Short Lead Time Orders from Retailers Putting Additional Pressure on Cotton Supply Chains

The recent USDA/FAS report on cotton said: Two factors primarily drove 2023 US product imports to slump; first, retailers lowered already burdensome inventories; second, retailers approached the 2023 shopping season (fall and winter) with greater caution amidst a potential US recession. How significant is this?
Ben Eaves: It is certainly significant as sustainable demand for raw cotton is driven from the bottom up; that is, driven by consumers buying textiles and garments. This in turn gives retailers confidence to replenish inventories and pass the order flow down their supply chains.

After the COVID-19 spending bonanza and rise of inflation, consumer pockets slowly began to tighten for the global majority, as disposable incomes shrank, savings pots were drawn down and credit card debt rose. This sort of indicators was bound to create caution for retailers.

Another trend that we have been hearing is that many retailers are placing smaller orders for their seasonal lines, then waiting to see which products sell well before replenishing those stocks weighted accordingly to popularity. It of course makes sense, but the replenishment orders are coming with shorter lead time demands and this is putting additional pressure on supply chains at a time when they are already facing many challenges like the Red Sea conflict, inflated input costs and in some countries USD liquidity issues.

Retail inventories have now plateaued and although they remain elevated, I am hearing that retail order flow is nearing pre COVID levels again so hopefully when raw cotton prices normalise again, we may see some stability. 

The Uyghur Forced Labor Prevention Act (UFLPA) is said to be one of the main reasons for the US importing less Chinese cotton, and this is expected to have a bigger impact in the coming days. Do you agree with that argument?
Ben Eaves: This is definitely a key reason in my opinion. Although the legislation doesn’t categorically ban the import of cotton products from the Xinjiang region (with the exception of the entities on the sanction list), which produces over 85% of Chinese cotton annually, it does place a nearly insurmountable burden of proof on the importer of goods to evidence that those goods were not produced using forced labour. The main difficulty here lies in enforcement and the inability to separate the forced labour economy from the regular economy and the view therefore that nearly all cotton textile or garment products (yarn, fabric or garments) originating from China have some tie to forced labour.

But given Xinjiang’s importance on a global scale, accounting for roughly 23% of total world cotton supply, yarn and fabric from China is often imported by garment producers outside of China in the likes of Vietnam and Cambodia and this can therefore disguise their origin, making detection even more difficult. 

As part of the enforcement efforts, US Customers and Border Protection (CPB) are to detain all shipments suspected of containing cotton from the Xinjiang region under a Withold Release Order, pending investigation. How the US CPB identifies these goods is not a matter of public record as it could jeopardise their efforts, but for the reasons cited above, this is a challenge in itself and could be an inherent limitation of the act. 

In an attempt to tackle this, the US CPB has partnered with isotopic testing company Oritain, whose traceability technique involves analysing the concentration of stable elements like carbon and hydrogen present in both the cotton and the environment it was grown. However, clearance by the isotopic testing alone is not sufficient to clear detained shipments. 

There are of course more limitations like de minimis shipments, the number of banned entities vs the wider market and lack of harmonious legislation from other countries which have led to many questioning the act’s effectiveness. However, the Department for Homeland Security recently held a hearing and concluded plans for tougher enforcement by the US CPB to address said limitations, which are set to come into place in the coming months. It’s probably too soon to comment on the effectiveness of the new measures but I can only see this as enhancing the enforcement.

There are possibly other contributing factors why the US is importing less Chinese cotton too, like the rise of supply chain legislation globally with a focus on due diligence and disclosure to ensure sustainable and traceable supply chains and avoid greenwashing, with hefty fines for those that fall foul. This will no doubt compliment the UFLPA (Uyghur Forced Labor Prevention Act) in forcing traceability and placing additional onus on the retailer when considering their supply chains. In addition, the former advantage of cheap labour/manufacturing costs in China has somewhat narrowed and so any pricing incentive for a retailer to manufacture or procure from China has also shrunk.

When all said and done, there’s no doubt products containing cotton originating from Xinjiang are still entering the US, but it is far simpler for retailers to avoid such supply chains and risk of goods being detained at US ports of entry and perhaps more importantly any potential reputational damage.

The cotton prices in India right now are the highest in nine months. Do you think the Indian cotton market is too volatile? From the risk point of view, how is Indian cotton being seen as a production point?
Ben Eaves: While spot Indian cotton prices may have seemed volatile, it could rather be defined as not volatile when compared with ICE futures. During the period when ICE futures dramatically broke out of the long-term range rising from roughly 82 c/lb in mid-January to 104 c/lb at the end of February, completing at nearly 27% move, Indian prices only rose by 13%.

For the majority of origins priced and hedged against ICE, spot rates were largely unable to detach from the benchmark or traders would have to wear significant losses. Given the Indian market is largely a fixed price market, spot rates were able to stay competitive.

During February, the widening of the spread between ICE and Indian spot prices inevitably ignited demand for spot Indian cotton from traders and fixed price buyers, particularly in China and Bangladesh. The faster pace of Indian spot sales and increase in exports, together with a slowdown in the pace of arrivals (110k–120k bales/day vs 170k–175k bales/day to meet the production estimate), lead to a perceived tightening of the Indian balance sheet particularly through July to September before 24/25 crop arrivals and therefore one would argue the price increase was justified, and not too far detached from fundamentals like ICE. 

Since the 10 c/lb drop in ICE futures prices, Indian prices have held firm. Again, the price is reflecting the need to ration demand for Indian cotton now.

From a production point of view, growers in India benefit from a generous minimum support price (MSP), therefore risk to producers of volatility is limited. It works like a free insurance policy. If spot rates drop below a certain level, the Cotton Corporation of India, under the ownership of the Government, will buy cotton from a producer to ensure steady cashflow for growers, offering security for growers to be able to continue growing cotton season after season. When prices are above the MSP, growers have the freedom to offer their cotton in a free market. 

Quite some time back, China had started stockpiling a lot of cotton. Even now (according to that latest USDA report), the ending stocks in China are still 50% of the global figures. What do you make of this?
Ben Eaves: Following the 2010/11 season which saw cotton prices spike to their highest ever level, China built up its reserve stocks over the two seasons that followed. During their stockpiling frenzy, stocks peaked at just under 13 million metric tonnes. Since then, the stocks were slowly brought down to levels more aligned with the historical approach, and over the past few seasons China Reserve stocks have ebbed and flowed between 1.5 million metric tonnes and 3 million metric tonnes, following a more rotational policy.

With regards to the USDA figures estimating China accounting for nearly 50% of global ending stocks, it is our view that the USDA is massively overestimating Chinese ending stocks. Our own in-house supply and demand estimates would see the USDA currently overstating China ending stocks by around 2 million metric tonnes, which results from a long term imbalance in the China balance sheet numbers. For the purpose of this exercise, assuming we use the USDA figures for the rest of the world, this would actually put Chinese ending stocks at closer to 37% of global ending stocks. Given China consumption estimates for the current season account for about 33% of world cotton consumption, these numbers should not look too unusual.

The bigger question might be, will the Reserve start to stockpile again, and if so when might they choose to do this. This is anyone’s guess for now.