patterns. The adherence of cotton to candlestick chart patterns has been proven in these examples not to be taken lightly.

Counts to new highs and lows Candlestick theory also makes use of an interesting sequence of counting, whereas a time sequence from an important event may be used to identify timing for the next key event. Candlestick theory holds that a market often corrects upon the eighth or ninth day of new lows or highs (which can be hourly, weekly or monthly sequences) from the last key event, corrects again after the twelfth to thirteenth day, and often completes the move upon the twenty-first day of new lows or highs. These ‘counts’ also coincide with the series and sequences established by the Italian mathematician, Fibonacci. This scientist evolved a statistical series of repetitions, using a simple approach that the next number in the series was, or is, the addition of the two previous numbers. The sequence beginning with zero, then one, then two, carries forward thus: 0 + 1 = 1; 1 + 1 = 2; 1 + 2 = 3; 3 + 2 = 5; 5 + 3 = 8; 8 + 5 = 13; 13 + 8 = 21; 21 + 13 = 34; 34 + 21 = 55; 55 + 34 = 89; 89 + 55 = 144; 144 + 89 = 233; and so on to infinity. The sequence of 0, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233 . . . bears much resemblance to the Japanese correction counts of 8, 13 and 21. These two cultures were separated by great distance in their theories of numbers, but each arrived at similar ideas and a working mathematical theory even though great time and distance existed between them. The trader and candlestick theorist must use, but not become engrossed with, this well-documented series. Counts from important highs and lows often occur at the identified series intervals, but sometimes an important reversal occurs with little correlation to the series. We will divert briefly from cotton, and show how one candlestick count of 21 new lows correctly timed a major low in a futures market that has strong correlation with cotton, that of the Commodity Research Bureau Index, commonly called the CRB (Fig. 13.3). Choosing the major high of 23 475 in October 2000, the index is seen to have bottomed about a year later at 18 425. This level represented a key fundamental value, Chapter 13/page 7

Cotton Trading Manual SPOT CRB 27000 26000 25000 24000 23000 22000 21000 20000 19000 18000

Jun-02

Jul-99

Oct-98

Oct-95

17000

30 YEAR SUPPORT AREA

13.3 Commodity Research Bureau Index, 1995–2002.

as it was near a 30-year low price. However, the candlestick count of new lows showed an exact 21 from high to low. Once again, the candlestick chartist was alerted to a key price reversal thanks to his precise counting of new weekly lows. A cotton trader knows that cotton follows roughly the broad movement of all commodities in the index, and we can see that during this period cotton followed nicely the overall bear trend in the index. The weekly chart for cotton also showed a rolling top during fall of 2000, then a persistent bear trend that culminated during the same week as the CRB. The candlestick count for cotton was 23 new lows, two more than the theory calls for, but a cotton trader watching the index would have known to be on the alert for a reversal on the basis of the CRB count.

Traditional methods Five-point signal This ‘five-point signal’ should not be confused with chartist RN Elliott and his technical analysis based on five waves, or sub-movements, of price change. The five-point signal is not seen often, but when it does occur can be a powerful tool in helping the technical trader recognize a major price reversal. The Five Point Buy or Sell signal states that waves one, three and five must exceed the wave that precedes it. To illustrate a market top, wave three will be higher than one, and wave Chapter 13/page 8

Technical trading five will be higher than three. Wave four will be lower than two. A time factor must also be included, as the Five Point Buy or Sell signal can take anywhere from six days to ten weeks. The shorter the time period, the more reliable the signal. Describing a Five Point bottom is opposite from that of the top, as wave three will be lower than one, and wave five will be lower than three. And wave four will be higher than two. Making use of this signal, traders have two chances, and should restrain themselves to only two, by which to enter a trade. Using a bottom, for example, the first buy should be made on the first day the market finishes above the high of the low day (this would be point five). The second entry would be executed the first day the low is above the high of the lowest day. After entry, the trader should use a stop-loss if the contract closes below point five. Keeping this analysis ‘cotton-specific’, a prime example of how well this pattern can work came via the May 1992 cotton contract. Spot futures had been in a long trending bear market, beginning in May 1991 at a high over 94 cents. The May 1992 contract had moved from just over 77 cents to a low near 54. The final low was a nice example of the Five Point Buy signal, as the May 1992 contract made this pattern on 24 trading days, and held all basic parameters necessary to complete the bottom. The move following the Five Point Buy was in the neighborhood of 1000 points, so the tech trader adopting this little-used chart pattern as a tool was well rewarded. The five-point signal also should be looked upon as a period of great uncertainty in the market. Following a big move up or down, the market finally reaches its conclusion, and the zigzag nature of the pattern contributes to confusion with its whipsaw action, and non-trending price. It is under those conditions that the five-point signal kicks in, and can be used to identify correctly the end of the previous move. In order to see the Five Point Buy signal, refer to a May 1992 cotton chart.

The cowboy wiggle There is a tricky little chart pattern from the late 1970s. Our name for the pattern is the ‘cowboy wiggle’, but this little-known pattern is also referred to as the ‘Lindall wiggle’, and other nicknames. It can upset traders, creating confusion and doubt, but once completed, it sometimes correctly identifies a top or bottom. For a bottom, there are five requirements, all of which must be made in eight trading days or less: • New low. • Take out high of low day. • Lower low than any previous day. Chapter 13/page 9

Cotton Trading Manual • Close higher than opening of same day (can, but does not have to be day of third step). • Close higher than previous day’s close. For a top, the time requirement remains the same: • • • •

New high. Take out low of high day. Higher high than any previous day. Close lower than opening of same day (can, but does not have to be day of third step). • Close lower than previous day’s close. It was not possible to come upon a good ‘cowboy wiggle’ for cotton, and it is a rare formation, but one that has to be taken seriously when it does occur.

Gann There is too much written by, and about, WD Gann to do justice in this chapter. But there is something to mention here concerning this chart trader of the early twentieth century. One concept Gann wrote of was his ‘natural squares’. These were used to identify support and resistance. By squaring numbers on charts of price or time, Gann projected other targets also in price and time. Going further, his ‘Square of Nine’ theory uses squares to use as a tool to project prices and turns years ahead. He derived what he called ‘Cardinals and Corners’ as a subunit of his ‘Square of Nine’ theory, which are numbers used the same way as squares. Scrutinizing a list of his cardinals and corners, we find that Fibonacci numbers of 144 and 233 coincide with Gann’s numbers of 145 and 233. Gann also used cycles in his studies of markets, concentrating on the number 90 as his most important, whether it was 90 days, 90 weeks, 90 months or 90 years. Other important cycles he used were 60, 50, 49, 45, 30, 20, 15, 13, 10, 9, 7, 5, 3 and 1. Note that of these, many coincide with Fibonacci series of 1, 3, 5, 13 and 21. Again, Gann is much too extensive to begin an in-depth review here, and we refer you to Trading Advantage and Turning Point, which can be purchased through magazines or circulars that focus on technical trading publications.

Elliott Again, this chartist simply wrote too much, and was written of too much, to be covered in these pages. Ralph Nelson Elliott began trading stocks in the late 1920s, and refined a theory of recurring price ‘waves’. The Chapter 13/page 10

Technical trading basic idea is that price moves in repetitive cycles, reflecting trader sentiment and the flow of psychology. Elliott extended the concept known as ‘Dow Theory’, identifying specific characteristics of patterns. His theory is based on the concept that there are two types of price formations. One is an ‘impulse’ wave, which is the main trend, and the other is a ‘corrective’ wave, which moves against the impulse. The impulse wave has five movements, three of which are in direction of the main trend. Two of the waves are corrective, and are against the trend. The corrective wave has three movements, two with the correction and one against. What is known as ‘Wave Principle’ is that large movements are composed of smaller waves, which can also be broken down into smaller waves. Sub-waves adhere to the pattern of the larger structure of which they are part. Say, if wave three of an impulse formation has a sub-wave, those sub-waves will honor the 1-2-3-4-5 impulse of its wave. The subwaves of a corrective wave four, which moves against the trend, has a down-up-down, or A-B-C structure, and would take the sub-waves of a B left in a correction. Elliott theory can be applied to a two-minute chart, or one of much longer periods such as weeks and months. Learning to use his principles can take some hard study, but, like those of Gann, can be very beneficial to the serious chart trader. Just a few publications are mentioned here: R.N. Elliott’s Masterworks, edited by Robert R. Prechter; The Complete Elliott Wave Writings of A. Hamilton Bolton, edited by Prechter; Elliott Wave Principle – Key to Stock Market Profits, by Prechter and Frost; and R.N. Elliott’s Market Letters, 1938–1946. A technical trader familiar with Elliott’s principles can pick any point on a cotton chart, and determine where in the minor and major movements the price is. Once he correctly identifies this point, which is no small achievement, he can then attempt to outguess market action by following the next series of impulse and corrective waves. Thus an Elliott technician can always have an idea of where the price has been, and is going, and can then determine if the market is due for a major price change or will just languish in minor sideways channels. The serious Elliott trader will probably have at least two, sometimes more alternatives with which price can move, and often has to wait for confirmation of one pattern or the other before committing to a trade. Refer to a monthly continuous cotton chart (not shown) to see the Elliott structure.

Volume and open interest Volume, as measure by total number of contracts traded in a particular period, is viewed as a measure of market strength or weakness. If volume is increasing while prices are moving either up or down, it is Chapter 13/page 11

Cotton Trading Manual likely that prices will continue their current price trend. On the other hand, a decline in volume is considered to signal that steam is running out in the direction of the current trend and consolidation or a reversal could be forthcoming. Dramatic market action that is common at market tops and bottoms is known as blow-offs and selling climaxes. Blow-offs occur at market tops. They usually occur after prices have moved higher over an extended period of time. At the end of the up move, prices rally sharply, accompanied by a large increase in volume. Typically, all of those that were going to buy at this level have done so. Profit-taking occurs and prices reverse, often suddenly, to the downside. Selling climaxes are simply the opposite of blow-offs. They occur at market bottoms after prices have been declining for an extended period of time. One final wave of selling drives prices sharply lower on significantly increased volume. Bargain hunters then jump in, buying, reversing the trend and sending prices higher. Open interest is the number of contracts that are trading for a particular contract. Expanding open interest in an uptrend represents new buying, and is bullish. On the other hand, expanding open interest in a downtrend represents aggressive new short selling, and is bearish. Declining open interest in an uptrend represents short covering, not new buying, and is bearish. However, declining open interest in a downtrend suggests the liquidation of losing long positions, and is bullish. At the end of an up move in prices, a levelling off or decline in open interest should serve as a warning that a reversal in the trend of prices is forthcoming.

The open Why are opening prices important to traders? Contrary to prevailing market wisdom, the opening price is perhaps the most useful of all intraday prices to a trader. Literature to date has dealt with opening prices in only a superficial manner. Exemplifying their overlooked importance, opening prices did not appear on any regularly published futures charts until the mid-1970s. Market advisers almost universally ignored opening prices, referring to them as unpredictable and having little significance in trading strategy, typically advising clients to wait until after the opening before entering or exiting from a position so that prices would have an opportunity to settle down. Reality shows that the opening price is invariably near either the day’s high or low, not distributed between them as you might suppose, with sometimes as much as nine out of ten sessions having the opening as either the high or the low of the day. Armed with this knowledge and the statistical probabilities of how far the opening price will be from either the high or the low, an astute trader can optimize his entries, exits and protective stops in the market. Chapter 13/page 12

Technical trading Opening prices are determined in the same manner as all other prices in the pit in New York, by outcry. If you are wondering about the pre-opening call prices issued by the different news services just before the market opens, here’s how they are arrived at. Locals and pit traders of the exchange poll key order fillers and traders, and unofficially estimate the opening price range or range of prices. The accuracy of this estimate varies greatly from time to time. Hence, one should use preopening calls with caution and only as a general guide, typically, as one might suspect, they are least accurate at the times when they could be particularly helpful. The opening price or prices are the prices at which the transactions occur in the trading pit immediately following the opening bell. The activity following the opening bell is frequently so hot and heavy in the cotton pit that it is not uncommon for two or more transactions to occur at different prices – this is referred to as a split opening or the opening range. The split openings are reported by the wire services, but are missing on many of the price quotation systems in order to conserve space on the display screen. Split openings should not be confused with Bid and Ask prices, which are totally different. Bid and Ask prices are quoted with a B and A following the price and represent the prices bid and ask in the trading pit without any transaction taking place. From many years’ trading in the cotton pit, it became apparent that the actual range that can be used safely as a valid opening range is the amount of time that each individual contract trades as it is opened by itself, independently of the other contracts. For instance, the July contract opens all by itself for a couple of minutes, then closes; then October gets its own two minutes, then December, and so on. Taking this knowledge and physically plotting it on a chart is very helpful. The opening range represents in a very brief amount of time a small range of prices that all the buyers and sellers from the day before actively trade at one time, and subsequently all of their day’s profits and losses start out at exactly the same points. Remembering that almost nine out of ten times, the opening range is at or near the day’s high or low and also using the prior day’s activity as another harbinger of forecasting is useful. Now we have a small range of points that all longs and shorts for that day and particularly the ones that entered the market on the opening will profit from immediately. The traders that got short on the opening and find themselves caught in a rally all have the same entry point. And so does the other side, the winning side; they all have the same entry point as well. So you can easily see that one small band of prices has a huge psychological impact as the trading day wears on, as many people all have the same entry points to their trades, which means that many traders will ultimately react in the same way. What typically happens is that all of the early shorts wait during a market rally Chapter 13/page 13

Cotton Trading Manual for the last minute to cover right on the close, as do the longs who hold out and hope for a rally, but upon not getting one also bail out on the close. This action more times than not sends the market scurrying away from the losing side on the close, making a bad situation only worse. The opening is usually so dependable in being around the highs or lows that one can also protect against losses predictably well too. In other words, if after having gone long, a trader should consider using a penetration back underneath the day’s opening range as a sufficient sell signal that he should get out of the way of a bad trade if this happened. The flip side, if a trader has gone short, is that he should consider using a penetration of the high of the opening range as a reason to liquidate. Now in order to ‘filter’ out any insignificant trading, we must use a parameter both above and below the day’s opening range that, from a trading perspective, we then consider a penetration out of this range important. The filter that cotton seems to work best on is about 30 points away from the extreme ends of the opening range. For instance, if July cotton opens one day trading from 3850 to 3865, that can be used as the opening range, with a filter of 30 points above the high, 3895, and 30 points below the low, 3820, as points to watch. The way this opening range concept seems most useful is in conjunction with the previous day’s activity that we have come to call the value range. This range is simply an average between the day’s low, high, close, added or subtracted from the average of the day’s high and the day’s low. For example, the high of the day is 3945, the low is 3880 and the close is 3904. The value range would be calculated by first averaging the high + low + close/3 = 3910. The high + low/2 = 3913. So the value range would then be 3910 plus or minus three points; the value range becomes 3907 to 3913 for that previous day. Plotting this against the opening range gives one the advantage of seeing both today’s psychological points as well as how today’s action is affecting yesterday’s trading. For instance, with an opening range that is right at the same level as the previous day’s highs and which turns out to be the low of the session after a half-hour or so, we have two very bullish signals and one should quickly either cover a short exposure or simply get long. And plotting the opening range along with the previous day’s value range now gives one a look at how today’s action is affecting traders as well as how it is affecting the previous day’s trading. If one sees, for example, that today’s opening range was at or near the previous day’s value range, and the market has moved higher than our 30 points above the opening high, here are two very bullish indicators, and one should immediately consider either covering one’s shorts, or getting long, and using the low of the opening range as a protective stop. Chapter 13/page 14

Technical trading

Reasonable risk, or trip to the casino? Technical analysis is not just for speculators, whom some hedgers disdain as casino gamblers. Hedgers on both sides of the balance sheet can use this broad spectrum of tools in order to minimize risk, place worst-case prices and enter legitimate price fixations. Too often it is the speculator who dominates the use of technical analysis, as the hedger, be he a farmer, feedlot operator or copper miner, eschews these methods for pure fundamental viewpoints on price movement. In so doing, hedgers fall into a trend of consensus thinking, whereby fundamentals become aware to all traders at about the same time, thus circumventing much, if any, forward price forecasting. Technical-based traders can at least use their work to ‘think ahead’, and try to out-think market direction, while pure fundamentalists are often market reactors to price, having to step in well after the market has made a significant move. Traders relying solely on fundamentals for price direction many times get ‘trapped’ in positions, because the news is the most bullish at a top and the most bearish at a bottom. By being able to recognize tops and bottoms, cycles, waves or other indicators, the technician can thereby make an end-around move, frequently exiting or entering positions days, weeks, even months before fundamentalists have an idea that a major price reversal has taken place. Trader psychology of course runs rampant with commodities, but fundamentalists seem to be swayed more into developing a mass thought pattern than do technicians. As technical systems and analysis is dominated by speculators, they almost always make more money than hedgers, merchants, farmers, etc. Whether he is a single person, trading one-lots in day-trades, or whether he operates a huge technical fund for a pool of speculators, this element follows rather than fights the trend, and goes with it, instead of hedging into the price move. The speculator also has a much different objective for using his technical analysis. He wants to cash in on big moves, while the hedger is often satisfied with a few points either way. The hedger may sell a cotton futures contract and be happy with a 50point gain against his cash position, while the speculator wants something much larger to sink his teeth into. He uses his technical skills to home in on big profits, while the hedger uses the market to lay off risks. This very different approach to trading separates the technically based speculator from the hedger, but both combine to make price discovery.

Much left out . . . In compiling this chapter on technical analysis, an effort has been made to tie the analysis to specific, actual events for cotton. It often happens Chapter 13/page 15

Cotton Trading Manual in other similar reports, that the generic nature of the reports is so common, and mundane, that too much or little is said and the reader has little confidence in the writing, or the writers. These generic articles with little red meat may will be written by people other than traders. Let us assure buyers and readers of this chapter – it was written by cotton traders. Having said that, we must inform you that much has been left out of this review on technical analysis. Only a quarter-century ago, quotes came across a mechanical tapeprinter, clacking away in the corner. Time delays often ran to ten minutes, quotes were mistyped, months were switched, and then the cotton trader always had to deal with those constant orange juice quotes that came while cotton was trading fast and furious. In the old days, at least prior to the communication boom, such fancy-worded technical indicators as relative strength, stochastics, ADX, momentum, oscillators, %R, ROC, ADX, average total range, and many others were not available to the overwhelming majority of the trading public. A few mathematics professors at Princeton perhaps had these instruments available, but even they had to wait until markets closed, and then laboriously entered data to have their slow-motion computers make all the indicators. Today, all of these and many, many more are available as a routine part of a quote service. It would serve readers of this chapter no use if we rehashed these indicators, which can be obtained by the trader at a flick of a mouse or push of a button. They appear instantly, in real time. This is not to say that these indicators are not useful, they all have their purpose. Again, we find that combining these signals with others makes technical analysis successful.

Conclusion The cotton market always follows fundamentals. There is no argument here. The issue is that fundamental discoveries can lie just beneath the surface before making themselves known to most traders, while the market is already moving. Some fundamentals deal specifically with that commodity, such as weekly sales and exports for cotton. These figures reflect just upon the cotton market, and bear no influence on other markets. Market reaction to such press releases is mixed, whereas by the time the press release is out, the actual sale took place about two weeks before. Thus, the futures bought or sold on these sales were long since made. All that is left is market psychology in reacting to the sale, and that can be muted or directly against the preconceived notion. Also, rumors and hearsay abound in commodity trading, and, more often than not, big sales, or poor small sales, have been ‘leaked’ far ahead of public press announcements. Fundamentalists thus find themselves trading after the fact, while technicians make decisions based on market movement alone. Chapter 13/page 16

Technical trading Other fundamental factors are so ‘macro’ in nature that their effect on a commodity is indirect, and underlying. The strength of the dollar affects cotton prices, but so do stock prices, the money supply, consumer spending, etc. These very broad factors have a very determined influence on cotton, but traders do not wake up one day and decide to sell cotton because retail sales may have been less than expected. Trying to trade on these terms is akin to catching a butterfly with one hand – very elusive. Readers of this chapter should come away with one very basic message on technical trading and analysis. That is, it works best when combined with a fundamental bias. Then the trader is at least operating with both eyes open and can make whole-market decisions without being surprised so often. A pure fundamentalist finds himself trading on old news, while the pure technician sometimes misses a major price reversal because he had no fundamental idea of the relative and historical value of the commodity.

Chapter 13/page 17

Part 5 Administration and management

14 Cotton controlling Peter Wakefield

Sampling Pre-shipment Post-landed

Classing Weighing Pre-shipment Landed Tare

Surveys Pre-shipment Exterior damage to bales Mixed pack bales Foreign matter

Who appoints the controller? Where are controllers located? Conclusion

The purpose of this chapter is to describe the primary responsibility of a cotton controller, why it is necessary to appoint a controller and, finally, the functions of the controller. Cotton can be sold directly from producer to consumer or it can pass through many hands. It is not unusual for us to see the same cotton pass through the hands of several merchants on its journey from producer to consumer. Importantly, each party in the chain wants to be sure that in the event of claims for weight quality, damage etc, there is somebody to look after their interests. This is also the role of the controller. In fact, it is the primary role of the controller. Cotton can be sold on either ‘shipped’ or ‘landed’ terms, and depending on the contract terms, one party to the contract will arrange and pay for any weighing/sampling charges, while the other party may appoint a controller for its own account to supervise all such weighing/sampling activities. When the same cotton passes through several hands on its way to the consumer, the different parties involved can appoint their own controller for their own account or accept the reports of the controller appointed and paid for by the first party to the chain. This is the role of the international controller, whose reports are accepted by producers, shippers, merchants and consumers worldwide.

Sampling Pre-shipment Depending on growth and contract terms, samples can be drawn at gin sites, intermediary warehouses or at or near to the ports. The international controller is normally appointed by buyers to draw an agreed percentage of samples from each lot, which can be; • classified by the international controller in the country of origin, or • forwarded to the buyer for classification and approval. It is important to remember that in many locations the controller is not permitted to remove any of the bands prior to sampling. He will first check to see he has the correct lot and then uses a knife to cut into the side of the bale in a direction parallel to the bands. The controller now carefully pulls out the sample, ensuring that it is removed in one piece. Next he will carefully place it onto a sheet of craft paper, first having recorded the mark and bale number on a tag and placing it within the sample. Several samples are placed on each sheet of paper, in rows. The number of rows and samples per row is dependent on the size of the paper and the samples. An average sample weighs between 150 and 200 grams. Once sufficient samples have been placed onto the paper, anything between 20 and 30 samples, the controller carefully turns the paper Chapter 14/page 1

Cotton Trading Manual inward onto and over the samples in a rolling motion until the paper resembles a tube – a roll of samples. After the paper has been rolled, sealing tape is used to close up the roll. This has two main functions: it prevents anyone tampering with the samples until they are classed, and it prevents any foreign matter getting into and onto the samples. After the roll has been sealed, the outside is marked with the lot number or mark of the bales, the date and location of the sampling, the number of samples within the roll, and any other pertinent information. The rolled samples can now be dispatched to the classing room or directly to a client.

Post-landed In this case the cotton is shipped to an end-user, and in the event of quality disputes suppliers will frequently instruct their controllers to draw reference or out-turn samples at random from a given percentage of bales, which are forwarded to the sellers. The procedure for this is very much as described for pre-shipment sampling. The main purpose is to allow the supplier to view the cotton that the buyer has received and thus to have a better understanding of the nature of any claim. Fortunately, most quality disputes are settled amicably. However, there are occasions when the parties involved decide to arbitrate their differences. This usually entails making use of an arbitral authority. The Liverpool Cotton Association (LCA) is the foremost arbitral authority. Its bylaws, trading rules and arbitration procedures are designed to apply to contracts covering the purchase and sale of cotton between firms in any two countries in the world. It is estimated that around 60% of all raw cotton traded internationally is bought and sold subject to the LCA Rules and LCA Arbitration. The LCA provides a simple standard contract that takes account of the following factors: • • • • • • • • • • •

growth and quality micronaire quantity price and terms weight basis payment shipment freight export duty or subsidy insurance war risk.

Such a contract, if properly completed, will help ensure that disputes are kept to a minimum and where they do arise they may be more quickly resolved. When a dispute arises and the contract is subject to Chapter 14/page 2

Cotton controlling LCA Rules, the party requesting arbitration is responsible for drawing and forwarding the samples to the agreed ‘Place of Arbitration’. The opposing party would normally appoint its own controller to supervise and seal such samples. Arbitration samples are to be drawn within 42 days of arrival of the cotton at the port of discharge (LCA Bylaw 334). Arbitration samples are to be drawn after weighing (LCA Rule 211). Arbitration samples are drawn from 100% of the bales unless the cotton is ‘Far East cotton’ (which calls for 10% sampling) or unless otherwise agreed between the buyer and the seller. The procedure for the drawing of arbitration samples is similar to the previously mentioned sampling techniques, but the main difference is that the bands are removed from the bales. Also the size of the arbitration sample is larger than the samples drawn at pre-shipment sampling. This relates to the removing of the bands to allow for a sample of between 200 to 250 grams to be drawn. The procedure for rolling the samples for dispatch to the arbitrators is very similar to that of the pre-shipment sampling. The main difference here is that the representative of both the buyer and seller, who may be the mill’s own staff and the seller’s controller, will jointly seal the samples prior to dispatch.

Classing In recent years, the art of classing has returned once again to the controller, with clients requesting that classing, or ‘take-up’, be offered in producing countries as well as in the main shipment ports. For the most part, manual classing remains the most common form of classing requested of a controller. This is the classing of samples previously drawn by the controller for the purpose of confirming the quality prior to purchase. This classing may be undertaken against the national standards of the producing country, universal standards or against private type samples. Although the generic term ‘manual classing’ is generally used for this classing service offered by a controller, the actual service usually comprises the evaluation of color and leaf, staple length and micronaire. More recently, the controller has been asked to include full ‘mechanical testing’ or HVI in his repertoire. In these circumstances, samples are either drawn by the controller, or are forwarded to the controller directly from gins. The controller’s report clearly states which of these conditions apply. On arrival at the controller’s laboratory, they are placed into trays, conditioned (either for 48 hours or by Rapid Conditioner) and tested. Following HVI testing the controller, unless otherwise requested, will also usually manually class the cotton for color and leaf grade. Chapter 14/page 3

Cotton Trading Manual

Weighing Pre-shipment Depending on growth and contract terms, cotton can be weighed at gin sites, intermediary warehouses or at or near to the ports. Cotton is normally weighed bale by bale, although bulk weighing is offered at some locations. Bales from different origins have different average weights, for example: Australia Pakistan USA Chad Cote d’Ivoire

230 kg 170 kg 226 kg 227 kg 220 kg

Again depending on contract terms and country of origin, the international controller is mostly appointed by buyers to carry out weighing at designated locations. It is usual for the controller to transport his own portable scales to the weighing location, although in some port locations a weighbridge scale may be used. With these scales it is most important for the controller to ensure when setting up that the scales are reading accurately. This is undertaken by the placing of certified ‘dead weights’ on the scales. Scales that can weigh a full truck cannot be recalibrated daily. It is usual for the local weights and measures authority in each country to test these scales on a predefined periodic basis; once calibrated, the adjusting mechanism is seal-closed. With weighbridge weighing it is important to ensure that all the wheels of the truck are driven onto the scale and that the same truck and trailer are weighed with full load and empty. In many locations the readouts are digital, but not always. However, it is normal for the recorded weights to be printed on individual tickets.

