Aug. 6 (Bloomberg) -- Allenberg Cotton Co., the world’s largest cotton merchant, is holding talks with rival Dunavant Enterprises Inc. on a merger, as fiber traders struggle with volatile prices and tight credit.

“Both parties are optimistic that we’re going to reach a positive resolution,” Joe Nicosia, Allenberg’s chief executive officer, said today by telephone from Cordova, Tennessee. He declined to comment on details or the timing of any agreement.

At least three major merchants faced financial difficulties after the benchmark cotton price in New York jumped to a 12-year high in March 2008 and then plunged to the lowest since June 2002, according to Mike Stevens, a Swiss Financial Services analyst. The credit crisis and recession also worsened the situation as banks curbed lending, analysts said.

“The world is changing and the cotton business is changing,” William Dunavant III, the chief executive officer of Memphis, Tennessee-based Dunavant, said in a telephone interview. “We view this as a positive event for both companies and the industry. We’re very excited about it.”

A deal between Allenberg and Dunavant would underscore “the untenable situation that developed mostly as a result of extreme volatility from last year’s runaway markets,” Stevens said from Mandeville, Louisiana. “I’m not sure we have ever seen anything like this: three major firms go out in one year.”

In October, Paul Reinhart Inc., the fourth-largest cotton merchant in the U.S., sought bankruptcy court protection. In September, the Richardson, Texas-based company told growers it faced a “severe liquidity crisis.” Reinhart lost as much as $80 million on cotton futures when prices surged in March 2008.

Other Departures

Weil Brothers & Stern Ltd., a Birkenhead, U.K.-based merchant, plans to close next year because the business has become too risky, according to Andy Weil, the head of its U.S. business. Albrecht, Mueller-Pearse & Co., a German trader with roots dating to 1902, filed for insolvency earlier this year.

While Dunavant’s CEO has cast a merger in a positive light, “many do not feel this way and almost all are saddened,” Swiss Financial’s Stevens said.

Allenberg, a unit of closely held commodities trader Louis Dreyfus & Cie. SA, handles more than 7 million bales a year, more than half the size of U.S. crop in 2008-2009. It had 2008 sales of $1.98 billion, the Memphis Business Journal has said.

Dunavant, also closely held, handles about 6 million bales, according to its Web site. The Memphis journal said it had revenue of $1.47 billion last year.

Closely held Cargill Inc.’s cotton unit is the second- largest fiber merchant, according to Allenberg’s Nicosia.

“We’re seeing a sharp contraction of the merchandising industry, which is not good for anyone,” Swiss Financial’s Stevens said. “From both a producer and mill standpoint, competitive bids and offers from major merchants are disappearing.”

Cotton futures for December delivery fell 1.4 cents, or 2.2 percent, to 60.86 cents a pound on ICE Futures U.S. in New York, the sharpest decline in almost two weeks. The most-active contract has gained 24 percent this year.

To contact the reporter on this story: Yi Tian in New York at ytian8@bloomberg.net.

Last Updated: August 6, 2009 14:40 EDT