July 20, 2006

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COLLEGE STATION – Severe drought that has decimated portions of Texas' cotton crop is causing many growers to evaluate insurance alternatives.

One alternative is to hedge the risk to countercyclical payments using the futures market, said a Texas Cooperative Extension expert.

"December futures slipped below 55 cents in late June," said Dr. John Robinson, Extension cotton marketing economist. "While this isn't a good thing for growers, it does present a viable situation for hedging countercyclical payments. If futures rise above 56 cents, countercyclical payments begin to erode at that point."

Hedging countercyclical payments is a timely move, Robinson said, as many growers don't have cotton in the fields. With the recent dip in the cotton futures market, buying a 56-cent call option is "reasonably affordable."

"It's like buying some inexpensive insurance," Robinson said.

After record-setting production in Texas the past two years, the 2006 crop is shaping up to be one of the worst. Texas cotton yielded 8.44 million bales in 2005, but half that harvest amount is predicted this year.

"It's just going to be a huge drop from the previous year," Robinson said.

The scenario is much like the one caused by the 1998 drought, only the weather and crop conditions appear to be worse, Robinson said.

Coupled with U.S. Department of Agriculture projections of lower 2006-2007 stocks and a possible 5 percent to 7 percent reduction in domestic stocks-to-use, Robinson said the potential is ripe for December 2006 futures to trade higher than the December 2005 contract. Those contracts peaked in the upper 50-cent range, he said.

"I think it's reasonable to see the December '06 contracts reach the low 60s, with the biggest caveat being on the demand side," Robinson said.

Harvest forecasts of 20-plus million bales are predicted nationally this year, and abandonment rates could eclipse more than 15 percent, Robinson said.

"If that happens, it all boils down to a forecast for higher prices," he said.

Cotton producers can stay updated with current market trends on the Web. Robinson distributes a weekly cotton marketing planner newsletter at http://agecon2.tamu.edu/people/faculty/robinson-john/index.html.