July 19 to July 23, 2021.
LOSSES AND DAMAGES
The sugar futures market in NY closed out Friday’s session at a strong high caused by the information released by UNICA about the damages caused by the frost that occurred this week hitting mostly the states of São Paulo and Goiás, which should reduce the expected production for the next crops.
The plant, already recovering from the water deficit, is now suffering because of the low temperatures. However, more cautious agronomists prefer waiting a few days to draw a more qualified opinion on the real impact of the frost. On the other hand, experts say the sugarcane that has been struck needs to be harvested right away so that it won’t lose quality.
The futures contract expiring in October/2021 in NY closed out at 18.10 cents per pound, 39 points above the previous week, or 8.60 dollars per ton. The other maturities that run until May/2024 closed out at positive fluctuations between 1.00 and 8.00 dollars per ton. As the real weakened against the dollar, the average of the quotations for the 2022/2023 and 2023/2024 crops converted by the exchange rate plus the coupon, showed an increase of R$69 and R$53 per ton respectively against the previous week.
If the crop failure prediction is confirmed, the price curve for the sugar traded in NY for the future crops, that is, 2022/2023 and 2023/2024, will increase, strengthening the scenario we have been discussing here and, just to remind our loyal readers, involves the recovery of the post-pandemic world economy, the energy policy in India focusing on ethanol production, the increase in per capita sugar consumption in the main consuming countries and the resumption of the domestic consumption of fuel whose prediction is at 7%, to name a few points.
In our view for the medium and long terms, the sugar futures market has room to go up 150 points for the maturities between May/2022 and March/2023 and 200-250 points for the maturities between May/2023 and March/2024, when these are listed as the first trading months. It remains to be seen if the prices in real per ton will stay as good as they are now, because the Brazilian currency is rather devalued against the dollar and, considering that the Brazilian Central Bank should increase interest rates in the course of this year, it’s likely that a solid inflow of foreign capital will occur, pushing the real to levels more in line with the long-term curve plus inflation (which today is at about R$4,700). The argument against this appreciation of the real is the troubled political context ahead of us for the election period in Brazil next year. That’s where our greatest risk and the ingredient that can bring down sugar quotations lie.
It’s worth noting that despite a better scenario ahead in dollars per ton, the current prices are very appealing and profitable and within the philosophy that “nobody goes bust with profit in the pocket”, the recommendation is to fix prices in real per ton and buy an out-of-the-money call for 100% of the performed fixations.
Anyway, the predictions for the crushing of the sugarcane in the Center-South present great fluctuation. There are people betting on 510 million tons of sugarcane, talking their book, and there are others already working with a reduction to 540-550 million tons.
If the Center-South crushes 540 million tons of sugarcane, the anhydrous ethanol production will most likely be equated and a possible disruption of supply will be ruled out. The problem lies on the production being well below that. A possible shortage of anhydrous will give ammunition for the government to follow through with the reduction in the mix, which today is at 27%, to a percentage which will balance out the product supply, causing a great risk to the image of the sector.
Since this government hits on everything that walks and points the finger to blame others, just like it “blamed” Petrobras for gas price hikes, or the governors for the high fuel price due to the ICMS (tax on good and services), it’s a fact that a temporary reduction in the mix, whatever percentage it is, can be treated as definitive causing an important loss of revenue for the industry.
The best thing to avoid a possible crisis is to get ahead of it, offering solutions. The agronomists and agricultural directors of the mills need to sharpen their pencils and get to a consensual production number that will enable the companies of the sector to present a number to the government and seek alternatives to avoid something that would turn out to be a disastrous shortage.
An executive of the market suggests that the major leading producers of the sector (representing almost 300 million tons of production) meet and put together a task force to produce an additional amount of anhydrous avoiding the risk of a possible unavailability of the product. If they are to act, they should start on it fast.
A possible reduction in the availability of hydrous is worked out via price, since the consumer will choose to fill up his car tank at the gas stations with the cheapest fuel per traveled kilometer. Anhydrous is an additive, so the lack of it causes a rupture in the gas supply structure and pricing. The sector will be hit hard by the damage.
But what if everything goes wrong? What if the sugar production is below 540 million tons and the sector can’t produce anhydrous to meet the demand? There are some options left, all of which are damaging: the costly import of corn ethanol and/or gas and the reduction of the mix.
Meanwhile, the funds have increased their long positions (based on last Tuesday) to 198,000 lots, a number which must have gone up during this week. Over the short term, caution about what might happen to prices in NY if the funds start taking profits is recommended. Look at what happened to the coffee market this week. It exploded due to the lack of payment of margin calls and compulsory liquidation of (badly) structured operations, they say. It was bloody.
As a friend reader put it, “the sugar market gives the impression that still has appetite to go up, but the implicit volatility points to the old saying that the ball goes on, but everybody is dancing closer and closer to the exit door”. That’s great.
You all have a nice weekend.
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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
