ICAC: Defaults raise cotton value chain costs

Record volatility in cotton prices during 2010/11 caused a surge in the number of contract defaults, disputes and arbitration cases. A record number of disputes related to contract performance, weight and quality erupted during 2011 in the cotton supply chain, from farmers to merchants to textile mills. Cotton prices were rapidly rising during the first half of 2010/11. The Cotlook A Index rose from mid 80 cents per pound at the start of August 2010 to a record 244 cents per pound on March 8, 2011. This unprecedented increase in prices caused a large number of growers in the USA, India (associated with a government ban on exports), Greece, Tanzania and other countries to default on cotton contracts, to delay delivery, or to deliver smaller quantity and lower quality than had been agreed in contracts with merchants.

Starting in mid-March 2011, cotton prices began declining, stabilizing close to US$1 per pound by the start of 2011/12. During this period, defaults by mills holding high priced contracts picked up substantially. It is estimated that Bangladesh alone defaulted on 150,000 tons of cotton causing losses to the trade estimated at US$150 million. A large number of defaults were also reported in Vietnam and Indonesia.


It is indicative that cotton associations are reporting an increased number of arbitration cases initiated during 2010/11. The International Cotton Association (ICA) reported that during January-November 2011, 224 arbitration cases were filed, compared with 80 cases filed during 2010 and an average annual volume of about 45 cases. The previous peak of 104 arbitration cases filed with the ICA was in 2006. For all of 2011 the number of arbitration cases could reach 250.

It is expected that the number of firms reported to have failed to fulfill arbitration awards will also grow and will appear on the CICCA (Committee for International Co-operation between Cotton Associations) default list during 2012. The most recent CICCA default list has 420 firms. During 2010, 13 firms were added to this list by all member association compared with 25 firms added during January-October 2011. The most recent sharp increase in the CICCA default list was recorded in 2009, when 71 firms were added. After a sharp price spike in

March 2008 caused mostly by speculation, many cotton-trading companies were weakened financially and were not able to fulfill their contractual obligations, or went out of business. As a result, the number of contract defaults and arbitration award defaults rose sharply and were reflected on the CICCA default list in 2009.

Many trading companies suffered substantial losses because of contract defaults, which were widespread during 2010/11. Noble, one of the largest commodity traders reported a net loss of US$17.5 million during the third quarter of 2011 compared with a net profit of US$157.2 million a year ago. This is the first loss by the firm in 14 years and it was caused by defaults on cotton contracts. Other large multi-commodity trading firms like Louis Dreyfus, Glencore, Cargill, Olam and others, could have incurred higher costs due to cotton contract non-performance by suppliers.

Losses suffered due to defaults could be in the billions of U.S. dollars. The value of world cotton production in 2010/11 is estimated at US$90 billion. Even if defaults were associated with just 2.5% of world production, the value of cotton involved would be US$2.25 billion. There are some estimates indicating that up to 10% of world production is involved, valued at US$9 billion. Not all of this value translates into losses as hedges placed by merchants could limit losses. A large number of contracts were re-negotiated.


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