There’s a battle over cotton that could affect its exchange traded note (ETN), and it’s anything but soft and fluffy.

The United States and Brazil have been in a war over cotton subsidies for around six years, with the United States on the losing end. The World Trade Organization has gotten involved, and things could get cotton-pickin’ scary. So far, the WTO has decided the Unite States is breaking the rules by subsidizing cotton exports. Sanctions could be in the billions of dollars, reports Stephen Beard for MarketPlace.

The Brazilian government is deciding whether or not to claim the sanctions, with a decision being made next year, reports Reuters.

Down under, a drought in Australia has put the cotton industry in a tight squeeze. The recent drought-like conditions have caused the entire continent of Australia to lose all of their cotton-producing regions, and growers have turned to other options, according to Michael Edwards for ABC News in Australia.

While one farmer says cotton gives a better return per hectare than any other crop, it’s also a water intensive endeavor. Its crop last year was the worst in three decades – so bad that many farmers are not even bothering with it this year.

Luckily, the United States is actually the leading cotton exporter, and second to China in production, so Australia’s falling production shouldn’t weigh down the industry too much.

iPath Dow Jones-AIG Cotton Total Return Sub-Index ETN (BAL) gives exposure to this shrinking industry through futures contracts, and is 100% cotton. Since its July 22 inception, it’s down 3.1%.

A cotton shortage could wind up stretching returns in this fund. The cotton industry is projected to produce 124.5 million bales in 2008-2009, down 1.4 million bales since July. World production is predicted to be down 2.8 million bales from July, according to the Cotton World Fax Update.

Tags: Agriculture, Australia, BAL, Brazil, Cotton, Emerging Markets, Latin America