WEEKLY COMMENT – JUNE 7 TO JUNE 11, 2021.
FRAGILE IN THE NEAR TERM, ROBUST IN THE LONG TERM
The sugar futures market in NY closed out the week with the contract for July/21 trading at 17.61 cents per pound, 10 points down against the previous week. The spotlight is on the futures contracts with longer maturity, whose prices appreciated over the week by up to eight dollars per ton.
It’s interesting to note that the price curve starts to yield slowly on shorter maturities and appreciate on longer maturities. I think this has to do with the perspective for better prices in cents per pound down the line and the pressure on shorter maturities because of the rollover of the funds and the lack of activity on the physical.
Nothing defies the market logic. Brazil has maximized sugar production which, even with the drought, will bring discomfort to the availability of the product. There is strong evidence that we will have a world surplus slightly pressuring the short term. An example is that July/October and October/March spreads show a carry equivalent to 3% per year countering the narrative of lack of product on the physical and lighting up an alert signal for the funds that are long by 238,000 lots, but rarely stay positioned like this on a cost-of-carry market.
The funds usually stay short on a carry curve and long on an inverted curve. In other words, depending on the way things go, I wouldn’t be surprised to see the funds turn short. The big question is who could provide them with liquidity if they decide to get out of the long position, selling this volume of lots? It’s something to think about and fear.
So, we have a market with a clearly neutral perspective slightly going towards bearish over the mid-term, but notably bullish over the long term. The average NY closing price for the 2023/2024 crop (May/2023 to March/2024) is a little below 15 cents per pound. We believe we will go up at least 150 points. What backs up this analysis over the long term is that India will look more and more inward and less and less at the international market, in a political change that will only bring benefits to that country.
The market might get out of control in a couple of years. I will explain. We have some pent-up demand for fuel. The consumption (gas equivalent) has dropped 5% against the accumulated over the previous twelve months, 49.6 against 52.2 billion liters, representing a decrease of 2.6 billion liters. Before the pandemic, in February/2020, the accumulated over twelve months pointed to 54.2 billion liters and the curve showed a yearly growth of 3.86%. If there was no pandemic, in theory, the consumption for April/2021 was projecting 56.6 billion liters or 7 billion liters more than today.
Can someone imagine what would happen to ethanol/sugar prices if this consumption materialized? And even so, with a smaller consumption, the hydrous market is at the highest nominal value ever. The point I would like to make is that we have a real possibility of firm prices due to the possible recovery of the economy, pent-up consumption that can speed up fuel demand and maybe recover pre-pandemic levels in 2-3 years, a sector whose area of growth is just about non-existent and will still have India decreasing export sugar availability.
This is not about excessive optimism, but pure arithmetic. The sugar world might be on the threshold of going over to another stage in terms of support price. The increasing consumption of 1% per year – a conservative rate – for the next years will demand another 11 million tons of sugar in 5-6 years.
But, of course, we must watch out for exogenous events – for what might go (really) wrong. The list is endless, but as a futurology exercise we can have: a) a third Covid-19 wave; b) the melting of oil prices; c) the fall of world consumption; d) political uncertainties in Brazil in 2022; e) change in gas pricing distorting the arbitrage with ethanol, to mention just a few.
The market says that at least 500,000 tons of export sugar, with fixed prices, won’t be delivered on the agreed date and have been rolled over to next year. Instead, the mills preferred to make ethanol that is at about 17.25 cents per pound today, almost 400 points higher than the average fixations of the mills for 2021/2022.
The concern over the effects of the current drought on the next crop has made some mills simply decide to fix export sugar prices for the 2022/2023 crop. Aversion for the risk of a possible margin call has also contributed to that decision. However, a point deserves to be mentioned: maybe the real will continue appreciating and the good fixations in real per ton will need higher prices in cents per pound to make up for the abandonment of the strategy.
Our viewpoint is still to fix prices in real per ton and, at the same time, buy the equivalent fixed volume (or at least the percentage of third parties’ sugarcane) in calls at the exercise price 200 points higher than the level of fixation.
The countryside of SP had some erratic rainfall ranging between 6 and 30mm, still insufficient to face the huge water deficit suffered by the sugarcane fields. That’s nothing to get too optimistic about.
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Mr. Arnaldo Luiz Correa is the Director at Archer Consulting. He is a Risk Manager with an experience of almost 30 years in the agriculture commodities market.
To get in touch with Mr. Arnaldo, write on arnaldo@archerconsulting.com.br
