Cotton price reform opens up space for futures market innovation, price fluctuations will become the norm

“The most core effect released by the cotton target price reform pilot is that the market mechanism is gradually playing a decisive role in cotton price formation.” Zhang Fan, chairman of the Zhengzhou Commodity Exchange, said this at the recently held “2014 Zhengzhou Agricultural Products (Cotton) Futures Forum.” He introduced that many positive changes have appeared in the cotton futures market, such as the convergence of cotton futures and spot price trends, and the obvious narrowing of the China-US cotton price spread, from a maximum of more than 6,000 yuan per ton to about 2,000 yuan at present.

“The futures market has the functions of price discovery and hedging, and plays an irreplaceable role in improving the agricultural product price mechanism.” Wang Xiaobing, deputy director of the Market and Economic Information Department of the Ministry of Agriculture, pointed out that the cotton target price reform pilot should not only promote the improvement of the competitiveness of the cotton industry through market-oriented reform, but also provide experience and reference for the establishment of price formation and market regulation mechanisms for other important agricultural products.

Price fluctuations will be the norm

Since the beginning of this year, the downward trend in cotton prices has been very obvious. As of October 16, the China Cotton Price Index fell to 14,792 yuan/ton, down 13% since the end of August. During the same period, the main Zhengzhou cotton contract was 13,635 yuan/ton, a decline of 4.3%. “Without the support of temporary purchase and storage prices, domestic cotton prices will gradually return to the market under the target price.” Wang Jianhong, deputy secretary-general of the China Cotton Association, said that cotton demand is expected to show recovery growth, estimated at 8.5 million tons, but whether this volume can actually be reached from the current market still depends on many factors.

Cheng Guoqiang, secretary-general of the Academic Committee of the Development Research Center of the State Council, pointed out that the current cotton market should adhere to the principle of market pricing, improve the price formation mechanism, let the market determine prices, reduce policy intervention as much as possible, and prevent policy implementation from evolving from production support to income support, that is, from coupled subsidies to decoupled subsidies. “It is necessary to implement the principle of subsidizing whoever plants, subsidizing more for planting more, and not subsidizing those who do not plant, so as to ensure the enthusiasm of growers.”

Cotton enterprise representatives attending the meeting believed that the target price policy not only protects the interests of cotton farmers, but cotton textile enterprises will also bid farewell to the era of high-priced cotton. “The target price policy helps straighten out the price relationship between cotton and textiles, enabling textile mills to restore and improve their competitiveness.” said Wang Wanxiang, general manager of China Cotton Group Co., Ltd.

Letting the market determine prices, this year's cotton price fluctuations will be the norm. It should be said that the operating risks of cotton textile enterprises have also increased compared with before. “The increase in spot operating risks has precisely left huge space for futures. Enterprises can use the futures market to discover prices, avoid risks, diversify risks, and lock in costs. The agricultural product futures and spot markets will be more closely integrated.” said Ren Xingzhou, director of the Market Economy Research Institute of the Development Research Center of the State Council.

Futures market innovation has a long way to go

“Only by improving China's futures market will domestic cotton enterprises have a stronger market awareness and accelerate integration with international standards.” Ma Wensheng, chairman of Xinhu Futures, believes that only when the futures market provides hedging protection can enterprises expand their scale, continuously carry out industrialization exploration, and expand their own distinctive business models.

Yan Feng, general manager of Hubei Yinfeng Cotton Co., Ltd., believes that in recent years the company has adopted two models to organically combine the futures market and the spot market. One is the “company + base + cooperative + cotton farmer” model, and the other is the “order + spot + futures” model. “The biggest highlights of the two models are, first, taking the base as the foundation to radiate to the surrounding areas and linking thousands of cotton farmers through cooperatives; second, using forward contract price hedging. For example, when the seed cotton purchase price is higher than the market price, risks can be locked in through market hedging.”

The target price reform for agricultural products has already broken the ice, and innovation in the futures industry will also catch up. Zhang Lei, general manager of CITIC Futures, said that if this cotton target price subsidy policy is viewed from the perspective of over-the-counter options, it is equivalent to a pulse-style put option. “The market has sold a put option on the subsidy price to all large cotton growers, but whether this option can be obtained depends on the government's implementation.” He believes that innovation in the futures industry should move from simply providing enterprises with hedging tools to providing industrial institutions with richer risk management tools and providing enterprises with diversified risk management products.

“In addition to cotton and cotton yarn futures, cotton futures options should also be launched as soon as possible. Only with complete tools can market institutions choose risk management methods according to their own needs.” said Yao Guang, general manager of Galaxy Futures. The target price policy is the first step in innovation. In the future, the cotton futures price may be used as a benchmark, and after considering factors such as planting and circulation, a certain range of premiums and discounts may be added, using flexible prices to optimize the target price so as to further advance the market-oriented pricing mechanism.

Wang Xiaobing, deputy director of the Market and Economic Information Department of the Ministry of Agriculture:

China's cotton improved seed subsidies and temporary purchase and storage have effectively promoted cotton production and market stability. Under policy guidance, this year's cotton area will be reduced to more than 63 million mu, with output of about 6.5 million tons, probably less than last year's output, but yield per unit area and quality have both improved.

Liu Keman, director of the China Cotton Reserve Information Center:

Under the new policy thinking, the cotton reserve policy must also make corresponding changes in regulatory objectives, regulatory methods, and regulatory mechanisms, adjusting supply and demand when necessary to make up for market failure, safeguard industrial security, and make regulatory methods more market-oriented.

Wang Jianhong, deputy secretary-general of the China Cotton Association:

The future development direction of China's cotton industry: In terms of production methods, increase the scale and mechanization of cotton production, encourage the development of e-commerce and modern logistics, and reduce logistics costs. In terms of demand, the domestic self-sufficiency rate should be maintained at about 2/3.

Cheng Guoqiang, secretary-general of the Academic Committee of the Development Research Center of the State Council:

The reform of the agricultural product price formation mechanism will develop in three directions: first, improving the minimum purchase price policy for wheat and rice; second, exiting temporary purchase and storage at an appropriate time; third, accelerating the establishment and improvement of risk management tools such as agricultural product futures.