Landed Consumers mostly purchase on the basis of landed weight. When purchasing on LCA terms the buyer has 42 days after the arrival of the vessel at the port of discharge in which to weigh the cotton (LCA Rule 216). Normally, cotton is weighed by the buyer (or his appointed representative) at his own cost under the supervision of an independent controller appointed and paid for by the seller. When weighing at destination it is important that the controller record the marks found on the bales and any ‘no mark’ or wrongly marked bale be accepted either at Chapter 14/page 4

Cotton controlling the average invoice weight or average landed weight in accordance with LCA Rule 217. Cotton can be weighed either bale by bale or in bulk (either in containers or on trucks). Bale-by-bale weighing is usually carried out at mills, while bulk weighing can be carried out at or near to the port or an intermediary weigh station at or near to mills. Each country seems to have its own system, which is probably determined by cost. For instance, cotton in Italy is weighed over weighbridges located at or near to the ports, while in Thailand most cotton is weighed bale by bale at the mills. Bale-by-bale weighing has the advantage of permitting the controller to check the scales with test weights prior to, during and after weighing.

Tare Parties to contracts have the right to challenge the invoice tare (LCA Rule 214). Actual taring should always be carried out after weighing, in accordance with LCA Rule 213 and in the presence of the opposing party’s controller.

Surveys Pre-shipment International controllers also carry out the following services at gin sites, intermediary locations or at or near to ports: • • • •

inventory stock checks on behalf of banks or owners of the cotton noting the exterior condition of bales that form the outsides of stacks counting (tallying) the number of bales being loaded to conveyances checking the condition of bales during loading.

Exterior damage to bales There are many forms of damage that can be caused by storing cotton in insufficiently protected places, or stained or dirty bales caused by dragging bales over dirty or oil-stained floors, or burst bales. Claims for such damage are frequently referred to underwriters, and it requires an experienced cotton controller to determine the likely cause and extent of such damage.

Mixed pack bales These are bales that are composed of more than one quality of cotton, or of bales that are composed of cotton and other substances, such Chapter 14/page 5

Cotton Trading Manual as say linters, etc. Experienced controllers should always check the exterior of such allegedly damaged bales, particularly the heads of the bales, which can indicate that bales are composed of layers of different qualities of cotton or indeed different substances.

Foreign matter Spinning mills are demanding higher specifications for the cotton they purchase, and foreign matter, or contamination, has become an increasing concern. From time to time, bales are found with foreign matter mixed into the cotton either before of during pressing. The only way to ascertain the quantity of such matter is to break opens the bales and inspect the contents layer by layer. This is usually undertaken by the controller, who will select at random a number of bales (usually a percentage of the bales pre-agreed between buyer and seller) for inspection. From this inspection, an average quantity of foreign matter and the length of time it takes to clean the bales are calculated. This calculation is then used by the buyer and seller to agree a settlement under which the buyer’s labor cleans the bales.

Who appoints the controller? The controller is appointed by either party to a contract. However, the services of the controller are frequently requested by banks, insurance companies, government bodies, shipping lines and warehouses.

Where are controllers located? The world of the controller is always changing. As trade flows adjust, controllers re-establish themselves to cover the requirements of their clients, but in general controllers are currently found in: • most cotton-producing countries • the main shipping ports for cotton exports • all destinations/countries where cotton is consumed.

Conclusion The above is a brief overview of the world of a controller, but why is it a necessary? We do not live in a perfect world and in many of the transactions that take place there is much money at stake. When you have such large values at stake, is it not prudent to have someone in attendance to protect your interests? Finally, what are the implications for failing to make use of controlling facilities? As stated, a lack of representation, and perhaps a loss. Chapter 14/page 6

15 Freight and insurance Peter Hirschfeld

Freight Terms and definitions The container trade Container terms and definitions Bills of lading Freight rates

Insurance LCA trade rules: clauses applicable to insurance Rule 205 Rule 206 Rule 207 Contingency insurance

Freight Terms and definitions Freight means the cost of moving the cotton from point of origin to the final destination. It can be divided into three aspects: • interior freight: covers transportation from an interior warehouse or gin yard to an ocean shipping port • ocean freight: covers the cost of ocean transport, from a shipping port to a specified destination • delivery to the final destination: covers the cost of moving the cotton from a port to the final destination, usually a spinning mill. The above definitions apply only to export shipments, ie when the cotton is transported partly over water. If the cotton is shipped to a domestic mill, eg US cotton to a US mill, the only freight cost is the interior freight. This also applies to cases when cotton crosses an international border via land transport (rail or truck), eg US cotton shipped to Mexican mills. Since the freight is a substantial part of the final landed-mill price of the cotton, it is necessary to define clearly in the purchase or sales contract who is responsible for booking space and for making the payment. The following terms are customary in the cotton trade: • FOB interior warehouse or gin: buyer receives the cotton at a specified point of origin; no freight is involved. • landed mill: This is standard for sales to domestic mills in cottonproducing countries. The cost of transporting the cotton from the interior to the mill is for seller’s account. • FAS/FOB vessel: Seller pays the freight from the interior to the (ocean) port of loading. FAS means ‘free alongside ship’ and is the correct expression. (FOB ‘free on board’ is misleading as the cost of loading on board the ocean vessel is usually part of the ocean freight, which is paid by the buyer under these terms. Yet the term ‘FOB’ has survived and is in common use in the trade.) Another variation is ‘FOB stowed’, a buying condition favored in the past by socialist countries. It means that the seller has to pay for the cost of loading aboard the vessel. The International Chamber of Commerce has recognized the difference between FAS and FOB in its Incoterms (see below): • CF (or CFR): means ‘cost and freight’. The seller pays both interior freight and ocean freight. CFR is used by many markets where the mills have their own insurance policies and prefer, in case of a major loss, to ‘have all their eggs in one basket’. Chapter 15/page 1

Cotton Trading Manual • CIF: means ‘cost/insurance/freight’. In addition to the freight the seller also pays for the marine insurance. These terms have been used by the cotton trade for many decades and the terms are well understood in the trade. However, in recent years the terms developed by the International Chamber of Commerce have gained gradual acceptance. Some terms useful for cotton trading are as follows (Incoterms 2000): • FAS (free alongside ship): seller delivers alongside ship in a named port of loading • FOB (free on board): seller delivers when the cotton passes the ship’s railing. From that point on the cotton is at buyer’s risk. Although not specifically mentioned, loading charges would be for seller’s account • CFR (cost and freight): seller pays the freight to a named port of destination • CPT (carriage paid to . . .): same as CFR but delivery to a named place in the interior • CIF (cost, insurance, freight): seller pays freight and insurance to a named port of destination • CIP (carriage and insurance paid to . . .): same as CIF but delivery to a named place in the interior. In case of CFR/CIF/CIP, most contracts stipulate ‘freight final’, so any change in the ocean freight is for seller’s account. Since freight rates are subject to considerable changes, through demand and supply, currency changes, oil price changes, etc, the seller has to be very careful when pricing cotton for forward delivery, especially for the new season. Freight rates are also strongly influenced by imbalances in world trade. For example, cotton rates from the US West Coast to the Far East have been unusually low for years because there is much more general cargo moving from Asian markets (eastbound) than is available for shipment from America (westbound). The carriers prefer to transport cotton at low rates rather than returning with their containers empty. On the other hand, exporters like the freedom to book with any line of their choice. Considering the advantages and disadvantages it is not surprising that mills in many markets have gradually switched from FOB terms to CFR. Most cotton to standard destinations is shipped under ‘liner terms’. These are clearly defined in the shipping business. A very small percentage of cotton, usually from and/or to non-standard locations, may be transported under charter terms, meaning that the buyer or seller will charter all or part of an ocean vessel, in order to get a lower freight rate or to get any transportation at all. Chartering is a highly specialChapter 15/page 2

Freight and insurance ized business where every word in the freight contract has a defined meaning. The responsibility for each cost item must be carefully negotiated before a charter contract is signed. Charter terms will not be examined closely here since, as stated, they are not used much in the cotton business.

The container trade Until the 1970s the only available ocean vessels were ‘breakbulk’, ie traditional ships built to pick up multi-cargo at various ports and transport it to various overseas destinations. But in the 1970s the shipping industry started experimenting with different ways to ship cargo. Without going into further detail, it is now clear that shipment by container has proved superior to other methods. Today nearly all cotton transported over water is shipped in containers. Containers are usually 40-foot boxes, which can contain about 40 000 lb of cotton (net weight). On occasion 20-foot boxes are also used. Unlike higher-value cargo, cotton does not benefit particularly from containerization since pilferage is not a major problem. However, since traditional breakbulk vessels are no longer built there is little choice. Containers have one enormous advantage over breakbulk: the cotton can be loaded in the interior (growing area) and transported all the way to the overseas mill premises. This is by far the most efficient way to ship cotton from the farm to the mill. Having said this, in some markets it is still difficult to ship containers directly to the mill, because of road limits and the lack of container unstuffing facilities at the mill. Another drawback from the mill’s point of view is that the traditional quality control at the port of importation cannot be done. For example, mills in Central Europe used to have their (breakbulk) cotton unloaded in Bremen, and the local forwarding agents would sample the bales for quality control. The mill then had the choice of taking the cotton, possibly with any allowance, or rejecting all or part of it. Today the cost difference between port unloading and direct delivery to the mill in the interior is so high that few if any mills can still afford the luxury of port control.

Container terms and definitions The cotton trade has had to come to grips with the definitions and terms used in the container trade. Accordingly a committee of trading and freight experts appointed by the American Cotton Shippers Association developed a complete set of definitions and trading rules known as ‘ACSA Container Rules’. These rules have been amended and refined over the years, and are now in general use all over the world. The Liverpool Cotton Association has added a breakdown of the various funcChapter 15/page 3

Cotton Trading Manual tions in the shipping of cotton, and who pays for each item under various contract terms (see Appendix 1 for a glossary of terms). These definitions and terms must be well understood by anybody trading in cotton for export. Some of the basic definitions that are being used by the shipping industry are listed below (from the LCA Rule Book): • Container freight station, ‘CFS’ and ‘container base’ mean a place where the carrier or his agent loads or unloads containers under their control. Typically this would be a port warehouse. • ‘Combined transport document’, ‘intermodal transport’ and ‘multimodal transport’ mean delivering cotton from one place to another using at least two different means of transport. This would apply to shipment from the interior in the country of origin, and/or delivery directly to the mill in the interior of the country of destination. • ‘Combined transport document’ means a bill of lading or other document of title produced by a shipping company, combined transport operator or agent covering cotton being moved by combined transport, intermodal transport or mutimodal transport. • ‘Combined transport operator’ means a person or firm that produces a combined transport document. • ‘Container yard’ and ‘CY ’ mean a place where containers can be parked, picked up or delivered, full or empty. A container yard or CY may also be a place where containers are loaded (or stuffed) or unloaded (or de-vanned). • ‘Full container load’ and ‘FCL’ mean an arrangement that uses all the space in a container. It is most efficient to ship in full containers since the freight is usually based on full boxes. That means stating the contract quantity in full containers (about 80 to 85 bales) instead of the traditional multiple of 100 bales. • ‘House to’, ‘container yard to’ and ‘door to’ mean loading controlled by the shipper at the place (house, CY or door) of his choice. Whoever books the freight must pay all costs beyond the point of loading and the cost of providing containers at the house, CY or door. • ‘Pier to’, ‘container freight station to’ and ‘container base to’ mean that the carrier controls the loading. The cotton must be delivered to the carrier at the pier, container freight station or container base. • ‘Point of destination’ means the exact place where the cotton is delivered to the person who has ordered it, or is delivered to his agent, and where the carrier’s responsibility ends. • ‘Point of origin’ means the exact place where the carrier or his agent receives the cotton and where the carrier’s responsibility begins. • ‘Shipper’s load and count’ means the shipper is responsible for the contents of the container. Chapter 15/page 4

Freight and insurance • ‘To house’, ‘to container yard’ and ‘to door’ mean delivery to the warehouse or mill yard selected by the person who booked the freight. • ‘To pier’, ‘to container freight station’ and ‘to container base’ mean that the carrier will unload (de-van) at his warehouse in the port of destination, in a container freight station or container base. The shipping industry unfortunately failed to agree on a common terminology when container shipping developed. Therefore different shipping lines use different expressions for the same terms. The above definitions in most cases cover the three most common terms used to describe the same function.

Bills of lading Prior to container shipping all cotton for export was loaded in sea ports, and there were only two types of bill of lading: • on board bill of lading (dated when the cotton was loaded on board the vessel) • custody bill of lading (dated when the cotton was received in the shipping port by the vessel’s agent). Today’s intermodal bill of lading affords much more flexibility, which benefits the exporter by giving him complete freedom to book. This goes into lower export prices. A typical intermodal B/L might cover the shipment of containerized cotton from Lubbock, Texas to a mill in Korea. It would be dated when the agent for the ocean carrier certifies that the cotton has been loaded in a Pacific port. The bill of lading would indicate CY/CY, meaning the shipper and not the carrier is responsible for the contents of the container (bale count and condition). The use of the intermodal bill of lading has been fully accepted worldwide. If the L/C contains a clause not permitting an intermodal B/L the exporter must demand that such clause by eliminated. It is customary to issue the ocean bill of lading (or intermodal bill of lading) in three originals, made out to order and blank endorsed. Since the B/L is a title document, in theory anybody holding the B/L can take possession of the cotton. The risk of the cotton falling into wrong hands is minimized by issuing the B/L ‘to the order of . . . ’ and letting the foreign bank insert the name of the buyer after payment has been received.

Freight rates The freight is usually charged in US dollars per container, or per 100 lb, or per metric or short ton. Chapter 15/page 5

Cotton Trading Manual The freight rates used to be set by so-called steamship conferences. The conference members would agree among themselves to charge fixed freight rates from certain origins to certain destinations. There were also carriers who did not belong to a conference (nonconference carriers) who tended to keep their freight rates slightly below the conference rates. The conference system gradually fell apart during the 1990s. Today it is customary for the exporters and the carriers to sign volume contracts, with the freight rate based on how much volume the exporter books during a certain time period with the carrier. This new system seems to work well with the smaller number of major cotton merchants and carriers. (The conference system was based on special government permission to meet and fix prices, which does not fit in well with today’s free enterprise system.) Of course, the new system favors the larger exporters to some extent. Since certain costs of the ocean carriers vary a great deal, it has become customary on many trade routes to divide the freight into components, as follows: • the base rate • a terminal receiving charge (TRC), covering the cost of handling the cotton from the place of receipt at the terminal to on-board vessel (this may also be called THC or CYC) • bunker adjustment factor (BAF), to offset rising fuel costs (also called FAF) • currency adjustment factor (CAF), usually a percentage of the base rate, used to offset a decline of the dollar against other major currencies. Carriers prefer to offer fixed freight rates that are good for the entire cotton marketing year (in the northern hemisphere, usually 1 August to 31 July). By having the most volatile components of the freight rate stated in the form of adjustment factors, they can still make changes if necessary without raising the fixed base rates.

Insurance Cotton should be covered by insurance from the time it is produced until the bale is consumed at the spinning mill. Whoever has title to the cotton is responsible to ensuring that he is covered. The main risk is of course fire. A cotton merchant must have a contract with a first-class insurance company. This is not only for his own protection but is also required by his bankers. He is obliged to inform the insurance company of any changes in the amount of cotton to which he has title. In practice, since stock reports cannot be sent to the insurance company every time the Chapter 15/page 6

Freight and insurance merchant’s paid stock changes, the insurance contract should state that the cotton is covered whether declared or not, from the moment it is paid until the time title has passed to the buyer. As a general principle, cotton is at buyer’s risk once the voyage has commenced, ie when it is on board the ocean vessel. This means that, from the date of the on-board ocean vessel, if the cotton is destroyed it will not be replaced but the buyer will receive payment from the insurance company.

LCA trade rules: clauses applicable to insurance The Liverpool Cotton Association’s trade rules cover much of the world’s trade in cotton. The clauses applicable to insurance read as follows: Rule 205 When a buyer or seller takes out insurance on a shipment of cotton under a contract made under our bylaws and rules, the insurance must include: • ‘marine cargo insurance’ and ‘transit insurance’ in line with the Institute Cargo Clauses (A) or Institute Commodity Trade Clauses (A), including cover against country damage risks as defined in Bylaw 100; • ‘war risk insurance’ in line with the Institute War Clauses (Cargo) or the Institute War Clauses (Commodity Trades); • ‘strikes, riots and civil commotion’s insurance’ in line with the Institute Strikes Clauses (Cargo) or Institute Strikes Clauses (Commodity Trades), and cover the invoice value of the shipment plus 10% (assumed profit). Rule 206 The following conditions apply to contracts where the seller is responsible for providing marine cargo insurance or transit insurance: a There must be a policy document or certificate of insurance. This document or certificate must be produced as one of the shipping documents. b If the cotton is country-damaged when it arrives or has been damaged in any other way before shipment, the parties must try to agree on an allowance. If they cannot do so, a Lloyd’s Agent or some other recognized authority must be asked to appoint a qualified surveyor to inspect the damaged cotton. The seller must pay: Chapter 15/page 7

Cotton Trading Manual – the buyer for any loss caused by the damage as set out in the surveyor’s report, if the loss is not covered by insurance; and – the cost of the survey c

If a charge is made for collecting the insurance claim and the buyer pays it, the seller must refund the buyer.

Rule 207 The following conditions apply to contracts where the buyer is responsible for providing marine cargo insurance or transit insurance: a Despite the fact that the seller is responsible for the cotton up to the time of shipment, the buyer must insure against country damage risk. b So that the buyer can arrange insurance, the seller must give the buyer the necessary details of each shipment. c If the cotton is country-damaged when it arrives or has been damaged in any other way before shipment, the parties must try to agree on an allowance. If they cannot agree on an allowance, a Lloyd’s Agent or some other recognized authority be asked to appoint a qualified surveyor to inspect the damaged cotton. If the damage took place when the seller was responsible for the cotton, the seller must pay: – the buyer any loss caused by the damage as set out in the surveyor’s report; and – the cost of the survey. Some explanation may be in order regarding ‘country damage’ referred to in LCA Rule 207. Country damage, as opposed to sea damage, is of a preshipment nature, ie when the cotton was still under the seller’s control. However, in practice, a cotton shipper does not see the bales before shipment. In theory, cotton warehouses are not supposed to load damaged cotton. If there is damage, the warehouse has the responsibility to clean up bales before loading, and advise the owner of any difference in weight, which the warehouse should compensate. But again in practice, this is not always done correctly, and damaged cotton arrives, causing the receiver considerable expense. It has never been possible to insure against country damage except as part of the marine insurance. Therefore in case of FOB/FAS or CFR shipments, the buyer’s insurance policy should cover country damage. Unfortunately, this is not well understood, and has led to many arguments between buyers and sellers. If damaged cotton arrives, the buyer must direct his claim against the insurance company that covered the marine cargo insurance. The Chapter 15/page 8

Freight and insurance insurance company should then seek reimbursement from the shipper who in turn will hold the warehouse at point of loading responsible. Regardless, many buyers will try to collect payment for country damage directly from the shipper.

Contingency insurance A shipper’s insurance policy should contain a contingency clause to cover the gray area when title to the cotton is being transferred to the buyer, eg if the cotton is destroyed after it has been loaded on board the ocean vessel but before the bill of lading has been issued; or if the cotton is destroyed on board the vessel but before the seller has been able to collect the invoice amount. In such cases it may be difficult to collect from the buyer’s insurance company no matter what the rules say. In case of CIF sales, the insurance policy should cover the cotton for up to 30 days after arrival at the port of destination, including delivery to the mill in the interior.

Chapter 15/page 9

16 Payments and documents Peter Hirschfeld

Terms and definitions Letters of credit Confirmed letter of credit Shipping documents Banking Weights

Terms and definitions The following payment terms are used in the cotton trade: • payment against an irrevocable letter of credit (L/C), to be opened by the buyer in favor of the seller through a bank specified in the contract, or any first-class bank in the seller’s country. The seller prepares documents in compliance with the L/C and sends them to the bank for collection. If there are discrepancies, the bank will have to ask the foreign bank for authorization to pay. Once payment has been made, the bank in the exporter’s country will forward the shipping documents to the foreign bank for transmission to the buyer. • payment upon first presentation of the documents: The seller sends the shipping documents to the foreign bank specified by the buyer. The buyer must remit the invoice value promptly upon receipt of the documents. If there are discrepancies the overseas bank must ask the buyer for authorization to pay. • payment upon arrival of the cotton at port of destination: This is similar to cash on presentation except that payment is only due on arrival of the cotton at the port of destination.

Letters of credit The bulk of export sales from any origin to any destination will specify payment by irrevocable L/C. ‘Irrevocable’ means that the buyer cannot withdraw the L/C once it has been opened. It is the buyer’s obligation to ensure that the L/C is opened in time to be in the seller’s hands by the first day of the contractual shipping month. The L/C should be valid for shipment within the contracted shipping month, and should allow for presentation of the shipping documents at latest 21 days after the last shipping date (21 days may sound unreasonable but experience shows that it often takes that long to assemble the shipping documents, invoice the cotton and send the documents to the bank). Every L/C should allow partial shipments. Partial shipments are disliked by both the shipper and the receiver, but allowing for the fact that cotton must frequently be shipped directly from various interior points to the ocean port for loading, partial shipments cannot always be avoided. There is no benefit in holding up a shipment of a thousand bales because one or two containers are stuck in an interior warehouse. In the days of breakbulk shipments it was customary to concentrate cotton in ocean ports, but this practice is no longer possible owing to increased costs. If the L/C is not in good order, the seller should request the buyer to amend it. Waiting for an amendment can delay the shipment, as it is Chapter 16/page 1

Cotton Trading Manual not reasonable to expect the seller to load the cotton with a faulty L/C. If the L/C is opened with a delay, the time to ship should be extended accordingly, ie the shipper should still have 30 days from receipt of the L/C to load the cotton.

Confirmed letter of credit A confirmed letter of credit is utilized when the bank in seller’s country that opened the L/C on behalf of the foreign bank guarantees payment even if the foreign bank defaults. This is only done in countries with recognized foreign exchange problems. If a confirmed L/C is required by the seller, it should be agreed upon at time of sale and specified in the sales contract. The contract should also state who pays the confirmation charge. If the seller presents a complete set of shipping documents to the bank he should be able to collect the invoice amount within a few days. However, if the bank finds some discrepancy in the documents, making it necessary to contact the buyer (through his bank) for authority to pay, this puts the seller in the risky position of having his cotton afloat to the overseas destination without having obtained payment. In such cases, the seller does not lose title to the cotton, but runs the risk of having an unintended consignment in a foreign port. The same applies to payment terms such as cash on first presentation or cash on arrival. These terms are used mostly in Europe. If the buyer does not take up the documents, the overseas bank must hold the documents for the seller until a solution is found.

Shipping documents Great care must be used when assembling a set of shipping documents. The exporter must be sure not only that all the documents stipulated in the L/C are present but also that they are drawn up strictly in accordance with the terms of the L/C. The bank in the seller’s country that advised the L/C on behalf of the foreign bank is not obliged to check the authenticity of the documents as long as they appear to be in good order. The following documents may be required by the letter of credit: • • • • • •

seller’s commercial invoice on-board bill of lading (3 originals) insurance certificate (CIF only) certificate of origin tag list, with the warehouse numbers for each bale quality test certificates (usually HVI values)

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Payments and documents • phytosanitary certificate (a government document stating that the cotton is free from injurious diseases) • any other documents or declarations required by the buyer or his bank.

Banking Some L/Cs will require the seller to draw on the L/C-opening bank with deferred payment, for instance 180 days’ sight. Unless it is part of the contract, this reflects credit arrangements between the buyer and the banks; the seller still gets paid upon presentation of the documents. Bank charges can add up to considerable amounts. As a rule, the L/C will contain a clause stating that all bank charges in the importer’s country are for his account, and all charges in the exporter’s country are for the exporter’s account. Banking rules apply a tolerance of 5% to the quantity of cotton to be shipped. However, this does not apply when the quantity is expressed in terms of packing units. For example, if the L/C covers a shipment of 480 bales, the bank would expect this exact number to be shipped. Since the bale weight of the cotton actually shipped varies, and the shipper usually cannot exceed the L/C amount, it is important for the exporter’s contract to state ‘about 480 bales’, and the L/C is issued with the same language. The word ‘about’ tells the bank to accept 5% tolerance even in case of packing units (ie bales). The tolerance never applies to shipments above the L/C amount unless the L/C specifically states a tolerance plus or minus from the L/C amount.

Weights In terms of weights, cotton can be sold under a number of terms (in all cases net weights): • • • •

original gin weights inbound warehouse weights outbound warehouse weights net landed weights.

For export, net landed weights are the normal terms. In this case, a controller must be appointed by the shipper to supervise weighing and sometimes sampling of the cotton upon arrival. Controllers are independent firms, and can be local or worldwide, such as SGS. The importer’s forwarding agent will weigh the cotton upon arrival at the port or other point of destination, and the controller supervises the procedure on behalf of the shipper. See also Chapter 14.

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17 Taxation, accounting, finance and risk management Peter Hirschfeld

Taxation Accounting Finance Financing cotton stocks Farmer cooperatives Collateral Producer financing Mill financing

Risk management Market risk Basis risk Supplier risk Customer risk Financing risk Weather risk Exchange risk

Taxation Cotton is an industrial raw material, and therefore not taxed by most countries. However, there are still a number of producing or importing countries that try to raise revenue from taxing cotton. Export taxes were a favorite tool for raising government income in many cotton-producing countries. Today the number of countries that tax cotton exports has dwindled. In cases where export taxes are still levied the exporter would have to pay them. This becomes a part of the export calculation, and simply means that the farmer gets less. Import taxes are also not very common today. In countries that tax cotton imports the taxes are paid by the importer, and of course passed on to the spinning mill. Other taxes vary greatly from country to country, and cannot be dealt with in this manual.

Accounting Accounting by cotton traders should be by the accrual method. Today cotton trading is a year-round business, with a large number of items open at any time that have to be accounted for when calculating the balance sheet. Clearly, accounting rules vary a great deal from country to country, but, where permitted, the best method to calculate profit and loss is to bring everything to market. That means to value inventory, open purchases and sales, futures and any other items that are market-related as of the last day of the company’s fiscal year. In the US this may be easier than in other countries as the value of inventories etc is closely related to the New York futures market. US tax law permits the ‘mark to market’ method for commodities, which gives a fairly accurate picture of a company’s financial condition as of a certain date. The ‘mark to market’ method of valuing inventory is really the only way to achieve this purpose, since the original cost of the cotton is meaningless, owing to market fluctuations. ‘Mark to market’ includes valuing open purchases and sales at the market as of closing, by comparing the purchase/sale prices (adjusted for estimated unpaid charges) with market values on the day of closing. The company must assess average costs that will have to be paid when calculating the value of open positions. Even unfixed ‘on-call’ purchases and sales must be valued at the basis prevailing at closing, to account for any changes in the basis. Prudent accounting also includes setting up reserves for weight and quality claims for shipments afloat. Reserves should be considered for defaults through non-delivery by farmers or non-payment by customers. Given the volatile market, Chapter 17/page 1

Cotton Trading Manual defaults are fairly common, even though cotton contracts have been recognized as legally binding by courts all over the world.

Finance Financing cotton stocks Cotton trading as a merchant (as opposed to a commission agent) requires substantial capital. In the US, for example, the merchant must usually pay cash to the farmer as soon as he receives the bales. Then comes the lengthy process of sampling, classing, application against sales, shipping from the interior to the port, loading onto an ocean vessel, obtaining the shipping documents, invoicing and finally collecting the invoice value. In other countries the merchant may pay after quality approval in the interior, or against shipping documents. Financing stocks is a major cost item. It can vary a great deal, depending on the origin of the cotton. Of course, if the cotton has been sold for later delivery, the shipper will have to include reasonable carrying charges in his sales price. Since cotton traders do not have sufficient liquid capital to finance their operations without bank loans they must secure bank lines of credit. This means that the merchant’s cotton stocks will be pledged to his banks as collateral. Close cooperation between cotton merchants and bankers is necessary to ensure that the merchant’s business runs smoothly while at the same time protecting the banks’ interests. The cheapest way to finance cotton stocks is with bank drafts, which the bank can discount in the market. However, since there is a daily in and out, due to paying for cotton and handling charges and collecting against invoices, a certain amount of the bank line has to be open account, meaning a somewhat higher rate of interest. Banking arrangements vary a great deal from country to country. A rule of the thumb is that cotton merchants can borrow about five dollars for each dollar of liquid capital.

