Study on a Price Mechanism for the Ghana cotton Sector

Transcription

1 Ministry of Agriculture Ministry of Trade and Industry Republic of Ghana Study on a Price Mechanism for the Ghana cotton Sector Final report Nicolas Gergely and Aly DIallo December 2011 The World Bank European Union i

2 Table of content 1 Introduction: Context of the mission and situation of the cotton supply chain in Ghana General presentation of possible seed cotton price mechanisms Objectives and expected characteristics Examples of price mechanisms in Western Africa Burkina Faso Togo Mali Other examples in Africa for countries with a zoning system Proposed principles of the price mechanism in Ghana The projection basis for the initial price Production cost of seed cotton Cost and return per zone and per farming system Needs of labor Farm budget and return to labor Details of farm budget The details of farm budget (with fertilizers subsidized) per zone and per farming system in Ghana are presented in annex Global cost and return and comparison with other West African countries Possible ways to improve competitiveness at field level Costs of cotton companies Methodology Input costs Variable costs Fixed costs Fees for the use of the GCCL ginneries Estimated results of the 2011/12 season Proposed price mechanism Specific constraints on the price mechanism in Ghana Principles and calculation of the initial and final prices Possible share of FOB price allocated to producers World market prospects Results of the simulation Required size and replenishment of the stabilization fund Price formula Comparison of prices given by the new mechanism and past prices paid to producers ii

3 6 Operation of the price mechanism and of the stabilization fund Operation of the price mechanism Revision of the mechanism Operation of the stabilization fund Initial funding Annex 1: Detailed cost calculation for cotton companies 37 Annex 2: Draft AGREEMENT ON THE PRICE MECHANISM..40 Annex 3: Detailed calculation of production costs 45 Annex 4: terms of reference..49 List of tables Table 1 : Expected performances of the cotton companies for the 2011/12 season... 1 Table 2 : Ginneries used by the 3 cotton companies in 2011/ Table 3 : credit package by company Table 4 : Estimate of variable costs in Ghana and comparison with West African countries Table 5 : Estimated transport costs for the three companies (GHC/ton lint cotton) table 6 : Estimated cost and profit for the 2011/12 season table 7 : Theoretical profit of the cotton company (with a producers share of 65% and increased producers share when world prices are below 80 cents table 8 : share of the surplus for the fund replenishment depending on initial and final prices (in Pesewas) table 9: comparison of prices given by the proposed mechanism with past prices paid to producers table 10 : Number of days of operation for Tamale GCCL ginnery table 11 : Theoretical depreciation and capital cost for a new ginnery table 12 : Variable standard processing costs table 13 : unit cost of extension staff table 14 : standard cost of extension network table 15 : Existing extension network for the companies table 16 : Standard administrative costs for a cotton company table 17 : Details of Ghana farm budget (2011/2012) table 18 : Details costs Upper East: tractor land preparation (2011/2012) table 19 : Details costs in Upper East: bullocks land preparation (2011/2012) table 20 : Details costs in North Central: tractor land preparation (2011/2012) table 21 : Details costs in Upper West: tractor land preparation (2011/2012) table 22 : Details costs in Burkina Faso, animal land preparation (2010/2011) table 23: Farm budget in Burkina Faso (2010/2011) List of graphs graph 1 : Comparison between ICAC projections and actual prices of cotton table 2 : Estimate of standard fixed costs for a cotton company graph 3: Evolution of world prices during the 2011/12 season graph 5 : evolution of cotlook index during the five last years graph 6 : Producer price as a function of world prices and producers share graph 7: producer price as a function of world prices with an increased producers share below 80 cents iii

4 graph 8 : profit of cotton companies as a function of production and world prices with an increased producers share below 80 cents List of acronyms CFR FNGPC FOB GCCL GHC GOG GOT ICAC LC MOFA MOTI NSCT SOTOCO SC Cost and Freight Cotton Farmers National Association of Togo Free On Board Ghana Cotton Company Limited Ghanaian Cedi Government of Ghana Ginning Outturn International Cotton Advisory Committee Lint Cotton Ministry of Food and Agriculture Ministry of Trade and Industry New Cotton Company of Togo Cotton Company of Togo Seed Cotton iv

