Wool markets in disarray - Spotlight on Markets

Wool Markets in Disarray

On February 1, 1991, the Australian Government canceled wool auction sales for 3 weeks, and on February 11 suspended the Australian Wool Corporation's (AWC) reserve price scheme until the end of the marketing year on June 30. Following Australia's lead, on February 12 the New Zealand Wool Board eliminated its market reserve price and minimum price schemes for the balance of the season. The two Boards will thus no longer operate price support levels at auction and buy wool that fails to reach these levels. As a result, when wool sales resumed on February 25, no market price intervention program was in place for the first time in nearly 20 years in Australia and 40 years in New Zealand. The freely operating wool market determined the price of wool according to supply and demand factors.

As expected, the Australian market indicator price dropped from its close of A704 cents to A454 cents per kilogram clean, or by a sharp 35 percent (10). The drop in New Zealand's market was less drastic. The price fell from NZ395 cents to NZ357 cents on the first trading day, representing a real fall in the price to wool growers from the minimum guarantee of NZ485 cents to NZ357 cents, or nearly 26 percent (8).

By the end of the first week of free market wool sales in Australia, the market indicator price had dropped to A428 cents (US$3.35), while that of New Zealand was NZ347 cents (US$2.16). In the second week, prices closed at A445 cents and NZ357 cents. In South Africa, the wool market reopened in the first week of March with prices generally following the Australian market. The South African market indicator price fell SA403 cents to close at SA947 cents (US$3.68).

In Australia, the Government agreed to lift the ceiling on its guarantee of AWC borrowings to only A$3.5 billion and extend its guarantee on all borrowings beyond 1992 until debts were reduced. Also, the Government agreed to contribute A$300 million toward a supplementary payments scheme to growers who sell their wool during the remainder of the season. Supplementary payments will make up the difference between the new auction price and the A700-cent reserve price level. The Government also agreed to provide additional funds for debt reconstruction, farm improvement, household support, counselling, and assisting individual farmers.

After deliberating what course to follow in the new marketing year beginning July 1, the Government on May 1 announced the permanent abolition of the wool price scheme. Moreover, the Government announced a reorganization of the industry, replacing the old AWC with three new statutory bodies: a new institution called the Australian Wool Corporation to be responsible for marketing and quality control; a Wool Research and Development Corporation; and a Wool Realization Commission, which will dispose of stocks. Sales from the stockpile, which had been frozen in February, will resume on July 1, with revenues going to pay off the old AWC's back debt (1).

Effect of Wool Price

Liberalization

Wool price liberalization is considered a significant forward step in providing substantial benefits for the industry, the individual growers, users, and taxpayers in Australia, New Zealand, South Africa, and elsewhere. In addition, the new policies ended uncertainties created in wool markets that had induced most buyers to wait before making purchases.

Fluctuations in wool prices are nothing new. They made a dramatic jump from 1986 to 1988, to the highest level in 30 years (fig. 1). In May 1988, the price of fine wool used for high-quality clothing and apparel peaked at US$13.04 per kilogram clean weight, CIF London. The price was triple the level of the trough 21 months earlier (August 1986). The price for coarse wool used mainly for carpets and rugs rose a relatively modest 60 percent from January 1986 to October 1988. The 1986-88 price increase for fine wool was still below the trough-peak surge that occurred during the international commodity price boom of the 1973 oil crisis. Between 1971 and 1973, the price for fine wool nearly quadrupled and coarse wool tripled.

High prices for wool, among other factors, have exerted a strong downward pressure on the quantity demanded since June 1988. The price level reached in 1988 was unsustainable, causing a slump in the market, especially for fine wool. Between May 1988 and January 1991, prices declined 43 percent for fine wool. Between August 1988 and January 1991, prices declined 47 percent for coarse wool (fig 2).

Australia's Role in Wool

Markets

Australia, the largest wool producer and exporter, takes a leading role in setting prices in world markets (figs. 3, 4, and 5). At the beginning of the 1988/89 season, the AWC set the minimum support price at A870 cents per kilogram clean for a weighted average of 13 wool categories. The new AWC support price was 35 percent higher than a year earlier, and 85 percent above 1984/85. The AWC's justification for raising the price floor was to cope with the depreciated value of the Australian dollar, especially in Australia's main wool markets in Western Europe. Over the last 5 marketing years (1984/85 to 1989/90), the depreciation of the Australian dollar was 42.8 percent against the German Mark, 41.7 percent against the yen, 25.9 percent against the pound sterling, and only 1 percent against the U.S. dollar.

The high Australian support price spurred domestic and foreign production. The increased production, combined with a slowdown in world consumption, forced the AWC to accumulate stockpiles of surplus wool to protect the price support level from moving below its set level. On May 31, 1990, the Government decided to intervene by lowering the floor price for wool 20 percent to A700 cents. In addition, the Government raised the wool levy charged by the AWC from 8 percent to 18 percent of growers' revenue on June 1, 1990.