Farmer cooperatives Farmer cooperatives work somewhat differently. They tend to pool their members’ cotton and only pay them an advance, with the balance to be paid at the end of the marketing year. And in those countries where the cotton industry is still under government control, the cotton authorities set prices, acreage etc based on world market conditions.

Collateral The collateral pledged to the banks as security for operating loans varies a great deal from country to country, depending on local condiChapter 17/page 2

Taxation, accounting, finance and risk management tions. In the US, warehouses used to issue paper receipts on a baleby-bale basis. This has now been largely substituted by electronic receipts, which make the handling much easier. It works like bookkeeping. The collateral handler credits the merchant for new incoming paid stock and debits the merchant for cotton released to a forwarder for shipment. In other countries collateral often consists of gin yard receipts for whole blocks of cotton.

Producer financing Producer financing is very common in many cotton-producing countries. It is often the only way for merchants to buy cotton for forward delivery. Obviously such financing entails a great deal of risk, as there may be few if any enforceable guarantees for the repayment of the loan by way of cotton deliveries. It is better to leave producer financing to the ginners who have much larger profit margins than the merchants.

Mill financing Mill financing is usually done by way of a time draft, eg 180 days’ sight, which can be discounted through the banking system without recourse to the seller. This type of financing has no risk for the seller as he gets paid upon presentation of the shipping documents. The credit risk is taken by the bank in the mill’s country. Some sellers will extend direct credit facilities to good customers, but this is less common. In the US, normal payment terms for sales to the domestic industry are cash after delivery. The mill receives the cotton at its warehouse, weighs it, checks the quality, and then pays the seller. If a mill goes bankrupt while the bales are at the mill and payment has not yet been made, title to the cotton is lost, and the seller becomes an unsecured creditor.

Risk management Cotton trading, as is common with other commodities, is a high-risk business, requiring a large amount of capital. Profit margins are small, owing to intense competition. For these reasons the number of major international merchants has diminished in recent decades, as some firms have shut down, others have gone bankrupt, and very few newcomers have appeared on the scene. Risk management is an absolute necessity. Risk cannot be completely avoided in trading, but it can and must be limited. The risk a cotton merchant takes has to be in some relation to the firm’s financial strength. Chapter 17/page 3

Cotton Trading Manual The following risks are considered below: • • • • • • •

market risk basis risk supplier risk customer risk financing risk weather risk exchange risk.

Market risk Cotton merchants can limit market risk, ie the risk arising from rising or falling cotton prices, by hedging. This means offsetting a purchase or sale of physical cotton with a counter-transaction (hedge). The most common way to hedge is with New York futures. Say the merchant buys 100 bales but has no immediate buyer for the cotton. He then sells one contract in New York (his hedge). Then, if the market goes up, he makes a profit on the physical cotton and takes a loss on the futures contract. In this way the market risk can be largely eliminated. Options are another tool that can be used for hedging. Handling options is not easy, and requires a comprehensive knowledge of how options work. Buying call or put options as a protection against a dramatic market move can be a legitimate hedge; selling options cannot be used for hedging, and is purely speculative. Hedging works best for US cotton, as the interior market prices will follow New York futures very closely. For non-US cotton, hedging in New York is more of a problem as the US market and other markets do not always move in concert. Dealers in non-US cotton sometimes hedge by buying one growth and selling another. This provides some protection against market risk but is far from perfect. Cotton merchants will take market positions, either long or short, but such positions represent only a small portion of the turnover. Decisions on market risk, ie long or short positions, are usually taken by top management. See also Chapters 10 and 11.

Basis risk Basis is defined as the difference between New York futures and the actual purchase or sales prices of physical cotton. The basis does not fluctuate as much as the market itself, but there is a certain amount of risk. There is no way to hedge against basis risk, and the merchant can only protect himself by limiting his exposure.

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Taxation, accounting, finance and risk management Supplier risk A large percentage of the crop in many markets is forward-contracted, either directly from producers or through exporters or government agencies in the country of origin. Forward-contracting is a valuable tool for both the cotton grower and the merchant. But it can only work if both parties are reliable. The grower must deliver the contracted cotton even if the market at time of delivery is much higher than his sales price. The merchant must pay for the cotton even if the market price at time of delivery is much lower than his purchase price. Unfortunately, there is no protection against default by a supplier. Both the grower and the merchant must be careful with whom they do business.

Customer risk This is similar to supplier risk. Sales to mills for forward delivery represent a large percentage of the merchant’s business. Failure of a seller to supply the contracted cotton forces the mill to replace the purchase; failure of a mill to pay for cotton bought at higher prices causes the seller to take a market loss as he must dispose of his cotton elsewhere. In cases where the cotton was sold for export, and payment is by L/C, failure to open the L/C is the equivalent of failure to pay. Again, there is no hedge against default by a customer. Merchants must know their customers, or rely on their agents in the export markets for guidance. In case of default, the injured party can apply for arbitration, for example at the Liverpool Cotton Association. The problem is how to collect an arbitration award. Default by a customer does not cause the merchant to lose actual cotton; the loss is in the market differences.

Financing risk As outlined above, financing of growers or spinning mills is a high-risk but sometimes unavoidable part of cotton trading. There is little protection against default. Risk management consists of knowing the other party well, and limiting the overall exposure to transactions involving financing. In some cases, a bank guarantee may be possible.

Weather risk Cotton is a product of nature, so the quality of the crop will vary from year to year, sometimes considerably. When a merchant sells new crop cotton to a mill, he must guarantee even-running quality as per the sales contract. If the crop turns out to be different from what was expected, owing to rains or a frost at harvest time, the merchant has

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Cotton Trading Manual a problem. He can either ask his buyer to accept a lower quality, or offer to substitute a different growth. When forward-contracting cotton, the contract may call for a fixed number of bales or tons, or it may be all the cotton produced on a farm. If a merchant contracts whole crops, he must estimate the approximate number of bales to be produced under normal conditions for hedging purposes. Then he must follow up from time to time by checking with the grower, or visiting the farm himself, and make any adjustment to the number of bales expected to be delivered against his purchase contract in his purchase book. If this is not done, the merchant may find himself either over- or underhedged, which can be costly.

Exchange risk Since the world market price for cotton is expressed in US dollars, purchases and sales in other currencies represent a risk. This can sometimes be hedged by buying or selling the contract currency forward.

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18 Contracts and arbitration Secretariat of the International Cotton Advisory Committee

Cotton sales contracts Sanctity of contracts General principles of arbitration Arbitration in cotton trade Quality disputes and technical disputes Awards Appeal Enforcement of judgments Defaults and sanctions

In the past, cotton trading activity was based upon the concept ‘Dictum meum pactum’, my word is my bond, and a lot of cotton was sold on a handshake. Inevitably, it became necessary to do more than shake hands, but trust remains the basis of cotton transactions. Nevertheless, the expansion of cotton trade has resulted in increased numbers of commercial disputes. The cotton industry has one of the oldest and most elaborate systems of private commercial law. Most contracts for the purchase and sale of cotton are outside the public legal system and are not enforced in court when disputes arise. Contracts are concluded under privately defined rules and subject to arbitration in a professional tribunal. By and large, arbitration is cheaper, faster and less expensive than litigation. The strong focus on personal relationships in the cotton industry makes reputation-based sanctions very effective, and most awards are complied with promptly. Commercial reputation is a vital asset in the cotton business. Agreements are mainly oral, and transactions worth millions of dollars can be made on the basis of a one-minute phone call. As cotton is generally sold for forward delivery, price volatility and quality variability make the commercial reputation of the seller particularly important to the buyer, and vice versa. Nonetheless, no arbitration system can provide an absolute guarantee to protect firms against unreliable or dishonest parties for whom even my contract is not my bond. The contract is the legal cornerstone of all transactions in business. A contract is a legally binding agreement between two or more parties, whereby each party undertakes specific obligations or enjoys specific rights, and is enforceable by law. A contract may be oral but it is generally written. Several conditions are required for a contract to be recognized as a legally binding agreement: • First, one party (the offerer) must have made an offer, a statement of intention to contract on specified terms made with the intention that, if accepted, it shall become a binding contract. A genuine offer must be distinguished from an ‘invitation to treat’, where a party is free to accept or reject the offers; • Second, the offer must have been accepted by the other party (the offeree) with an intention to be legally bound. A contract will not be binding unless the parties have expressed themselves with reasonable certainty. Acceptance will not be effective unless communicated to the offerer by the offeree. The communication of acceptance must be actually received by the offerer, and the contract will become effective when and where acceptance is received; • The third condition in the formation of any contract is consideration, which means that the offeree has to give something (generally a Chapter 18/page 1

Cotton Trading Manual payment) in return to convert a simple promise made in his favor into a binding contract.

Cotton sales contracts • A contract is an agreement between parties to buy or sell cotton. The cotton trade is founded on the principle that a verbal commitment between the seller and the buyer (face to face or on the phone) is contractually binding. The seller reconfirms the verbal commitment in writing by telex, facsimile or e-mail, then prepares a written contract and sends it to the buyer, who signs it and returns it to the seller. The formal contract records the terms of the business previously agreed upon between the parties. Delivery of the correct quantity of raw cotton, at the appropriate time, within the established specifications, and at the agreed price is essential for the cotton spinning industry. A written agreement between the buyer and the seller must be clear, since it may be executed months later by someone who did not take part in the negotiations, and concise because simplicity is always better than complication. A clear and comprehensive cotton sales contract must include adequate specifications of the expected fiber quality and shipment performance to avoid any misunderstanding at a later stage. • Quantity can be specified in bales, pounds or in metric tonnes (generally with a tolerance of 3%). • Origin and growth specifies the origin of the cotton to be exported. • Crop year is specified because quality is affected by seasonal conditions. • Quality: cotton quality description should include grade, color, staple, micronaire and strength (if applicable). Quality is described On Description (in terms of Universal Standards), On Type (cotton is sold on basis of the seller’s private type or sample for grade and color) or On Government Class (based on USDA classification). Whatever method is chosen, values must be clearly stated, including the method of measurement and whether they include a tolerance in the form of a claim limit. • Allowances for quality variation covers the value differences to be applied if the cotton delivered does not match the quality contracted. • Sampling requirements concerns the percentage of arbitration samples to be drawn on arrival of the merchandise by an approved controller. • Price: the sales contract price can be ‘fixed’ or ‘on call’ and is usually in US cents per pound. The sales price of a fixed price contract is final at conclusion of the sale and does not change, regardless of fluctuations in market prices. When cotton is offered ‘on call’, the Chapter 18/page 2

Contracts and arbitration

• •

• •

•

• • •

•

price is based on premiums or discounts (basis ‘on’ or ‘off’) to a certain month of the NYBOT futures or the Cotlook Indexes. The base price of the cotton will remain unfixed until the buyer instructs the seller to ‘fix’ in order to establish the final contract price by adding the market price level to the contract basis. Delivery terms: the most commonly used are FOB, FAS, CNF or CIF. Shipment terms can be for one month or several months, with partial shipments allowed or not, transshipments and time for unloading containers. Weights concerns the way cotton is weighted is specified (‘certified shipping weights final’ or ‘net landed weights final’). Insurance carrying charges are assessed against the buyer in case the shipper would have to carry the cotton longer than foreseen in the contract, bearing additional cost of interest, insurance and storage. Arbitration: the purpose of an arbitration clause is to make sure that in the event of a dispute over quality or technical matters, both parties have a right to arbitration under the procedures of the association under whose rules the contract was negotiated and that any subsequent award can be enforced under the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. Payment: letter of credit, cash against documents and others. Export duty or subsidy (if any) War risk, force majeure: force majeure is not an acceptable reason to cancel a contract made under the rules of any of the major associations, and is not recognized in English law. If the contract is not performed, it must be invoiced back to the seller. Special clauses: if the contracting parties wish to exclude or change any of the standard clauses, or to introduce special clauses, each change must be agreed by both parties.

Flexibility in contracting is important, and the commercial details of any contract are a matter for agreement between buyer and seller. The buyer and the seller are free to set aside or change any of the trading rules laid down by association. This freedom to negotiate specific requirements carries with it an obligation to clearly record what has been agreed in the contract. International Shipment Contract forms intended for use by Members’ Registered Firms (+ electronic version) are available on the International Cotton Association’s website www.lca.org.uk/publications. The ITMF (International Textile Manufacturers Federation) Guidelines for Purchasing Raw Cotton 1999 (Spinners Committee) can be downloaded free from the website www.itmf.org/publications. This booklet is intended to provide a set of guidelines to buyers Chapter 18/page 3

Cotton Trading Manual and sellers for use during negotiation and preparation of a cotton sales contract.

Sanctity of contracts The principle of the sanctity of contracts is enshrined in the commercial and contract law of most trading nations. The cotton industry believes that when a contract is made, it should be executed as agreed. If circumstances change after a contract has been agreed, the parties must not be permitted to ignore their legal obligations. The abrogation of contractual responsibilities threatens the cornerstone of the entire trading system. The principle of the sanctity of contracts implies that, as a general rule in the cotton trade, contracts cannot be cancelled. If a contract has not been or is not to be performed, owing to any circumstances whatsoever, it cannot be treated as cancelled but it must be closed by being invoiced back to the seller. Invoicing back means that the buyer sells back to the seller the same quantity of cotton as in the original contract, at the initial contract price or at the current market price, whichever is higher. In other words, unless agreed otherwise by the buyer, the non-performing seller must compensate the buyer for the price difference if the market rises between the date of the contract and the date of invoicing back because the buyer is assumed to need the cotton he initially purchased. The Committee for International Co-operation between Cotton Associations (CICCA) was established in 1976 in order to provide a forum for determining how best to promote the sanctity of contracts and maintain high standards of trading practices, which in turn should help avoid disputes. At present, CICCA comprises 14 cotton associations: Australia Cotton Shippers Association (Australia); www. austcottonshippers.com.au Bolsa de Mercadorias & Futuros (Brazil); www.bmf.com.br Association Française Cotonnière (France); www.afcot.org East India Cotton Association (India); www.eicaindia.org Japan Cotton Traders’ Association (Japan); www.jcta.co.jp Centro Algodonero Nacional (Spain); www.centroalgodonero.com The International Cotton Association (UK); www.lca.org.uk Belgian Cotton Association (Belgium) Alexandria Cotton Exporter Association (Egypt); www.alcotexa.org Bremer Baumwollbörse (Germany); www.baumwollboerse.de Associazione Tessile Italiana (Italy); www.ant.it Gdynia Cotton Association (Poland); www.cotton.org.pl Izmir Mercantile Exchange (Turkey); www.itb.org.tr American Cotton Shippers Association (USA); www.acsa-cotton.org Chapter 18/page 4

Contracts and arbitration CICCA represents over 1600 companies trading raw cotton on the international market. The purpose of CICCA is to ensure that when a contract is made it is executed as agreed. If not, the disadvantaged party should be adequately compensated through the arbitration process. CICCA is working towards the harmonization of rules governing raw cotton trade. Any cotton sales agreement should be drawn up under the basic contract conditions of an internationally recognized cotton association, representing the legislative body under which disputes may be settled by arbitration. However, a simple standard contract form of a recognized association may not be sufficient to protect the interests of both parties in certain circumstances, or under specific requirements. No one enters into a contract expecting it will go wrong. However, forward trading is the principal method of conducting cotton business, and risks that things will not go as anticipated are higher with forward trading than with spot purchases. Therefore, disputes will occur no matter how watertight the contract is. In the cotton business, contracts are often renegotiated amicably when one party is unable to perform, most of the time with appropriate price adjustment. When disputes cannot be settled amicably, it is usually necessary to resort to arbitration. Parties to a contract generally agree in advance to refer disputes to an arbitration authority. Cotton trade associations provide dispute resolution services for members and non-members, and generally require members to arbitrate disputes with other members as a condition of membership. An impartial and independent arbitration aims at bringing both parties to a contract back to the position they would have reached if the contract had been fulfilled as expected. Through its member associations CICCA provides a framework of rules, checks and balances to enable cotton trading to take place in an orderly way. Default rules cover contract formation, performance, quality, delay, payment and damages.

General principles of arbitration Arbitration may be broadly described as a private process, which commences with the agreement of parties to submit that dispute for decision by a tribunal of one or more arbitrators. The decision or award is final and legally binding on both parties. In ancient times merchants often referred their trading disputes to another merchant of high esteem, and the disputing parties agreed to abide by his decision. Such customs of merchants were developed into legal rules over the years, and the practice of arbitration was eventually given a statutory basis. There was an enormous growth in the use of arbitration during the twentieth century, and most international trade contracts now incorporate an arbitration clause. In 1985, the United Chapter 18/page 5

Cotton Trading Manual Nations Commission on International Trade Law (UNCITRAL) published a Model Arbitration Law, and recommended it to UN member states as a basis for arbitration law reform throughout the world to assist world trade. Arbitration is a process where, by agreement, parties to a contract submit their differences or disputes to the consideration and decision of one or more independent persons. Arbitration has the force of law. Generally, an arbitrator’s decision, called an award, may be enforced in the courts just as a judgment of the court. Arbitration is a private procedure. Only the parties to the arbitration agreement may attend any arbitration meeting or hearing. Arbitration is a very flexible procedure and can be adapted to suit the particular dispute. The parties are free to agree how their disputes are resolved, subject only to such safeguards as are necessary in the public interest. Because of its flexibility, arbitration can and should be cheaper and quicker than going to court. Arbitration is about the application of common sense with the purpose of reaching reasonable decisions on matters relating to commercial dispute based upon commercial practice and experience. Arbitration has been the preferred method of dispute resolution for over 150 years in the raw cotton trade.

Arbitration in cotton trade An arbitration agreement is an agreement to submit present or future disputes to arbitration. The agreement may be oral, but most contracts contain an arbitration clause, as the parties assume that disputes might arise under the contract, and, in that case, should be resolved by arbitration. The majority of arbitration agreements are entered into before the dispute arises, although it is possible to agree to go to arbitration after a dispute has arisen. A standard arbitration agreement clause provides that in the event of any dispute, it will be resolved by arbitration in accordance with the bylaws of a specified cotton association. The contracting parties must also agree on the procedure under which the arbitration will be conducted. Most cotton sales contracts make reference to the rules and arbitration procedures of a recognized association. Cotton associations have established procedures laid down in their rules and bylaws, which firms in dispute, the arbitrators and the association itself are obliged to follow. Association contracts contain legally approved forms of words intended to protect the rights of both sides. For example, the International Cotton Association Limited international shipment contract form includes the following arbitration agreement: Chapter 18/page 6

Contracts and arbitration All disputes relating to this contract will be resolved through arbitration in accordance with the bylaws of the International Cotton Association Limited. This agreement incorporates the bylaws which set out the Association’s arbitration procedure. Parties to the contract agree not to take legal action against each other over a dispute suitable for arbitration, other than to obtain security for any claim, unless they have first obtained an arbitration award from the ICA and exhausted all means of appeal allowed by the Association’s bylaws. Arbitration is a voluntary process. Except for statutory arbitrations, no party can be forced into arbitration against his will. Both parties to the contract must consent to arbitration. When parties enter into an arbitration agreement, they are legally bound by it. A party cannot unilaterally withdraw from an arbitration agreement he has entered into, and the agreement may be enforced against him. Nevertheless, one party may not be aware that the contract contains an arbitration clause; or one of the parties may not have fully understood the implications of an arbitration clause. The right of a party to go to arbitration cannot be denied if the contract contains an arbitration agreement. The agreement remains dormant until there is a dispute. The commencement of arbitration proceedings should follow a period of negotiation aimed at resolving the dispute amicably. In the cotton industry, the overwhelming majority of disputes and claims are resolved amicably. Agreeing to arbitrate is a major step. Arbitration commences when one firm informs the other, in writing, that it intends to proceed to arbitration and agrees to appoint an arbitrator. It is not necessary however, to obtain the approval of the other party to commence arbitration. The other party must, nevertheless, respond positively and agree to the choice of arbitrator(s). If a party disputes the fact that a written arbitration agreement exists, it should contest it in writing. If there is a written arbitration agreement and arbitration has been commenced properly by one party but ignored by the other, the party wishing to proceed should apply to the trade association to consider making a compulsory appointment of an arbitrator. The essential parties in arbitration are the firms in dispute and the appointed arbitrators, known in law as the ‘tribunal’. Arbitrators can act and determine awards entirely independently, as private citizens. The role of an arbitral authority is generally to facilitate and promote arbitration. The association does not advise arbitrators what to decide, or even to assist them to decide. However, the association becomes the arbitral authority if an arbitration agreement invokes trade association bylaws or if a member of a trade association acts as an arbitrator by virtue of his membership. In certain circumstances, the arbitral body Chapter 18/page 7

Cotton Trading Manual can refuse arbitration, for example to a company that has been suspended or expelled from the association. Both parties must pay careful attention to the deadlines laid down by the procedures. If not, one side may lose the right to quality arbitration or find that, in technical arbitration, arguments are not accepted because they have been submitted late. The parties have an obligation to act on time; likewise the arbitrators have a duty to produce timely awards. Quality and weight claims should be verified within a specific period after being detected. In the ICA bylaws claims for mixed bales, ‘unmerchantable cotton and for foreign matter must be made within six months of the date of arrival of the cotton’. The ITFMF Spinners Committee recommends ‘If contamination is detected at the spinning mill, an international controller selected by the two parties should verify the claim within two weeks after detection.’ The arbitration is deemed to have commenced on the date when one party writes to the other requiring it to agree to the appointment of an arbitrator, or provides the name of their appointed arbitrator, requesting that the other party appoint their own. In most cotton disputes a two-person arbitration panel is appointed. Still, nothing prevents the parties in dispute from agreeing upon a single arbitrator or more than two arbitrators. The parties may agree upon the same arbitrator, in whom they both have confidence. Arbitrators will commonly possess a great deal of technical knowledge relevant to the general subject matter of the particular dispute and will have technical knowledge and experience of the cotton trade rather than legal qualifications. If the parties are unable to agree on an arbitrator or if one party refuses to appoint an arbitrator, someone else has to appoint an arbitrator for them. This appointer will normally be named in the contract providing for arbitration or will be named in the rules, which both parties have agreed to abide by in the event of a dispute. Usually it will be the president of a professional institution or the president or chairman of a trade association. Some arbitration agreements specify that the arbitrator has to be appointed by an independent appointing body. In a multi-member tribunal, there is normally an odd number of arbitrators (3, 5 or 7) to avoid the problem of the tribunal being equally divided on an issue. One of the arbitrators is chosen to act as chairman. Some three-person tribunals comprise three arbitrators, one of whom will be chairman, whereas others comprise two arbitrators and an umpire. The function of an umpire differs from that of an arbitrator. The umpire attends the proceedings and receives all the documents along with the other arbitrators. However, he takes no part in the arbitration unless the other two arbitrators disagree regarding a decision. In this case, the other two arbitrators stand down and the umpire continues and takes the decision as if he were sole arbitrator. Chapter 18/page 8

Contracts and arbitration The appointment of an arbitrator usually terminates on completion of his task, when he has made a final award. However, the arbitrator’s appointment may come to an end earlier than anticipated, if he dies or resigns, if his authority is revoked by agreement between the parties, if he is removed by the court owing to some irregularity in his appointment or justifiable doubts about his impartiality, if he does not have the qualifications specified by the arbitration agreement, in case of physical or mental incapacity, or if he misconducts the proceedings. The arbitral institution is granted immunity from legal action, limited to its appointing function. The arbitral institution is not liable for the acts of the arbitrator it appoints. The only exception to this immunity is if the arbitral institution is proved to have acted in bad faith. Unless the arbitrator acts in bad faith, he will not be liable for anything done in the discharge of his functions. However, if the arbitrator resigns he immediately loses immunity from suit until he makes a successful application for relief from liability. The potential exposure to legal action is intended to discourage arbitrators from resigning. Each party is jointly and severally liable to pay to the arbitrator reasonable and appropriate fees and expenses. Should one party fail to pay, the other party will be liable for the whole of the arbitrator’s fees, even if the other party is ordered to bear those fees in the arbitrator’s award. The duty of arbitrators under the law is to make timely, independent and disinterested decisions. The tribunal must act fairly and impartially, giving each party a reasonable opportunity of presenting a case and rebutting that of its opponent, and adopt procedures suitable to the circumstances of the particular case, avoiding unnecessary delay or expense. The tribunal only has jurisdiction if there is a valid arbitration agreement under which he is appointed, providing his appointment has been properly made. Further, he only has jurisdiction to decide upon those disputes referred to him and permitted by the arbitration agreement. An invalid arbitration agreement and an invalid appointment as arbitrator are reasons for lack of jurisdiction. Other reasons for lack of jurisdiction are that the arbitration agreement is not sufficiently widely worded to allow a matter in dispute to be referred to arbitration, or the matters on which the arbitrator has been asked to decide have not been validly referred to arbitration; or the arbitrator has been asked to decide a matter that should not be decided in arbitration, but in the courts (for example a criminal matter).

Quality disputes and technical disputes As a natural product cotton is not always of even running quality. Unlike many commodities that can be objectively graded, cotton classing has Chapter 18/page 9

Cotton Trading Manual traditionally been a rather subjective process. The non-homogeneity of cotton and the difficulty of describing a particular bale with precision lead to very frequent quality disputes. Most quality claims are resolved amicably but recourse to quality arbitration is frequent. If the quality of the cotton delivered fails to meet the quality contracted, the seller must pay the buyer an ‘allowance’. However, the seller cannot claim any compensation if the cotton shipped is of better quality than required by the contract. The amount is often agreed upon amicably. If there is no agreement on the compensation, the dispute must be referred to arbitration. Unless the buyer and seller agree otherwise, the value differences published by the association under whose rules the cotton is traded will apply. These value differences normally cover grade, staple length and, in some cases, strength. If arbitration on quality is required, samples for arbitration must be drawn within a specified delay after the arrival of cotton (ICA bylaws stipulate that ‘samples must be taken within 42 days’ and that ‘arbitration must be commenced within 49 days’ of the date of the arrival of the cotton). Quality disputes can be settled by two sworn classers who make a binding judgment on the value of the cotton delivered. Disputes over grade are generally decided by visual examination, while disputes over other parameters (staple length, micronaire, strength and uniformity) are best decided by HVI testing. The arbitrators will use market evidence, together with the association’s value differences, to decide what allowance is due. The means of measuring the parameters concerned should be specified in the contract. The award of the arbitrators can be appealed once. All disputes other than quality disputes can be decided by a technical arbitration procedure. The most frequent causes of technical disputes are failure of the buyer to open the letter of credit on time, and failure of the seller to ship cotton on time. Theoretically, under existing cotton trading rules, if the L/C is not opened on time or the cotton is not shipped on time, the contract may be closed out and invoiced back at the expiry of the deadlines, or extended by mutual agreement. Practically, under normal circumstances, closure of the contract would be of no interest to the buyer and the seller. Thus, most contracts contain a clause stipulating that expenses (‘carrying charges’) representing the financial cost of any delay (late L/C or late shipment) should be applied to cover the period from the deadline to the opening of the L/C or the shipment of cotton. If the cotton is not shipped on time, or the buyer fails to open the L/C on time, the buyer or seller must either inform the other party of the breach of obligations and invoice the cotton back immediately, or agree to an extension. If not, he is considered to have accepted the delay. Chapter 18/page 10

Contracts and arbitration Association rules do not allow contracts to be cancelled for these or any other reasons unless both parties agree otherwise, and the concept of invoicing back applies whether the market is rising or falling. If matters cannot be resolved amicably between the parties themselves, arbitration would be necessary. Arbitration would aim at adequately compensating the injured party in order to put it in the financial position it would have enjoyed if the other party had performed as agreed at the time the contract was concluded, and at preventing one party from making a fortuitous profit at the expense of the other.