5 PREFACE Following the collapse of the cotton sector during the previous decade, the Government of Ghana has adopted in November 2010 a revival strategy for the cotton sector, based on exclusive zones granted to three private new cotton companies (OLAM in the Upper West, Wienco in the Upper East and Amarjero in the Central Region). Under this new organization (the legal framework of which is still under finalization) each of the three cotton companies provides inputs and technical advises to producers, buys the seed cotton from producers and sells the lint and the seeds on the market. Ginning is, at least for the first season (2011/12), done by the three companies in the former parastatal cotton company s (GCCL) ginneries, against a user fee which is still to be fixed. The three companies started their operation in the 2011/12 season, and the expected total production for this first season is tons (6 500 tons in average for each company). For the implementation of this new sector policy, GOG has requested the assistance of the World Bank, in consultation with other partners. The World Bank s assistance included, among others, the design of a pricing mechanism for seed cotton. Following a first mission, which took place in April, 2011, aimed at proposing a producer s price for the 2011/12 season (first season under the new sector organization), the World Bank commissioned a team of Consultants, under EU AAACP funding, to propose a permanent and sustainable pricing mechanism for seed cotton, applicable to the three zones and acceptable by all parties at stake (the cotton companies, the farmers organizations, the Ministry of Food and Agriculture and the Ministry of Trade and Industry, jointly in charge of the sector supervision). The team in charge is composed of Nicolas Gergely, team leader, and Aly Diallo. The Consultants spent two weeks in Ghana 1. During their stay, they met with the Ministries involved in the supervision of the cotton sector (MOFA and MOTI), the three cotton companies and the farmers representatives. At the end of the mission, a preliminary presentation of the main findings was made to the stakeholders on November 5, Following this mission, a draft report was presented and a workshop was organized in Accra, on December, 14, 2011, with the presence of the two consultants. This workshop was followed by discussions with the farmers representatives and cotton companies on December, 15, on the findings and conclusions of the draft report. These discussions led to amend some of the conclusions of the draft report to make it acceptable by all parties. This final report takes into consideration the comments received by the consultants during the workshop, as well as the discussions held with stake holders on the following day. 1 respectively from October, 20 to November, 6 and from October, 16 to November 2, v

6 Executive summary General presentation of possible seed cotton price mechanisms All cotton sectors in which seed cotton trade is not open to free competition, as it is the case in most West African countries, need some kind of pricing mechanism. It is widely recognized, on the basis of the lessons learnt, that such mechanisms should be as simple and understandable by producers as possible. They should be based on verifiable and non manipulatable data. They should not be disconnected from world prices, but should also result in a fair distribution of risks and profits between producers and cotton companies. The report analyzes the experience of Mali, Burkina Faso and Togo in the operation of such mechanisms. All the three countries have adopted a mechanism based on the allocation to producers of a pre defined share of the FOB price of lint cotton (and also seeds, in the case of Mali), the percentage allocated depending on the specific characteristics and efficiency of the value chain in each country. All three countries have also adopted a dual pricing system, with the initial price (calculated at the start of the season) based on anticipated world market price, and a final price (calculated at the end of the season) based on actual prices during the season. If the final price is above the initial price, a premium is paid to producers. In Burkina Faso, the price mechanism is complex, and aimed at smoothening the impact of world market fluctuations, by basing the initial price on the average world price of the two previous seasons and of the projected price for the coming season. This mechanism includes a smoothing fund, replenished when the final price is higher than the initial price. Mali has a less sophisticated system, with a stabilization fund aimed merely at stabilizing prices between the start and the end of the season. It is replenished when the final price exceeds the initial price, and used to compensate the cotton company in the reverse case. Togo s mechanism is even more simple, as it does not have yet a stabilization fund (although its creation is currently considered). Production cost of seed cotton The credit package for inputs delivered by the cotton companies to producers and for tractor services is in average 335 GHC/ha 2. The seed cotton production cost ranges from 0,63 to 0,71 GHC/kg ($ 0,39 to 0,44/kg), assuming a yield of 1 ton/ha, which is the expected performance in 2011/12 for farmers applying the full input package. Despite subsidized fertilizer, this cost is among the highest in Western Africa, because land preparation is done by tractor (which is very expensive for small and scattered plots), and because the cost of labour is apparently higher than in other West African countries. Costs are higher in the Upper West than in the two other zones, but this is compensated by the fact that this zone has the best yield potential. At the current yield, one can assume that the seed cotton price has to be at least 0,70 GHC/kg in order not to discourage farmers to grow cotton. The production cost decreases however when the yield increases, and a 20% gain in yield would result in a 17% decrease in cost/kg. Productivity gains are therefore essential to the long term competitiveness of the Ghanaian cotton. 2 The cost of the credit package for the cotton company is however higher (368 GHC in average), as some components of the package are charged to producers at their full cost vi

