Sugar: Brasilia is Making Fools Of Us All

The sugar market in NY closed the week as if it had never opened. After making new lows in the middle of the week, causing those who use stops to monitor their hedging positions diligently to be furious, the market weekly variation was only six points lower in relation to the previous week’s closing. This for May/13, that ended Friday quoted at 17.97 cents per pound. The remaining months closed between one-point lower and seven points higher. It would have been better to stay home watching House of Cards.

The slower beginning in the crushing of a harvest directed towards ethanol diminishes the possibility of a physical delivery of sugar against May in NY, whose expiration occurs seven days business days from now. The May/Jul spread traded at a premium of almost five dollars per ton at one point, reflecting this worry.

A very respected analyst in the fuels market observed this week in an event occurred in the interior of Sao Paulo state that “after the logistical black-out we will have the fuels black-out”. The growth in the fuels consumption has not been followed by better logistics in the import of gasoline or by the supply of ethanol, which despite a harvest that will deliver more than 25 billion liters, is still insufficient to attend the potential total demand of fuels. And the vehicles fleet has grown 7% in the last 12 months. The black-out in the fuels sector would be the “crowning” of Dilma’s efficient administration which, paraphrasing the cover of the last edition of the magazine “Veja”, is not only “stepping on the tomatoes”. I am writing this report as a travel on the highway linking Sao Paulo city to Santos. I observe the luminous road signs that inform the drivers about the heavy traffic of trucks going towards the port and that there is a traffic jam of three miles. This is the Brazil cost which corrodes a good portion of the producers’ income, who pay this cost via either the abusive freight or the diminishing of the basis (commercial premium or discount against the exchange) when trading their contracts FOB of their products. The average production costs for sugar in the Center-South, for example, is of 15.55 cents per pound ex-mill. The producer pays more than 200 points on average to get his product to the port. Compare this with the logistical costs of other countries to see how expensive Brazil is. Meantime, the government continues to burn money to sponsor the World Cup and the Olympics, events deemed “essential” to the life of Brazilians. Brasilia is making a fool of us all.

The debt of the sugar and ethanol sector according to several sources in the market is equivalent to R$ 85 per ton of crushed sugar cane. If the Center-South is crushing 585 million tons, we may then estimate that the total debt is R$ 49.7 billion. Using as basis the estimate of production by Archer Consulting divulged in the beginning of this month, of 35.6 million tons of sugar and 25.2 billion liters of ethanol, and the closing prices of this week, the total income of the sector should be R$ 66.2 billion.

The performance of the commodities so far this year is giving us headaches. Corn has dropped 6.6%, sugar 8.4%, wheat melted almost 9% and the metals copper, gold and silver have dropped 14%, 16% and 24% respectively.

Although the sugar fundamentals are pointing downwards, continuing to make happy the bears, the funds are oversold and this may be an uncomfortable situation. On Friday’s session, a buying volume that totaled 7,000 lots raised the market to higher levels at the blinking of an eye. It is estimated that the funds have reduced their shorts to “only” 85,000 lots (4.3 million tons of sugar). The Brazilian sugar exports for Mar/13 had the best performance ever for a March month, with a volume of 1,940,373 tons. The accumulated exports of 12 months (Apr/12 to Mar/13) reached 26.8 million tons, an increase of 7.4% in relation to the same period in the previous year. The value of sugar exports was 13.589 billion dollars for the period. With ethanol, the accumulated exports for the 12 months reached 3.48 billion liters, a growth of 84.1% in relation to the same period in the previous year, and brought in 2.4 billion dollars at an average price of 690 dollars per cubic meter.

There are things that are hard to believe and confound the analysts who are more attentive to the financial and commodities markets. This past Friday we had the IPO of a sugar producing company. The initial price was R$ 15.00 per stock plus R$ 0.25 paid for a put with strike price of R$ 16.57 expiring in 15 months. The inclusion of the put was necessary to attract the more cautious investors. Well, the market initiated the trading at R$13.00 per stock, lower 13% therefore. Independently of that sophisticated financial engineering which ended up creating a synthetic call with a 7% yearly return, it was also surprising that during the week a senior trader of that group, in a conference in Europe, said that the sugar price in NY should go down to 15 cents per pound, following the parity with ethanol! Unless the bonus of that company is paid with puts, how can one understand such statement?

Have a good week everyone.