Awards Arbitration is not complete until there is an award. Awards are generally more compensatory than punitive. The arbitrators have to take into consideration what is actually written in the contract, rather than what the contracting parties might have intended. The case must be decided in accordance with the law chosen by the parties as applicable to the dispute. The arbitrator has power to make more than one award and to make awards at different times on different aspects of the disputes. Each award is complete in itself and constitutes a final decision on the matters it applies to. The form of the award must comply with certain requirements. The award must be in writing; dated and signed by all the arbitrators (or, in the event of disagreement, by all the arbitrators assenting to the award), stating the seat of arbitration. Unless parties have agreed otherwise (or if the award follows settlement), the arbitrators must give their reasons when making technical awards (a reasoned award), but they are not obliged to do so when making quality awards. There is, if necessary, a process available for correcting awards. To be valid the award must deal with all the issues in dispute, be certain and not ambiguous as to its effect. An award must not be obtained by fraud or be subject to admission of irregularity by the arbitrator. The award and the way it was procured must not be contrary to public policy. An award brings to an end the arbitrator’s competence and authority to deal with the issues in dispute. The award is final and binding on the parties. The award can only be challenged if the contract provides for a scheme of arbitral appeal. An award is an instrument that can be used to enforce the decision against the losing party.

Appeal Most cotton trade associations make provisions in their rules for an appeal. If no challenge is raised at the end of the period for appeal Chapter 18/page 11

Cotton Trading Manual (normally 28 days), the award is judged to be final and binding. At this point the successful party will expect fulfillment of the award. Finally, means must be in place for the enforcement of an award.

Enforcement of judgments In most instances, the losing party complies with the award. However, if a party refuses to abide by an award, the other party will need to take enforcement action through the courts. Unless arbitration is governed by law, the resulting award will not be enforceable in law and it may, therefore, be of little help to either party. Arbitration awards are made under the law of the country in which the arbitration authority is located. The law of the arbitration must be distinguished from the law of the contract. Unless otherwise agreed, the award must be in accordance with the law of the contract, even though the law of the arbitration is different. An award must be registered as a judgment in the courts to be eligible for enforcement. The court accepts the decision of the arbitral authority and that it is final and binding on both parties. The governments of 125 nation states have agreed to make valid arbitration awards, enforceable, under member country law, through the New York Convention of 1958 (The Convention on the Recognition and Enforcement of Foreign Arbitral Awards), which provides the most extensive network presently available for the enforcement of decisions to resolve disputes. Most countries say that they will not enforce an award made by a country that is not itself a signatory. An award is enforced when a court assists in compelling the unsuccessful party to comply with the terms of the award.

Defaults and sanctions When an arbitration decision goes against them, some companies do not abide by the arbitration award. No arbitration system can provide an absolute protection against unreliable or dishonest parties, and bankrupt companies are unlikely to pay their dues. Trade associations are not debt collection agencies and can only provide limited assistance if awards are not honored. However, trade associations inform all their members and CICCA member associations about the defaults. Default lists are widely publicized. Failure to comply with a valid award is grounds for suspension or expulsion from most cotton trade associations. The purpose of the default list is to deter a company from engaging in malpractice. Membership in a recognized trade association is crucial to participation in the international cotton trade, and having the reputation of being unreliable severely undermines business opportunities for defaulters, which is usually sufficient to induce merchants to Chapter 18/page 12

Contracts and arbitration abide by arbitration decisions. However, CICCA’s procedures for enforcement are not always well known or understood, and governments’ support for the enforcement of awards is not very strong. It has been estimated that the amount of arbitration awards over a recent six-year period exceeded US$120 million, and about half of this amount is still owed by defaulting parties. At time of writing, there are 263 defaulters, merchants and spinners on the CICCA default list. The average size of awards owed by defaulting parties is less than $200 000. Disputes in domestic cotton transactions in producing countries seem less frequent than disputes in international transactions. Exporters and arbitration bodies complain that many importers are unreliable in a fluctuating market, and do not comply with arbitration awards. Some importers believe awards are biased towards merchants. There are several reasons why parties default on contracts, including malevolence, financial difficulties, and lack of knowledge of the raw material and of the trading rules. Most cotton contracts are based on the by-laws of individual cotton associations. Despite similarities, individual by-laws do differ in many details given the professional and legal traditions of a given country. These differences, and the lack of knowledge about them, may lead to serious misunderstandings and defaults when realizing the contract. Many contracts are written in a confusing manner, not providing sufficient details to safeguard the interests of both exporters and importers. Many quality disputes arise from an incorrect description of cotton in the contract and from a lack of standardization in classification and testing. Disputes over contamination by foreign matter (undetectable during the testing of raw cotton) and by stickiness suffer from the lack of recognized methods to assess the damages. Some companies do not accept that the law of the seat of arbitration applies, and attempt to challenge arbitration awards in their own courts. Small Indian mills importing cotton are highly critical of the prevailing system, complaining that exporters refuse to incorporate clear and detailed specifications of terms and conditions in the contracts, and take advantage of these flaws to escape liability in the event of claims. These mills deplore the fact that exporters insist on arbitration being handled by the International Cotton Association (ICA, previously Liverpool Cotton Association, LCA), asserting that the ICA is primarily a body of cotton traders, and that arbitration is heavily biased against the buyers interests in favor of cotton suppliers. In addition, small importers find membership of the ICA prohibitively expensive, while ICA arbitration fees are high for non-members. Indian mills requested their government that import of cotton into the country may be permitted only on condition that any arbitration arising from the transaction be handled by the Indian Council of Arbitration Chapter 18/page 13

Cotton Trading Manual (same acronym: ICA), a professional arbitration body with no affiliation with either cotton or textile sectors. Indian mills made several recommendations: that there should be no differentiation in arbitration/administration fees between members and non-members of the arbitration body; that arbitrators should include professionals from all major exporting and importing countries, and that there should be no stipulation that an arbitrator should necessarily be a member of the arbitration body (panels of WTO’s Dispute Settlement Body always consist of professionals from outside the WTO, who do not represent any WTO members); that there should be testing laboratories designated by the arbitration bodies in major exporting and importing countries, whose findings should be binding on arbitrators in disputes on quality; that arbitration awards should record and analyze all evidence and arguments presented before arbitrators, and that the reasons for accepting or rejecting them should be part of the recommendation of the arbitrators. Performance risk insurance has been considered as a possible solution to avoid losses from defaults. However, rating companies on the basis of financial strength, credit history and past contract performance would not be easy. Cotton trading companies are generally reluctant to divulge information about their operational, financial details and credit standings, and it would be challenging to obtain the information necessary for risk evaluation, especially from small companies and textile mills remotely located in developing countries. Many of the defaulting parties are private textile mills in developing countries and are not members of cotton associations. Higher premiums would serve as a disincentive to conducting trade with companies that have defaulted on contracts in the past. Most of the cotton trading companies, especially large companies, practice in-house risk assessment, and prefer to rely on their commercial judgment when entering into contracts with risky counterparts, rather than paying high insurance premiums in a very competitive environment with slim margins. It is felt that good commercial judgment, combined with information on defaulting companies provided by trade associations, helps to contain the risks associated with forward trading.

Chapter 18/page 14

Part 6 References

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References National Cotton Council (NCC) (2004). Cotton Counts Its Customers. NCC website http://www.cotton.org National Cottonseed Producers Association, Inc. (1950). Processed Plant Protein Feedstuffs, 8th edn. Memphis: NCPA, pp. 12–17. N.N. (n.d.) Stapeldiagramm-Apparat USTER Bedienungsanleitung. Schweiz: Zellweger Uster AG. Otto S (1994). ‘What Does the Spinner Need?’ Paper presented to the Ismailia International Workshop, Cotton Production Prospects for the Next Decade. Parry J (1982). Guide to World’s Commodity Markets. London: Kogan Page. Pavaskar MG (1969). ‘Why Does Organized Industry Assail Futures Markets?’ Economic and Political Weekly, vol. IV, no. 52 (27 December). Pavaskar MG (1971). Marketing of Cash Crops: Efficiency of Futures Trading. Bombay: Krishna Raj. Perkins HH (1983). ‘Identification and Processing of HoneydewContaining Cottons’. Textile Research Journal, vol. 53, no. 8. Ramey HH (1982). The Meaning of Cotton Fiber Fineness. International Institute for Cotton. Rees GL (1972). Britain’s Commodity Markets. London: Paul Elek Books. Roche J (1994). The International Cotton Trade. Cambridge: Woodhead Publishing Limited. Schenek A (1984). ‘Massnahmen zur Vermeidung von Reklamationen bei der Verarbeitung von Baumwolle’. Textilpraxis International, vol. 6, pp. 559–563. Schenek A (2000). Naturfaser-Lexikon. Frankfurt am Main: Deutscher Fachverlag. Schenek A (2002). ITMF – Progress Report. Bremen: ITMF Committee on Cotton Testing Methods. References/page 10

References Schenek A, S Knittl, M Qaud and A Schleth (1998). Short Fiber Content Determination by Means of AFIS. Bremen: International Cotton Conference. Scherer JAB (1916). Cotton as a World Power: A Study in the Economic Interpretation of History. New York: Frederick A. Stokes Co. Schleth A (2000). Status Report on Short Fiber Content Measurement. Bremen: ITMF Committee on Cotton Testing Methods, Working Group on Fiber Length. Schneider T (2002). ITMF Committee on Cotton Testing Methods, Chairman’s Report. Bremen: Working Group on Fiber Length. The SEAM website http://www.theseam.com/media/Seaminsert.pdf Shaw AJ (1985). Introducing SIRATAC. Gunnedah, NSW, Australia: Agfact, Division of Plant Industries. Shofner FM and CK Shofner (2000). Cotton Classing in the New Millennium. Bremen: International Cotton Conference. Shofner FM, CK Shofner and Z Yupeng (2002). New Fiber Classification Methods. Bremen: International Cotton Conference. Shofner FM, YT Chu and D Thibodeaux (n.d.). An Overview of the Advanced Fiber Information System. Bremen: International Cotton Conference. Shofner KS and F Shofner (2000). Schaffner Technologies Report to the ITMF. Bremen: ITMF Committee on Cotton Testing Methods, Working Group on HVI. Spinlab, Inc. (1988). History and Description of Calibration Cottons. Knoxville: Spinlab Inc. Stead BF (1981). The Cottons of Egypt. Liverpool: Pyramid Surveys. Steadman RG (1997). ‘Cotton Testing’. Textile Progress, vol. 27, no. 1 (The Textile Institute, Manchester, UK). Strolz H (1999). ITMF Cotton Contamination Report. Zürich: ITMF Secretariat. Strolz H (2001). ITMF Cotton Contamination Report. Zürich: ITMF Secretariat. References/page 11

References Stuhlfauth N (2002). ITMF Committee on Cotton Testing Methods, Chairman’s Report. Bremen: Working Group on Dust and Trash. Sumner D (2001). ‘Are Green Payments Actually Decoupled?’ Organized Symposium presentation at American Agricultural Association Annual Meetings, Chicago. Temming H, H Grunert and H Huckfeldt (1972). Temming – Linters. Glückstadt: Technische Informationen über Baumwollcellulose, Peter Temming AG. Textiles Intelligence Limited (2001). Textile Outlook International (January). Thibodeaux DP (2002). ITMF Committee on Cotton Testing Methods, Chairman’s Report. Bremen: Working Group on Maturity. Thibodeaux DP, K Rajasekaram, JG Montalvo Jr and T Von Hoven (2000). The Status of Cotton Maturity Measurements in the New Millennium. Bremen: International Cotton Conference. Tobler MI and S Schaerer (2002). Environmental Impacts of Different Cotton Growing Regimes. Bremen: International Cotton Conference. Toyne B, J Arpan, A Barnett, D Ricks and T Shimp (1984). The Global Textile Industry. Trollinder N, D Guthrie and W Meredith (1995). ‘Cotton Biotechnology’, Cotton Physiology Today, vol. 6, no. 1 (January) (Memphis: National Cotton Council). USDA (1997). 1997 Census of Agriculture. Washington DC: USDA, National Agricultural Statistics Service. USDA (2001a). Cotton Ginnings, 2001 Summary. Washington DC: USDA, National Agricultural Statistics Service (May). USDA (2001b). ‘USDA Announces WTO Notification of US Domestic Support Payments for 1998/99 Marketing Year’. News Release No. 0107.01. Office of Communications (22 June). USDA (2002). ‘Aligning US Farm Policy with World Trade Commitments’. Agricultural Outlook (January–February). Washington DC: USDA, Economic Research Service. References/page 12

References USDA (n.d.). ‘Commodity Costs and Returns’. Washington DC: USDA, Economic Research Service. website www.ers.usda.gov. USDA–AMS (1999). The Classification of Cotton. US Department of Energy and the Textile, Clothing Technology Corporation website http://www.dama.tc2.com Watson MD (1997). Sticky Cotton – Causes, Detection and Future Expectations. Raleigh NC: Cotton Inc. Watson MD (2002). ITMF Committee on Cotton Testing Methods, Chairman’s Report. Bremen: Working Group on Stickiness. White GS (1836). Memoir of Samuel Slater: The Father of American Manufactures Connected with a History of the Rise and Progress of the Cotton Manufacture in England and America. Philadelphia. Wilcut JW (1995). ‘Weed Management with Herbicide Resistant Transgenic Varieties’. In Proceedings, Beltwide Cotton Production Research Conference. Memphis: National Cotton Council. Williams J (1986). The Economic Function of Futures Markets. Cambridge, MA: Harvard University Press. World Bank (1996). India – Managing Price Risks in India’s Liberalized Agriculture: Can Futures Markets Help? Report No. 15453-IN. World Bank: Country Department II, South Asia Region, and United Nations Conference on Trade and Development: Commodity Division. Wright G (1971). ‘An Econometric Study of Cotton Production and Trade, 1830–1860’. The Review of Economic and Statistics, vol. LII, no. 2, pp. 111–120. Wulfhorst B and H Külter (n.d.) Baumwolle Faserstoff-Tabellen nach P.A. Koch. Frankfurt am Main: Deutscher Fachverlag. Yamey BS (1959). ‘Cotton Futures Trading in Liverpool’. Three Banks Review, pp. 21–38.

References/page 13

Part 7 Appendices

Appendix 1 Pricing and risk management glossary Secretariat of the International Cotton Advisory Committee

Basis is the difference between the specific futures contract price and the cash price for cotton at a local delivery point. Normally, the futures price should be equal to the present cash price plus the cost of storage, insurance and interest charges necessary to carry the commodity to the delivery month of the contract. In addition, basis pricing also reflects the location (port of delivery) and the quality differential of the commodity. Basis risk is the risk associated with a widening or narrowing of the basis between the time a hedge is established and the time it is liquidated. Buyer is a market participant who takes a long futures position or buys an option. An option buyer is also called a taker, holder or owner. Call option is a contract that gives the buyer/taker the right to buy the underlying futures contract at a stipulated price (strike price) at any time up to the expiration of an option, or to establish a long position in cotton futures. The buyer pays a premium to the seller/grantor for this contract. A call option is bought with the expectation of a rise in prices. Cash-settled is settling or meeting the obligations imposed by an expiring contract by means of cash payment, as opposed to physical delivery or receipt of a commodity. Cash payments are determined by value of contract, or market-to-market price. Most contract holders eliminate their positions through offsetting positions. Less than two percent of all futures contracts are held until expiration. If a futures contract holder chooses to hold the contract to expiration, a cash settlement may be made. A cash settlement essentially represents the difference between the contract value at the time of original purchase or sale and the contract value at expiration. However, the buyer and seller do not exchange the full value of the contract, but the difference in the contract value, compared with the original price. Clearing house is the entity of the exchange responsible for recording transfers and settlements of exchange-traded futures and options and the guarantor of all options. It is also charged with assuring the proper conduct of the exchange’s delivery procedures and adequate financing and trading. When accuracy of all reported transactions has been verified, the clearing house then assumes the financial obligations to all traders. It becomes the buyer to every seller and the seller to every buyer. All contracts not offset by the end of trading are settled by delivery. A seller with open short contracts during the delivery period must either deliver the product or buy back the futures contract originally sold. Delivery can only be made from a location or a warehouse approved by the exchange. The buyer of a futures contract who has not liquidated his long position will receive and must accept delivery at some permitted location and must make payment in full for the product. Appendix 1/page 1

Cotton Trading Manual Closing-out transaction is liquidation of an existing long or short futures or option position with an equal and opposite transaction; also called offset. Collar is a compound option position consisting of a put and a call option in order to establish a fixed floor and ceiling. Collars are also known as fences, min-maxes or by other similar names. Commodity Futures Trading Commission (CFTC) is a US federal regulatory agency established in 1974 to oversee futures trading and the operation of organized exchanges in the US. Cotlook Indexes (A and B) are published daily by a private company Cotlook Ltd and are intended to represent the level of competitive offering prices for cotton delivered to North Europe on the international raw cotton market. The Cotlook A Index is an average of the cheapest five quotations from a current selection of the 16 Cotlook quotations for principal Upland cottons traded internationally. The A Index was first introduced in 1966. The base quality of the A Index is middling 1–3/32
. The Cotlook B Index is an average of the cheapest three from a current selection of the eight Cotlook quotations for coarse count cotton (such as strict low middling 1–1/16
) used for spinning coarse count yarns. The B Index was first introduced in 1972. The geographical basis for the Cotlook quotations is North Europe, and the terms quoted are CIF (Cost, Insurance and Freight). See Cotlook quotations. Cotlook Dual Index system is intended to provide two sets of competitive levels of offering prices for cotton to be shipped both during the current season and the next season. The nearby or current season’s pair of A and B Indexes are for cotton to be shipped no later than August/September and forward season’s pair of Indexes are for cotton to be shipped no earlier than October/November. Forward Indexes are usually introduced early in a calendar year as soon as next season’s offers are available. See Cotlook quotations. Cotlook Limited is a private company founded at the end of 1920s in Liverpool and is the publisher of Cotton Outlook. The company publishes cotton news and has been compiling and publishing the Cotlook A Index of raw cotton values and other quotes for cotton of different varieties since 1982. The A Index is used in many different ways by various countries and trading organizations. Cotlook Ltd sells its cotton news and price services by subscription, including CIF Quotes, Cotlook Daily Internet Service, and Cotton Outlook Weekly Internet Service, Price Series and other information services. Cotlook Limited is a subsidiary company of The Outlook Group Limited. Other members of the group include Liverpool Cotton Services, which is a provider of cotton arbitration services. Cotlook quotations are estimated daily by the editorial staff of a private company, Cotlook Ltd based in Liverpool, and are intended to indicate the competitive level of offering prices. Prices are CIF North Appendix 1/page 2

Pricing and risk management glossary Europe, cash against documents on arrival of vessel, including profit and agent’s commission. Cotlook collects information on offering prices from many sources and makes an assessment of prices with an unavoidable element of subjectivity. The Cotlook quotations are not contract prices, and traders are not guaranteed to conclude business at quoted levels. The Cotlook quotations are used to calculate A and B Indexes to represent the level of competitive offering prices on the international raw cotton market. Exercise is to elect to buy or sell, taking advantage of the right (but not the obligation) conferred by an option contract. Exercise/Strike price is the price, specified in the option contract, at which an options holder may buy or sell the underlying futures contract upon exercise of his option. Expiration date is the date on which an option contract expires; the last day an option can be exercised. Floor broker is a person who, in or surrounding any pit, ring, post or other place provided by a contract market for the meeting of persons similarly engaged, executes for another any orders for the purchase or sale of any commodity for future delivery and receives a prescribed fee or commission. Floor trader is an exchange member, also called a local, who usually executes his own trades by being personally present in the pit or place for futures and options trading. Forward contract is an agreement between buyer and seller for the sale of cotton of a specified quality and quantity for delivery at a specified future date. A price may be fixed in the contract; parties may agree to fix the price at any date in the future or upon delivery. Forward contracts are not usually traded on an organized exchange and most often result in the physical delivery of cotton. Forward contracts are also called cash contracts. Fundamental analysis is an analysis concerned with economic factors, comparing the relationship between the supply and demand for a given commodity. Futures contract is a commitment to make or take delivery of a specified quantity and quality of cotton at an agreed price at a specified future date. Futures contracts are traded on an organized exchange. Futures contracts have standard delivery dates, trading units, terms and conditions established by the exchange. Futures contracts are sold and purchased through members of commodity futures exchanges. Qualified members may execute transactions for commission brokers, be retained by independent clients, or speculate for profit. Futures markets provide a number of advantages. They represent an efficient way of buying and selling commodities for future delivery, particularly seasonal farm crops. A futures contract also represents a valid agreement of purchase or sale of a physical commodity. Appendix 1/page 3

Cotton Trading Manual Futures hedge is a zero sum arrangement, when what is gained on one side of the market is forfeited on the other (futures or cash). Hedging is taking a position in a futures or options market offsetting a position held in the cash market to minimize the risk of financial loss from an adverse price change. The major function of a futures market is to provide facilities where commercial companies can hedge their price risks. The price to the public is reduced, because hedging enables processors to reduce operating costs. The ability to reduce risk by hedging makes the cost of financing lower. Basic hedging with futures contracts is achieved when a position in the futures market is approximately equal and opposite to the position held by the hedger in the cash or physical market. There is often a strong relationship between futures and cash markets. The quotation for each unit is expressed in the same way in both the cash and futures markets. The fact that traders know that deliveries can be made is the principal reason why futures prices preserve a continuing relationship with cash market prices. Since futures market prices typically move in tandem with the cash market over the course of time, tending to converge as contracts mature, a gain in the futures market will offset a loss in the cash market, or vice versa. In-the-money is an option with intrinsic value. For calls, the strike price must be below the current market price of the underlying futures contract. For puts, the strike price must exceed it. Intrinsic value is a measure of the value of an option if exercised immediately and represents the profit differential between the option strike price and the current underlying futures market price. Last trading day is a day on which trading ceases for the maturing (current) delivery month. The NYBOT rules specify the last trading day in the Cotton No. 2 futures contract as the 10th business day prior to last delivery date, which is the 7th to the last business day of the month. Long describes the position of someone who has bought cotton, futures contracts or options and has not yet offset that transaction with a sale or delivery of cotton. The opposite of Short. Long hedge is a purchase of a futures contract in anticipation of a cash market purchase. It is usually used to protect against a rise in the cash price. Margin is a good-faith deposit or collateral (usually a small percentage of the contract’s full value) deposited by a client with his broker, or by a broker with the clearing house to ensure that market participants will meet their contractual obligations against open futures contracts. The margin is not a partial payment on a purchase. An initial or original margin is the total amount required by the broker per contract when a futures position is opened. Because the exchanges’ clearing house guarantees contract performance to its members, the exchanges and Appendix 1/page 4

Pricing and risk management glossary the clearing house establish minimum margin levels for each market and periodically adjust them to reflect market activity, especially price volatility. Maintenance margin is a sum that must be maintained on deposit at all times. If a customer’s equity in any futures position drops under the level because of adverse price action, the broker must issue a margin call to restore the customer’s equity. See Variable limit margins. Margin call is a request from a brokerage firm to a customer to bring margin deposits up to minimum levels, or a request by the clearing house to a clearing member to bring clearing margins back to minimum levels required by the clearing house rules. Fluctuations in the futures market result in daily debits or credits in the margin account of a contract holder and cause margin calls. Mark-to-market is a daily cash flow system used by US futures exchanges to maintain a minimum level of margin equity for a given futures or option contract position by calculating the gain or loss in each position resulting from changes in the price of the futures or option contracts at the end of each trading day. Minimum price fluctuation is the smallest allowable increment of price movement in a given contract, also known as a tick. Naked option is the sale of an option without holding an offsetting position in the underlying futures contract. Naked position is an unprotected long or short position in a cash or futures market. Nearby is the nearest listed-trading month of a futures market. Notice days are when a notice of delivery shall be issued and tendered. According to the rules of the NYBOT, it is the fifth business day prior to the day of delivery. Offset is liquidating an existing long or short futures or option position with an equal and opposite transaction. On call sales are a customary practice used in the physical cotton trade and are stipulated in the rules of the Liverpool Cotton Association, widely used in the international cotton trade. On call sales are agreements to sell cotton with the price to be fixed at a later time, based on a specified quotation by the seller or the buyer. If the final price is to be fixed based on a futures market quotation: • On buyer’s call, the seller must fix the final price of cotton sold on call on the buyer’s instructions, before the first notice day of the futures contract month. This must be done before the invoice is sent. If the buyer does not give instructions in the time agreed, the seller can fix the price when the market closes on the day before the first notice day of the futures contract month. The seller must notify the buyer about this immediately. If the parties agree that the price can be fixed after shipment, the cotton must be invoiced at a provisional Appendix 1/page 5

Cotton Trading Manual price, and the difference will be paid by one of the parties based on the final price. • On seller’s call, the roles of the buyer and the seller are reversed. Open interest is the total number of futures or options contracts in one delivery month or one market that have not yet been offset by an opposite transaction nor fulfilled by delivery (one side only). Open outcry is a public auction wherein verbal bids and offers are announced in trading rings at an exchange. Option on a futures contract is an agreement between two parties that gives a buyer/holder the right, not the obligation, to buy or sell a specified quantity of futures contracts at a specified price (strike price) anytime on or before the expiration date regardless of the market price of that commodity. The buyer/holder pays a premium to the seller/writer for this option. There are no margin calls for purchases of options. An option contract has the same standardization of quality, quantity and location as a futures contract. There are two types of options: Call option and Put option. Options have become an important hedging tool. Each option has a price paid by the buyer to the seller and determined in the marketplace. One of the largest advantages to buyers of cotton futures options is that the buyer can enjoy the price protection afforded by the futures market in the event of unfavorable price moves, while sharing the economic benefits of favorable price changes. Options positions can be discharged by coming to expiration, usually the second Friday of the month preceding the underlying future expiration. Options can be liquidated by an offsetting transaction. Options are a flexible price risk management tool. Option buyers enjoy limited risk with unlimited profit potential. They can never lose more than the premium they paid. Users can fix prices at various levels, in effect using options as price insurance. Options make significant new pricing strategies available. Out-of-the-money is a call (put) option in which the strike price exceeds (is less than) the current market price of the underlying futures contract. Position is an interest in the market in the form of open commitments, either long or short. Premium is an amount paid by the buyer of an option to its seller. Premiums are determined in a trading pit and have two components: intrinsic value and time (extrinsic) value. Price limits are usually set by exchanges for daily price moves. The NYBOT sets price limits at 3 cents per pound, which in certain cases can be expanded to 4 cents per pound. There are no price limits on the expiring contract on or after its first notice day. Put option is a contract that gives the buyer/taker the right to sell the underlying futures contract at a stipulated price (strike price) at any time Appendix 1/page 6

Pricing and risk management glossary up to the expiration of an option, or to establish a short position in cotton futures. The buyer pays a premium to the seller/grantor for this contract. A put option is bought with the expectation of a decline in prices. Seller/Writer/Grantor of an option is an individual who sells an option, establishing a short position. Series of options are options of the same type (either puts or calls, but not both), covering the same underlying futures contract, having the same strike price and expiration date. Settlement price is a daily price at which a clearing house clears all trades. It is based on the closing range of that day’s trading and is the basis for both margin calls and (if applicable) the next day’s price limits. Short describes the position of someone who has sold cotton, futures contracts or options and has not yet offset that transaction with a purchase or delivery of cotton. This is the opposite of Long. Short hedge is the sale of a futures contract in anticipation of a cash market sale. It is usually used to protect against a decline in the cash price. Southern Mill Rules: With the organization of the American Cotton Shippers Association in 1924, the American Cotton Manufacturers Association agreed to jointly sponsor trading rules for the shipment of cotton to south-eastern mills. The Southern Mill Rules were agreed to in 1925. Previously, trades were governed by the Carolina Mill Rules of 1915, or by individual mill terms. In the early 1900s, most cotton textile manufacturers were located in New England. Contracts between merchants and mills were made under the New England Mill Terms and quality arbitrations were handled by the New England Cotton Buyers Association located in Boston, Mass. With the movement of textile manufacturers to the south-eastern states and the merger of the American Cotton Manufacturers Association with the northern Cotton Textile Institute in 1949, creating the American Textile Manufacturers Institute, Inc., the New England Mill Terms were rescinded in the 1950s. Revisions to the Southern Mill Rules to meet changed conditions of trade are considered yearly in a meeting between the Cotton Committee of ATMI, the Executive Committee of the Domestic Mills Committee of ACSA, and Amcot. • Amcot was founded in 1971 as an association of the four major US cotton marketing firms. They are Calcot, Ltd, PCCA (Plains Cotton Cooperative Association), Staplcotn (Staple Cotton Cooperative Association) and SWIG (Southwestern Irrigated Cotton Growers). • American Textile Manufacturers Institute (ATMI) is the national trade association for manufacturers of textile mill products made in the United States. As such, ATMI’s primary purpose is to provide its members with a forum to develop united approaches to industryAppendix 1/page 7

Cotton Trading Manual wide, national issues. ATMI’s members produce approximately 80% of all textiles made in the US and process some 75% of all domestically grown cotton consumed annually in the US. Speculator is one who assumes the price risk that hedgers seek to avoid with a goal of receiving a profit resulting from price movements in the futures or options markets. Speculators provide liquidity and have the equity to absorb changes in price levels. Large quantities of risk capital are attracted to one location. Speculators help minimize price fluctuations by increasing the number of bids and offers in the marketplace. A publicly known value for a commodity is created and an alternative market is provided. Spreads are simultaneous positions in the same contract but in different months or simultaneous positions in related contracts for the same or different months. There are two spread modes: • Carry mode is the difference between the prices of two contract months and equals the cost of carrying cotton during the interval between the expiration dates for the two contracts. • Inverted mode is where prices for nearby contract months are higher than prices of future months. This typically occurs in tight markets. Strike/Exercise price is the price, specified in the option contract, at which an options holder may buy or sell the underlying futures contract upon exercise of his option. Swaps are cash-settled, bilateral agreements between two parties. The swap transaction does not entail physical delivery of cotton. It is not exchange-traded, but rather an over-the counter (OTC) instrument offered by brokers to customers to protect against adverse price movements, usually utilizing a non-New York quote, in order to avoid basis risk. There is a concrete buyer and a seller for each swap contract, and parties are matched with the help of a broker. The buyer of a fixed price swap for a forward month is due money from the seller should the reference price in the forward month be higher than the agreed swap price on a predetermined quantity of cotton. Likewise, the buyer will owe money to the seller should the reference price in the forward month be lower than the agreed swap price. By entering into the swap transaction, parties can effectively lock in a fixed price by entering into the physical cotton market in the future to match their swap positions with a physical cotton position. This hedging strategy is similar to hedging with cotton futures. However, there is no basis risk for quality descriptions different from the New York futures contract. Most of the terms of the swap contract such as quantity, reference quote, settlement month or date are negotiable between the parties. As opposed to exchangetraded contracts, cotton swaps transactions involve a counterparty credit risk, and it is customary for counterparties to offer and/or request Appendix 1/page 8

Pricing and risk management glossary letters of credit for a specified percentage of the total value of the swap contract. Technical analysis is concerned with price data rather than economic factors, with a presumption that current prices already reflect supply and demand relationships. Price projections are made based on certain chart patterns. Time (extrinsic) value is the portion of a premium that exceeds the intrinsic value. The time value of an option reflects the probability that the option will move into-the-money. Therefore, the longer the time remaining until expiration of the option, the greater is its time value. Variable limit margin is the performance deposit required whenever the daily trading limits on prices of cotton futures are raised in accordance with exchange rules. In periods of extreme price volatility, some exchanges permit trading at price levels that exceed regular daily limits. At such times, margins are also increased. Variation margin is a payment required upon margin call. Volume of trading is the number of contracts traded during a specified period of time (one side only). It may be quoted as the number of contracts traded or as the total of physical units, such as bales or tons.