7 Costs of the cotton companies Three types of costs should be distinguished: input costs (which is the part of the cost of inputs which is not charged to producers), variable costs, and fixed costs. The cost of inputs not recovered from producers (which is an implicit subsidy to producers paid by the cotton companies) amounts, for this season to 33 GHC/ha or 98 GHC/ton of lint cotton produced. To this cost should be added the loss on input credit recovery, which is not known for the time being, but should be around 3% of the credit package (or 30 GHC/ton of lint cotton). Those input costs (128 GHC/tone of lint cotton) may vary from season to season, depending on the pricing policy of inputs decided jointly by the cotton companies and the producers. The variable costs of the cotton companies (which do not depend on the volume of production) are estimated on the basis of interviews of the three cotton companies and of comparison with costs of other comparable cotton companies in West Africa. Variable costs amount to 557 GHC/ton of lint cotton ($348), excluding the fee for toll ginning by GCCL. This cost is 4% lower than the current costs in Mali and Burkina Faso, reflecting Ghana s comparative advantage as concerns the cost of energy, the lint transport cost and port and handling charges. Variable costs are 3% higher than the average for OLAM s zone and 3% lower for Armarjero s zone, due to different distances to the port, but this is also compensated by the production growth potentials of the zones. Fixed costs (or administrative and structural costs) are estimated at 2,4 millions GHC per company in 2011/12. The fixed cost per ton of lint cotton is therefore very high in 2011/12 (908 GHC/ton or $568), considering an average production of tons for each of the three companies, but should decrease to 312 GHC/ton once each company reaches a production of tons, considered by the three companies as a reachable target within a period of 2 to 3 years. Such cost would be very competitive as compared to the main West African cotton companies, which are burdened by overcapacity and overstaffing in relation to their recent production decline. In addition to those costs, the fee payable by the cotton companies for using GCCL s ginneries has also to be accounted for, although it has not yet been fixed. Although this is beyond their scope of work, the Consultants suggest that this fee could be a proportion (for instance, 25% for Tamale and Tumu ginneries, which are more than 30 years old, and 50% for Bolgatanga, which is 13 years old) of the full depreciation and capital cost for a new ginnery, which would be around 82 GHC/ton of lint cotton ($ 51). The difference between the fee on cotton ginned in GCCL s ginneries and the full depreciation and capital cost could be paid by the cotton companies as their contribution to the initial funding of the stabilization fund (the expected amount would be in the range of GHC or $ per year for the three companies). On the basis of these costs estimates and of actual and projected world prices during the season (from April 2011 to March 2012), the companies should, despite their high fixed costs, make a small profit of approximately $ 346/ton of lint cotton, provided they were able to sell their lint on the market evenly during the season (as world prices have been following a declining trend). Proposed price mechanism vii

8 The world market prospects are more favorable for the coming years than it was in the past decade, although world prices are expected to continue to decline in the short term from their current level, due to an increase of the world supply. In the medium term, it can be reasonably assumed from ICAC s analyses that prices should vary between a minimum of 70 cents/lb to a maximum of 100 cents/lb. In view of the economic prospects of the cotton value chain, the price mechanism should aim at maintaining an attractive producer price, at least for the start of the revival process, in order to boost production, while giving the cotton companies acceptable profit prospects compensating the risks taken, once they have reached their production target. The mechanism proposed for Ghana is inspired from the Malian model, while remedying its identified weaknesses. The mechanism would be based on the principle that producers should receive a fixed part of the FOB price, after deduction of the input cost (implicit subsidy plus non recovered input credit), which has to be calculated at the beginning of each season, based on agreed input selling prices, input actual costs and evidenced repayment rate of the previous season s credit. The initial price, announced in April, would be calculated as a percentage (X%) of the FOB expected price, on the basis of the ICAC projection 3. The FOB price in GHC is calculated by converting the world price quotation to GHC/kg and by subtracting the costs from FOB to CFR terms of trade, assumed to be 4 cents/lb. In this calculation, ICAC projection would be capped at 100 cents/lb, in order to eliminate extreme situations, for which the predictability of the ICAC model is limited. The initial price is the price paid to producers upon collection of the seed cotton at the village collection point. It applies to grade 1, and the price for grade 2 is calculated on the basis of a discount of 0,1 cedi/kg. The recommended proportion of the FOB price allocated to producers (X%) is the proportion of FOB price which allows the cotton companies to make a normal profit margin of 10% of their turnover for a production of tons of seed cotton for each company (the medium term production objective) and for a world price of 80 cents/lb (average projection), all other variables remaining unchanged. Simulation models show that this proportion is 65%. This proportion would give a producers price of 0,70 GHC/kg of seed cotton for a world price of 80 cents/lb, and a producer price of 0,89 GHC/kg for a maximum world price of $1/lb (assuming that the amount of implicit subsidy on inputs remains unchanged). With such a producers share, the producers price would however fall below 0,70 GHC/kg if world prices fall below 80 cents/lb, which would put the whole value chain at risk, as there would be no more incentive to grow cotton. It is therefore recommended to adopt a rule increasing the producers share when world prices are under 80 cents, in order to smoothen the producer price close to 0,70 GHC: for instance the producers share would be 70% when world prices are under 71 cents, 69% when world price are between 71 and 74 cents, 68% when world prices are between 74 and 76 cents, 67% when world prices are between 76 and 78 cents, 66% when world prices are between 78 and 80 cents and 65% above 80 cents. Simulations show that such a flexible proportion would be acceptable by the cotton companies (which would still break even with a production of tons and a minimum world price of 70 cents, considered as unlikely in the short term). 3 or on the forward Cotlook quotation for index A, if ICAC projection is not available viii

