Sugar Market: Weak Demand, New Pricing Methodolgy Possible

The NY sugar market closed Friday lower 19 points (4.19 dollars per ton) in relation to the previous week. Mar/14 traded at the low of 17.93 cents per pound during the week, closing it at 18.06 cents. The remaining months also showed losses up to May/15 (losing 3.50 dollars pr ton on average). There was a slight uptick on the subsequent months to Oct/16. However, we should note that with the real devaluation for the week of 2.71 %, the sugar closing in reals was R$ 961.00 per ton FOB equivalent (plus the polarization premium), which is 18 reals per ton higher than the previous week. The market seems to have maintained a balance despite the real devaluation. The current tone is indefinite with a split view in the market between those who are bullish from here (especially after Nov 22nd – read below) and those who are bearish, who say that demand is weak (which is true).

The funds bet heavily during the sugar rally ended up being of a short duration. According to the São Paulo-based Future Analysis Consulting, the average entry price of the funds in their immense position is 17.98 cents per pound. We hope that the funds still have a little more room to go or even to add to their bullish position. Since the end of the year is fast approaching and the fund managers will need to show positive results, we could assume that there may be a position liquidation to diminish the risk on their longs. However, if fundamentals will give the support, we can see at the end of the year levels around 19.00 to 19.50 cents per pound.

It is already in the hands of the Petrobras council, the approval for a pricing methodology – this has been confirmed by the executive directory (Ms Maria das Gracas Foster plus six more directors) – which contemplates an automatic price readjustment for gasoline and diesel fuels at intervals to be defined, based on tangible variables such as the reference prices of these fuels in the international markets, the exchange rate and whether the products are refined or imported. In a communiqué to its shareholders, Petrobras said “it is taking into consideration a mechanism which will prevent the effect on the price adjustments to the final consumers regarding the volatility of the international prices”. We imagine that the simple solution here to accomplish this is to use the methodology of average prices. The Council will meet this coming November 22nd.

If this is in fact approved, this methodology (there are no details at the moment) will represent a complete change in the ethanol market. The return of the price predictability, of transparency and especially the understanding of potential investors for the sugar and ethanol sector regarding price formation, will all help to move forward in the medium to long term the growth of production for sugar cane in Brazil, which has been stalled so far by the myopic policies of the federal government.

The fact that one will be able to correlate prices in the international oil markets to the internal price formation for ethanol will enable investors (whether foreigners or local mill owners expanding their companies) to have price visibility, even though at times the price correlation of oil and gasoline goes out of sync. Gasoline has its prices quoted in the futures market abroad up to November 2016, while oil has its futures prices going all the way to December 2019. And ethanol in Brazil? Nothing. And this lack of information damages the sector and scares away potential investors, leaving Brazil behind other countries, as it has been the case with the Dilma government.

The minister of economy fears that the increase on fuel prices – unavoidable when the new formula (whatever it is) is approved and applied by Petrobras – will feed the inflation. Who is going to win this battle then in the end? The minister himself or Petrobras?

Well, here we have a problem that even for the oracle of Delphi is of an indecipherable solution. Delphi was a temple dedicated to the god Apollo where the ancient Greeks would make a pilgrimage to in order to have their questions presented to the gods. They say that the pythonesses, Apollo’s priestesses, would prophesize during an altered state of consciousness and that these prophecies were considered irrefutable truths. Our problem at hand though is that the president of the Petrobras council and the minister of the economy are the same person.

In any case, if this methodology is approved, we will have a different year in 2014, where we will see advantages to those who will pay close attention to a strict risk management policy, needed to mitigate risks regarding problems that may arise during a year with presidential elections. If there is a real devaluation, sugar in NY should accompany the parity in reals per ton up to the arbitrage limit with the hydrated ethanol, which will reflect in more reals needed for gasoline imports. In other words, even if the real devalues, sugar can only drop to the limit of this arbitrage with ethanol. If the dollar devalues in relation to the real, the crop will tend to be less ethanol biased, and the high on sugar prices will be limited by the same relation. Will it be an interesting year? We will have the answer on Nov 22nd.

In the 6th and last forecast by Archer Consulting for the 2013/14 crop, we have kept the volume of sugar cane at 578 million tons, with a production of 33.4 million tons of sugar and 578 billion liters of ethanol, basically unchanged from the previous estimate in June of this year.

According to the model developed by Archer, the 2nd estimate for price fixation for the mills for the 2014/15 crop points to 6.67 million tons fixed at an average price of 17.70 cents per pound without polarization.

Have a good week.