Wool

Caroline Gunning-Trant

The demand for wool has been severely affected by the global economic downturn, which has caused the eastern market indicator (EMI) price for wool to fall significantly this season. In November 2008, the EMI reached a two and a half year low of 723 cents a kilogram clean. The demand for wool began to show some signs of recovery in March 2009, given the sustained growth in the Chinese domestic retail sector and dwindling stocks in the wool processing pipeline. Between March and May 2009, the EMI increased 15 per cent despite the concurrent appreciation of the Australia to US exchange rate. Against this backdrop, the EMI is estimated to be at 795 cents a kilogram clean, which is 16 per cent lower in 2008-09 than the previous year.

In 2009-10, the EMI is forecast to be 820 cents a kilogram clean, which is a 3 per cent increase from the current financial year. This is an upward revision to the price forecast presented in the March quarter 2009 Australian commodities and can be attributed to expected strong growth in Chinese domestic retail sales combined with a downward revision of Australian shorn wool production.

A couple of factors mitigate any greater increase in the price for 2009-10. First is the continued effect of the global recession on retail spending in OECD countries. While there are tentative signs of recovery in several OECD countries, retail spending is expected to remain subdued through 2009 and into 2010 given increasing unemployment rates and the effect on consumer confidence. Lower retail sales growth will continue to have an effect up the supply chain, with total demand for raw apparel wool expected to remain weak in 2009-10. The second factor which could put downward pressure on the EMI is the assumed appreciation of the Australian dollar relative to the US dollar in 2009-10, which causes wool to be more expensive for foreign buyers.

Chinese retail demand supporting prices

Between July and early November 2008, the EMI dropped by 151 cents, or 17 per cent, as the global economic downturn caused demand to fall significantly. The decline in demand is best reflected in the price of wool in US dollars, the principal currency in which wool is traded on international markets. Between July and November, the decline in the EMI in US dollar terms fell from US840 cents a kilogram to US485 cents a kilogram, a fall of 42 per cent.

The EMI fluctuated around US500 cents a kilogram throughout the Australian summer, a price not seen in almost three years. The drop in the underlying demand for wool reflected the outlook for the global economy and more specifically for consumer spending in the large industrialised economies of the United States, the European Union and Japan.

While demand for China’s apparel exports has fallen sharply with the global recession, domestic retail demand has grown strongly. Retail sales in China grew by more than 21 per cent in 2008, with year on year growth in November and December (the two months following the global financial crisis) still at 21 per cent and 19 per cent, respectively. Between January and April 2009, retail growth grew by an average rate of 15 per cent year on year and is expected to average about 14 per cent for 2009 as a whole. While 7 percentage points lower than 2008, this growth rate is significant and has been credited in large part to the Chinese Government’s fiscal package of US$585 billion. It is assumed that Chinese domestic demand will be the principal driver of demand for Australian exports of raw wool in 2009-10.

In the major apparel importing and consuming economies of the United States, the European Union and Japan, retail sales have been severely affected by the global recession because of increasing unemployment rates and the drop in consumers’ incomes. With only a modest improvement in retail sales in these economies expected toward the end of 2009, import demand for apparel will remain sluggish. Since the demand for raw wool is derived from the demand for apparel, this outlook will put downward pressure on the demand for raw wool from Australia’s two major export markets, China and Italy, in 2009-10.

Smaller sheep flock pushing down wool production

In 2008-09 the relative price of sheep meat to wool increased markedly. Demand for sheep meat persisted despite the global economic downturn and this was clearly reflected in the sustained rise in saleyard prices for lambs and sheep. Over the same period, wool prices declined significantly. As a result, producers turned off a large number of lambs, as well as non-breeding adult sheep which had previously been retained for wool production. Against this backdrop, shorn wool production is estimated to fall by 13 per cent in 2008-09, to 355 000 tonnes.

This estimate has been revised downwards since March 2009 because of prolonged dry conditions for most of the season in south-east Australia and an upward revision to the number of lambs slaughtered.

The lower number of non-breeding adult sheep in the flock and the greater proportion of ewes joined to terminal sires are expected to be the principal factors keeping the cut per head unchanged in 2009-10, at about 4.25 kilograms a head. Given the downward revision to the size of the national flock to nearly 70 million head by the end of 2009-10, it is forecast that shorn wool production will fall to around 330 000 tonnes, a 7 per cent decline relative to 2008-09 and the lowest since 1925.