9 producer price (GHC/kg) producer price as a function of world price (with increased producers share below 80 cents) 1,00 0,80 0,60 0,40 0,20 0,00 0,65 0,68 0,70 0,74 0,79 0,84 0, world price (cents/lb) profit/turnover 20% 15% 10% 5% 0% profit of cotton companies as a function of production and world prices (with producers share = 65%) world price tonnes tonnes tonnes tonnes The final price would be calculated similarly to the initial price, but on the basis of the average Cotlook index A (current or forward, depending on the period) during the season, starting in April year N and ending end of March year N+1. This average, converted into FOB price by deducting the FOB to CFR cost (4 cents/lb) is called the reference price. It is the price at which the cotton companies are assumed to have sold their lint cotton. The final producers price is calculated by deducting the input cost from the reference price, and by applying the same producers share ratio (X%) as for the initial price. The mechanism would include a stabilization fund, aimed at stabilizing prices within the season. If the final producers price is lower than the initial price, the cotton companies would be compensated for the difference, provided the amount of the fund is sufficient. Otherwise, the unpaid amount will be a debt of the fund towards the cotton companies. As long as the debt is not paid, the initial price for the following season would be reduced by 5%, in order to reduce the risk for the cotton companies and to generate surpluses. If the final price is higher than the initial price, the difference (called surplus) would be shared between the replenishment of the stabilization fund and the producers, who will receive a premium on the initial price already paid. The share of the surplus to put into the replenishment of the fund would depend on the level of the final price, as a smoothening factor of world prices fluctuations: the share could be 40% for a final price less or equal to 0,8 GHC, 50% for a final price of more than 0,8 GHC and less than 0,9 GHC, and 70% when the final price is above 0,9 GHC. Simulations suggest that this proposed price mechanism is robust within the considered world price limits. If it had been applied in the past five years, it would have resulted in producer prices substantially higher than those actually paid. The parameters used for the calculation of the producers share 4 should be reviewed after a period of 3 years, and the share recalculated accordingly. It is worth noting that the profitability of the cotton companies is impacted positively, although to a minor extent, by any depreciation of the cedi (as income are related to US dollars and most costs are related to import costs). Operation of the price mechanism and of the stabilization fund 4 ginning outurn ratio of 42%, selling price of cotton seeds of $ 180 ex ginnery, total fixed costs of 2,5 millions GHC/company, variable costs of 645 GHC/ton lint cotton (including depreciation of ginneries and capital cost), FOB to CFR cost of 4 cents/lb, exchange rate of 1,6 GHC/dollar ix

10 A draft agreement to be signed by the cotton companies and producers representatives, detailing the regulation of the mechanism and giving the calculation formula and details, is included as an annex to the report. The operation of a price mechanism is typically one of the responsibilities of a cotton sector interprofessional body, the creation of which is currently under consideration. 5 Until this body becomes operational, the mechanism could be operated by an interim committee grouping the three cotton companies, representatives of the cotton farmers associations for the three cotton zones, and two government representatives without voting rights. The entity in charge of the management of the fund should: Collect the data necessary for the operation of the mechanism (ICAC projection, Cotoolk indexes, volume of production of each cotton company, input cost) Apply the regulations and the formula for the calculation of initial and final prices and for the premium and allocation of the surplus to the stabilization fund, when applicable Establish payment orders for the eventual repayment to the cotton companies and for the eventual replenishment of the stabilization fund Verify, after a three years period, the validity of the parameters and, if necessary, modify the producers share accordingly. The stabilization fund should be considered as the property of the inter professional body, or if its creation is delayed, of a cotton stabilization fund association, duly registered, with the three cotton companies and the producers association as members. The fund should be deposited in a commercial bank (to be selected through competitive bidding) within the framework of a management mandate. The bank would be responsible for issuing payment requests or for paying cotton companies, on the basis of the requests sent by the interprofessional body, for verifying the conformity of these requests to the mechanism regulations and for providing the inter professional body with regular statements of accounts. The amount deposited on the fund should be remunerated by the bank at the best commercial interest rate. In order to be operational as soon as created, the fund would need an initial funding, which should be sufficient to cover a 5% gap between the world price projection and the actual average world price. This represents, for a global production level of tons, an amount of $2,2 million (3,5 millions GHC). If the cotton companies agree to contribute, as proposed (see Section 4.4), up to GHC to the fund for the current and the next seasons, the remaining financing need would amount to $ 1,6 million. The Government may want to consider or approach technical and financial international partners, to contribute to the initial funding, as it clearly contributes to the sustainability of a value chain which is essential to reduce rural poverty in Northern Ghana, currently the area of the country most affected by poverty. 5 See Bioche, François, Yaw Owusu Adomah, and Dr Lennox Agobsu (2011). Study to prepare statutory texts for Ghana institutions for the management and regulation of the cotton sector x