The Government's objective was to increase significantly wool sales and stabilize prices. However, the new measures proved to be insufficient. In the 1990/91 season (which started in July 1990), demand was sluggish and prices continued to move only a few cents above the A700-cent floor price, indicating a fundamental weakness in the price structure. Consequently, the AWC was obliged to purchase more wool, swelling its stockpiles from 3.06 million bales on July 1, 1990, to nearly 4.8 million in January 1991. Moreover, financial activity by the AWC in defense of floor prices depleted its huge reserves, and it resorted to borrowing, exceeding the maximum Government guarantee level of A$2.5 billion, and reaching an all-time high of A$2.8 billion.

In October 1990, the Government again increased the wool levy, from 18 percent to 25 percent of growers' revenue. The new legislation also included a provision for a maximum wool levy up to 30 percent and a surcharge on the wool tax of up to 20 percent from the beginning of the 1991/92 season, if necessary. In November 1990, the Government approved a proposal to slaughter 20 million head out of a national flock of 173 million, and imposed quotas to cut overall wool production by 25 percent over the 12 months beginning July 1991.

The AWC reportedly wanted the floor price scheme to continue, but the Government balked at forecasts from the Australian Bureau of Agricultural and Resource Economics that stockpiles would rise from 4.8 million bales to 8.7 million over the next 2 years, requiring an increase in the AWC's federally guaranteed debt from A$2.8 billion to about A$4 billion (5).

Changes in Market

Fundamentals

The decline in wool prices since May 1988 was basically a result of changes in supply and demand fundamentals. Usually, when demand is exceptionally high, a rapid increase in price acts as a useful rationing device; some buyers drop out of the market and some substitute other fibers for wool. Five major factors can be pinpointed as influencing the current world wool market: (1) A deceleration of economic growth rates in the Organization for Economic Cooperation and Development (OECD) countries; (2) the economic situation in China, the USSR, and Central Europe; (3) competition from man-made fibers; (4) record world wool stockpiles; and (5) actions of the AWC.

Deceleration in OECD

Economic Growth Rates

A slowdown in economic growth in OECD countries, the principal wool consumers, is usually accompanied by decreasing expenditure on clothing in general and wool clothing in particular. For example, the recent deceleration in economic growth rates in Western Europe depressed consumer expenditures for clothing. This was reflected in a 5-percent decrease in wool textile manufacturing in the first quarter of 1990 for the 11 OECD countries for which data are available (11). The industry contraction started in worsted processing, but later spread to combing and weaving.

Consumption of raw wool in the EC, the world's largest single market, declined by 3.7 percent from its level 2 years earlier (table 1). Japan also cut imports because of its large wool reserves and increased imports of intermediate and finished wool textile products from low-cost manufacturers in other Asian countries. In 1989, U.S. and Japanese wool use was low, 5.5 and 4.0 percent, respectively, below 2 years earlier. The setbacks in Europe and Japan substantially built up wool stocks at the producer, industry, wholesaler, and retailer levels, and caused a further slowdown in the demand for raw wool. [Tabular Data Omitted]

The Economic Situation in

China, the USSR, and

Central Europe

Recent political changes in China, the USSR, and Central Europe created a chain of economic events with a substantial impact on world demand for wool. Consumption in these countries was 40 percent of the world total in 1989, down from 41.5 percent in 1988 (table 1). Import demand was 21.3 percent of the world total, down from 25.7 percent in 1988.

From 1978 to 1988, China had been the fastest growing wool market and importer in the world. However, following the Tienanmen Square events of June 1989, China's import demand for raw wool and wool semi-manufactures (tops, yarn, and fabric) was weakened by foreign exchange shortages. Consequently, during the 1989/90 season China's wool imports dropped by 44.3 percent, forcing its wool textile industry to operate far below capacity (table 2). In addition, a large proportion of wool tops and yarns that were ready for shipment to the Chinese market in 1989/90 ended up instead in storehouses, or were sold below cost. This created excess capacity in several wool processing countries, and cut their import demand for raw wool.

A shortage of foreign exchange also hampered the USSR, where wool imports in 1989 were approximately 15 percent below 2 years earlier (table 2). Before 1989, wool imports had not grown sufficiently to compensate for the declining size of the national flock and domestic production. In addition, the USSR failed to repay some debts to wool exporters in Australia and New Zealand, causing trade to stop near the end of the 1989/90 season. In Central Europe, import demand for wool decreased 9.3 percent below the previous year due mainly to political and economic upheavals, and lack of foreign exchange. [Tabular Data Omitted]

Competition From Other

Fibers

In reaction to the record prices for wool, fabric manufacturers switched to substitutes containing mainly cotton and man-made fibers. At the same time, technical developments in the manufacture of man-made fiber and in the processing of cotton knitwear provided a wide range of texture choices and caused more substitution.

