March 2021 cotton futures have continued to rise this week, finishing on Thursday, February 18, at 88.56 cents. They are now up 13.1% since the start of the year. This increase in cotton price is largely driven by the improving situation of the global economy. Additionally, the prospect of a new stimulus bill that could come as soon as early March has encouraged investors to keep driving these prices higher. Another reason that cotton prices have been pushing higher is that crude oil futures have also been pushing higher in recent weeks. There is a direct effect between crude oil and cotton prices because of the interrelatedness of the two commodities. By looking at crude oil prices, we can get a better idea of where cotton futures might be going in the future.
How are cotton and crude oil prices related?
The price of crude oil directly affects cotton pricing in two main ways. First, crude oil is burned and generates steam that drives turbines and creates electricity. Cotton growers deal with energy and electricity costs because cotton farming is an extremely energy-intensive process. Other energy costs include general electricity costs, irrigation, fuel for combines, and other machinery. They all increase the price of cotton because they contribute to the healthy growth and harvest of the product.
Secondly, crude oil is one of the main ingredients in polyester production. Polyester is the main competitor of cotton because of its usage in clothing across the world. It also accounts for 55% of the market share, which is more than half of the global fiber market, while cotton only accounts for 27%. Therefore, the price of one can directly influence the pricing of the other. If the price of crude oil jumps, then polyester jumps as well. In turn, the demand for cotton will increase as a substitute, and the price will increase because of increased demand.
Furthermore, because cotton is often shipped overseas, crude oil prices also affect cotton prices because increased gas prices for tankers will raise the cost of shipping cotton overseas. Another way shipping costs affect cotton prices (and other commodities) is the massive global container shortage caused by skyrocketing shipping rates. As China and many Asian countries export more to the West than they import, they are sending over tankers full of containers. But these containers are not being returned at the same rate. Therefore, causing a severe container shortage in Asia.
When looking at shipping prices compared to a year ago, the rise is quite evident. In December 2020, spot freight rates were 264% higher from Asia to the North Americas route. Additionally, the rates are up over 145% year over year. As we look at the lowest of low shipping prices of March 2020, freight rates from Asia to the U.S. and Europe are up over 300%. Until this trade imbalance fixes between the West and Asia, specifically China, this trend will most likely persist.
Where are crude oil prices headed?
The best place to look for where crude oil prices are heading in the near, middle, and long-term future are the future markets. Since the start of February 2021, March crude oil futures are up 12.17%, June is 12.02%, and October 9.07%. These crude oil futures signify that prices are expected to increase soon but may level off in the long term. The current increase in price is likely due to increasing demand as the global economy recovers from the COVID-19 pandemic shock.
We can also use an exponential smoothing method to see where we think crude oil prices are heading in these different time frames. Using an exponential smoothing method with an alpha level of 0.5, which weighs actual future prices more heavily than previous forecasts, we can get a good idea of a trend-line of where these prices will be by mid-month of the listed months (March, June, October). As pictured below, is the expected future market price of crude oil by mid-March for each of these time frame outlooks.
Figure 1. The expected future market price of crude oil by mid-March.
Figure 2. The expected future market price of crude oil by June.
Figure 3. The expected future market price of crude oil by mid-October.
As we can see, all these points to higher future prices in the near term, but not a concerningly high amount. There has been a general increase in the last couple of weeks in all these monthly future markets. However, the momentum of these increases appears to be running out as oil-producing countries increase production to meet these new demands. Either way, oil futures should be expected to increase or remain elevated in the coming months.
Where are cotton prices headed?
In total, we can project that cotton prices will continue to rise in the near term as increased demand is not matched equally by supply. In the most recent report by the USDA, projections of world production of cotton were at 114.1 million bales, which is an increase of 1.3 from their last. The projections of world demand for cotton were at 117.2 million, which is also an increase of 1.5 million from their last report. With this continued imbalance in supply and demand on the worldwide markets, coupled with increasing crude oil prices, cotton prices in the near and far future markets continue to rise. If we use the same exponential smoothing method as before for oil prices with an alpha of 0.5, we can project where March 2021 cotton future prices will be.
Figure 4. The expected future market price of cotton by March 2021.
As we can see, the future prices for cotton for March 2021 are expected to continue to rise at modest levels. Anyone in the textile industry is guaranteed to have felt these price increases in recent months. We should expect to continue to deal with elevated cotton prices in the very near and middle-term future.