11 1 Introduction: Context of the mission and situation of the cotton supply chain in Ghana After a period of progressive collapse of the cotton sector, mainly due to poor sector organization, the Government of Ghana decided in November, 2010 to adopt a revival strategy for the sector. The key objectives of the Government s Cotton Sector Revival Strategy are to: (i) reform the cotton sector and rapidly scale up cotton production; (ii) promote cotton as a cash crop for Northern Ghana similar to cocoa in southern Ghana; (iii) restructure the Ghana Cotton Company Limited (GCCL); (iv) separate the cotton production from ginning functions; and (v) promote and allocate three exclusive cotton zones under concession to reputable and financially strong cotton companies. Following this strategy, GOG entered into a transitional concession contract with three companies, each being given an exclusive zone: - ARMAJARO Plexus Ghana Limited for the North Central Zone covering Tamale, Savelugu, Tolon Kumbugu, Yendi, Bimbilla, Wullensi,Salaga, Bole, Damango, Buipe, Sawla Tuna Kalba and Kpandai. - Wienco Cotton, for the North Eastern Zone covering Kasina Nankana, Tongo/Nabdam, Bawku West, Bawku Municipality, Garu Tempani, Bongo/Builsa, West Mamprusi, East Mamprusi, Bunkpurugu, Gushiegu, Saboba Chrerponi, and Zabzugu. - Olam Ghana Ltd for North Western Zone.The North Western Zone covering Sissala East, Sissala West, Jirapa Lambusie, Lawra, Nadowli,Wa East, Wa West, and Wa Municipality Ghana Cotton Company Limited (GCCL), a parastatal which was previously the main player in the industry has been de linked from production and was expected to concentrate on ginning for the incoming companies under a toll ginning arrangement for the 2011/12 season. The three incoming companies started to select farmers in their respective zones before 2011 planting period, distributed inputs on a credit scheme to farmers, and set up their own extension network to provide technical assistance and supervise their farmers. The expected production performances of the three cotton companies for the 2011/12 season are summarized below (it must be noted that the expected yields are still uncertain as well as the production estimates) : Table 1 : Expected performances of the cotton companies for the 2011/12 season OLAM WIENCO Amarjaro total area planted (ha) number of farmers area/farmer (ha/farmer) 1,0 0,6 1,0 0,8 expected production (tons SC)

12 At the time of the Consultants mission (end of October, 2011) the three companies were preparing for the buying campaign, scheduled to start in November, As none of the three companies has its own ginnery, arrangements have been made with existing ginneries: Armarjaro will use GCCL s ginnery in Tamale, Olam GCCL s ginnery in Tumu and Wienco will use GCCL s ginnery in Bolgatanga and the ginnery belonging to a former cotton company (Nulux) in Tamale. As GCCL is currently bankrupt, the three companies have to hire permanent and casual personnel to run the ginneries and had to pay for the spare parts and maintenance of the ginnery they will respectively use. Table 2 : Ginneries used by the 3 cotton companies in 2011/12 GCCL Tamale GCCL Bolgatanga GCCL Tumu Nulux Tamale Cotton company using the Amarjaro Wienco Olam Wienco ginnery Year of construction ? Theoretical capacity 150 tons/day 226 tons/day 150 tons/day 112 tons/day (assuming 19 hours/day) The price of seed cotton to be paid to farmers for the ongoing season has been fixed at 0,86 GHC/kg, following the recommendations of a consultancy which took place in April 2011 and approved by a stakeholders workshop. This price was determined on the bases of world price projections at the time of the consultancy (126 cents/lb), on estimated costs for the cotton companies and assuming a 15% margin for the cotton companies. As the incoming cotton companies had not started to gin at that time, their costs were estimated on the basis of GCCL costs and standard costs from other West African countries. It was agreed at the time of the consultancy that a more sustainable and robust price mechanism would further be developed including eventually a stabilization fund to be operational for the following cotton seasons. 2 General presentation of possible seed cotton price mechanisms 2.1 Objectives and expected characteristics In a cotton sector which is not open to free competition among ginners (such as most cotton sectors in West Africa and, in particular, in Ghana, where a zoning system is being newly implemented), the seed cotton price cannot be determined by supply and demand. Until the 1990s, seed cotton prices in West African cotton sectors were often set by the cotton companies (which were usually parastatals) or by the Government. This resulted often, when world prices were high, in producers receiving a much lower share of the world price than they should, or, when world prices were low, in producer prices unsustainable for the cotton companies. In order to avoid such situations, price mechanisms were developed in a number of West African countries during the last decade, on the basis of world prices. Such mechanisms aim at calculating the producers price as a percentage of world prices. The main function of such mechanisms is to set the price of seed cotton prior to sowing and to maintain it during the whole growing and marketing 2

