Sugar: The Future Of The Market

The sugar market in NY closed the week pretty much unchanged on the first maturities for the 2015/2016 harvest, but at a vigorous high for the maturities beyond the curve, starting in May 2016 with increases up to 7 dollars per ton. With the real appreciation, NY didn’t go up as much, and the values in real per ton decreased. NY closing value for May/2016, converted to real via hedge for the same maturity and discounted present value is 14% above the value for May/2015. For capitalized and debt-free companies in dollars, it is a great pricing. In order to take advantage of a possible high, an operation with options can be made, for example. You’d better keep an eye open for opportunities.

Changing subjects a little, it is recommended not to make predictions taking into account specific situations only. That sugar exports have been weaker over the past twelve months compared to the same period last year doesn’t mean we can definitely claim they will be like that forever and ever. With a broader data analysis, we can say that sugar export growth in Brazil over the past ten years has been 3.6% a year; at this rate, the volume will double every 20 years.

On the fuel market, where ethanol is included, the growth is stronger. Over ten years, fuel consumption in the country increased 7.6% on average yearly, that is, at a rate which makes it double in a little over nine and a half years. And there is a huge chance that Brazil will grow in ethanol consumption. Today, ethanol participation, be it directly at the pump (hydrous) or in gas (blended with anhydrous at a 25%-proportion), adds up to 42%. By the end of 2009, this participation was at 54.5% and it just didn’t keep up for reasons known by everyone in the sector: lack of transparency of the federal government in fuel pricing which not only pulled ethanol out of the picture for lacking competitiveness against gas at an artificially low price, but also drove away investors who didn’t see possible new investments in the sector happening.

A fallacious argument that is heard in discussion groups is that if we had expanded at that rate by the mid-2000s, today we would certainly be grinding more than 700 million tons in the Center-South and if prices are bad now with a harvest perspective of 580 million tons, just think what they would be like with this amount of sugarcane. This is not quite like it. The price we pay for artificiality is usually very high, especially in commodities. The sector is footing the bill and it will for a long time.

If we had a free fuel market in Brazil which kept up with gas price fluctuations on the foreign market, I have no doubt that protection tools referenced to gas foreign price converted to real via non-deliverable forwards, so-called NDF, would be available to market participants. What we have going on today is a Russian roulette. Over 50% of the sugarcane is destined for producing a product that doesn’t allow the mills to have adequate risk management for its mitigation. The result is a huge risk increase having an effect on the balance sheets of the companies.

Another debatable point, two paragraphs above, is if the prices are bad now. We have shown several times here that although the sugar market has plummeted over the past three years from 24 to 12 cents per pound, the fact is that the price curve in real has had a much smaller fluctuation. Over the same period we have had a peak of about R$1,120 per ton and a minimum of R$725 per ton.

If we focus on the price curve for sugarcane products, export sugar and internal market, and anhydrous and hydrous ethanol, we will see that the traded market values have been above the curve of production cost most of the time, not taking into consideration the financial cost or eventual revenue from cogeneration.

So how does the story end? My main point takes us to where do we go from here? What is the future of the market? Being totally conservative and taking for granted that the world sugar consumption will grow only 1.76% a year (though several associations and institutions have put this growth above 2% yearly), and assuming that the internal market for ethanol in Brazil will be limited to only 35% of the fleet consuming this type of fuel, and that the country will keep its current market share, in 2020 we will have to crush 800 million tons of sugarcane – a 180-million-ton expansion in 5 years. Even with Europe entering the market in 2017, the situation is far from being comfortable.

The sugar futures and physical markets are sadly watching the continuous decrease in the number of active participants. If we look at the number of active mills, trading companies and brokers ten or twenty years ago and compare that to what we see today, it is disappointing. Judicial recovery, close-downs, mergers and acquisitions, narrow margins, high risk, regulation are – in each of their operation areas – the main evils which have wiped out a lot of the acclaimed past key players. This week, in sync with this shrinking market, Jefferies has announced its departure from commodities selling the broker’s book to Societe Generale. Just the high level of the professionals who are pulling out is enough to regret the loss of yet another participant.