Appendix 1/page 9

Appendix 2 International cotton organizations and associations Secretariat of the International Cotton Advisory Committee

African Cotton Association Alexandria Cotton Exporters Association American Cotton Shippers Association Association Française Cotonnière Associazione Tessile Italiana Australian Cotton Shippers Association Belgian Cotton Association Bolsa de Mercadorias & Futuros in São Paulo, Brazil Bremen Cotton Exchange Centro Algodonero Nacional China Cotton Association East India Cotton Association European Cotton Confederation Gdynia Cotton Association

International Cotton Association Izmir Mercantile Exchange Japan Cotton Traders Association Karachi Cotton Association Liverpool Cotton Association Russian Cotton Association The ICAC Membership Plenary meetings Standing Committee The Secretariat Coordinating agencies Publications

Participants in international trade in many countries are organized into national cotton associations, many with an international character. The membership of some associations includes both domestic and foreign organizations and individuals. Cotton associations serve the interests of cotton producers, buyers, sellers and consumers by providing trading rules and mechanisms to resolve trade disputes and by serving as arbitration authorities. Cotton associations promote and facilitate cotton trade in a fair and orderly fashion to the benefit of a sound world cotton economy. In addition to maintaining trading rules, cotton associations provide other important services, such as technical and quality arbitration, traditional and HVI classing, forums for international conferences and discussions of cotton affairs, training seminars around the world, market information and statistics. Cotton associations differ in organization and representation, some serving mostly exporters or producers and others, importers and spinners. A number of the associations, such as ACSA, play an important role in formulating national cotton policies, which have a significant impact on international trade in cotton. Information, statistics and training provided by the associations is a valuable contribution to a better understanding of the complexities of the market, which many participants of the cotton trade can benefit from. Fourteen of the largest cotton associations with similar objectives comprise the Committee for International Cooperation between Cotton Associations (CICCA). Each of the CICCA member associations acts independently, but uses CICCA as a forum for discussion and collective action when appropriate. CICCA promotes trading rules and arbitration practices of its member associations and stands for the concept of sanctity of contracts and good trading practices. CICCA objectives include assistance in ensuring that dispute resolution procedures are adhered to and any consequential awards upheld. CICCA circulates to member organizations a consolidated list of firms reported to have failed to properly comply with valid arbitration awards made by member organizations. CICCA publishes a directory of all firms affiliated with its member associations. Membership in the 14 CICCA member associations accounts for more than one thousand firms associated with the cotton industry. Members of these associations handle the bulk of world cotton trade.

African Cotton Association The Association Cotonnière Africaine – African Cotton Association (ACA) – was founded in 2002 and is composed of 27 private and public organizations from 11 countries in Western and Central Africa and is headquartered in Burkina Faso with a representative office in Paris. The Association was founded out of concern shared by many of the Appendix 2/page 1

Cotton Trading Manual producing countries about government policies in some of the major producing countries subsidizing cotton production and leading to market distortions. The Association plans to work with other international associations on upholding fair cotton trading rules and the sanctity of contracts. Informational and educational work will play an important part in the association’s activity.

Alexandria Cotton Exporters Association Cotton traders founded the Alexandria Cotton Exporters Association (ALCOTEXA) in 1932. As a non-profit and non-trading organization, ALCOTEXA deals with issues related only to Egyptian cotton. Nonmembers of ALCOTEXA are not allowed to trade cotton in Egypt. Membership in ALCOTEXA includes cotton trading and ginning companies. All exports of cotton from Egypt are subject to the terms of the Egyptian Contract. The Association has a Board, Management Committee, Expert Cotton Classers and Government Sworn Experts on its Arbitration and Appeal Boards. All export sales from Egypt are based on Egyptian Testing House Terms, and arbitration is provided in Alexandria. Major functions of ALCOTEXA as a regulative authority include formulation of the export policy and setting sale prices (indicative or minimum). The Association revises export prices weekly. The association conducts contract registrations. Twice a year the ALCOTEXA publishes The Egyptian Cotton Gazette, which contains a variety of statistics on Egyptian cotton, articles and data on trade, policy and technical issues. ALCOTEXA is a member of CICCA.

American Cotton Shippers Association The American Cotton Shippers Association (ACSA) is the national trade association in the USA of cotton merchants, cotton shippers and exporters of raw cotton, primary buyers, mill service agents, and of firms allied with these services. Its membership is composed of four Federated Associations: Atlantic Cotton Association; Southern Cotton Association; Texas Cotton Association and Western Cotton Shippers Association. ACSA has about 150 member firms, which handle an estimated 80% of the cotton sold to domestic mills in the US. Many of the ACSA members are also members of other world cotton associations, including the LCA. ACSA firms account for the bulk of international cotton trade handled by members of those Associations.

Appendix 2/page 2

International cotton organizations and associations ACSA was organized in 1924 and joined with the American Cotton Manufacturers Association to formulate the Southern Mill Rules. ACSA, like the LCA, actively promotes fair trading practices, sanctity of contracts and requires strict adherence to contractual obligations and arbitration awards. ACSA provides an environment of fair trade through established rules and industry practices that encourage favorable resolution of all disputes. One of the objectives of ACSA is to educate producers and mill customers on the prudent and appropriate use of available risk management instruments that will enable them to maximize their profit potential. In conjunction with the American Textile Manufacturers Institute, ACSA maintains the Cotton States Arbitration Board in Memphis and has its own representatives on the appeal boards of cotton associations in Germany, France, Belgium, UK, Spain and Japan, and has arrangements with the Bombay Appeal Board to be represented. ACSA is actively involved in evolving regulations, rules and arbitration procedures, governing cotton trade with importers of US cotton, dealing with cotton associations and exchanges. ACSA actively promotes increased cotton use in the USA and throughout the world. ACSA is very active in international cotton affairs and was one of the initiators of the Committee for International Cooperation between Cotton Associations (CICCA). It represents the US cotton trade in various international forums, such as ICAC and ITMF. One of the most important functions of ACSA is to represent the interests of the US cotton merchandising industry before the US government and Congress, advising government agencies of the industry’s views on existing or proposed regulations and national laws. ACSA collaborates with producers, processors and users of cotton in formulating farm programs and marketing provisions affecting the commodity. It cooperates with other sectors of the cotton industry on issues related to cotton trade, establishing specialized committees on quality and standards, gins, compresses and warehouses, futures contracts, domestic mills and others. Policy issues of ACSA are discussed at its annual conventions attended usually by several hundred participants. In 1995, ACSA and Rhodes University in Memphis, Tennessee entered into an educational partnership designed for those entering the cotton industry or desiring to expand their knowledge of the trade in cotton. A comprehensive nine-week residential course of study is offered on all aspects of cotton production and marketing including US and world production trends, classification and fiber properties, processing, merchandising, shipping, and manufacturing, with an emphasis on trade terms, domestic and international trade rules, ethics, forward and spot contracts, and the appropriate use of futures and options contracts.

Appendix 2/page 3

Cotton Trading Manual

Association Française Cotonnière The Association Française Cotonnière (AFCOT) is more than a hundred years old and has about 80 members, including firms based in France and other countries. Membership includes cotton merchants, agents, shippers, controllers, transport organizations, ports, banks and spinners. AFCOT is ruled by a board of directors composed of members, usually merchants and controllers. AFCOT has several committees, including the Advisory Committee for Arbitration and Supervision of the Types, and the Committee on Value Differences. AFCOT publishes Le Havre General Rules, which regulate contracts for the sale of cotton and arbitration. According to a 2003 estimate, up to 100 000 tons of cotton are traded annually in Europe under AFCOT Rules. AFCOT has a laboratory equipped for fiber testing. The Association issues a news bulletin to its members with trade statistics and other cotton-related data. The annual dinner of AFCOT is attended by hundreds of cotton representatives from France and abroad. AFCOT is a member of CICCA.

Associazione Tessile Italiana The Associazione Tessile Italiana dates back to 1883 and has close to 300 member firms operating in raw cotton marketing, cotton and linen spinning, weaving and finishing industries in Italy. It is estimated that members of the Association account for 70% of the volume handled by the represented industries. The Raw Cotton and other Fibers Section of the Association focuses on cotton issues. The Raw Cotton Arbitration Chamber operates within the Association and serves to resolve disputes arising from cotton contracts based on the trading rules. The Association has a technical laboratory equipped with modern instruments used for cotton fiber tests and research. Substantial efforts are devoted by the Association to the promotion of cotton textile products at fashion shows. The Association represents the industry on issues related to international trade, trade duties and quotas, currency and customs regulations. It provides training and consulting services to its members, including financial analysis and market research, insurance and currency markets analysis. The Association is a major source of economic and statistical data produced by its Economic Research and Statistics Bureau. The Association has a variety of publications on cotton and linen technical and economic issues. Its two-volume statistical yearbook contains national and international statistics on production, trade, stocks, consumption of cotton and other fibers. There are monthly statistical publications with data on trade, employment and output in the spinning sector. Appendix 2/page 4

International cotton organizations and associations One of the major functions of the Association is to negotiate the national collective labor contract for the industry. It maintains contacts and negotiates with Italian government authorities and trade unions in the industry. The Association provides specialized consulting services on direct and indirect taxation and fiscal issues. The Association is a member of CICCA.

Australian Cotton Shippers Association The Australian Cotton Shippers Association was established in 1984. It is comprised of all major merchants in Australia. The Association trading rules serve to achieve the major objectives of the Association, including preserving the sanctity of contracts, the integrity of the Australian trading industry and facilitating compliance with contractual obligations and adherence to arbitration awards. The Association promotes the interests of the members in overseas markets and is an active participant in CICCA.

Belgian Cotton Association The Belgian Cotton Association is composed of about forty Belgiumbased merchants, brokers, spinners and controllers, and foreign firms registered as associate members, including merchants from the USA and Switzerland. Major functions of the Association include maintenance of trading rules and arbitration. The Association has an Executive Committee of the Chamber of Arbitration, which issues value differences for cotton of different origins. Twelve arbitrators serve in Quality and Commercial Arbitrations and Appeals. The annual report of the Association includes data on Belgian and international cotton markets. International cotton merchants and representatives from Belgium and abroad attend the annual dinner of the Belgian Cotton Association. The Association is a member of CICCA.

Bolsa de Mercadorias & Futuros in São Paulo, Brazil The Bolsa de Mercadorias & Futuros in São Paulo (BM&F), Brazil, was founded in 1917 and is an exchange where gold, currencies and a number of agricultural commodities, including cotton, are traded in futures and cash markets. As far as cotton is concerned the Exchange has the elements of a cotton association of traders and as such is a member of CICCA. The Exchange plays an important role in Appendix 2/page 5

Cotton Trading Manual regulating domestic trade, exports and imports of cotton in Brazil. The Exchange provides classification services and establishes standards for Brazilian cotton. The Exchange settles disputes between traders and provides arbitration. A special committee at the Exchange fixes value differences for different grades in relation to Type 6. A substantial part of all contracts traded in Brazil is made subject to the rules of the BM&F and is registered with the Exchange. The Exchange collects and publishes statistics related to cotton and is active internationally in promoting the sanctity of contracts and fair trading practices.

Bremen Cotton Exchange The Bremen Cotton Exchange was founded in 1872 and now represents more than 200 merchants and users of cotton. The Bremen Cotton Exchange provides international trading rules, technical and quality arbitration, traditional and HVI classing. The Exchange conducts fiber testing and research and expert surveys. Trading rules of the Exchange regulate trade in raw cotton, linters, cotton and man-made fiber wastes and provide a basis for quality and technical arbitration and effective means for the settlement of disputes. Bremen cotton trading rules are used most widely in Germany, Switzerland and Austria. Bi-annual International Cotton Conferences held by the Bremen Cotton Exchange deal mostly with technical issues and are attended by a large number of participants. The Exchange organizes seminars where participants receive training in cotton classing and other technical subjects. In 1969, the Bremen Fiber Institute was founded, which works as a laboratory for the Exchange. The Institute is equipped with an HVI test line and modern spinning and weaving equipment. The Institute’s research is focused on cotton fiber properties for processing. The Exchange is a member of CICCA. The Bremen Cotton Exchange provides statistics and information on the domestic and international cotton market, technical issues, value differences, freight and insurance. The Exchange issues an annual report and the Bremen Cotton Report every two weeks.

Centro Algodonero Nacional Centro Algodonero Nacional (CAN) in Spain was founded in 1903 in Barcelona. It represents all the sectors related to the marketing of raw cotton and its sub-products. The major objectives of the Centro are to create fair trading conditions and to promote the sanctity of contracts. The rules of the Centro are internationally known and recognized as the Barcelona Contract. The Centro has the capacity for quality arbitration and appeals. It has a laboratory, which can perform fiber testing. Appendix 2/page 6

International cotton organizations and associations Membership of the Centro includes more than 100 individual members, cotton firms and associate members. Member firms and about 30 individual members operate as cotton merchants, agents or brokers. It is estimated that most of the sales of cotton in Spain are made subject to Barcelona rules. The Centro provides its members a variety of services, disseminates cotton information and statistics, and is a member of CICCA.

China Cotton Association (CCA) The China Cotton Association, established in 2003, is a non-profit organization with the status of ‘national mass organization legal person’, which incorporates cotton farmers and their cooperative organizations; enterprises engaged in the production, purchase, processing and operation of cotton; cotton textile enterprises; and cotton research institutes. The CCA’s activities include macroeconomic investigations and research into the economic development of cotton; making policyrelated and legislative proposals to government; gathering, analyzing and releasing information on cotton; formulating and supervising implementation of rules and regulations for cotton production; providing policy-related and legal consultancy; organizing personnel training, technical exchanges and international cooperation; supervising and participating in international lawsuits and protecting the interests of China’s domestic cotton industry. The CCA functions under the supervision and management of the Ministry of Civil Affairs and the professional guidance of the All-China Federation of Supply and Marketing Cooperatives. The highest level of authority in the CCA is the Members’ Representative Conference, of which the executive organ is the Board of Directors. A permanent Secretariat is at the service of the Board of Directors.

East India Cotton Association The East India Cotton Association (EICA) was established in 1922 and has about 400 members including buyers, sellers, brokers, exporters, importers and other participants in the cotton market. By-laws of the EICA provide trading rules for spot and forward sales of cotton. The Association is managed by the Board of Directors through various subcommittees. There are 18 regional associations and 10 marketing societies registered under it. The Rules of the EICA provide mechanisms for arbitration and settlement of disputes. The EICA has a panel of Sworn Surveyors, an Umpire and a provision for appeal. One of the major functions of the Association is to prepare and maintain grade and staple standards of all cotton varieties grown in India. The Association has a laboratory for fiber quality evaluation and conAppendix 2/page 7

Cotton Trading Manual ducts HVI cotton fiber testing. The Daily Rates Committee fixes and releases daily prices for various descriptions and staples and grades. The EICA publishes other market data in its weekly bulletin. The bulk of cotton traded in India is regulated by the rules of the NonTransferable Specific Delivery Contract of EICA. The association is a member of CICCA.

European Cotton Confederation (ECC) The ECC was founded in 2001 as a result of efforts under the European Contact Group to harmonize cotton-trading rules for cotton trade in Europe. The purpose of the ECC is to produce a harmonized European contract accepted by all the European cotton associations. The Liverpool Cotton Association, the Gdynia Cotton Association, the Bremen Cotton Exchange, the Associazione Tessile Italiana, Centro Algodonero Nacional in Spain, Association Française Cotonnière and the Belgian Cotton Association have joined the confederation.

Gdynia Cotton Association The Gdynia Cotton Association (GCA) was founded in 1935 and is composed of over 100 member-companies from 15 countries. Membership of the GCA includes cotton textile mills, cotton merchants and research institutions. The GCA By-laws and Rules are used as the basis for international cotton contracts and stipulate in detail cotton arbitration and testing procedures. The major objectives of the Gdynia Cotton Association include settlement of quality and technical disputes arising from cotton trade by the Court of Arbitration at the GCA, laboratory quality testing and representation of member interests before government authorities and international organizations. The GCA provides cotton classification courses for cotton classers in Polish, English and Russian languages and publishes value differences tables and a directory of member firms. The Gdynia Cotton Association organizes international discussions at the bi-annual International Cotton Conferences in Gdynia. The Association collects statistics on cotton imports and consumption in Poland, which it publishes annually. The GCA is a member of CICCA.

International Cotton Association See Liverpool Cotton Association.

Appendix 2/page 8

International cotton organizations and associations

Izmir Mercantile Exchange The Izmir Mercantile Exchange in Turkey was founded in 1881. Like the BM&F in São Paulo, the Izmir Exchange functions as a trading platform for spot sales of cotton and as an association of cotton traders. The Exchange serves as a price discovery instrument for spot sales of cotton and has been engaged in designing a cotton futures contract for potential introduction on the exchange-trading floor. The Exchange maintains trading rules, provides information and statistics, and is a member of CICCA.

Japan Cotton Traders Association The Japan Cotton Traders Association was founded during the 1950s and is composed of about 80 Japanese cotton importers, domestic raw cotton traders and firms engaged in related businesses, such as shipping agents, transportation and warehousing, banks and insurance. Members of the Association handle the bulk of cotton imports in Japan and imports by Japanese-owned spinning mills in other Asian countries. The major objective of the Association is to strive for the sound development of cotton import and domestic trade, trying to improve the basic terms and conditions for trade. The Association is entitled to settle any claim or dispute that may arise in connection with the import and domestic trade of cotton. JCTA makes recommendations to the government and its agencies and cooperates with other international associations and organizations on issues related to cotton trade. JCTA conducts research and collects statistics related to cotton and issues a number of publications, including a statistical yearbook. The Association is a member of CICCA.

Karachi Cotton Association The Karachi Cotton Association (KCA) was established in 1933 to regulate and facilitate domestic and export trade in cotton. It has about 250 members, including cotton growers, ginners, textile mills, exporters, commission houses and others. The KCA is ruled by a 21member Board of Directors, of which 17 are elected annually from the membership of the KCA and four are nominated by the Government and represent the Ministries of Agriculture, Commerce, Finance and Industry. The Rates Committee of the KCA, appointed by the Board, establishes daily spot rates based on cotton transactions throughout the country. By-Laws and Rules of the KCA regulate cotton trade and provide arbitration of disputes between parties.

Appendix 2/page 9

Cotton Trading Manual The KCA provides traders with contract forms and adopts standards for cotton. The Association issues a Daily Cotton Market Report, containing information on spot prices and other statistics related to cotton. The KCA advises the government on various aspects of cotton policy and maintains liaison with ginners and textile mills. The Association founded the KCA Institute of Cotton Grading and Classing, which provides training to representatives of the cotton industry.

Liverpool Cotton Association* The origins of the Liverpool Cotton Association (LCA) date back to 1841 when cotton brokers in Liverpool formed an association and drew up a set of trading rules. In 1882, merchants joined brokers and formed a new association named The Liverpool Cotton Association. The membership of the LCA includes buyers and sellers of cotton, international merchants, government marketing organizations, spinners, banks, cotton controllers and others involved in the cotton business. One of the major functions of the LCA, as well as other associations, is to reduce risks involved in international cotton trade and to provide an effective mechanism for settlement of disputes arising between parties involved in trade and to uphold equitable trading practices and the sanctity of contracts worldwide. The Association provides a set of By-laws and Rules, which are widely accepted and cover all aspects of international trade. Membership in the LCA is in excess of 300 registered firms in over 60 countries worldwide. It is estimated that over 60% of the world’s cotton trade is bought and sold under the Liverpool Cotton Association By-laws and Rules. The LCA has the largest share of registered firms that are based overseas, when compared with the other cotton associations. In fact it is the only Association with a majority of member firms based overseas. About 600 official copies of the Rule Book are in use around the world. Contracts made subject to Liverpool Rules are dependent upon Liverpool Arbitration in the event of a dispute between parties. The LCA provides a well-established two-tier arbitration system for both quality and technical (non-quality) disputes. Contracts written under LCA rules are subject to the Laws of England; however, arbitration awards can be legally enforced in most cotton-trading countries. In the event that a firm refuses to abide by arbitration or appeals a decision, the firm is included on a default list, which is distributed among all members of the LCA and 13 other principal cotton associations worldwide, and

* To reflect the membership base and the nature of the Association’s business activities, on 9 December 2004, the Association was renamed the International Cotton Association (ICA). Appendix 2/page 10

International cotton organizations and associations may be suspended from registration with the LCA. The default list is reviewed annually. One of the most important functions of the LCA is the training it provides on aspects of international trade in cotton. The LCA holds an annual marketing seminar in Liverpool and has also conducted tens of seminars in different countries. The seminars are devoted to the principles of contracting, arbitration, futures and options trading, banking and other aspects of international cotton trade. The LCA also serves as a forum for international discussions of world cotton affairs and cooperates closely with other cotton associations and international organizations, such as ICAC, ITMF and CICCA. The LCA annual dinner is one of the major world cotton events and is usually attended by hundreds of members and guests of the Association. The LCA provides cotton laboratory testing, including HVI testing. The LCA publishes a bimonthly Value Differences Circular, which contains quote differences for grade and staple for various growths, applicable in case of Quality Arbitration and Appeal. The LCA also issues a Directory of Membership, Contract and Arbitration Award forms and other publications.

Russian Cotton Association The Russian Cotton Association was established in 2000 by leading Russian cotton-trading companies and was joined by other cotton and textile-related organizations as well as by a number of foreign merchants. The Association represents the industry in government organizations and aims at establishing fair trading rules and the principles of sanctity of contracts in the Russian cotton market. It has created a volunteer dispute resolution court comprised of the members of trade organizations as a first step in establishing arbitration procedures. The Association provides a forum for discussion of issues of importance for the cotton merchandising industry and organizes international conferences twice a year during national textile fairs in Moscow.

The ICAC The International Cotton Advisory Committee (ICAC) is an association of governments having an interest in the production, export, import and consumption of cotton. It is an organization designed to promote cooperation in cotton affairs, particularly those of international scope and significance. It affords its members a continuous understanding of the world cotton situation and provides a forum for international consultation and discussion. The Committee has consultative status with the United Nations and its specialized agencies, and cooperates Appendix 2/page 11

Cotton Trading Manual closely with other international organizations in matters of common interest. The Committee cooperates with the Common Fund for Commodities on cotton projects. The Common Fund for Commodities (CFC) is an international intergovernmental organization affiliated with the UN system and based in Amsterdam, The Netherlands. Ten cotton projects involving approximately $20 million in funding from the CFC have been approved since the ICAC was recognized as the international commodity body for cotton in the early 1990s. The functions of the ICAC are defined in the Rules and Regulations, copies of which are available on request. These are: • To observe and keep in close touch with developments affecting the world cotton situation. • To collect and disseminate complete, authentic and timely statistics on world cotton production, trade, consumption, stocks and prices. • To suggest, as and when advisable, to the governments represented, any measures the Advisory Committee considers suitable and practicable for the furtherance of international collaboration with due regard to maintaining and developing a sound world cotton economy. • To be the forum for international discussions on matters related to cotton prices. The Committee is the outgrowth of an International Cotton Meeting held in Washington, DC, in September 1939. At that time, world stocks of cotton had reached nearly 25 million bales, of which over half were located in the USA. The following ten producing countries were convened – Brazil, British cotton-exporting colonies, Egypt, French cottonexporting colonies, India, Mexico, Peru, the Sudan, the USSR and the USA – to discuss problems of overproduction, rising stocks and falling prices. The principal objective was to take concerted international action to avoid chaotic developments in the world cotton economy. The ICAC met for the first time in Washington, DC in April 1940. At first, membership was limited to cotton-producing countries. After the fourth meeting, an invitation to join the Committee was extended to ‘all other United and Associated Nations substantially interested in the production, export or import of cotton’. At the fifth meeting, in May 1946, it was decided to establish a Secretariat and a governing Executive Committee consisting of representatives from six cotton producing- and six cotton-consuming countries. A beginning was also made with the statistical and economic information program, which became an intrinsic part of the Committee’s work. Subsequently, in 1948, it was agreed to replace the original Executive Committee with a Standing Committee in which all countries would have a voice. Appendix 2/page 12

International cotton organizations and associations Membership Membership in ICAC is open to all members of the United Nations or of the Food and Agriculture Organization of the United Nations, expressing an interest in cotton. Any other government expressing an interest in cotton shall be eligible to apply for membership. The annual budget of the Committee is supported by assessments to member governments, subscriptions to publications and participant fees at meetings. Forty percent of the total assessment is shared equally among member countries. The remaining sixty percent is allocated based on the average trade in raw cotton in the four most recent cotton seasons. There are more than 40 member-countries in the ICAC divided almost equally between cotton-producing and cotton-consuming countries.