13 season, so that both producers and the cotton company can assess the expected profitability on the investments they must make in order to produce and process cotton. It is widely recognized that a price mechanism should have the following characteristics: It should be simple, transparent and easily understandable by stake holders, so that they be able to control its implementation and verify the calculations It should be based on verifiable and non manipulatable parameters (such as world price indexes and standard unit costs); it cannot, in particular, be based on the companies actual costs and marketing performances, which can be manipulated by the cotton companies, and which would generate no incentive for the cotton companies to maximize their cost efficiency and their marketing performances It should result in a fair distribution of profits and risks between the cotton companies and the producers: both parties are entitled to make higher profits when world prices are high, and to share the risk related to depressed world prices As much as possible, the proceeds of both the cotton companies and the producers should not fall under the breakeven point, below which the gross incomes do not cover the costs; this is especially true for producers, who might abandon cotton if the crop becomes non profitable, or massively use the fertilizers provided on credit by the cotton companies on more profitable crops. Cotton companies, if they have enough cash reserves, may take the risk of maintaining for a few years their operation even if it becomes non profitable, expecting a rebound of the world market, but they will also have to abandon production if this rebound does not take place Price mechanisms are sometimes asked to fulfill an additional function, which is to stabilize prices through a longer period of time than a growing season. The past experience in many West African countries has shown that any stabilization system which does not take into account the market trend becomes soon unsustainable and fails to transmit market signals to producers. Sophisticated price mechanisms have however been elaborated, in particular in Burkina Faso, in order to smooth the impact of world price fluctuations on domestic price of seed cotton across crop years while taking into account the medium term market trend. 2.2 Examples of price mechanisms in Western Africa Burkina Faso Cotton sector organization. The organization of the cotton sector in Burkina shifted in 2004 from one cotton company with a monopoly of cotton marketing and processing to three companies with exclusive marketing and processing rights over well defined zones. The current organization is therefore somewhat similar to the one being introduced in Ghana. Principles of the mechanism. Burkina Faso has a long tradition of seed cotton pricing mechanisms, as the first mechanism dates from After a number of modifications, due to the fact that the initial mechanism turned out to be unsustainable in periods of low world prices, a new mechanism was adopted in 2006 and slightly revised in

14 The new mechanism is based on the basic principle that the share of the FOB price allocated to farmers is 60%, and should rise to 62% as soon as production reaches tons, corresponding to the existing processing capacity. The mechanism includes an initial price, based on the world market trend, and eventually a premium paid to producers at the end of the season, if the evolution of world prices during the season is favourable. The mechanism aims to smoothen the fluctuations of the world market. Initial price. The initial price is set at latest on April, 1 st of each season. It is based on a trend price, calculated as the average FOB price for the two last seasons and the forward price for the current season 6. The trend price is the basis for determining the floor price, which is 95% of the trend price, and the ceiling price, which is 101% of the trend price. The initial price/kg of lint cotton is equal to 60% of the floor price (or 60% of 95% of the trend price) expressed in FOB equivalent and in local currency/kg. The initial price/kg of seed cotton is 42% (assumed ginning ratio) of the above. Reference price calculated at the end of the season. At the end of the season, a reference price, assumed to be the price at which cotton companies have sold the lint produced, is calculated as the average of daily Cotlook indexes A Far East (expressed in FCFA/kg and after deduction of FOB to CFR assumed costs ( amounting to 4 cents/lb in 2011) between January of the year n 1 to February of the year n (14 months), assumed to be the period during which the cotton companies sell the bulk of their production. Months during which the three cotton companies have sold less than 1% of the lint production of the season are excluded from calculating the reference price. The smoothing fund. The mechanism includes a stabilization fund, called smoothing fund which is used to compensate the cotton companies in case the reference price is lower than the initial price paid to farmers, and which is replenished when reference prices are higher. The smoothing fund was initially funded by a loan from the Agence Française de Développement to the Government of Burkina Faso, sub lent to the cotton Inter professionnal association, grouping the producers association and the cotton companies association. The operating rules of this fund are, however, sophisticated, in order to ensure the sustainability of the fund and to contribute to the price fluctuation smoothening: There is no intervention of the fund when the reference price is between the floor and the ceiling prices (95% and 101% of the trend price), considered as a non intervention band. If the reference price is lower than the floor price (95% of the trend price), the cotton companies are paid the difference between the reference price and the floor price, in as much as the fund has the required resources. Otherwise, the fund has a debt towards the cotton companies, which will be paid in the subsequent years. If the reference price is more than 101% of the trend price, the surplus between the reference price and the ceiling price (101% of the trend price) is shared between the replenishment of the smoothing fund, producers and the cotton companies: o First comes the replenishment of the smoothing fund: the amount of the replenishment is determined by a formula, the principle of which is to allocate a 6 If the forward price is not published for a minimum of ten days at the time the initial price is calculated, the anticipated price for the current season is the ICAC projection, published by April, 1 st 4

