We have been covering movements in cotton prices for some months now on this 'In the News' blog. In September 2010, cotton prices reached a record high at that time breaching the dollar a pound barrier. One of the features of the cotton market, like many other commodity markets, is the use of futures contracts which can lock in high prices now for deliveries of supplies in the future. The purpose of these futures contracts is to give some certainty to both buyers and sellers and aid planning but if prices continue to rise they can cause problems.
The buyer of the contract to supply cotton at some point in the future at a price agreed today has to ensure that s/he has enough supplies to honour delivery when it comes due. That means that s/he may have to buy cotton at much higher prices to meet the delivery and so risk making significant losses. For this reason, the seller of the contract (the buyer of the cotton) must put up collateral as a sign they will honour the contract. This is called a 'margin call'. As prices rise, the margin that must be put up increases.
Since last October, cotton prices have continued to increase and are now over $2 a pound. This rise in price has led to accusations being made that contracts signed some time ago are not being honoured. In this case it is merchants (buyers of cotton from growers) who are accusing growers of reneging on contracts. Contracts could have been signed between growers and merchants several months ago when the price of cotton was les than a dollar a pound. Growers may have thought the price at that time was 'high; and so would benefit from entering into a futures contract; few would have foreseen the dramatic rise in the price of cotton which has been witnessed since then.
What this means is that some growers will be getting prices far lower than the current market price. At the time they entered the contract the price they got may have seemed attractive but now it does not. There are reports that buyers of cotton are taking legal action against growers in Texas for refusing to honour contracts. Once the trust is broken between buyer and seller the market runs the risk of breaking down. No-one is suggesting that such a thing is happening and it seems that it is a minority who have refused to honor the contracts they have entered into. However, the market as a whole seems to have been rattled by the reports. Some farmers are claiming that it is not dishonour that is making them fail to meet their obligations but simply the fact that they do not have the supplies available after lower crop yields caused by dry weather meant they simply did not have enough cotton to meet their contract.