By pooling their cotton with 70 other growers, Larry Nelson and son Kevin were able to market one-third of their 1998 crop at a strong 63 cents/lb by late May. And they sold the remainder of their pooled cotton by late summer, when drought fear caused the strongest price rally in a year.
Like others, the Nelsons feared that harvest prices would be sub-60 cents, near the government loan rate. High U.S. planting intentions, increased stocks and sagging exports depressed prices. But as spring ended and summer's heat emerged, dry weather in Texas (which has 25% of U.S. production) sent prices up.
The Nelsons took advantage of the market surge and marketed early. The marketing pool, which the elder Nelson established, made price management a lot easier.
They grow about 1,600 acres of cotton in West Texas near Tulia. Larry has an even bigger stake in the region's production - he operates three gins. He developed the pool as a service to the 70 growers who signed up, as well as to generate higher prices for himself and his son.
"We placed half our projected production in the pool," he says. "We then encouraged producers to place half their crop within the program, and then try to beat our price with the remainder of their crop with their own marketing.
"We have at least 18,000 bales in the pool, which gives us a good marketing tool with buyers."
In the pool, farmers contract acres. Nelson estimates the yield. Then, when the market rallies, he fixes a price with buyers based on a certain amount of production and a fixed basis that coincides with December futures. Before harvest, the fixed prices on sales are averaged and growers receive that amount over the loan rate, less the basis.
The average basis for the West Texas region is up to 10 cents/lb under futures. With the large amount of pooled cotton available to buyers, Nelson was able to obtain a favorable basis. In his first pricing when the market rallied in late May, he fixed one-third of the pooled cotton at 71 cent December futures, less the basis. That provided a price of about 63.5 cents.
Another third was fixed in June, at 76 cents.
The pool ended its pricing in August by marketing its final one-third at a futures price above 75 cents.
"That gave us a pool average of about 74 cents," says Nelson. "Our average price to the farmer is about 65 cents."
"We're usually looking for at least a 62 cents net on all our cotton through this program," he says. "If there are even stronger rallies to the 75 cents level, we encourage producers to price more of their cotton in the program."
Besides creating a better marketing program for his operation, Nelson hopes the pool creates better market awareness among farmers.
A first step is knowing when cotton prices will likely be highest. Leading cotton economists say that 10 or more years of historical data indicate that May, June and July are the peak times to sell.
"Even if a grower doesn't have a clue about futures or options, he can forward contract a third of his cotton in May, a third in June and a third in July, and usually be in the top third of the market for the year," says Kim Anderson.
"Historically, that's when prices are most likely to rally," says Anderson, an Oklahoma State University extension economist. "On the other hand, prices historically have already fallen before we get to harvest."
Carl Anderson, Texas A&M University extension economist, agrees, adding that hitting the cotton market is like hitting "a moving target." He likes the pool concept along with other risk management tools.
"First, when the market rallies, get a floor under it before it's gone. But be careful about creating a price ceiling," says Anderson.
He recommends buying New York Cotton Exchange put options for floor-price security.
Dale Stemple, a cotton marketing broker/consultant with Amarillo Brokerage Co., says the Texas drought scare created good marketing opportunities in early summer. December '98 futures jumped to 74 cents-plus, a level that hadn't been approached for months.
"I advised growers to buy puts on half their crop," says Stemple.
On June 1, a 72 cent December put cost 2.3 cents/lb, less commission fees. A 71 cent put was 1.75 cents; a 70 cent put, 1.40 cents.
Depending on how much a grower wanted to spend, that range of puts provided a good cushion for prices, says Stemple. Puts are also an alternative for dryland growers afraid to forward contract their production for fear of drought or other conditions. Growers can buy puts, then take profits if prices fall by either selling the puts or exercising them into short futures positions.
If growers have not marketed all or a portion of their crop and prices have taken their traditional season-end plunge, there are still methods of recapturing a portion of lost profits.
"If harvest prices are low, consider selling the cotton, then buying March or July call options for the following year," says Texas A&M's Anderson.
If prices rally after harvest and into the next year, the call option can be sold back for a profit to help offset low harvest cash prices. This strategy enables the grower to sell his crop to meet financial obligations and not be faced with storage costs while waiting for a higher price.
"It's going to cost $3-5 per bale per month to store the cotton," says Stemple. "I've never seen a situation in which buying a call option didn't out-pay storing the crop."
If harvest cash prices plunge to the mid-50 cent range, a big crop comes in and exports remain low, consider storing cotton as opposed to the call-options strategy, says Kim Anderson in Oklahoma.
"That would likely mean prices were below the loan," he says. "Growers could put the cotton in the loan, then receive an LDP (loan deficiency payment - formerly called the POP), or the difference between the loan rate and the cash price. When the market goes down from the 58 cent loan, they could redeem it at, say 52 cents, then pocket the 6 cent LDP. The LDP could then be used to buy a call and take advantage of any unforeseen rally."