15 larger share of the surplus to the fund when the fund is empty than when it is close to its maximum agreed capitalization of 10% of the crop value o The amount of the surplus remaining after replenishment of the fund is then distributed up to 60% to producers (as a premium above the initial price already paid) and up to 40% the cotton companies Management of the smoothing fund. The smoothing fund belongs to the Inter professional cotton association, and is operated by a commercial bank (selected through a competitive tender), according to a management contract between the bank and the association. The calculation of the initial price, of the premium due to producers and of the replenishment of the fund is done both by the association and by the bank, although the final decision is made by the association. The bank receives a fee of $ per annum for its services, and pays a 6% interest on the amounts deposited on the fund. The Agence Française de Développement, as initial financier of the fund, keeps a non objection right on all decisions affecting the operation of the fund as long as the loan is not fully repaid. Results of the price mechanism. The mechanism has been applied for the last four seasons. According to an external evaluation performed in 2011, the mechanism has been correctly applied by the stakeholders. The smoothing fund has proved to be sustainable thanks to its complex rules of replenishment, and it has been replenished to its maximum by the end of the 2010/11 season. The mechanism has been able to avoid too sudden changes in the initial price from one season to the other. However, it is not fully understood by producers, because of its complexity, despite several training sessions. Furthermore, in 2010/11, season during which world price reached an unprecedented peak, the calculation of the reference price had to be reviewed in order to eliminate from the calculation the last months of the season, during which world prices were extremely high but did not correspond to a real demand from traders Togo Organization of the cotton sector. In Togo, marketing and processing of seed cotton is the monopoly of the Nouvelle Société Cotonnière du Togo (NSCT), created in 2009, following the bankruptcy of the former parastatal company, SOTOCO. NSCT s capital is owned by the State (60%) and by the producers associations, FNGPC (40%). Cotton production had dramatically fallen in the last years of SOTOCO (from tons to less than tons), and the viability of the new cotton company is conditioned by its capacity to revive production in order to optimize the utilization of the processing capacity and to reduce its fixed costs The price mechanism. A price mechanism has been established in 2009 and approved by the cotton company and the producers association. The mechanism was designed on the basis of the experience of other West African countries, with the objective of being as simple and easily understandable by stakeholders as possible. It is based on the principle that producers should receive a given share of the world price, and on the principle of a dual payment: an initial price paid at the time of the collection of seed cotton by the cotton company, and a premium eventually paid at the end of the season, if world prices increase during the growing/harvesting period. As it was established at a time when the world price was very low, and as no external donor could be identified to finance it, the mechanism was designed so that it could function without a stabilization fund, the creation of which 5

16 was postponed until conditions become more favorable. Another objective of the mechanism was to give an incentive to farmers to increase production. The share of the world price allocated to producers is 61% if the seed cotton production of the previous season is less than tons, 62% if the production is between and tons and 63% if the production is more than tons, taking into consideration the fact that increasing production results in decreasing the fixed costs per kg of lint. Initial price. The initial price of seed cotton is set before May, 31, at the beginning of each season. It is based on the Cotlook forward index published on May 1 st, or, if not available, on the ICAC projection published the same day. The index, converted in USD/kg is then converted into local currency by using the average exchange rate for the month of April. The initial price in lint cotton/kg is the index in local currency multiplied by the share allocated to producers (61 to 63% depending on the production level). The price in seed cotton is obtained by multiplying by the ginning outturn ratio, assessed to be 42%. Reference price and payment of a premium. At the end of the season (end of May year n), the reference price, at which the cotton company is assumed to have sold, is calculated as the average of monthly averages of Cotlook indexes for the current season between May year n 1 and April year n, converted in local currency at the average exchange rate for each considered month. If the reference price is higher than the initial price, the surplus is wholly due to producers and paid as a premium by June year n. If the reference price is lower than the initial price, the Government is required to pay the difference to the cotton company, as long as a stabilization fund is not created. Implementation of the mechanism. In the absence of an inter professional board, the mechanism is managed by a joint committee including the cotton company and the producers association, with two government representatives attending as observers Mali Cotton sector organization. The Cotton Sector in Mali is currently characterized by the monopoly of purchase and ginning of seed cotton by the Malian Company for Textile Development (CMDT) and by the presence of cotton oil mills, which buy and process cotton seed. Two textile companies process less than 5% of lint cotton produced nationally. Cotton sector privatization is underway, and a tender has been launched for the sale of the cotton company broken down into four regional subsidiaries : - Following the international tender, a Chinese operator was chosen for two subsidiaries; negotiations are underway to sell 61% of the shares of these two subsidiaries; - A cotton classing office has been created to handle the cotton classification for all companies: the office will be paid by the cotton companies; - An Inter professional cotton board has been established and includes, for a start, CMDT and the cotton farmers association. After privatization, two or three cotton companies will operate in the cotton sector with 61% of the shares for the private operators, 20% for the State of Mali, 17% for cotton farmers and 2% for cotton companies workers. 6