Plenary meetings At the invitation of a member government, plenary meetings of the Advisory Committee are held each year. Meetings alternate as much as possible between cotton-exporting and cotton-importing countries. A provisional agenda and time schedule for each plenary meeting is prepared by the Standing Committee. Provision is made for the exchange of information on the cotton situation in various countries and for discussions on international policy matters. Since the mid-1960s, technical seminars on subjects of interest to research workers have been held as a part of the plenary meeting. The Secretariat of the Committee publishes the formal proceedings of each plenary meeting. The official languages of the ICAC are Arabic, English, French, Russian and Spanish. Full simultaneous interpretation is provided at plenary meetings.

Standing Committee A Standing Committee, consisting of representatives of all member governments, gives continuity to the activities of the ICAC between plenary meetings. The Standing Committee convenes in Washington. Attention is given to the current world cotton situation, cotton policy matters, and also to assignments from the plenary meetings.

The Secretariat The Secretariat of the Committee is located in Washington, DC, and is composed of an international staff headed by an Executive Director whose appointment and contract of employment is determined by a plenary meeting. The Secretariat assists the Committee in carrying out Appendix 2/page 13

Cotton Trading Manual its work program by developing and publishing statistics and analyses of the world cotton situation; by carrying out a program of work to disseminate information on cotton production research; by cooperating with other organizations to promote a sound world cotton economy; and by facilitating discussions on matters related to cotton prices.

Coordinating agencies Each member government is required to establish a ‘permanent national coordinating agency’ to provide the Secretariat with statistics on the cotton situation and to distribute publications and reports received from the Secretariat. Under this cooperative arrangement, there has been continued improvement in the quantity and quality of statistics on cotton available on a world basis. Coordinating agencies are frequently called upon to supply information requested by special inquiries from the Committee. Their cooperation has made possible work surveys on various subjects of importance to member governments.

Publications Regular publications of the ICAC Secretariat include: Cotton This Week, Cotton This Month, Commitments This Month, Extra-Fine Cotton This Month, COTTON: Review of the World Situation, The ICAC Recorder, COTTON: World Statistics, World Textile Demand, World Cotton Trade, The Outlook for Cotton Supply, Production and Trade Policies Affecting the Cotton Industry, Agrochemicals Used on Cotton, Bale Survey, Classing and Grading of Cotton, Current Research Projects in Cotton, Growing Organic Cotton, Insecticide Resistance and its Management in Cotton Insects, Survey of the Cost of Production of Raw Cotton, Survey of Cotton Production Practices, The World Market: Projection to 2005, Proceedings and Statements of the Plenary Meeting and ICAC Documents on CD-ROM.

Appendix 2/page 14

Appendix 3 Cotton trading organizations Secretariat of the International Cotton Advisory Committee

Largest organizations Large organizations Medium-sized organizations Smaller and specialized organizations Banks Cotton trading organizations: listing Largest organizations Large organizations Medium-sized organizations

The list of cotton trading companies compiled by the Secretariat of the ICAC consists of about 500 firms engaged, at least in part, in international trade in cotton. Companies are divided into four categories by relative size. Organizations are also grouped by type of ownership: government, cooperative or private. The world cotton industry is not highly concentrated by the standards of industrial markets and the international cotton shipping industry is highly competitive. However, concentration is underway.

Largest organizations There are 19 companies trading over 200 000 tons of cotton annually, with a combined volume of about 7.7 million tons, or 38% of world production. Eight of the world’s largest cotton-trading companies are based in the US, three in Uzbekistan, two in Switzerland, two in Australia and one each in Belgium, Japan, France and the UK. Among those firms, 16 are non-governmental companies, including four cooperatives.

Large organizations The combined volume handled by the group of large companies (annual volume: 50 000 to 200 000 tons), is estimated at 3.9 million tons in 2003, accounting for 20% of world production. Thirteen of the 49 large organizations are based in the US.

Medium-sized organizations There are currently 44 firms in the medium category (annual volume: 20 000 to 50 000 tons) with an estimated overall volume of 1.3 million tons.

Smaller and specialized organizations The most recent survey includes 363 firms in the category of smaller companies accounting for 1.8 million tons of combined volume. A full list of the smaller and specialized cotton trading companies with more details and contact information can be obtained at www.icac.org.

Banks The list of banks involved in providing services to the cotton industry includes 25 banks from nine countries. Appendix 3/page 1

Cotton Trading Manual COTTON TRADING ORGANIZATIONS (FIRMS ARRANGED BY SIZE, ESTIMATES MADE BY THE SECRETARIAT OF THE ICAC*)

Company name

Country

Largest organizations (annual volume: more than 200 000 tons) Allenberg Cotton Co, Cordova USA Cargill Cotton, Cordova & Liverpool USA Dunavant Enterprizes Inc, Memphis & Australia USA Paul Reinhart AG, Winterthur & Richardson SWITZERLAND Staple Cotton Cooperative Association, Greenwood USA Plains Cotton Cooperative Association, Lubbock USA Chinatex, Beijing, China CHINA (MAINLAND) Weil Brothers & Rountree, Inc, Las Cruses, Montgomery & Liverpool USA Plexus Cotton Ltd, Liverpool UK Ecom USA Inc, Dallas & Switzerland USA Namoi Cotton Cooperative Ltd, Wee Waa, NSW AUSTRALIA Olam International Ltd, Singapore SINGAPORE Joint-Stock Company Innovatsia, Tashkent UZBEKISTAN State Joint Stock Foreign Trade Company ‘Uzmarkazimpex’ Tashkent UZBEKISTAN Calcot Ltd, Bakersfield USA Louis Dreyfus Cotton International NV, Antwerp BELGIUM Uzprommashimpeks, Tashkent UZBEKISTAN Aiglon Dublin Ltd, Geneva SWITZERLAND Queensland Cotton Corporation Ltd, Brisbane & Fresno AUSTRALIA Toyo Cotton (Japan) Co, Osaka & Dallas JAPAN Compagnie Cotonnière Copaco, Paris FRANCE Large organizations (annual volume: 50 000 tons to 200 000 tons) Toyoshima & Co Ltd, Nagoya JAPAN Cargill Cotton (a Division of Cargill Plc), Liverpool only UK Paul Reinhart Inc, Richardson only USA Anderson Clayton Corp, Fresno only USA Cukurova Cotton Cooperatives Association Cukobirlik, Adana TURKEY Sincot Pte Ltd, Singapore SINGAPORE Colly Cotton Marketing Pty Ltd, Sydney AUSTRALIA Cotton Marketing Organisation, Aleppo SYRIA Albrecht, Müller-Pearse & Co Gmbh & Co, Bremen GERMANY Jess Smith & Sons Cotton, Llc, Bakersfield USA The Cotton Corporation of India Ltd, Mumbai INDIA International Cotton and Textile Trading Co Ltd, Lugano SWITZERLAND Cottip SA, Geneva SWITZERLAND Otto Stadtlander Gmbh, Bremen GERMANY

Type

Private Private Private Private Cooperative Cooperative Government Private Private Private Cooperative Private Government Government Cooperative Private Government Private Private Private Private Private Private Private Private Cooperative Private Private Government Private Private Government Private Private Private

* A full list, including specialized firms and contact information, is available from the Secretariat of the ICAC. Appendix 3/page 2

Cotton trading organizations The Sudan Cotton Company Ltd, Khartoum Baumann Hinde & Co Ltd, Southport Bruce Allbright Cotton, Fresno C.A. Galiakotwala & Co Ltd, Mumbai Gill & Co Ltd, Mumbai Kotak & Co Pvt Ltd, Mumbai Mambo Commodities, Paris Toyo Cotton Co, Dallas only Volcot America Inc, Phoenix The Cotton Company of Zimbabwe Ltd, Harare Arco Cotton Agents (ICT International Cotton Trading), Milan Colly-Houchin, Inc, Bakersfield Eastern Trading Co, Inc, Greenville Glencore Grain Rotterdam Bv, Rotterdam Power International, Moscow SA Goenka, Barcelona Société Cotonnière du Tchad Cotontchad, Paris Gap Pazarlama AS, Istanbul Société d’Importation et de Commission, Le Havre American Cotton Suppl. Intl, Lubbock Auscott Ltd, Sydney NSW Battistel Amiotti Srl, Milan Cottagon Italia Srl (Paul Reinhart), Milan Daewoo Corporation, Seoul Devcot SA, Lille Dunavant Enterprises Pty Ltd, Moree NSW only FCA Comexim Ltd, Moscow Forte Handelsggesellschaft Mbh, Vienna Indutech Spa, Milano Jaume Artigas, Barcelona J.G. Boswell Company, Pasadena Macquarie Cotton International Montgomery Co, Inc, Lubbock Weil Brothers & Stern Ltd, Liverpool only Medium-sized organizations (annual volume: 20 000 Toyoshima USA, Inc, Cordova Esteve Brothers & Co, Inc, Dallas Etem Ozsoy Tarim Ticaret Ve Sanayi As, Izmir Glencore International Ag, Baar Rhein-Schelde Handelsgesellschaft Fp Mostert Kg, Neuss Sumitomo Corporation, Osaka Violar SA, Larisa Cargill Zimbabwe Pvt Ltd, Harare Friedrich W. Kaemena & Co Gmbh, Bremen M. Schiefer Trading Co, Lubbock Pamteks AS, Adana Savannah River Cotton Company, Waynesboro Taevertex, Ghent ACM, Inc, Collierville Cargill Tanzania Limited, Dar es Salaam Central Cotton Company Limited, Liverpool

SUDAN UK USA INDIA INDIA INDIA FRANCE USA USA ZIMBABWE

Government Private Private Private Private Private Private Private Private Private

ITALY USA USA NETHERLANDS RUSSIA SPAIN CHAD TURKEY FRANCE USA AUSTRALIA ITALY ITALY R. of KOREA FRANCE AUSTRALIA RUSSIA AUSTRIA ITALY SPAIN USA USA USA UK

Private Private Private Private Private Private Government Private Private Private Private Private Private Private Private Private Private Private Private Private Private Private Private Private

to 50 000 tons) USA USA TURKEY SWITZERLAND

Private Private Private Private

GERMANY JAPAN GREECE ZIMBABWE GERMANY USA TURKEY USA BELGIUM USA TANZANIA UK

Private Private Private Private Private Private Private Private Private Private Private Private

Appendix 3/page 3

Cotton Trading Manual Clark Cotton Group of Companies, Johannesburg Quetta Corporation Ltd, Moscow Sekhsaria Exports, Mumbai TCT United SA Volcot Switzerland Ltd, Winterthur Weil Brothers Cotton Aust Pty Ltd, Queensland Francis & Company, Inc, Memphis Compagnie Ivoirienne pour le Développement des Textiles CIDT First American Cotton Co, Lubbock Knowles-Taylor Cotton Co Inc, Matador Luis Jover SA, Barcelona Lyons Cotton, Inc, Memphis Société Nationale pour la Promotion Agricole Sonapra, Cotonou Modern Nile Cotton Co, Alexandria Newcot Ltd, Chene-Bougeries Bangladesh Textile Mills Corporation, Dhaka Castellano & C Snc, Milan Compagnie Cotonnière du Benin, Cotonou Cotton Distributors Inc, Lausanne Ecom Agroindustrial Corp Ltd, Pully only Industrie Cotonnière Beninoise, Cotonou Label Coton, Cotonou Queensland Cotton Corp Ltd, Fresno only Ritis International, Cotonou Société Beninoise de Representation Sobere, Cotonou The Cotton Production & Marketing Board Ltd, Herzlia Yamachu Mengyo Co Ltd Osaka, Osaka

Appendix 3/page 4

SOUTH AFRICA RUSSIA INDIA URUGUAY SWITZERLAND AUSTRALIA USA

Private Private Private Private Private Private Private

COTE D’IVOIRE USA USA SPAIN USA

Government Private Private Private Private

BENIN EGYPT SWITZERLAND BANGLADESH ITALY BENIN SWITZERLAND SWITZERLAND BENIN BENIN USA BENIN BENIN ISRAEL JAPAN

Private Private Private Government Private Government Private Private Government Private Private Private Government Cooperative Private

Appendix 4 The rise and fall of cotton futures exchanges John Baffes

The history of cotton futures exchanges Africa North America South America Europe East Asia South Asia

Conclusions

As we saw in Chapter 1, the history of cotton futures exchanges dates back to the late part of the nineteenth century when cotton was traded in futures exchanges located in Egypt, the US, the UK and France. In the early twentieth century, cotton futures contracts were traded in China, Germany, India and Japan while later Pakistan and Hong Kong introduced cotton contracts (Table A4.1). With the exception of the New York Cotton Exchange, however, all cotton futures exchanges ceased operations. In fact, if one excludes some sporadic trading at the São Paulo Commodity Exchange up to 1989, the only exchange in the world trading cotton futures for the 15-year period between 1981 and 1996 was the New York Cotton Exchange (Evans and Mahoney 1997). In the recent past some countries have expressed interest in introducing cotton futures exchanges. A few of them, namely Brazil, China and India, have already launched cotton futures contracts. This survey focuses on the history of cotton futures exchanges by paying particular attention to the historical and socio-economic conditions as well as the policy environment under which cotton futures exchanges were developed, what led to their success, and the reasons for their demise, which is the subject of the next section. The discussion of the exchanges is based on a regional breakdown. The third section concludes and offers some lessons.

The history of cotton futures exchanges Africa Cotton was first grown commercially in Egypt in the 1820s. To develop and subsequently protect the domestic textile industry, the government of Egypt initially promoted cotton production and handled all marketing and trade through a parastatal. By 1849 cotton had become a vital element of the Egyptian economy; the subsector was liberalized and Egypt became a major cotton exporter. The rapid expansion of the sector created the opportunity to manage price risk, and this gave birth to the Alexandria Cotton Futures Exchange, the first cotton futures exchange in the world (Hafez 1946). Although the exchange was formally established in 1861, cotton futures contracts were traded on an informal basis as soon as liberalization of the cotton sector took place. Another reason for the relatively quick establishment of the exchange was the prevailing views regarding speculation. In many places futures trading by speculators at that time was considered to be a form of gambling and thus an illegal activity. In the US, for instance, the 1867 Illinois Elevator Bill declared all grain futures contracts, except those by owners of grain, to be illegal (Hieronymus 1977, p. 85). Although the Appendix 4/page 1

Cotton Trading Manual Table A4.1 Exchanges trading cotton futures contracts, 1861 onwards Exchange/Contract AFRICA Egypt Alexandria Cotton Exchange NORTH AMERICA US New York Cotton Exchange US New Orleans Cotton Exchange US Chicago Board of Trade US World Contract SOUTH AMERICA Brazil São Paulo Commodity Exchange Brazil São Paulo Commodity Exchange EUROPE UK Liverpool Cotton Exchange

Period

Origin of cotton traded

1861–1961

Egyptian

1870– 1880–1964 1924–1964 1992–1994

American American American American

1919–1989 1996–

Brazilian Brazilian

1882–1964

American, Egyptian, Indian American American American

France Germany UK EAST ASIA Japan

Le Havre Futures Market Bremen Cotton Exchange London Commodity Exchange

1882–1965 1914–1971 1969–1975

Osaka Sampin Exchange

1910–1941

China Hong Kong SOUTH ASIA India Pakistan India

Shanghai Cotton Exchange 1911–1941 Hong Kong Commodity Exchange 1977–1981

American, Chinese, Indian Chinese American

Bombay Cotton Exchange Karachi Cotton Exchange Indian Cotton Contract

Indian Pakistani Indian

1922–1966 1955–1971 1998–

Source: Compiled by the author

futures contracts in Chicago never became illegal, such legislation did impose a stumbling block in the smooth development of futures exchanges. By contrast, speculation in Egypt was deemed legal. Hafez (1946), for example, succinctly summarized this view as follows (p. 78): ‘The establishment of this market [ie the Alexandria Cotton Futures Exchange] did not meet with any legal difficulty owing to the nonprohibition of this form of transaction, whereas it was considered illegal to establish such markets in other countries, as dealing in futures was prohibited and considered a form of gambling.’ The articles of operation of the Alexandria Cotton Exchange, which shaped it into a modern exchange, were issued in 1927. Initially, only one contract was traded (brown cotton). After experimenting with different contracts for a number of years, the following contracts were traded by 1936: Sakellaridis and Giza 7 (delivered in odd months) and Ashmouni (delivered in even months). The contract size was 250 Appendix 4/page 2

The rise and fall of cotton futures exchanges kentars (equivalent to 2500 pounds). There was also a cottonseed contract traded in all months except October. Until World War II, the exchange operated uninterruptedly and was the most influential factor behind the cotton pricing mechanism in Egypt. Notwithstanding its success, the exchange entered a turbulent period after World War II. Consistent with the central planning thinking of the government of Egypt, the view that speculation should not be taking place was gaining popularity and eventually prevailed in the policy-making arena (Hansen and Marzouk 1965). As a result, the exchange closed from 1952 to 1955 in addition to being closed from 1940 to 1949 during and after World War II. Although from 1955 on it was open, with a short interruption during the Suez Canal Crisis, control over prices and trade of cotton was exercized at the national level by the Egyptian Cotton Commission (Abdel-Fadil 1975). In particular, under legislation enacted in June 1953, all cotton to be exported or delivered to domestic textile mills had to be accompanied by a certificate indicating that it had been purchased from the Cotton Commission, which itself would frequently trade futures contracts at the exchange. The exchange lost its economic basis for existence and its functions were officially suspended in 1961 – the year, ironically, which marked its 100th birthday.

North America The New York Cotton Exchange (NYCE), the largest cotton futures exchange in the world, has been trading futures contracts since 1 October 1870. Currently, the NYCE contract, whose size is 50 000 pounds, uses Memphis No. 2 cotton as the cash price equivalent for quality specification and delivery purposes. The NYCE, which is regulated by the Commodity Futures Trading Commission (a US government entity established in 1974), to this day is considered the most important cotton futures trading centre in the world. Recognizing the lack of a hedging instrument for non-US cotton, NYCE introduced a ‘world’ cotton futures and options contract in October 1992 (Roche 1994). The contract was supposed to provide a hedging mechanism for non-US cotton producers and merchants. With a trading unit of 50 000 pounds, the contract was to be settled using a consecutive 5-day average of the Cotlook A Index. While in its first year of operation the trading volume reached 12 000 contracts, in the subsequent two years the contract failed to attract continuing attention. The contract was eventually delisted from the NYCE in 1994. There were several reasons for its failure: First, there was a lack of an equivalent spot market with well-defined quality specifications and physical delivery location – note that the A Index is a simple average of offers, not necessarily a price at which actual transactions Appendix 4/page 3

Cotton Trading Manual take place. Second, there were fears that the settlement price (ie the consecutive 5-day average of the Cotlook A Index) could be manipulated. Third, the contract was quoted, traded, and settled in $US. However, non-US cotton merchants and traders who were supposed to be the main users of this contract needed to hedge their position in other currencies, hence not finding it an attractive hedging tool. In addition to NYCE, the New Orleans Cotton Exchange was trading cotton in the US. Although the exchange officially operated since 1871, trading of futures contracts started almost a decade later, while its volume was about one-third of NYCE’s volume (Lipartito 1983). The New Orleans Cotton Exchange traded two contracts (50 000 and 25 000 pounds) with similar characteristics to the NYCE contract, ie delivery taking place in the months of March, May, July, October and December and regulated by the Commodity Exchange Act. Contracts could be traded for as far ahead as the traders wished but typically the trade was confined to a year. As with NYCE, the New Orleans Cotton Exchange interrupted its operations for four months (July–November 1914) owing to World War I and briefly during the Bank crisis in March 1933 (Boyle 1935). The US government’s policy of maintaining large stocks of cotton through CCC between the 1950s and the early 1970s inevitably drew cotton merchants and speculators out of the New Orleans cotton market, as was the case with NYCE. Hence, the importance of the exchange gradually declined and its operations were officially terminated on 9 July 1964. A third US exchange to launch a cotton contract was the Chicago Board of Trade, which introduced a futures contract in December 1924. The size of the contract was 25 000 pounds and it was supposed to represent cotton grown in Texas (some of its characteristics were similar to the NYCE contract). Despite being located at the most important futures trading center of the world, the Chicago contract never played an important role in the US cotton market as cotton trading was overshadowed by the exchanges of New York and New Orleans (Brand 1964). Evidence also indicates that merchants and traders did not find the contract useful because its quality specifications were too narrow to fit the type of cotton it was supposed to represent. During the 1950s the Chicago contract fell into dormancy and was eventually delisted from the board in 1964.

South America The São Paulo Commodity Exchange was established in 1917 (BMSP 1987). It first traded cotton futures in 1919, with a contract size of 500 arrobas (equivalent to 7500 kg). In 1922, the trading volume reached 14 000 contracts, and by 1926 cotton-related activities were the Appendix 4/page 4

The rise and fall of cotton futures exchanges exchange’s major sources of income, followed by sugar and rice. However, in the three-year period following the 1929 financial crisis the volume dropped by 90% compared to the same period prior to the crisis. Trading of cotton futures at the São Paulo Exchange flourished during World War II, with a trading volume of 43 000 contracts in 1941 and an average of 200 000 contracts between 1944 and 1946. During the 1950s, however, futures trading declined again. In 1953, the exchange recorded its worse performance with a volume of less than 700 contracts, while little over 1600 contracts were traded annually between 1956 and 1959; gradually, the cotton futures market lost its importance and the contract ceased trading. In 1968, the contract was reinstated and, although the exchange traded an annual average of 350 000 contracts between 1975 and 1986, the volume declined again and in 1989 the contract ceased trading once more, leaving NYCE as the only exchange in the world trading cotton futures. In November 1996 the São Paulo Commodity Exchange reintroduced the cotton contract (Guitchounts 1997). The new São Paulo contact, with a size of 12 750 kg, is delivered to various locations in Brazil in the months of March, May, July, October and December. The contract is quoted and traded in $US but is settled in Reals. The exchange rate used for settlement is the one reported by the Central Bank of Brazil. In effect, therefore, trading the São Paulo cotton contract also implies the undertaking of $US/Real exchange rate risk. It was anticipated that the contract could serve as a hedging instrument for the South American cotton-producing countries given that the region’s crop (part of the southern hemisphere’s crop) moves within a different time frame from that of the US crop (part of the northern hemisphere’s crop), the principal influence of the NYCE contract. Initially, the volume was far below expectations as the contract failed to attract attention from hedgers and speculators. For example, in the first year of its operation, the daily trading volume averaged only 58 contracts. Recently, however, the volume of trade has increased considerably, mainly in response to the increase of the domestic Brazilian production.

Europe Cotton futures trading in Liverpool has a rather long history. According to Dumbell (1923), cotton trade was taking place in Liverpool on a small scale as early as the mid-eighteenth century. Cox (1925) makes reference to speculation at the Liverpool cotton market as early as the beginning of the nineteenth century. Two events that shaped the futures trading of cotton at the Liverpool market were the invention of the Appendix 4/page 5

Cotton Trading Manual steamship and the installation of the transatlantic cable (Rees 1972). The first rules of futures trading were adopted in the mid-1860s by the Liverpool Cotton Brokers Association by gradually amending the original ‘to arrive’ contracts. Following efforts by the Brokers Association in 1870 to increase market efficiency and also create a ‘hedging’ medium, a clearing house was organized in 1874 while in 1878 the ‘Cotton Brokers’ Bank’ – a branch of the Bank of England – was formed. Finally, the Liverpool Cotton Association was created in 1882 as a result of settling the split between merchants and brokers that had taken place a few years earlier (Ellison 1886). Futures trading was formally introduced at the Liverpool Cotton Exchange in 1882 under the aegis of the Liverpool Cotton Association. Initially, four contracts were listed: an American contract, an ‘empire and miscellaneous growths’ contract (which also included Indian cotton but attracted very little attention), and two Egyptian contracts (Garside 1935). The size of the contracts, which were traded in British pounds, was 48 000 pounds and they could be traded up to 25 months ahead. Cotton futures trading in Liverpool, as was the case with other futures markets, was suspended with the outbreak of World War II. The exchange resumed operations in 1954 by introducing one American cotton contract; two Egyptian contracts were also introduced later without success. The post-war level of trading activity, however, had been much lower than the pre-war level while the trend had been downward with very little speculation taking place. Between 1954 and 1957, for example, only 5800, 3200, 2000 and 1000, respectively, contracts were traded. The principal reason for the limited scale of futures trading in the post-war period was government intervention in most cotton-producing countries, including the US, Egypt and Sudan. As Yamey (1959) pointed out (p. 24): ‘These controls have necessarily led to a contraction of futures trading, a type of trading which flourishes in conditions in which neither public nor private market controls are operative.’ Responding to these circumstances, the exchange officially terminated trading of cotton futures in 1964. Le Havre, the main cotton trading centre in France, operated a futures market from 1882 by trading primarily American cotton; it also traded coffee, pepper and wool. The contract size was 11 000 kg (24 350 lb), deliverable in the months of January, March, May, July, October and December and could be traded up to a year ahead (Garside 1935). The exchange, which was initially trading American cotton, worked in partnership with the New Orleans Cotton Exchange until the beginning of the twentieth century (as had been the case with the exchanges of New York and Liverpool). However, cotton from French colonies dominated trade at Le Havre market after World War Appendix 4/page 6

The rise and fall of cotton futures exchanges I. The decolonization of Africa and the lack of trading activity after the mid-1950s led to a substantial reduction of trading volume. The exchange officially suspended futures trading in 1965. Bremen has been the major cotton-trading centre in Germany since late nineteenth century. The Committee for the Trade of Cotton was founded in 1872 by cotton traders and brokers. The committee established the Bremen Cotton Practices from which the rules of the Bremen Cotton Exchange emerged. Futures contracts were first traded in Bremen in 1914. The outbreak of World War I forced the exchange to cease its activities. Although the cotton market became active in 1919, trading of futures contracts did not re-emerge until six years later, primarily because quotations in foreign exchange were prohibited while the hyperinflation prevented the German mark from being used for quotations (Bremen Baumwollbörse 1997). Futures trading resumed in 1925 and contracts were delivered in various months up to one year ahead, traded in $US (Garside 1935). The exchange was trading American cotton with a trading unit of 11 340 kg (equivalent to 25 000 lb, half the size of the unit of the US exchanges). The Bremen Cotton Exchange closed in 1939 because of World War II and resumed operations in 1956. The new contract of 11 000 kg was delivered in March, May, July, October and December and was traded in German marks. As was the case with the Liverpool Cotton Exchange, the newly established Bremen contract did not attract an adequate number of speculators, hence it never reached the pre-war level of trading activity. Reflecting upon the low turnover of contracts, the Bremen board decided to discontinue quoting futures prices in December 1971 (Bremen Baumwollbörse 1972). Following the closure of the Liverpool and Le Havre exchanges and the inability of Bremen to launch a cotton contract, the need for a hedging instrument in the European cotton market again became apparent. Responding to this need and based on the Liverpool experience, the London Commodity Exchange introduced a cotton futures contract in 1969 (Rees 1972). In order to capture a significant part of continental European trade, delivery points were set to be in Belgium and Holland while the trading currency was $US. The size of the new (American) cotton contract was 22 050 lb (10 000 kg). However, as was the case with the continental exchanges, the contract did not receive adequate attention and eventually was delisted from the exchange in 1975.