Synthetic fibers are the major competitor for fine wool types in manufacturing worsted yarn. As a result, for the first time in 6 years, consumption of man-made fibers has gained at the expense of natural fibers, to the point that overall wool consumption in nine reporting countries was 2 percent lower in the first quarter of 1990 than in the first quarter of 1989, with a corresponding rise in competing man-made fibers (11).

Record World

Wool Stockpiles

By the end of the 1989/90 season world wool stocks rose to nearly four times their beginning level, exerting substantial downward pressure on prices. In Australia during this period, wool stocks rose an unprecedented 16 fold, from 188,300 bales to 3,037,381 bales. These stocks far surpassed the 1974/75 record of 1,616,200 bales. New Zealand faced a similar situation, with stocks held by the Wool Board quintupling during the season, and reaching the highest level since 1982. Also in South Africa and Argentina, stocks rose substantially (11).

Since the beginning of the current season on July 1, 1990, till the end of January 1991, wool stockpiles continued their trends. In Australia, stocks reached 4,765,627 bales, in New Zealand nearly 700,000 bales, and in South Africa 272,989 bales (10).

Action of the Australian

Wool Corporation

Wool marketing in Australia used to be conducted directly by brokers representing producers through auctions to the agents of overseas buyers. Auction sales were run privately and freely, not subject to direct export regulations or control. In 1973, however, the Australian Wool Board joined the Australian Wool Commission to establish the AWC.

The AWC took a leading role in determining and operating a reserve price scheme for individual qualities of wools. It established the floor price in consultation with the Wool Council of Australia, which represents the 60,000 growers who funded the effort by contributing a percentage of their wool income as a levy. These levies were used to promote marketing, research, and to finance the floor price scheme for growers. The AWC bought wool at auction when bidding was below the floor price, and resubmitted the stockpiled wool to the market when prices improved or the agreed-upon price was reduced. Wool boards in New Zealand, South Africa, Argentina, and Uruguay usually maintained reserve prices at levels equivalent with the AWC, after adjusting for quality differences and the conversion factor to clean wool.

Outlook for Wool Supply

and Demand

In the short run, factors influencing supply/demand forces in the international market for raw wool indicate wool prices will remain low. On the demand side, prospects for import growth in major markets of Western Europe, Japan, and the United States remain dim. With current stocks high in relation to world production and consumption, any pickup in demand along the wool textile pipeline should be reflected relatively slowly in auction trade offerings and prices. Labor costs in the textile industry favor imports of intermediate textile goods and finished clothing and apparel. In addition, demand by the critical importing regions of China, the USSR, and Central Europe, while less predictable, has been sluggish and is likely to remain so during the balance of the 1990/91 season, mainly due to slowdowns in economic activities and lack of foreign exchange.

On the supply side, world production is forecast to increase by nearly 1 percent at the end of June 1991 over the previous year (2). Over the longer run, world wool production will most likely decrease because of the Australian Government's abolition of the floor price scheme, cutting the size of the national flock, and imposing production quotas. These measures will most likely induce a major structural adjustment of the wool industry in Australia and other major producers. In Australia, the direct impact will be to reduce farmers' returns from wool, restrain growth in domestic production, and make growers switch to growing other, more profitable crops over the next few years. Wool production is expected to increase in China, the EC, and other small markets. However, these countries' wool production is mainly of coarse types. Consequently, imports of fine types will accelerate, where consumers demand more and higher quality textiles as their incoming rise.

References

[1]. "Australia Will Abandon Wool

Price Scheme." The Journal of

Commerce, May 1, 1991.

[2.] Australian Bureau of Agricultural

and Resource Economics

(ABARE), Agriculture and Resources

Quarterly, Vol. 4, Canberra,

1990. [3.] . Commodity

Statistical Bulletin, Canberra,

December 1990. [4]. . "Submission

to the Wool Review Committee,

Wool Price Stabilisation," Canberra,

Australian Government Publishing

Service, December 1990.

[5]. Brown, Kevin. "Australia Abandons

Wool Price 'Floor'," Financial

Times, February 12, 1991.

[6.] Bureau of Agricultural Economics,

Wool Situation and Outlook 1985,

Canberra, Australian Government

Publishing Service, Canberra

1985.

[7]. Commonwealth Secretariat International

Wool Textile Organization.

Wool Statistics, London,

June 1990, and previous issues.

PHOTO : FIGURE 1 Wool Prices Ran Up in 1987

PHOTO : FIGURE 2 Recently, Wool Prices Have Plunged

PHOTO : FIGURE 3 Wool: Australia Top Exporter, EC Top Importer

PHOTO : FIGURE 4 Australia Produced Nearly a Third of the World's Wool in 1989/90

PHOTO : FIGURE 5 Australia Dominates in Fine Wool Production

PHOTO : FIGURE 6 Raw Wool Consumption Expands and Shifts

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