17 Principles of the mechanism. Until 1989, the seed cotton price was set by the government. In 1989, a price mechanism was set up under a first program contract with initial and final price and a stabilization fund belonging to the state of Mali, CMDT and cotton farmers. Other contract plans followed the first one with minor changes. The principles remained the same, with producer prices depending on CMDT (at the time bad) results. The cotton farmers disagreed with the price announced for 2000/2001 season and went on strike. Since that season, a first mechanism, taking into account the sub region prices and the world market price of lint, was applied. The application of the first mechanism led to large deficits for CMDT in 2002/2003 and 2004/2005 and there were no funds to support these deficits. For this reason, the mechanism has been modified to provide funds for deficits. It was decided, initially, to allocate FOB prices between cotton farmers (60%) and CMDT (40%), to set an initial price below the world market price and a final price based on sales and to set up a support fund belonging to cotton farmers. The support fund was replenished, at startup, with support from the European Union. During the 2011/2012 season, and given the high cost of CMDT, the stakeholders agreed to change the share of FOB price and to give 55% to cotton farmers and 45% to CMDT, instead of 60% and 40% respectively. The Support Fund and the newly inaugurated (but inadequately prepared and documented) Inputs Fund are part of price mechanism. The application of the mechanism was done, until 2010/2011, by a technical committee chaired by the representative of the Minister of Finance. Starting 2011/2012 season, the application of the mechanism is done by the Price Commission of the Cotton Inter professional body of Mali. This Commission is chaired by the representative of cotton farmers. Initial price. The seed cotton initial price for a season is set based on projected world lint prices. It is set no later than April 1 st, each year. To set the initial price, the CMDT conducts simulations on the formula of the final compensation of producers using the ICAC publications (WAF Cotlook Index or New York futures prices) and CMDT sale prices before setting the initial price. The final compensation is calculated with some production assumptions. The initial price is set somewhat below the final remuneration calculated to reflect the risks of non achievement of world market prices. Final price calculated at the end of the season. The final price of seed cotton is calculated at the end the season. If the final price is greater than the initial price, the supplement calculated will be divided as follows, starting season 2011/2012: - Additional price for farmers: 25% - Support fund: 10% - Input fund: 50% Farmers fund: 15%. If the final price is less than the initial price, the difference will be paid to CMDT from the support fund belonging to farmers, provided it is possible to do so. If not, farmers will have to pay the difference the next season. Before 2011/2012, the supplement calculated was divided between: 7

18 - Additional price for farmers: 50% - Support fund: 50% The support fund and its management. The mechanism includes a support fund used to pay to CMDT the difference between final and initial prices, in case the final price is less than the initial price. In case of higher final price, 10% of final remuneration is put in the Support Fund. The Support Fund is the exclusive property of seed cotton farmers. The resources are used exclusively to refund CMDT in case of overpayment of cotton farmers. The management principles of the support fund are: - The custody of the resources is given to a bank; - The Bank Manager pays the Fund an interest rate of 6,12% per year; - An agreement between the Bank Manager and the President of the Farmers Union defines the conditions for the bank fees and the interest to be earned by the fund. - The amounts to be paid out of the Support Fund for CMDT shall be notified to the Bank Manager by the Minister of Finance - All withdrawals are jointly signed by the President of the Farmers Union and the authorized representative of the Bank; - The Bank Manager prepares an annual report on the management of the Fund for the President of Farmers Union with copies to the Minister of Finance and the General Director of CMDT. Results of the price mechanism. The application of the seed cotton price mechanism has been evaluated from 2005/2006 to 2010/2011. After these six seasons, the final remuneration of cotton farmers was higher, each season, than the initial price, with the exception of the 2008/2009 season. Currently, the support fund has a substantial positive balance. However, there is a risk of slippage because the stakeholders have introduced into the mechanism, in 2011/2012, the Input Fund and the operating funds of the National Union of Cotton Farmers Cooperatives Other examples in Africa for countries with a zoning system Mozambique has no price formula. A minimum indicative pan seasonal and pan territorial price is set for every season by negotiation between the industry and farmers organizations, under the umbrella of the Ministry of Agriculture. This minimum indicative price is very much related to the world prices of cotton. In 2011, the minimum price was 50 US cents/kg. In Côte d Ivoire, the stakeholders adopted in 2008 a new price mechanism proposed by the Consulting company COWI. In this mechanism, the initial price is determined at the beginning of the season, and the final price calculated at the end of the season, based on a share of the world price allocated to producers, as in Burkina Faso and Mali. The producers share is however not constant, and depends on the volume of production. For a production of tons, assumed to be the normal production level, the producers share is 63,5 % of the world price of lint, considered as the equilibrium share. If the production is below this threshold, the producers share is reduced accordingly following a formula. The producers share can thus vary as a function of the production volume, between a minimum of 50% and a maximum of 70%. 8