The effect of the widespread autumn rainfall across most parts of the wheat-sheep zone, with the exception of Western Australia, is likely to improve pasture availability relative to last season. This could have a slight positive effect on cut per head, as well as provide an incentive for producers to turn off fewer sheep despite the high prices being offered.

China’s export share increasing

Between July 2008 and April 2009, the quantity of greasy wool exported was 8 per cent lower, and export values 18 per cent lower, compared with the same period last season. The largest decline occurred in November and December following the global financial crisis, when export volumes fell nearly 25 per cent compared with a year earlier. This decline reflected expectations about future consumer spending at the time.

Following the three week auction close over the Christmas break, stronger than expected retail sales growth in China and dwindling stocks in the wool processing pipeline led to a typical two month surge in demand.

Interestingly, excluding November and December, total export volumes of greasy wool between July 2008 and April 2009 only fell less than 4 per cent. More than 71 per cent of the shipments over this period were destined for China, an increase of 7.9 percentage points year on year, as European demand for Australian wool fell significantly.

In 2008-09 the total volume of wool exports, which includes shorn wool, semi-processed wool and skins expressed as greasy wool equivalents, is estimated to be 10 per cent lower than 2007-08 at 442 000 tonnes. This estimate reflects the lower supply of wool available given shorn wool production and relatively low stocks of wool on-farm and in brokers’ stores. Given the decline in wool prices, export returns in 2008-09 are estimated to be $2.29 billion, 18.3 per cent lower than last season.

In 2009-10, total exports of wool are forecast to fall by a further 8 per cent, to 405 000 tonnes, in line with the decline in shorn wool production. China will continue to be the primary export market for Australian shorn wool. However, the export share is expected to decline slightly as European buyers are expected to be more active in the market in the second half of the season. Export returns are forecast to fall by 7 per cent to $2.12 billion in 2009-10.

Wool remains competitive during economic downturn

The global economic downturn has affected the price of wool and the prices of those fibres with which wool competes. As discussed above, the price of apparel wool has fallen significantly since the beginning of 2008-09. However, the competitiveness of wool is not determined by its price in absolute terms but by its relative price to other fibres, namely cotton and polyester. Since January 2008 there has been a general downswing in the wool to Cotlook ‘A’ and wool to polyester price ratios, as the price of wool has fallen proportionately more than both of these fibres. This means wool has become increasingly more competitive relative to cotton and polyester.

The Cotlook ‘A’ indicator price fell more than 30 per cent between July 2008 and March 2009 before regaining some ground through May. Over the same period, the wool to Cotlook ‘A’ ratio has been quite variable: decreasing from an above-average level at the beginning of the season to an eight year low in January 2009, before regaining ground by the end of May 2009. Between July 2008 and May 2009, the average wool to Cotlook ‘A’ price ratio was approximately 25 per cent lower than over the same period a year earlier at 4.2:1, and 11 per cent lower than the 2000 to 2008 average. In 2009-10, the forecast modest strengthening of the price of wool relative to the stronger forecast for the Cotlook ‘A’ indicator price is expected to result in a decline in the wool to Cotlook ‘A’ ratio to approximately 3.8:1, which will further increase wool’s competitiveness relative to cotton.

The average price of polyester staple fibre also declined in 2008-09. This reflected weak consumer demand as well as the fall in petroleum prices, a key component in the production of polyester. Polyester prices fell by about 20 per cent between July 2008 and April 2009, although like cotton, they were quite volatile. The wool to polyester price ratio averaged 3.1:1, nearly 15 per cent lower than the 2000 to 2008 average ratio of 3.6:1. This reflects the relatively steeper decline in wool prices to polyester. Assuming polyester prices will increase roughly in line with crude oil prices in 2009-10 (as per the historical trend), it is expected that the wool to polyester ratio will decline further in 2009-10 given wool’s more modest forecast price increase.

Wool outlook
			2007-08	2008-09	s	2009-10	f	% change
Sheep numbers		million	77	73		70		– 4.1
Sheep shorn		million	94	84		78		– 7.1
Wool production (greasy)
– shorn		kt	408	355		330		– 7.0
– other		kt	39	34		31		– 8.8
– total		kt	447	389		361		– 7.2
Wool exports (balance of payments basis)
– volume (gr. equiv.)		kt	492	442		405		– 8.4
– value		A$m	2 796	2 285		2 118		– 7.3
Market indicator (clean)
– eastern		Ac/kg	945	795		820		3.1
– western		Ac/kg	947	763		795		4.2
Auction price (greasy)		Ac/kg	599	500		525		5.0