Sugar Marker Susceptible To Strong Reaction In Price

The NY sugar market closed Friday with Mar/14 quoted at 15.73 cents per pound, higher for the week 4 dollars per ton. The remaining months closed higher between 26 to 38 points, or 6 to 8 dollars per ton.

The lack of rains in the producing regions has sustained the market, which has recovered partially the losses incurred this year at the NY sugar exchange. But this correction moment may be only the beginning of a complete change in prices. Several mills we have contacted say they are worried about the lack of rains, which should affect the production itself and the level of sugar in the cane. It is too early to have a number for the 2014/15 crop, but some producers say equal to the 2013/14 in the best-case scenario (around 595 million tons).

With the speculative funds carrying an immense naked short position around 110000 lots, representing around 5.6 million tons of sugar equivalent, although a bit comfortable still due to their entry price, the market is subject to a strong reaction in prices.

The first and most important indication of this possibility (aside from the drought) is the significant increase of the implied volatility of options. The traders are paying more now for the options. An example: when the market traded at the low of 14.70 cents per pound at the end of January, a call option at the money, that is one whose exercise price is the closest to the market level, was being traded at an implied volatility of 15 % to 16 %. Last Tuesday, when the market reached the latest high (16.38 cents per pound), the implied volatility traded at 25 %. To give an idea as to what this represents, the cost to protect an eventual price increase in the market went from 4.30 dollars per ton to 6.00 dollars per ton.

Let us observe the scenario that is unfolding for the sector. In one hand, we have the perception that the drought may affect the sugar cane crop much more than previously thought. The sales of autos and light vehicles have increased 1 % in relation to the same period in 2013. There is less sugar cane and more vehicles consuming ethanol. With the sugar world consumption growing between 1.5 % to 2 % on an annual basis and the internal consumption with vegetative growth, we would have to grow in sugar cane a volume sufficient to attend all of this demand, that according to the more conservative calculation by Archer Consulting, indicates 35 million tons. If we have the drought confirmed and a smaller crop as a result, these 35 million tons will not be there anymore, plus the growth in consumption and the fact that the beginning of the 2014/15 crop to be more ethanol oriented, we could see the prices at the NY sugar market appreciate at least to the limit of the arbitrage with the hydrated ethanol, which today is on average 250 points above the VHP level. So will we see NY at 18.50 cents per pound before May 1st? Raise your hand if you believe it.

The consumption of fuels in Brazil in the 2013 calendar year was 51.896 billion liters, an increase of 5.85 % in relation to the same period last year. The increment of consumption last year was 2.866 billion liters, totally supplied by the anhydrous ethanol (1.761 billion) and hydrated (1.097 billion). The ethanol consumption represented 39.2 % of the total, an increase of 3.6 percentage points. In 5 years, the average consumption growth was 6.17 %. The forecast for fuels consumption, by Archer Consulting, for the 2014/15 crop is 22.9 billion liters of ethanol and 32.4 billion liters of gasoline A.

A reader questions via e-mail if the problems of the sector could be resolved with the return of the CIDE (Contributions of Interventions in the Economic Dominium). Well, from the point of view of the investor from abroad, the tax of exclusive competence of the federal government is an instrument of intervention that makes fragile any development of a strategic plan, since it can be changed at a stroke of a pen. Brazil does not have today any privilege in relation to other emerging nations so that the CIDE ends up being one more complicating factor in terms of one deciding where the money will land. The sector does not have a way out but to go the free market route. They can invent as many mechanisms as they want, but these will always be palliative in nature and will not give any assurance to those who intend to invest in the sector in a professional way. Besides, when the CIDE was created, the presupposition was that it would have an incentive effect (to increase the consumption of one product in relation to another, causing economic dependency by the country to this product). That did not occur however. What distorts the market and prevents new investments from being made is the lack of transparency in the price formation gas prices freezing to the consumers. It is as simple as that.

The average price in the sugar market in January (taking NY closing times the dollar as published by the Central Bank, with polarization premium) was R$ 843.61 per ton against R$ 884.51 per ton in the previous month, a drop of 4.62 %. Looking only at sugar in NY, the drop on the corresponding averages was 6.12 %. Whoever did not hedge their dollar lost even more.

The percentage of price fixation for the 2014/15 crop in the NY sugar market on Jan 31st 2014, according to the Archer Consulting model was 40.42 % and the average price was 17.34 cents per pound FOB Santos (without polarization). The equivalent in reals per pound is 39.92. The percentage level is on line with those from last year and below the 2012/13 crop, which at that time a year ago was showing more than 50 % fixed.

The energy blackout that the country experienced during the week is only the tip of the iceberg of all the structural problems. Dilma’s incompetence is tremendous. Never before have we had in the history of this nation people so inept in the federal government. They buried millions of dollars to build a seaport in Cuba, helping the murderous dictator there, while we have seen both in the past and recently and will see it again as well, congestions at the local ports for the shipments of sugar and soybeans. It is really too much.

A renowned executive from the sector hit the bull’s eye. At the beginning of last year he said that 2013 would be noted by logistical blackouts (which we had) and 2014 for energy ones (which is here as well). People are lining up at his door awaiting his next forecasts.