East Asia East Asia has been the home of three cotton futures exchanges: Osaka in Japan and Shanghai in China prior to the World War II and Hong Kong in the 1970s. Osaka was the major cotton trading centre of Japan, Appendix 4/page 7

Cotton Trading Manual trading American, Chinese and Indian cotton. The Osaka Sampin Exchange was established in 1894 with the intention to trade futures contracts on raw cotton, cotton yarn, and cotton cloth (Garside 1935). From 1894 to 1910 the trading was confined to cotton yarn only while futures trading in raw cotton of American origin was instituted in 1910. The cotton contract was equal to 4800 pounds and trading was confined to delivery in the current month and the succeeding six months. The contact was traded for four years, discontinued trading in 1914, and was reintroduced in 1927. Most of the trading was for account of Japan but some orders from China, India and other countries were occasionally executed. The exchange closed in 1941 owing to World War II. Although the exchange reopened in 1951, the cotton contract was not introduced again. Shanghai, the largest trading centre in China, was formerly one of the largest cotton trading centres of the world. It traded Chinese, American and Indian cotton. The Shanghai Cotton Exchange, which was established with the help of British and Japanese traders involved in the successful opening of the Osaka Sampin Exchange, introduced futures trading in 1911 and was trading Chinese cotton. The size of the contract changed several times over the years, ranging between 4000 and 8500 pounds. For the greater period of its operation, the exchange traded two contracts with delivery twice a year, trading for four months ahead. During the 1920s Shanghai’s Cotton Exchange volume equalled about one-third of the Chinese production. The trading volume fluctuated significantly in the 1930s. The exchange closed in 1941 following the outbreak of World War II and attempts to reopen it after the war were unsuccessful in view of the government’s opposition. The Hong Kong Commodity Exchange introduced a cotton futures contract in May 1977, along with contracts on sugar, soybeans and gold (Parry 1982). In the first year of its operation it traded 1151 contracts. After surviving a difficult year in 1979 with a trading volume of only 507 contracts, its turnover reached 14 630 contracts in 1980. Although Hong Kong is a transit point to a substantial amount of cotton and presumably the contract was to serve regional interests and needs, its specification indicates that it was a substitute for the NYCE contract, hence directly competing with it. For example, consider the following characteristics of the Hong Kong contract: (i) the cotton was American; (ii) the size of the contract was 50 000 pounds (equal to the NYCE contract); (iii) the delivery point was Galveston, Texas (not Hong Kong); and (iv) the contract was traded in $US (not in $HK). Cotton futures trading at the Hong Kong Commodity Exchange lasted four years. In 1981 the contract was delisted as the exchange shifted its emphasis from commodities to financial products – in 1995 its name also changed to Hong Kong Futures Exchange. Appendix 4/page 8

The rise and fall of cotton futures exchanges See Appendix 5 for further discussion on the increasing role of cotton exchanges in China.

South Asia South Asia has been the home to two futures exchanges: Bombay (India) and Karachi (Pakistan). India has a rather long history of futures trading. Trading of cotton futures started informally in 1875 after the country emerged as a major cotton exporter, following the disruption in US cotton supplies to the UK caused by the American Civil War. Cotton futures trading was formally introduced in 1922 when the government of Bombay enacted the Cotton Contracts Act, which granted recognition to the East India Cotton Association and gave it the authority to administer a cotton futures contract equivalent to 19 600 pounds. Because of price ceilings imposed by the government, the futures market closed in 1929. When it reopened in 1932, more regulations were put into place. In 1952 the government prohibited the trade of options (under the Forward Contracts Regulation Act) and limited the flexibility of the futures contract, in turn making it similar to a forward contract. In 1966 the Indian government prohibited the trade of cotton futures altogether (along with a number of other commodities). The official reason given for the prohibition was that cotton producers, who were supposed to be the intended beneficiaries of the futures market, were not receiving any benefits. Furthermore, it was believed that futures trading is appropriate only when the commodity is abundantly available. For example, Lal and Parmar (1995) who appear to subscribe to this view, wrote (p. 146) ‘. . . the government of India suspended the same [ie cotton futures trading] because of the persistent shortage in cotton and the strident rise in prices’. Pavaskar (1971), however, opposed this view by showing that the futures pricing mechanism in India was indeed efficient; in fact, when he compared his findings with those of Dow (1941), he found that the Bombay market was more efficient than Liverpool. Moreover, Pavaskar (1969) had earlier argued that the real reason behind the prohibition of the cotton futures trading was the strong lobby of the textile industry, which had vested interests in limiting (or even banning) cotton exports in order to keep domestic cotton prices lower than their world counterparts. The Indian government attempted to introduce the cotton futures contract again in 1987, albeit without success (Lal and Parmar 1995). Following an extensive feasibility study of commodity futures exchanges in India (World Bank 1996), a cotton futures contract was introduced again in 1998, along with a number of other commodities. With a trading unit of 55 bales (equivalent to 9350 kg), the Indian Cotton Appendix 4/page 9

Cotton Trading Manual Contract (ICC) is regulated by the Indian Cotton Association, Mumbai, and is traded and settled in Indian rupees. ICC volume has been low mainly because of lack of speculative activity. Trading of cotton futures in Pakistan commenced in 1955. The Karachi Cotton Association developed the rules for operating a futures market similar to those existing in other countries. The importance of a liberalized policy environment was also recognized in Pakistan. For example, Farooqui, Keaton and Miller (1958) wrote (p. 169): ‘Again, here it is historically true that the free market can do a much better job without restrictions.’ It has been estimated that about 70% of the cotton produced in Pakistan was going through the Karachi Cotton Exchange. Only one futures contract was traded (Sind NT fine) with four delivery months (January, March, May and July). In 1971, the government of Pakistan introduced the price program under which the Cotton Export Corporation, a public enterprise, became the bulk purchaser of cotton. The main features of the price program (which was fully implemented in 1976) were to provide guarantee prices to cotton producers, fix ginning charges, levy export duty and ultimately dictate how much cotton was to be exported (Huque 1987). It was under this program that futures trading at the Karachi Cotton Exchange was terminated in 1971.

Conclusions A number of important observations can be drawn from the preceding historical review, some of which are specific to the cotton market and some to futures exchanges in general. One can divide the 140-year history of cotton futures exchanges into three sub-periods: (i) the preWorld War II period during which numerous cotton futures exchanges with high trading volume and liquidity coexisted (Alexandria, Le Havre, Liverpool, New York and New Orleans); (ii) the period between the end of World War II and the 1973 commodity price boom during which there was no futures exchange trading cotton contracts at a significant scale (mainly a reflection of government policies); and (iii) the post-1973 period during which the New York Cotton Exchange has been by far the dominant (and for an extensive period of time the only) cotton futures trading centre. Cotton futures exchanges have been successful under a variety of circumstances. For example, they have been successful as self-standing operations as well as part of another exchange, some of them trading one and others trading multiple cotton contracts. They have been located in both large cotton-producing countries with domestic textiles and non-producing importing countries. They have been successful in both developed and developing countries. However, if one had to single out the most important conditions prevalent when the Appendix 4/page 10

The rise and fall of cotton futures exchanges cotton futures exchanges were established, that would be the liberalized marketing and trade environment in cotton-producing countries along with the legality of speculation, which is a vital element for sufficient liquidity of the futures contract. Also, judging from the fact that apart from World War I, the only two occasions that NYCE disrupted its operations were during the banking crisis of 1933 and the terrorist attacks of 11 September 2001, a well-functioning banking system appears to be another important condition. In most cases the creation of the futures exchanges preceded the legal and regulatory framework. In fact, there has been a clear pattern in the earlier cotton futures exchanges: initially, the contracts were traded for a number of years on an informal basis; subsequently, one or more contracts were formally introduced, typically under the aegis of a cotton traders’ or merchants’ association; finally, many years later, the regulatory authority established the rules and regulations of futures trading. On the other hand, trading of futures contracts took place simultaneously or shortly after the development of the spot market exchange, in many cases in response to the need to have an institution with well-defined trading rules and specifications of the commodity in question. In fact, this reason has been cited as a third reason for the existence of futures markets – the other two are hedging and price discovery (Williams 1986). Of the four reasons that Hieronymus (1977) cites as causes of the demise of a commodity futures exchange, namely government prohibition, lack of demand, weak contract terms, and boycott by commercial interests, the two former appear to have been by far the ones responsible for the demise of most cotton futures exchanges. Outright government prohibition was the reason for the demise of the Alexandria, Shanghai, Bombay and Karachi exchanges. Government intervention (and consequently lack of demand), especially the US stockholding policy by CCC, caused the demise of two US exchanges (New Orleans and Chicago) and those in Europe (Bremen, Le Havre and Liverpool). Lack of demand was the reason for the ‘world’ cotton contract’s failure to take off (which in turn appears to be a likely reflection of weak contract terms). One may put the Chicago and Hong Kong cotton contracts into that category as well, judging from their characteristics and low level of trading activity. The currencies in which cotton futures were traded appears to have been an important issue. Prior to the abolition of the gold standard, currency conversion for trading and settling futures contacts was not an issue as long as there were no restrictions on capital movements. In the post-1973 period, however, hedging or speculation in cotton (or any other) futures in another currency involves exchange rate conversions at flexible (and hence unpredictable) exchange rates.

Appendix 4/page 11

Appendix 5 The increasing role of cotton exchanges in China Secretariat of the International Cotton Advisory Committee

The China National Cotton Exchange Zhengzhou Commodity Exchange

The China National Cotton Exchange The China National Cotton Exchange (CNCE) was created by the central Government to help reform China’s (Mainland) cotton circulation system and regulate cotton trade. The CNCE is headquartered in Beijing and its major functions are facilitating transactions, price discovery, risk management, information and providing guidance for China’s cotton production, circulation and consumption. The policy-cotton transaction of CNCE is an online trading system similar to an auction. From 1999 to 2003, more than 3.8 million tons of policy-cotton have been sold on the exchange and the transactions totaled about 40 billion RMB (US$4.8 billion). The CNCE has played an active role in regulating cotton supply and demand, and supporting the development of the textile industry. Trading prices on the CNCE have become the ‘barometer’ of cotton supply, demand and price trends in China (Mainland) and they have a significant impact on international cotton prices. Commodity-Cotton auction trading was introduced by CNCE on May 8, 2002. Based on the experience of commodity-cotton auctions, the CNCE introduced cotton forward e-trading in December 2002. Sellers and buyers send offers to sell or buy cotton to the CNCE. The transaction system of CNCE determines trading prices on principles of price priority and time priority, produces electronic trade contracts, and implements the transfer of cotton at the delivery warehouse certified by the CNCE. The major cotton companies and cotton textile mills of China participate in the forward trade of cotton. The CNCE forward e-trading of cotton has the following terms: (1) Varieties traded are 229B and 428B domestic saw ginned cotton. Cotton with neighboring grades and staple lengths can be used in delivery. (2) Time of delivery. Delivery shall be made in the appointed month, and the two trading parties can sell and buy commodity cotton for delivery within as far forward as six months. When the two parties agree, they can apply for delivery ahead of schedule. (3) Place of delivery. The CNCE has approved more than 60 warehouses in the major cotton production areas nationwide. If the two parties agree, delivery can be made in a non-appointed warehouse. (4) Quality assurance. All cotton that is delivered to a warehouse appointed by the CNCE shall undergo ‘notarizing inspection’ made by the China Fiber Inspection Bureau. (5) Cash settlement. The CNCE is responsible for settlement between parties. The buying party makes payment to the CNCE first, and the CNCE gives the payment to the selling party after the buying party takes the cotton. (6) Assurance of contract performance. The CNCE requires a deposit on each transaction and operates a daily debt-free Appendix 5/page 1

Cotton Trading Manual settlement system. If one party breaches a contract, the other party will receive compensation. The CNCE is planning to launch the forward e-trading platform for ‘bonded-cotton’. ‘Bonded-cotton’ means the cotton has been delivered to bonded warehouses and inspected by China Inspection and Quarantine Bureau (CIQ), but not declared to Customs. The trade of bonded cotton has the following terms: (1) Varieties traded are Strict Middling, Staple 1.1–8¢, MIC 3.5–4.9, saw ginned, the US or Australian produced cotton. Cotton with Good Middling and Middling, Staple 1.5/32 and 1–3/32¢ ~ 1–1/16¢ can be used in delivery. (2) Place of delivery. Delivery can be made at the bonded warehouses in Tianjin, Qingdao, Shanghai, Ningbo and Zhangjiagang. (3) Quality assurance. The CNCE will entrust the CIQ in Tianjin, Qingdao, Shanghai, Ningbo and Zhangjiagang to inspect the cotton with the HVI instrument according to the US cotton standard. The CIQ report on quality and weight will be the basis for settlement, the buyers and sellers can apply for re-inspection. (4) Cash settlement. The offer will be in RMB, including the charge of inspection, warehouse storage, Customs declaration and excluding the tariff, VAT, exchange of foreign currency. Settlement will be made by International Trade Limited set by the CNCE. The CNCE will guarantee for settlement between parties. CNCE is open to cotton traders from all over the world.

Zhengzhou Commodity Exchange Zhengzhou Commodity Exchange (ZCE), located in the capital of Henan province, established in 1990, is one of the three futures exchanges currently active in China. Zhengzhou Commodity Exchange launched futures trading on five commodities (wheat, corn, soybean, green bean and sesame) on May 28, 1993 and other products such as plywood, cotton yarn, treasury notes and so on were listed in later years. In 1998 the China Securities Regulatory Commission approved ZCE to trade wheat and green bean futures. Cotton contracts were introduced on June 1, 2004. ZCE is a non-profit organization regulated by China Securities Regulatory Commission (CSRC). The method of trading at ZCE is electronic trading only (no open outcry pit). The exchange is strongly regulated in terms of position limits, daily price limits and strict margin rules (see Table A5.1). The size of one cotton contract is five tons. The base quality is grade 328B saw ginned upland cotton (equivalent to Middling 1–3/32, with micronaire 3.5 to 4.9.). Grade 428 and up are also deliverable at a premium or a discount. The Fiber Inspection Bureau classes the cotton when it is placed in an exchange-appointed warehouse. Appendix 5/page 2

The increasing role of cotton exchanges in China Table A5.1 Cotton No. 1 Futures Contract Specs Contract Size Price Quote Tick Size Daily Price Limit

5 MTs Yuan (RMB)/MT 5 Yuan (RMB)/MT 4% above or below the previous trading day’s settlement price. Contract Months Jan, Mar, Apr, May, Jun, Jul, Aug, Sep, Oct, Nov and Dec Trading Hours 9:00–11:30 a.m. 1:30–3:00 p.m. Beijing time, Mon–Fri Last Trading Day The tenth business day of the delivery month. Delivery Date The twelfth trading day of the delivery month. Deliverable Grade 328B saw ginned upland cotton (standard Grades GB1103-1999). Substitutions at differentials see Delivery Rules of ZCE. Delivery Place Exchange-appointed delivery warehouses Margin Rate 7% of contract value Trading Fees 8 Yuan (RMB) /contract (including risk fund) Delivery Method Physical delivery Ticker Symbol CF

The open interest and trading volume surpassed 100,000 contracts only one year after introduction. This information appears with the permission of the China National Cotton Exchange and the Zhengzhou Commodity Exchange.

Appendix 5/page 3

Appendix 6 Cotton promotion Brooke Lewis

The rise of synthetics Future promotional requirements Market research – the first essential step Strategic choice of target markets What to promote?

International initiatives COTTON USA Mark The Australian example: education The International Forum for Cotton Promotion

Responsibility for cotton promotion

Cotton makes up just over 40% of the world’s fiber market and, up until a decade ago, enjoyed over half the share of the world market. Few other products in history have been as successful at holding market share, with comparatively little activity in the area of promotion on a world scale. The benefits and values of cotton products have always sold themselves to consumers. Breathability, coolness, moisture absorption and strength are qualities of cotton that are immediately obvious to consumers. But will these characteristics continue to be so obvious? And can the world’s cotton industry take the risk that consumers will always want to buy cotton products?

The rise of synthetics The world cotton industry is facing increasingly strong competition from the synthetic fiber market that is pouring millions of dollars into research and development of new and improved fibers. What are most concerning are advances in fabrics that look, feel and have all of the qualities of cotton – without being cotton. CoolMax® is one such example and was one of the first performance fabrics launched by DuPont in 1986. The promotional material for the new version CoolMax® Alta explains the fabric has ‘a cottony soft handle, superior moisture management, a semi-matte lustre and lowpill properties’. What’s new about this is that these ‘smart’ fabrics are being heavily promoted by their developers and are gaining increasing attention from media, retailers, fashion and industrial designers. For example, DuPont launched a new denim/LYCRA® blend with a US$10 million consumer advertising campaign in the US and Europe in 2001 and a US$50 million campaign in Asia. This was one of the first times that a synthetic fiber producer marketed directly to consumers. Up until relatively recently, consumers did not have much choice in the fabrics they could buy to wear – and most of the choices were natural fibers. Now consumers have an immense range of choices, and they are increasingly choosing synthetics. The world cotton industry’s research and development efforts need to not only assess the needs of consumers, but to respond to those by producing new and improved forms of cotton. While the total tonnes of cotton consumed continues to rise, cotton’s market share fell from 50% in 1986 to 40% in 2000. Interestingly, its share rose slightly in the 2001/02 season to 40.7%, the first rise in a decade. However that good news is not expected to last, with ICAC estimating that the market share of cotton will decline to 38.3% by 2010. Appendix 6/page 1

Cotton Trading Manual

Future promotional requirements An historical lack of activity in the promotion of cotton to consumers is a real concern for the world cotton industry and poses a threat to its future. The world cotton industry cannot afford to sit back and hope cotton will continue to sell itself, particularly when its competitors are gaining ground year by year. With few exceptions, the generic benefits of cotton and cotton products are simply not promoted to consumers in many of the key markets. There are some isolated incidences of brand-owner promotion, but few generic campaigns delivering positive messages about cotton products. One of the basic problems is that there are few national organizations whose core business includes the promotion of cotton. Promotion, marketing and communications are specialized skills requiring trained and experienced professionals. Many national cotton organisations lack personnel with these skills or experience, or marketing departments whose main role is the promotion of cotton. Those organisations that are promoting cotton in some way are often restricted by limited financial resources and competing priorities. Promotion is just one strategy to boost cotton consumption, but it is one so limited at the moment that it needs considerable investment and expansion if the world trend towards synthetic fibers is to have any chance of being reversed. If the world cotton industry is serious about using promotion to regain its market share long term, there are certain developments that need to occur in a two- to five-year timeframe: • The establishment of national organizations with expertise and resources to deliver promotional campaigns to consumers, or the restructuring of existing national organizations to deliver cotton promotion. • The establishment of compulsory labeling laws in all countries for fiber content of garments and other products. • Comprehensive consumer market research to determine consumer needs and the expectations of fiber quality and characteristics. • The development of comprehensive promotional and marketing campaigns tailored to the needs of consumers. • The commitment of resources to the delivery and evaluation of those campaigns. • Constant monitoring of competitor behavior (synthetic fibers). • Support, advice and coordination from the International Cotton Advisory Committee through the International Forum for Cotton Promotion.

Appendix 6/page 2

Cotton promotion Market research – the first essential step One of the first basic rules of any marketing or promotion campaign is ‘find out about your market’. Campaigns cannot be targeted or effective if they are not directed at the right people with the right messages. And while the world is becoming increasingly globalized, there are many cultural, religious, political and social differences that change the way people consume cotton in any given country. There cannot be one campaign for all people. National organizations must make it a priority to find out about their own consumer markets, and tailor campaigns to suit them. Cotton’s synthetic competitors are doing just that. At a recent Asia Pacific Textile, Clothing and Footwear Forum in Taipei, a representative from DuPont stated that ‘through market research, we have identified four key consumer benefit platforms – functionality that is of primary interest to consumers: comfort, easy care, durability and style. We now connect fiber innovations to these benefit, or functionality, platforms. We do so through partnerships with downstream players for technical developments and marketing relationships.’ DuPont carefully maps its consumers’ needs through continuous investment in consumer socio-cultural research, and develops and markets products that clearly meet those needs. Cotton Incorporated and Cotton Council International in the USA are among the few organizations strongly committed to market research of its consumers. Weekly and monthly monitoring of consumer behaviour is conducted across various sectors, and this information is regularly reported to the textile industry and the community. This research also forms the basis for the many consumer advertising and promotional campaigns that are helping boost demand for cotton in the US. A joint project by Cotton Incorporated and Cotton Council International called ‘The Global Monitor’ was a multi-country research study of consumer attitudes and behaviors modeled after Cotton Incorporated’s Lifestyle MonitorTM. Approximately 500–550 people, aged 15–60, were interviewed by telephone or in person in countries including Japan, Hong Kong, South Korea, Taiwan, Brazil, Colombia, Italy, France, Germany and the UK. This represents one of the only international studies of consumer attitudes to cotton ever conducted and is a valuable tool for promoters of cotton around the world.

Strategic choice of target markets In developing a marketing or promotional strategy, it makes sound business (and common) sense to assess the size of each of the markets for cotton. It is often automatically assumed that promotional funds are

Appendix 6/page 3

Cotton Trading Manual best spent in the area of consumer fashion because clothing is the obvious link between people and cotton. However, fashion is not the biggest market sector for cotton. Industrial markets make up a much bigger share of the market, and cotton products in this sector are also being replaced with synthetic alternatives. A good example is on the cotton farm itself. Where once ropes, tarpaulins and bale covers were made from natural fibers, today those same products are made from polyester or polypropylene. Why? Because synthetic products are cheaper, last longer and in many cases are much stronger. This raises two key questions: what is the global cotton industry doing about meeting the needs of these specialized markets, and should the promotional efforts of national cotton organizations also work to increase demand in non-consumer markets? It is also important for the cotton industry to look to the future. How will cotton be used in five, 10 and 20 years’ time, and what plans are in place to access those new markets? The only obvious example once again comes from the US. Cotton Incorporated is actively trying to identify new markets for cotton and markets that have strong potential for increased cotton usage. Research studies have been conducted in areas such as the potential in the uniform market and in the non-woven absorbent products market.

What to promote? There are two sectors of the world cotton industry that need promotion: the product and the industry. Consumers more and more often are making purchasing decisions not just on price or quality but also on the ethics of the industry behind the product. Some of the key attributes that consumers are looking for are environmental credentials, sympathetic labor policies, ethical business practices and, increasingly, the use of genetically modified materials. Large multinational companies are commonly advertising their ethical attributes, alongside those of the product, and this is a direct reflection of what consumers are looking for. The cotton industry needs to be seen as a good steward of land and water resources, to be contributing to the well-being of local communities and national economies, and it needs to have sound business practices. Organizations in all cotton-producing nations have a responsibility to promote their industry at the local and national level. High levels of awareness, community acceptance and positive perceptions of the cotton growing and processing industries will have positive flowon effects on world demand for cotton in some of the biggest consumer markets. Appendix 6/page 4

Cotton promotion Promotion of the product itself is also very important. There has been much work done in this area, in identifying the factors about cotton that consumers respond to and using these as the platform for promotional campaigns. More needs to be done. Cotton has many positive attributes that consumers need to be reminded of time and again.

International initiatives While overall there is little activity in the area of cotton promotion, there are some positive initiatives in certain countries that have made a difference to cotton consumption in those countries. These projects should be used as an example to others and the industry should work together to share ideas, concepts and costs. Two examples are COTTON USA Mark and the priority accorded to education in the Australian cotton industry. Another is the development of the International Forum for Cotton Promotion (IFCP).

COTTON USA Mark Cotton Council International (CCI) developed its international trademark, the COTTON USA Mark, in 1989 after conducting extensive consumer research and consulting with a leading international design firm. The COTTON USA Mark is used as a sign of quality to promote raw cotton fiber as well as cotton yarn, fabric and finished products containing a majority of US cotton. Advertising and public relations campaigns were launched in key markets in Western Europe, Japan, South Korea and Taiwan to promote the COTTON USA Mark. The success of the campaigns in these original target markets and the increased globalization of the textile industry led CCI to expand its promotional efforts to Southeast Asia and Latin America. In CCI program countries, consumer awareness and preference for products bearing the Mark increased from 19% in 1989 to 43% in 1998. In CCI’s primary program markets in Asia, awareness had reached 61%. In South Korea, awareness reached 84% and in The Philippines 85%. This is a practical example of how serious investment in cotton promotion can yield positive results.

The Australian example: education Education of young people is a major priority for Australia’s cotton industry. Funded by cotton growers, Cotton Australia has an education center based in Sydney, New South Wales. Approximately 7000 students are taught face to face each year about the Australian cotton industry from field to fabric. Subject areas include geography, science, Appendix 6/page 5

Cotton Trading Manual agriculture, business studies and textiles and design. Education is a long-term promotional strategy that offers a quality interaction and leaves students with deeper knowledge. In July 2001, the Cotton Discovery Centre commissioned Roy Morgan Research to conduct a survey measuring the level of teacher and student satisfaction with the Cotton Discovery Centre. It was the first time the CDC had been independently evaluated after four years of operation. The evaluation was therefore crucial for the CDC staff to know which parts of the program worked best and which needed changing or revamping. For the most part, the results of the survey were extremely favorable. A key finding showed that only 33% of students entering the CDC had a positive view of the cotton industry. However, this figure rose to 80% following students’ visit to the CDC. Similarly, before entering the CDC, the students’ knowledge of the cotton industry was self-rated as ‘good’ or ‘very good’ by only 15% of students. This figure increased dramatically to 71% when leaving the CDC. Cotton Australia also has an Education Outreach program that takes cotton education to rural and remote areas, mainly where cotton is grown. Rural and regional primary schools are visited, and interactive displays with education programs are installed at major metropolitan shows that allow a rural message to be brought to city people.

The International Forum for Cotton Promotion One positive initiative in the last few years has been the development of an International Forum for Cotton Promotion (IFCP). The IFCP is a sub-group of the International Cotton Advisory Committee, set up at the 59th Plenary Meeting in Cairns, Australia. Its objective is ‘to encourage national marketing development programs through the exchange of ideas and experiences, for the purpose of increasing international cotton consumption and market share’. The first task of this group was to compile a booklet of the cotton promotion activities of its members. This booklet is a practical tool that can be used to generate promotional ideas, plans and strategies within member countries with the ultimate aim of increasing world demand for cotton and cotton products. While the IFCP does not have millions of dollars to spend, it is a positive step towards a collaborative approach to world cotton promotion, and is recognition by the world industry that cotton promotion is an increasingly important issue. Any national organization wishing to become a member of the IFCP is expected to contact the International Cotton Advisory Committee. Appendix 6/page 6

Cotton promotion

Responsibility for cotton promotion Who should take responsibility for demand enhancement for cotton? Should those countries where cotton is grown, manufactured or sold be ultimately responsible? For example, what incentive is there for Australia to promote cotton to Australians when 96% of the crop is exported? The answer is that if all importing and exporting nations made a concerted effort to promote cotton, the overall demand would lift and the whole industry would benefit. Growers, merchants, spinners, weavers, brand owners and retailers all have a stake in cotton’s future and all have responsibilities in cotton promotion. As each year goes by, many more millions of dollars are spent by the synthetic fiber market on new and improved fibers and their marketing. At the moment, the world cotton industry is not keeping pace in either respect. All sectors of industry must act together to reclaim and build traditional markets and find new ones – and fast.

