World Sugar Market – Weekly Comment -Episode 21

We need to keep on improving

The sugar futures contract in NY suffered a drop over the week. March/2022 – the first contract – closed out Friday at 19.77 cents per pound, a 29-point downturn against the previous week, representing a 6.40-dollar-per-ton shrinkage. May/2022 closed out at a 9-point drop only. All the other contracts on the curve running from July/2022 to July/2024 had a positive variation of 5 dollars per ton on average.

I’m running the risk of sounding like a broken record, but the fact is that the activity on the physical market has diminished, a claim that can even be contradictory in face of the strong sugar fundamentals, but in our view, it just reflects the slowdown of the global commercial turnover with companies working hand to mouth, reducing stocks and postponing new purchases until they feel comfortable with a possible economy recovery.

The increase in maritime freight price which has sucked the profit margins gets into the trading companies’ rationale and causes this slowdown. Experts on the maritime freight market don’t believe the price will get to palatable levels for the trading companies before the last quarter of 2022.

Over the medium term, I believe that the perspective of sugar prices is positive. Today Brazilian mills should be fixed by close to 40% of the volume to be exported in the 2022/2023 crop, which starts in April next year. Right now, nobody believes in sugarcane production in the Center-South in 2022/2023 being over 550 million tons of sugarcane, which can impact prices, because this volume won’t be enough to meet the increasing demand for fuel in the country and the sugar export commitments.

Oil keeps reaching higher prices on the international market strengthening the thesis that we can get to three digits next year – that is, about a 25% increase. The impact of such an increase on the consumer given the fuel pricing structure in Brazil is a 10% increase that – if combined with the weakening of the real in a turbulent presidential election year – can be explosive.

The greatest risk the sector is running today is to see the ethanol mix in gas be reduced by the federal government due to a potential shortage problem. This is a scenario that must be avoided at all costs because it puts the expansion, consolidation and sustainability of the sector at stake.

Another risk is the migration of sugarcane producers to other cultures that offer better profitability, greater flexibility and greater availability of financial tools that allows them to maximize productivity gains. Take soybean, for instance. The soybean producer via a barter operation, with the issuing of CPR (Rural Product Note) with the major fertilizer and input companies, can exchange soybean bags for units of these products, doing away with the harmful risk of price changes. That’s not as easy for the sugarcane supplier/grower.

Another point that deserves being discussed is the Consecana (methodology that defines the remuneration of the sugarcane grower) which has always tried to represent the value of the sugarcane within the production chain as transparently as possible. Nobody doubts it is about a model that was so successful that has been copied by other agricultural products. However, models need to be updated so as to improve effectiveness and optimize results in the continuous search for efficiency.

But what does Consecana lack? For some years I have been pointing out the inefficiency of the index when we come up against inverted markets, which is the case now. First, let’s explain what an inverted market is. It’s when the price of the futures contracts with a shorter maturity is greater than the price of the futures contracts with longer maturities. This usually occurs when there is a smaller availability of the product or when the currency curve (real) distorts the future prices in cents per pound due to the disparity between internal and foreign interest rates, which is the case now. There are other reasons, but let’s stick to these only.

And how can this affect Consecana? Well, I recall November/2016 when sugar in NY was trading at 21.90 cents per pound for May/2017 – first maturity of the 2017/2018 crop – which would start in five months. At that time, we recommended pricing in NY due to the huge profitability it would provide.

The mills resisted fixing prices corresponding to third parties’ sugarcane because the risk is NY still going up and the mill might see the expected profitability dwindle due to a greater Consecana. What happened when we got to April/2017? Well, the sugar market had melted 600 points (equivalent to R$720 per ton today). The mill that didn’t fix because the sugarcane belonged to third parties and the sugarcane grower lost money because his payment depends on the fixation of the mill.

It’s obvious that the system needs extensive discussion so that situations like that – which occur today, for example – don’t happen again. We need to create a robust mechanism so that everybody – the mill and the sugarcane supplier/grower – can make the most of it. The way it is now, it’s a no-win system. It works reasonably well on cash and carry markets (the opposite of inverted market, that is, those where the futures price is greater than the price with shorter maturity), but it is inefficient on markets that demand a little more creativity.

You all have a great weekend.

To read the previous episodes of World Sugar Market – Weekly Comment, click here

To get in touch with Mr. Arnaldo, write on arnaldo@archerconsulting.com.br