abare.gov.au - Australian commodities – March quarter . volume 16 . number 1 2009

Wool

Outlook to 2013-14

Caroline Gunning-Trant

The Australian wool industry continues to contract as the profitability of producing wool relative to meat worsens. Falling wool demand attributed to the global economic downturn, combined with the high price for lamb, has led to a further reduction in the size of the national flock. Despite the decline in the production of shorn wool, prices are not forecast to increase until there is some recovery in the global economy and in consumer spending. Consequently, prices in 2009-10 are forecast to be 770 cents a kilogram clean, 2.5 per cent lower than 2008-09, as the demand for raw wool is not expected to turn around until early 2010.

In the medium term, renewed consumer spending will lead to stronger demand for wool. Once this happens, prices are expected to rebound quickly in the face of a low supply of shorn wool, combined with a relatively low Australian dollar. This is expected to lead to a slight expansion in the flock, particularly toward the end of the outlook period.

Shorn wool production driven by contracting flock size

By the end of 2007-08 the national sheep flock was estimated to be 79 million, the smallest flock size since 1919. The steady decline in the number of sheep has been a result of the long-term trend away from wool production. More recently, prolonged drought and high feed costs, combined with strong prices for sheep meat and declining profitability from wool production, have led many producers to either reduce the size of their flocks or to exit the industry. Since 2003-04 alone, the flock size has fallen by 20 per cent.

Seasonal conditions have improved in many wool producing areas since 2006-07. However, the effect of the global economic downturn on wool demand, and hence the wool price, has put additional pressure on wool producers to find alternative enterprises to increase revenues. Strong prices for grains provided the incentive for many producers to concentrate their efforts on cropping while high lamb prices prompted other producers to shift the focus of their operations to the production of meat.

The size of the national flock will be the principal determinant in the size of the wool clip throughout the outlook period. The number of sheep shorn is forecast to fall by 8 per cent in 2009-10. While the improved seasonal conditions in 2008 in many wool growing areas translated to better quality wool from several states, the lower proportion of wethers in the flock is constraining average cut a head from returning to its long-term average of about 4.5 kilograms. This additional factor is also having an influence on the overall size of the clip.

Wethers are large, non-breeding animals that produce a significant amount of wool relative to ewes and lambs. However, wethers are also the first animals to be sold when producers reduce the size of their flock. The fleece of ewes and lambs is finer and lighter than the fleece from wethers. Consequently, with fewer sheep shorn and fewer wethers in the flock, shorn wool production is expected to fall by 8 per cent in 2009-10 to 341 000 tonnes.

Production of shorn wool is forecast to show growth from 2011-12 through to the end of the outlook period as producers retain more wethers in response to stronger demand and higher prices. However, despite the expected turnaround in production, by the end of the outlook period it will still be roughly 5 per cent lower than in 2008-09.

Micron profile changing

Since the early 1990s the proportion of superfine wool (19.5 microns or less) in the clip has been trending upwards. In 1992-93 superfine wool accounted for only 7.6 per cent of the wool tested by the Australian Wool Testing Authority (AWTA). By 2006-07 it had peaked at 35.6 per cent of the clip, although some of the wool was recognised as being hunger-fine. Since then the proportion of superfine wool in the clip has decreased slightly, as good seasonal conditions in some wool growing areas have resulted in better wool growth, as indicated by a broadening of fibre diameter, improved fibre quality, and less tender and hunger-fine wool. Notably, much of the shift away from superfine was into the 19.6 to 22.5 micron range.

Prices to recover over outlook period

The Australian eastern market indicator price (EMI) for wool declined steadily throughout 2008 in the face of weakening global consumer demand for semi-durables, which include woollen apparel and textiles. Weak demand is most clearly reflected in the price for wool expressed in US dollars, the currency in which most of the trade takes place. The EMI in US dollars fell more steeply than the EMI in Australian dollars. The depreciation of the Australian dollar has largely shielded the EMI in Australian dollars from an equivalent decline. The effect of the exchange rate is evident by the increasing gap between the EMI in Australian and US dollars, which historically tracked quite closely to one another. From the beginning of 2008-09 to the week ending 13 February 2009, the EMI in US dollars fell 43 per cent, from US840 to US479 cents a kilogram clean. However, the price of wool in Australian dollars over the same period fell only 16 per cent, from 874 to 730 cents a kilogram clean, although it should be noted that the EMI (not adjusted for inflation) has not been below 800 cents a kilogram clean since October 2006.

With the global economy assumed to enter a recovery phase in late 2009, demand for raw wool is not expected to rebound until early 2010. Renewed demand at this point is likely to reflect expectations of stronger consumer spending on apparel and textiles later in the year, corresponding to the winter buying season in the northern hemisphere. Despite the price increase expected in the second half of 2009-10, the EMI is forecast to be 770 cents a kilogram clean for 2009-10 as a whole, still 2.5 per cent lower than 2008-09.

There is no reason to expect that demand for wool will not rebound as quickly as it fell providing the right economic conditions are in place for consumer confidence to be restored. In the medium term, the economic recovery of those countries that are major consumers of woollen products, such as the European Union, the United States and China, will sustain the demand for wool. As a result, prices (in 2008-09 dollars) are expected to increase from 2010-11 to 2013-14.

