The Mariana Trenches of Sugar

The sugar market in NY closed the week slightly higher by 22 points for Oct/13, quoted at 16.28 cents per pound. Mar/14 also closed higher, followed by May/14 and Jul/14. After that, only red figures to May/16. Remember when we insisted here that the Oct/Mar spread was too high, with carrying charges above 13.5 % per year? Well, it has narrowed now to 10.7 %, which makes more sense. From 98 points of carrying it dropped to 70, a 6 dollars per ton variation.

The price curve in NY showing carry to Mar/14 combined with a stronger dollar and the possibility to lock it via financial instruments for expiration months to the end of the harvest, shows a better return for sugar and somewhat establishes a ceiling in the ethanol production, which would have to have better prices to avoid the migration of more sugar cane towards sugar. In other words, the production mix may have reached its limit pro-ethanol due to prospects of better return for sugar along the curve. Sugar in reals for next year shows greater return, which are growing over the average production costs, around 15 % to 19 %.

Although the market hardly noticed the global surplus that has shrunk from 9 million to 3 million tons since prices keep falling, it is difficult to accept that we will have prices beginning in 2014 at the 15 cents per pound level. Weather, lack of investments, growing sector debts, oil above 100 dollars, all of these factors should change the fundamentals scenario for sugar in the next 2 years. The market becomes more susceptible to funds covering if an exogenous factor shakes the easy stance of the bears. We are close to the Mariana trenches of the market, which is at its lowest point since July of 2010. As with the depths of the Pacific Ocean, also in the sugar market life at this level becomes unbearable.

The open position from the beginning of July to now has grown 42000 contracts. These are the ones who sold at the average of 16.31 cents per pound. It seems to be a bit vulnerable. If the volatility of the options begins to increase, be on the alert since the funds which are short may begin to repurchase their positions.

The crushing figures published by UNICA accumulated almost 181 million tons of processed sugar cane in the Center South, which, assuming that the crop will be 585 million tons, represents a 30.94 % of the estimated total. In the last five crops, the crushing percentage in the same period compared to the total of the respective years, varied from 24.10 %, the lowest (last year) to 38.73 %, the highest (in 2010/2011). The market interpreted that Brazil has a lot of sugar and continued to signal weakness. If we projected the crushing of sugar cane based on the average of the last five years, we would get to a crushing in the Center South of 583 million tons. With the same criteria, the sugar production would get to 32 million tons and ethanol’s would be 25.5 billion liters.

Many are asking if the NY sugar market is experiencing its lowest moment since the creation of the current format in 1961. To attempt to answer this question, we used 2 criteria. First, to count the number of days that the market closed lower or unchanged in the last 250 sessions and after that, to compare the percentage drop in the same period. In the last 12 months the NY sugar market has dropped 31.1 %, but this percentage is far from being the contract record, which happened in 1975, with an annual drop then of almost 80 % (it fell from 65.20 cents per pound to 13.18 cents in 12 months). It is not even the greatest drop since 2000, since we have already seen a 49.2 % collapse in the 12 months. In May/07 the price was 8.65 cents per pound, and the year before it stood at 17.03 cents. Therefore, in terms of percentage drops on an annual basis, the market currently has not repeated the drastic performances of the past.

How about in terms of the number of days the market has fallen or unchanged in a 12-month period? Well, the record in this case is 165 days. In other words, in a period of 12 months, almost 2/3s of the closings were in the red. Too bad for the producers. This record then, is in the far away period of May of 1962, when most of the executives of the sector today were not even born. From 2000 onwards, the record is 149 days (almost 60 % of the sessions of the year), In June of 2007, when sugar was being traded at 9.06 cents per pound.

How about today? Well dear readers, we have had 146 days of falling or unchanged prices, out of 250 days. In other words, under this criteria, we are really close to the apex, or actually the floor, the lowest point in the last 13 years and of the previous record of 150 days from September of 1968. Unbelievable.

On the other hand, from the point of view of positive returns to the producer, this is not the worst time. Quite the contrary. Converting the NY sugar closings in reals with the Central Bank quotes, the values obtained by the mills (as long as they do not have liabilities in dollars) have a good return vis-à-vis the average production costs. This year, for instance, the average of sugar price in reals per ton is 703.15 ex-mill against an average production cost, as per the Archer Consulting Model, of 666.59 reals per ton ex-mill. The equilibrium point based on the dollar exchange rate of the Friday would be 15.56 cents per pound. This figure would be in theory the floor. But at this price, mills would have difficulty to pay for their financing costs.

Interestingly, by fixing the dollar rate of the beginning of the year and comparing the values in reals along 2013, the average adjusted quote in NY in the period is 17.6850 cents per pound against the 17.6700 in the real world, showing that both (exchange rate and sugar) compensate each other. Note the following though, this thinking reinforces the idea that it is to one’s advantage to do the NDF (term contract with financial liquidation) of sugar in reals since it eliminated the risk of margin calls in the futures operations in NY and the dollar.