The sugar market in NY witnessed a climate of hysteria at last Thursday’s session when prices skyrocketed within minutes, making October/2016 trade at 23.45 cents per pound, the highest level since July 25, 2012. To the despair of the trading houses which were/are short, panic set in and contaminated all the other maturity months along the price curve, which now stretches up until July 2019.
As in other similar cases, where you go to the kitchen for some coffee and when you come back the market has gone up 100 points in your face, decision-making is jeopardized because under this kind of environment, rationality, unfortunately, weakens and the argument which not rarely wins out in situations like this is “not to do anything because we don’t know what will happen”. It’s now that in nine out of ten similar situations a great opportunity to fix good prices is missed.
Between Thursday’s high and the next session’s low, there was a more than 7% fall. October closed the week’s session at 22.13 cents per pound – a 35-point high against the previous Friday. All the other maturity months closed at larger highs against last week’s closing.
The average closing price of NY (first maturity month) is at 20.89 cents per pound, slightly over the 20.61 cents per pound we predicted in our model and mentioned here in our comment on August 19.
Some factors could have contributed to the sudden price increase. The market comments, for example, that a wash-out volume, which shows the sugar availability can be smaller than what the market anticipated. The wash-out consists of an operation where the seller/producer (mill) repurchases his short position (for the trading company) because he realizes he won’t produce the volume he had promised to deliver, or repurchases to resell on a more profitable market. In our case, the first example is dominating. If the mill has already fixed the sugar, the trading company has to repurchase the fixed position on the futures market feeding into the price increase. The situation gets worse if the mill doesn’t pay for the difference between the original fixed price and the repurchase price on the futures market, making way for contract renegotiations and all the resulting implications. In short, a headache for the trading companies in a year in which the basis hasn’t helped them a whole lot.
The fact that a big VHP buyer was in Brazil during the week, increasing the suspicion that the market high also caught him off guard and that he might not be as covered as he would normally wish others would think he was, might also have contributed to the high. Lastly, the real appreciation, which was trading at 3.1800, might have played into that high as well.
We repeat that we must stay focused. The market should rise. A small correction is still possible, but the goal is still 24-25 cents per pound as of March 2017. It is good to see that the mills are taking advantage of the opportunities and continue to build a highly profitable average price for the next harvest.
The drop in option volatility shows that with a rising market we have seen traders selling calls to add value to the fixations or selling puts to reduce acquisition costs. We don’t think there has been option purchase to make up for the margin calls.
An important thing that should be remembered in strategic discussions which happen every day is the fact that Petrobras has announced that the gas price traded at the pump today is above the international parity and, therefore, it is considering aligning it with that of the foreign market. Undoubtedly, this is one the best news piece produced by Pedro Parente’s competent administration. According to our model, the fair gas price at the pump, so that it is aligned with the international market would be R$2.9100 per liter. We don’t know whether the price reduction will come with the CIDE. It looks like it won’t, for many economists, among which Professor José Roberto Mendonça de Barros, MB Associates, claims the CIDE is inflationary. Admitting the gas price reduction will happen from 2017 on, we have two important results: the first and most obvious one is the increase in consumption, though ethanol price will be equally pressured. The second one, is that upon setting a criterion for fuel pricing, Pedro Parente throws the doors wide open to the entry of those possibly interested in investing in the sugar-alcohol sector, which needs to grow by at least 200 million tons of sugarcane over the next five years in order to meet not only the demand for sugar but also for ethanol. Pricing transparency is the least we need to grow sustainably. 2017/2018 promises to be very good.
The third pricing estimate by the mills on the futures market in NY for the 017/2018 harvest shows, according the model developed by Archer Consulting, that up until late August/2016, 5.61 million tons had already been fixed (21.2% of the estimated export).
The average price found was 16.49 cents per pound. In previous harvests, the maximum percentage of accumulated fixation until August had been 17% in 2012/2013. The average adjusted value of fixation, considering the NDFs, point to R$1,507.80 per ton, or 65.64 real per pound. July and August had a low average daily volume of trading in the NY exchange. The expectation is that the number in September will grow substantially since the average of traded contracts in September up to now has been 210,000 daily lots against 85,000 in the two previous months.
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Have a nice weekend.
Arnaldo Luiz Corrêa