Australia produces more than 85 per cent of merino wool finer than 19.5 microns globally (AWI 2004). This is wool used in the production of high-quality and lightweight apparel. Despite the fact that many major retailers have declared they will no longer sell woollen apparel produced from wool from mulesed sheep beyond 2010 (a procedure where skin around the breech area of the animal is surgically removed to prevent fly-strike), buyers for these retailers could have some difficulty sourcing this quality of wool from other countries. This price forecast assumes that the Australian wool industry will meet its commitment to phase out mulesing by the end of 2010. Assuming global economic growth rebounds by 2010-11, retailers are likely to be influenced primarily by consumer demand in determining the range of woollen products made available.

Despite the assumptions of this forecast, for many producers the uncertainty facing the industry after 2010 has prompted them to evaluate alternative options to control fly-strike, including breeding of bare breech animals or changes to management. Producers are also awaiting the results of research into mulesing alternatives supported by Australian Wool Innovation (AWI). In terms of product differentiation, those growers who currently choose not to mules have the option of voluntarily declaring their wool as such using the Australian Wool Exchange (AWEX) National Wool Declaration (NWD). The NWD was implemented at the beginning of 2008-09 and provides information to buyers about mulesing, dark or medullated fibres and chemical usage. To date, no price benefits have been observed from declaring wool from non-mulesed sheep.

Lower wool supply to keep exports down

Between July and December 2008, the total volume of greasy wool exports fell by 10 per cent compared with a year earlier. This was largely the result of lower shipments to the European Union (Australia’s second largest export market) which fell by 32 per cent, equivalent to roughly 10 300 tonnes of wool. Exports to China over the same period fell by 3 per cent compared with a year earlier; a decline driven by a 20 per cent fall in export volumes during the month of December. The lower volumes of wool being shipped to Australia’s two principal export markets is a clear indication of waning consumer demand in China’s principal export markets for woollen apparel which has resulted since the onset of the global financial crisis. However, it should be noted that China’s relative importance as Australia’s primary export market actually increased between July and December as the proportion of total wool exports destined for China increased to 67 per cent, 5 percentage points higher than the same period a year earlier.

Total exports of wool, including greasy, semi-processed and wool on skins, are expected to decline in 2009-10, as a result of continuing weak demand in both Europe and China. Australian wool exports are expected to be 409 000 tonnes in 2009-10, a decline of 8 per cent compared with 2008-09. Lower prices will compound the decline in export earnings, which are forecast to fall 13 per cent to $1.93 billion.

China will continue to be Australia’s largest export market for greasy and semi-processed wool in the medium term. For Australia, maintaining a good relationship with such an important trading partner is critical since, according to the International Wool Textile Organisation (IWTO), China processes 43 per cent of the world’s raw apparel wool, produces 36 per cent of wool clothing globally, and exports roughly 44 per cent of world woollen knitwear, menswear and womenswear combined. Domestic demand in China is also important to the Australian wool industry given it accounts for about 17 per cent of the world retail demand for apparel wool.

As the global economy recovers, expectations of a resurgence in consumer demand for semi-durables in late 2010 are expected to translate to an increase in demand for greasy wool almost a year earlier given the required processing time to convert greasy wool to a finished woollen product. However, lower wool production through the medium term will limit the extent to which this demand will be met and exports can increase. While shipments are expected to rebound starting in 2011-12, total wool export volumes by 2013-14 are forecast to be 14 per cent lower than 2007-08. Similarly, despite the forecast for higher prices, export earnings in real terms by 2013-14 are projected to be 25 per cent lower than in 2007-08 at $2.15 billion.

Competitiveness of wool

The extent to which stronger consumer demand translates into stronger demand for any particular fibre will depend largely on competition among fibres at intermediate processing stages, but also at the retail stage. In textiles manufacturing there is a high degree of substitutability between various fibres, including wool, cotton and synthetic fibres, such as polyester and acrylic.

Mid-micron wool, between 19.5 and 23 microns, typically competes with cotton and synthetics for use in the markets for knitwear and menswear which are highly sensitive to changes in price. The versatility of cotton and synthetics in the world fibre market creates a highly competitive fibre market in which wool is but a small player. According to the IWTO, in 2007 it was estimated that wool constituted around 2 per cent of total world fibre production while cotton constituted around 37 per cent and man-made fibres about 59 per cent.

In 2007-08 the prices for synthetic fibres, the main substitute for wool, increased steeply in line with oil prices. Synthetic fibres, polyester in particular, is produced from refined petroleum or natural gas and therefore its price is sensitive to changes in the world oil market. Polyester prices were equally responsive to the fall in oil prices in the first six months of 2008-09. However, because wool prices fell proportionally more over the same period, the competitiveness of wool actually increased relative to polyester, as was evident in the declining trend of the 21 micron wool to polyester price ratio. Based on the price outlook for wool and oil, wool is forecast to remain relatively more price competitive in 2009-10 as well.

Cotton prices are expected to strengthen in 2009-10 and over the medium term but to still average lower than 2007-08. Thus, wool’s competitiveness relative to cotton will improve in 2009-10 given the current price forecast but will deteriorate out to 2013-14 as wool demand recovers and prices increase.

Over the medium term, stronger global demand for all types of apparel will put upward pressure on the price of all fibres. Manufacturers are highly responsive to changes in supply and demand conditions affecting the relative costs of fibres, as well as consumer preferences for fibre types, and will alter fabric blends accordingly.