Appendix 6/page 7

Appendix 7 The enforceability of arbitration awards Neal P. Gillen Executive Vice President & General Counsel, American Cotton Shippers Association

The ethos of the cotton industry The cotton industry conundrum The United Nations New York Convention Quantifying the cotton industry enforceability problem Factors contributing to defaults The occurrence of disputes Industry action: negotiation – enforcement – industry default lists

The ethos of the cotton industry The cotton industry functions as an open network, ubiquitous with accurate price data and other vital market information. The members of the network, utilizing transparent market information, serve one-another by producing a commodity, adding value to it, offsetting price risks, protecting the commodity’s value, shipping it for manufacturing, and then creating it into new products which stimulate additional production. The participants in this network, which moves cotton from the field to the mill, share the norms or values of fairness, truth, and reciprocity beyond those necessary for ordinary market transactions. This is what makes the cotton industry unique. That is why its business is conducted on a different basis from all other industries. In such a system it is essential that rules be complied with, that trades be fair, and that disputes be resolved through impartial arbitration that is affordable to the participants. Participation in the cotton supply trade network carries with it the obligation to adhere to a set of well-established principles grounded on the assumption that the corresponding party will honor his contract, resolve disputes through amicable negotiations, or submit the dispute to a recognized and impartial industry arbitration forum. Since its inception the cotton trade has used as its principle capital the social capital of trust, which acknowledges the existence of shared values or norms and requires the adoption of these positive values in the industry’s reciprocal business transactions. This has been the essence – the tradition – of the cotton trade. In recent years, the patterns of trade have changed as textile production moved from the developed to the developing world where many of the participants were unfamiliar with the rules-based system, premised on contract sanctity, utilized by the international cotton trade. Most mills in the developing countries have recognized the critical need for such a system for the assurances it provides through timely delivery of cotton at the contract price. A minority in the emerging markets has not readily accepted this essential ethic of trade and has deemed a price swing against their position as reason to abrogate their contractual obligations and to ignore arbitration awards in such circumstances. Their very participation in the cotton and/or textile business adds significantly to the costs of doing business, and jeopardizes a wellestablished system of trade and its participants who perform the essential risk management functions for the producers and the manufacturers.

The cotton industry conundrum If arbitration is the most efficient, expedient, fair, and least expensive manner to resolve a dispute in the cotton industry: Appendix 7/page 1

Cotton Trading Manual • Why is it that many participants in the world’s emerging cotton markets are reluctant to make use of this relatively simple and informal process designed by participants in the cotton industry to resolve differences quickly without resort to the expensive and protracted process of litigation? • Why is it that some cotton textile mills in countries enjoying an expansion in their textile manufacturing industry have failed to honor arbitration awards? These issues must be resolved to ensure that the principal participants in the market – the producers, merchants, cooperatives, and mills – can survive and compete. This resolve is also imperative to ensure that defaulting participants in the market do not receive a competitive edge over their colleagues who honor their contractual obligations. It is essential that all market participants embrace a proven dispute resolution system. Qualified members of the industry who have no commercial interest or connection with either of the disputing parties conduct the cotton industry arbitrations. The arbitrators are fully familiar with the rules, customs and practices of the trade and they strive to ensure that the dispute between the parties is resolved fairly so that the cotton trading system can continue to function with the necessary high level of integrity. Simply put, there is no better way to remedy a misunderstanding or to right a wrong in a business transaction. Though the obvious benefits of arbitration are long recognized throughout the world, there are those still to be convinced within the cotton trading system, particularly those in the emerging markets. It is imperative that those who question a trading system, and its established rules, based on centuries of successful fair trade, be convinced that such a system serves the best interest of producers and mills since it enables them to sell and purchase cotton at competitive prices by locking in such prices well in advance of delivery with the guarantee of payment and/or delivery.

The United Nations New York Convention On June 10, 1958 the delegates to the United Nations ratified the provisions of the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention). The signatories ratifying this treaty and the countries adopting its provisions agreed to recognize and enforce ‘arbitral awards made in the territory of a State other than the State where the recognition and enforcement are sought, and

Appendix 7/page 2

The enforceability of arbitration awards arising out of differences between persons.’ ‘The term “arbitral awards” shall include not only awards made by arbitrators appointed for each case but also those made by permanent arbitral bodies to which the parties have submitted.’ The essential provision of the Convention requires that ‘each Contracting State [nation] shall recognize an agreement in writing under which the parties undertake to submit to arbitration all or any differences which have arisen or which may arise between them in respect of a defined legal relationship, whether contractual or not, concerning a subject matter capable of settlement by arbitration.’ Further, ‘the term “agreement in writing” ’ shall include an arbitral clause in a contract or an arbitration agreement, signed by the parties or contained in an exchange of letters or telegrams [telexes, facsimiles or e-mail]. The UNCITRAL Model Law on International Commercial Arbitration (Model Law) defines an arbitration agreement as follows: (1) ‘Arbitration agreement’ is an agreement by the parties to submit to arbitration all or certain disputes which have arisen or which may arise between them in respect of a defined legal relationship, whether contractual or not. An arbitration agreement may be in the form of an arbitration clause or in the form of a separate agreement. (2) The arbitration agreement shall be in writing. An agreement is in writing if it is contained in a document signed by the parties or in an exchange of letters, telex, telegrams or other means of telecommunication which provide a record of the agreement, or in an exchange of statements of claim and defense in which the existence of an agreement is alleged by one party and not denied by another. The reference in a contract to a document containing an arbitration clause constitutes an arbitration agreement provided that the contract is in writing and the reference is such as to make that clause part of the contract. Further, Section 7 has been interpreted to mean that a contract or written agreement to arbitrate exists if the terms and conditions of the contract contain a reference to a standard set of arbitration rules available to the parties such as the Rules and Bylaws of the International Cotton Association (ICA) (until December 2004 the Liverpool Cotton Association (LCA)). The New York Convention and the Model Law provide a framework for the international trade in cotton to resolve disputes through arbitration and to have the awards, rendered by the arbitral body, enforced in the domiciliary country of the losing party.

Appendix 7/page 3

Cotton Trading Manual Currently, 134 countries1 have agreed to participate in the New York Convention and have ratified the treaty.2 Four ICAC member countries, Chad, Pakistan, Sudan, and Togo have not ratified the treaty. Further, international cotton merchants are selling cotton to mills in three nonICAC member countries that have not ratified the treaty: Burma: El Salvador, and the United Arab Emirates.

Quantifying the cotton industry enforceability problem Considering the large volume of cotton traded in the export market each year, some 29 million bales with an approximate value of $7.3 billion, the overall record of contract execution through payment and the timely delivery of the cotton pursuant to the terms and conditions of the contract is significant. The level or degree of defaults, however, is estimated by ICAC to add approximately $300 million to the costs of doing business each year. If cotton is to remain competitive with synthetic fibers, the additional cost of doing business must be reduced. Further, the additional cost limits the viability of the cotton trade and the availability of cotton in those markets with a high level of defaults. Those suppliers willing to sell in markets with an attendant risk of potential contract defaults, out of necessity, will include a risk premium in the price of cotton to offset such risk. In some instances the sellers require the purchasing mills to 1 Albania, Algeria, Antigua & Barbuda, Argentina, Armenia, Australia, Austria, Azerbaijan, Bahrain, Bangladesh, Barbados, Belarus, Belgium, Benin, Bolivia, Bosnia & Herzegovina, Botswana, Brazil, Brunei Darussalam, Bulgaria, Burkina Faso, Cambodia, Cameroon, Canada, Central African Rep., Chile, China, Colombia, Costa Rica, Cote d’ Ivoire, Croatia, Cuba, Cyprus, Czech Rep., Denmark, Djibouti, Dominica, Dominican Rep., Ecuador, Egypt, El Salvador, Estonia, Finland, France, Georgia, Germany, Ghana, Greece, Guatemala, Guinea, Haiti, Holy See, Honduras, Hungary, Iceland, India, Indonesia, Iran, Ireland, Israel, Italy, Jamaica, Japan, Jordan, Kazakhstan, Kenya, Kuwait, Kygyzstan, Laos, Latvia, Lebanon, Lesotho, Lithuania, Luxembourg, Macedonia, Madagascar, Malaysia, Mali, Malta, Mauritania, Mauritius, Mexico, Monaco, Mongolia, Morocco, Mozambique, Nepal, Netherlands, New Zealand, Nicaragua, Niger, Nigeria, Norway, Oman, Panama, Paraguay, Peru, Philippines, Poland, Portugal, Qatar, Rep. Korea, Rep. Moldova, Romania, Russian Fed., St. Vincent &, Grenadines, San Marino, Saudi Arabia, Senegal, Serbia & Montenegro, Singapore, Slovakia, Slovenia, South Africa, Spain, Sri Lanka, Sweden, Switzerland, Syria, Tanzania, Thailand, Trinidad & Tobago, Tunisia, Turkey, Uganda, Ukraine, United Kingdom, United States, Uruguay, Uzbekistan, Venezuela, Vietnam, Zambia, Zimbabwe. 2 Hong Kong and Taiwan have adopted the New York Convention. Hong Kong is now part of China, which has adopted the Convention, while Taiwan is no longer a member of the United Nations.

Appendix 7/page 4

The enforceability of arbitration awards advance 10–20% of the contract value at the time of sale, another 15% prior to shipment, and the balance in cash on arrival before releasing the cotton to the buyer. In 2004 there were 268 parties from 55 countries who were listed by the Committee for International Cooperation between Cotton Associations (CICCA) for failing to honor an arbitration award. Of the 288 defaults by the 268 parties, the Liverpool Cotton Association (LCA, now ICA) issued 222 awards totaling US$89 million. Most of the entities listed for failing to pay their outstanding arbitration awards were textile mills or buyers who failed to perform their contracts in declining markets along with a few merchants and farm cooperatives who failed to perform as sellers in rising markets. Almost 60% of the defaults occurred in seven countries that have expanded their textile production in recent years. Three countries accounted for 37% of the defaults, India, Bangladesh, and Pakistan (a non-signatory of the New York Convention). By comparison, in 1999 there were 164 mills from 44 countries listed in default on 188 LCA arbitration awards totaling US$61 million. At that time, 58% of the mills listed in default were from seven countries that had just begun to expand their textile production. All of the countries in that category with the exception of Portugal continue to pose problems. Between 1999 and 2004 the number of mills listed in default increased in 20 countries, and improvement was shown in five countries. Analyzing the default data by year shows that of the 288 outstanding defaults on arbitration awards, 61 defaults occurred in 2002. The level of defaults is attributed to the precipitous price decline occurring in the 2000–01 marketing year.

Factors contributing to defaults Since a majority of the defaults are occurring in relatively new markets it is obvious that a number of factors can define the problem, including cultural and ethical issues ingrained in business practices or customs regarding contractual obligations, particularly in the yarn spinning sector, restrictive currency regulations that inhibit hedging and in some cases outright prohibitions against hedging, and lack of familiarity with international trading rules and arbitration procedures along with the consequences of failing to comply with these universally acceptable precepts. The yarn-spinning sector is a particular concern since a rulebased structure is virtually non-existent in the world yarn trade. Therefore, a merchant finds himself selling to a yarn spinner under a well-established and respected set of trade rules while the yarn-spinner is selling into a predatory market lacking the rules and ethical standards common to the raw cotton trade. In a declining market the yarn-spinner Appendix 7/page 5

Cotton Trading Manual is almost certain to experience defaults on his high priced yarn sales. This being the case, it is highly likely that he will default on his highpriced purchases of raw cotton. In the countries with the highest level of defaults, particularly India and Pakistan, most of the mills in default are yarn spinners. Those selling into these new markets must acknowledge each of these factors. Further, the individual merchants or their trade organizations should consider undertaking a comprehensive and large scale educational effort to familiarize the new buyers with the prevailing trade rules, the protections and expectations of those rules – that the seller will deliver and the buyer will make payment and accept delivery with the understanding that the parties will utilize the available dispute resolution procedures when differences arise, and the additional protection of the industry’s system of listing parties in default for failing to honor a contract or an arbitration award. Such an effort cannot succeed until the trade and the mills in the countries with high levels of defaults fully comprehend and support the necessity for a rules-based system and are convinced that dispute resolution through arbitration is fair, impartial, affordable, and enforceable. It is also imperative that those countries now actively engaged in the purchase and/or sale of cotton in the world market undertake the necessary reforms in their financial and currency regulations to permit their cooperatives, producers, ginners, merchants, and textile mills to make effective use of the available risk management alternatives that will protect them against adverse price movements.

The occurrence of disputes Fortunately, disputes arise infrequently, but they do have a pattern of occurring when prices move up or down within a short time span. Usually, few people are involved and they also fit into a pattern: new textile mills or mills in emerging markets inexperienced with international trade rules and contractual obligations, new and/or undercapitalized mills who lack the financial ability to work through a price cycle of raw cotton and yarn prices, and new or inadequately financed traders who failed to deliver because they were either speculating, did not anticipate the price increase, or failed to hedge their purchases and sales or did so and their bank withdrew the financing necessary to maintain their margin requirements. Also, factor in the dishonest buyer or seller, albeit rare, who has no intention to perform should the market move against his or her position. The majority of market participants understand the attendant risks involved in a prospective trade and they act prudently in their business undertakings. Problems occur, however, when new markets emerge, as they have on the Indian subcontinent, Turkey, Mexico, and China in Appendix 7/page 6

The enforceability of arbitration awards recent years. In such situations new and different business conditions prevail. There is usually a rush to establish and tie-up the new business. Therefore, the risk exposure to merchants is greater in such markets. Because of a lack of prior dealings there is no credit or payment experience with the buyers. As long as the price is stable or increasing, the contracts are secure. When prices decline, however, outstanding and undelivered contracts are at great risk and defaults or renegotiations are likely to occur. The buyers in the emerging markets are also at risk to unscrupulous sellers when such markets initially open. Such sellers have attempted to deliver marginal qualities or reduced weights, and some have even attempted to pass off gin motes and gin waste as upland cotton. This usually happens when buyers, unfamiliar with the established and reliable merchant firms, accept contract terms and conditions significantly better than those offered by the trade. As is often the case, when the price or the terms appear to be too good to be true, they usually are and the market losses suffered by the buyer far exceed the potential savings or eventual profits envisioned at the time of the purchase. Merchants, by their very nature, are prone to take risks, but such risks are usually calculated by exercising prudence to the fullest extent possible through appropriate risk management tools, credit investigations, and insurance coverage. The due diligence for a merchant is far more difficult to undertake compared with that for a textile mill which can be assured of delivery pursuant to the terms and conditions of the contract solely by dealing with reliable firms that are well known in the international market.

Industry action: negotiation – enforcement – industry default lists In today’s market climate a disputant who is likely to pay the full amount of the award and the accumulated interest is a party who is more likely to have been willing to resolve the issue amicably at the outset of the dispute making an arbitration unnecessary. Therefore, a negotiated settlement following the rendering of the award requires the willingness to compromise. Failing that, it is incumbent upon the prevailing party to enforce the award. Though the major cotton producing, trading, and textile manufacturing nations have adopted the New York Convention there is a problem of enforcement in the developing countries. The court systems in these countries frequently discourage enforcement action because of their out-dated and cumbersome procedures, protracted schedules, and in some instances corrupt court officials that must be relied on to produce a judgment. Therefore, there is a reluctance to undertake the unknown Appendix 7/page 7

Cotton Trading Manual costs to litigate in such systems. Should one choose to do so, securing the necessary judgment may also prove to be a hollow victory as the final step involves locating the necessary assets to satisfy the judgment. This can also prove to be a long drawn out process, and in many instances there are few if any assets to be found. The remaining alternative in such situations is to give notice to the other members of the industry of your unresolved contract problems advising them that dealing with such a party, should they still remain in business, could place one in financial jeopardy. This is accomplished by submitting the name of the defaulting party to one of the above named organizations for consideration for listing on a published Default List. Complaints of default are submitted to the various industry associations for examination along with the related documents verifying the complaint. Upon verification, the defaulting party is notified and usually provided with 14 days in which to respond. If the response establishes that the party is at fault or if there is no response, the party is placed on a Default List. In the event the party alleged to have been in default provides information that places the matter in doubt, the case is then submitted to a Committee for review. If the Committee determines that a complaint is not valid or is questionable, the party is not placed on the Default List. If the complaint is determined to be valid, the party is listed in default, but the party can be removed should the dispute be resolved. Parties are listed in default for failing to open a Letter of Credit on a timely basis or refusing to pay upon delivery when the terms of the sale call for payment on arrival. In these cases, the party can be removed from a default listing by opening up the Letter of Credit, taking delivery and making payment, by paying offsetting damages for not taking delivery, or by agreeing to arbitrate. The cotton industry, particularly the merchant trade and the cooperatives, perceives the undertaking of business dealings with a party listed in default to be an imprudent assumption of an economic or unworthy credit risk since the party has an established record of defaulting on a contract or not honoring an arbitration award. In fact, dealing with a defaulting party could invite an action for interfering with the contractual rights of the entity who placed the defaulter on the list. Also, in cases where the defaulting party is a textile mill, the mill takes the risk that any cotton it purchased subsequent to its default could be seized to enforce a legal judgment. In recent years, the trade rules of the LCA (now ICA) and the American Cotton Shippers Association (ACSA) have been tightened to disallow defaulting parties or those dealing with defaulting parties from access to industry arbitration systems to resolve disputes. In some cases, trade organizations have sanctioned members by imposing Appendix 7/page 8

The enforceability of arbitration awards monetary fines or reprimands for knowingly and/or willfully dealing with defaulting parties since they interfered in the possible resolution of an outstanding dispute. These rule changes are expected to achieve the desired effect of reducing the number of contracts and arbitration awards in default. The new rules are viewed to be legitimate and reasonable in the United States and the European Union as the rules are aimed at enhancing the honesty and integrity of the cotton trade. They are designed and intended, not to limit competition within the trade, but to prevent economic harm to trade members by defaulting parties who buy from, but do not compete with the trade.

Appendix 7/page 9

Appendix 8 World cotton supply and use Secretariat of the International Cotton Advisory Committee

Appendix 8/page 1

26/27 27/28 28/29 29/30 30/31 31/32 32/33 33/34 34/35 35/36 36/37 37/38 38/39 39/40 40/41 41/42 42/43 43/44 44/45 45/46 46/47 47/48 48/49 49/50 50/51 51/52 52/53

0 0 0 0 0 0 0 0 0 0 201** 0 0 0 0 0 0 0 209 211 230 254 249 233 234 246

0 0 0 0 0 0 22 305 22 547 23 914 25 425 28 732 28 537 36 040 35 448

Yield Kg/ha

0 0 0 0 0 0 0 0 0 0 33 096** 0

Area 000 ha 6 365 5 288 5 973 6 073 5 895 6 081 5 507 6 004 5 300 6 023 7 018 8 346 6 422 6 353 6 934 6 223 5 813 5 399 5 329 4 651 4 757 5 501 6 450 7 154 6 645 8 427 8 736

Prod

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 6 509 5 696 4 259 3 270 3 351 3 708 2 678 3 417

Beg stks

Cons

3 294 3 201 3 158 3 135 2 947 2 875 2 829 3 125 2 820 2 859 3 227 2 818 2 569 2 723 1 643 1 587 1 244 938 895 1 882 2 118 2 077 2 524 2 628 2 724 2 661 2 612

0 0 0 0 0 0 0 0 0 6 343 7 007 6 384 6 609 6 557 6 130 5 597 5 312 4 987 4 997 5 350 6 134 6 486 6 341 6 749 7 638 7 657 8 044

Thousand metric tons

Imprts

3 553 2 826 3 132 2 806 2 762 2 897 2 879 2 995 2 502 2 971 3 093 2 749 2 557 2 811 1 467 1 262 834 880 1 097 2 005 2 084 1 935 2 419 2 767 2 636 2 671 2 594

Exprts

5 696 4 259 3 270 3 351 3 708 2 678 3 417 4 070

End stks

1.06 0.69 0.50 0.53 0.55 0.35 0.45 0.51

S/U* ratio

53/54 54/55 55/56 56/57 57/58 58/59 59/60 60/61 61/62 62/63 63/64 64/65 65/66 66/67 67/68 68/69 69/70 70/71 71/72 72/73 73/74 74/75 75/76 76/77 77/78 78/79 79/80

Yield Kg/ha 271 267 279 275 283 308 318 314 297 320 330 345 359 350 351 374 348 369 392 402 418 418 390 393 396 380 425

Area 000 ha

33 422 33 445 34 078 33 417 32 032 31 657 32 326 32 445 33 057 32 633 32 968 33 366 33 133 30 915 30 670 31 692 32 658 31 778 33 024 33 818 32 558 33 285 30 001 31 513 34 966 34 000 33 100 9 068 8 930 9 508 9 183 9 053 9 760 10 286 10 201 9 832 10 444 10 877 11 504 11 898 10 836 10 780 11 856 11 379 11 740 12 938 13 595 13 615 13 926 11 706 12 385 13 860 12 933 14 084

Prod

4 070 4 626 4 862 5 349 5 124 4 810 4 609 4 407 4 551 4 532 5 260 5 845 6 312 6 879 6 032 5 068 5 240 4 656 4 681 4 851 5 434 5 727 7 352 5 770 5 232 5 963 5 255

Beg stks

Cons

2 877 2 756 2 882 3 409 3 092 3 043 3 788 3 804 3 463 3 638 3 879 3 811 3 809 3 934 3 828 3 718 3 932 4 086 4 031 4 528 4 408 3 734 4 188 3 951 4 250 4 320 5 093 8 443 8 678 8 972 9 352 9 343 9 942 10 531 10 231 9 982 9 845 10 362 11 165 11 429 11 618 11 752 11 772 12 010 12 173 12 721 13 034 13 469 12 641 13 336 13 122 13 133 13 703 14 127

Thousand metric tons

Imprts

2 916 2 686 2 830 3 438 3 061 2 937 3 772 3 667 3 367 3 450 3 910 3 721 3 712 3 974 3 805 3 640 3 880 3 875 4 111 4 640 4 294 3 814 4 183 3 806 4 239 4 346 5 073

Exprts

4 626 4 862 5 349 5 124 4 810 4 609 4 407 4 551 4 532 5 260 5 845 6 312 6 879 6 032 5 068 5 240 4 724 4 605 4 799 5 358 5 727 7 373 5 770 5 232 5 963 5 257 5 257

End stks

0.55 0.56 0.60 0.55 0.51 0.46 0.42 0.44 0.45 0.53 0.56 0.57 0.60 0.52 0.43 0.45 0.39 0.38 0.38 0.41 0.43 0.58 0.43 0.40 0.45 0.38 0.37

S/U* ratio

Cotton Trading Manual

Appendix 8/page 2

Appendix 8/page 3

est. proj. proj. proj. proj. proj.

33 667 33 948 32 569 32 137 35 217 32 792 29 503 31 238 33 522 31 640 33 050 34 710 32 238 30 430 32 114 36 056 34 111 33 746 32 846 31 929 31 766 33 381 29 924 32 192 35 920 34 764 35 393 35 559 35 914 36 323 411 442 445 451 546 532 518 564 546 549 574 596 557 554 584 564 575 595 569 598 612 644 645 644 729 687 698 708 715 717 13 831 14 991 14 479 14 499 19 247 17 461 15 269 17 609 18 301 17 365 18 978 20 677 17 943 16 861 18 762 20 330 19 599 20 094 18 705 19 095 19 457 21 490 19 294 20 717 26 196 23 900 24 699 25 170 25 670 26 048 5 152 4 994 5 852 5 926 6 121 10 247 11 366 8 251 7 668 7 312 6 146 6 709 9 313 8 694 7 028 7 561 9 129 9 844 10 674 10 937 10 359 9 953 10 771 8 663 8 072 10 566 10 610 10 768 10 914 11 073

* Stocks-to-use ratio equals ending stocks divided by consumption. ** Annual average during 1934–1938. Source: ICAC.

80/81 81/82 82/83 83/84 84/85 85/86 86/87 87/88 88/89 89/90 90/91 91/92 92/93 93/94 94/95 95/96 96/97 97/98 98/99 99/00 00/01 01/02 02/03 03/04 04/05 05/06 06/07 07/08 08/09 09/10 4 555 4 405 4 350 4 617 4 602 4 763 5 516 5 094 5 654 5 431 5 220 6 497 5 690 5 766 6 458 5 805 6 134 5 737 5 390 6 034 5 734 6 229 6 540 7 284 6 871 8 068 8 261 8 363 8 533 8 838 14 215 14 147 14 452 14 655 15 108 16 589 18 198 18 117 18 470 18 675 18 574 18 636 18 634 18 496 18 278 18 405 19 049 18 990 18 451 19 603 19 845 20 305 21 235 21 355 23 278 23 856 24 541 25 024 25 511 26 022 4 414 4 373 4 261 4 309 4 520 4 479 5 755 5 121 5 726 5 293 5 073 6 091 5 525 5 911 6 312 5 999 6 049 5 973 5 508 6 111 5 881 6 448 6 676 7 255 7 294 8 068 8 261 8 363 8 533 8 838 4 994 5 852 5 926 6 121 10 247 11 366 8 251 7 668 7 312 6 146 6 709 9 312 8 694 7 028 7 561 9 129 9 844 10 672 10 937 10 359 9 953 10 771 8 663 8 072 10 566 10 610 10 768 10 914 11 073 11 099

0.35 0.41 0.41 0.42 0.68 0.69 0.45 0.42 0.40 0.33 0.36 0.50 0.47 0.38 0.41 0.50 0.52 0.56 0.59 0.53 0.50 0.53 0.41 0.38 0.45 0.44 0.44 0.44 0.43 0.43

World cotton supply and use

Appendix 9 Conversion factors Secretariat of the International Cotton Advisory Committee

Weight Bales Area Length Yields Price Other

Weight Metric ton Pound Kilogram Long ton Arroba (Brazil) Candy (India) Cantar, metric (Egypt) Cantar (Sudan) Centner (USSR) Dan (China) Quintal (Argentina) Quintal (India) Quintal (Mexico) Quintal (Peru, Spain) Maund (Pakistan) Picul (China)

Kilograms 1000 0.4593 1 1016 15 355.62 50 44.93 100 50 45.95 100 46.026 46 37.3242 50

Pounds 2204.6 1 2.2046 2240 33.069 784 110.23 99.04 220.46 110.23 101.3 220.46 101.47 102.43 82.286 110.23

480 lb bales 4.593 480 0.004593 4.666 0.068895 1.6333 0.2296 0.20635 0.4593 0.2296 0.211 0.4593 0.2113 0.2113 0.1714 0.2296

227 233 327 170 230 185 200 191 181 225

500 514 720 375 507 408 441 420 400 496

1.04167 1.0702 1.5 0.7808 1.05625 0.85 0.9186 0.875 0.83333 1.033

Acres 1 0.24710 1.038 2.47103 1.72 0.16473

Hectares 0.40469 0.1 0.42 1 0.696 0.06667

0.24710

0.1

Bales Australia Colombia Egypt India/Pakistan Mexico Nigeria South Africa Sudan Tanzania/Uganda USA

Area Acre Dunams Feddan Hectare Manzana Mu (China, 1/15 hectare) Stremma (Greece, 1/10 hectare)

Appendix 9/page 1

Cotton Trading Manual To convert from:

To:

Multiply by:

Length Centimeter Centimeter Foot Inch Inch Kilometer Meter Meter Meter Mile Millimeter Yard 32nd of an inch

Inch Millimeter Centimeter Centimeter Millimeter Mile Inch Yard Foot Kilometer 32nd of an inch Meter Millimeter

0.3937 10 30.48 2.54 25.4 0.6215 39.37 1.09361 3.2808 1.60934 1.25984 0.9144 0.79375

Pound per acre Pound per acre Kilogram per hectare Pounds per acre Kilogram per hectare Kilogram per hectare

0.89219 106.1895 94.74 58.9709 0.0169575 1.12084

Dollars per ton Cents per pound

22.046 0.04536

Pound per sq. yard Kilogram per sq. meter Square yard Square meter Ounce

1.84336 0.54249 1.19603 0.8361 0.0353

Yields Kilograms per hectare Cantar per feddan Cantar per feddan Quintal per manzana Quintal per manzana Pounds per acre

Price Cents per pound Dollars per ton

Other Kilogram per sq. meter Pound per sq. yard Square meter Square yard Gram

Appendix 9/page 2