The sugar market in NY closed the week at 15.31 cents per pound in July/2017, an 82-point fall, or the equivalent to more than 18 dollars per ton. The other trading months didn’t let up either. Seventy-three to thirty point falls, from 16 dollars per ton to 6 dollars per ton, with larger weight on shorter maturities.
The macro scenario is jeopardizing the more detailed analysis about the sugar market. The heavy volume of sales of commodities and risk assets all over the world blurs the view and makes us lose focus. In the yearly accumulated, gas and sugar dropped by 21%, oil by 17%, ethanol by 12%. Even the funds went short, and are now short in sugar (it is estimated by 20 thousand lots). It’s not exactly the kind of news we would like to hear.
Despite this dark scenario for the mills, we believe that the downside risk of the sugar, at this 15.31-cent-per-pound level, is limited. It won’t be able to stay below 16 cents per pound too long for structural reasons: production cost (in Brazil and in other countries), proximity to ethanol parity, cash flow squeeze affecting cultural cares and eventual expansions for the next years. The more the market falls irrationally and speculatively, the more violent the correction will be.
Last February 17, in an exclusive report for our clients, when NY was trading at 20.30 cents per pound, we said that sugar prices starting in April could suffer a violent fall if there wasn’t a meaningful change in the fundamentals. There was no change and from that date to April 28 we were astonished watching the futures contract in NY plummet from 20.30 to 16.04 cents per pound, that is, a 21% devaluation.
There are many lessons to be learned from this market, but the most important one is discipline. This is one of the points we insist on most in our considerations about the sugar market and any commodity: there must be discipline for an adequate risk management.
Our mathematical model (remember that models fail) shows that the average price for May is 16.51 cents per pound, that is, 1% better than the average price seen in April, which was 16.34 cents per pound. Despite Friday’s closing being way below this value and the average in May up to now 15.76 cents per pound, 16.51 seems to be too optimistic. Our view is that the market anticipated the pressure that would occur at the peak of the harvest in July. This kind of anticipation had already occurred before. In May last year the model showed 14.78 and the average was 16.68 (that is, better), then in November the model showed 22.72 and the effective average ended up being smaller: 20.87. I wonder if the fall shown by the model to happen in July got ahead of itself.
For June, the model shows a slight fall: 16.36 cents per pound. July should have the greatest pressure and the model shows a 100-point discount against June, that is, 15.36 cents per pound. From August on, the model believes prices will start to bounce back slowly.
Speculatively, it can be said that the sale of a put at exercise price of 15.00 cents per pound (45-point premium at Friday’s closing) and the sales of a call at exercise price of 17.50 cents per pound (12- point premium at Friday’s closing) constitute a strategy compatible to what the model shows. If July expires below 15.00, you will be long at 14.43 cents per pound; if it expires above 17.50, you will be short at 18.07 cents per pound.
On making a projection about sugarcane yield for the next harvests (up to 2021/2022) comprising the Center-South and the North/Northeast, we assumed a total expansion of the sugarcane field by 2% a year and kept the sugar mix at about 47-48%. The result was a deficit of accumulated sugarcane of 115 million tons over the next five years. This volume corresponds to 10.6 billion liters of ethanol. If the sector doesn’t invest in the expansion of the agro-industry we will have to import corn ethanol and/or gas. Since we assumed in the projection that the mix will primarily serve the sugar market, this one doesn’t show deficit.
The data is relatively conservative since it estimates the fleet of vehicles for 2021 at 41.5 million units, of which 9 million are gas-run and 32 million are flex vehicles. Conservatively, we also estimate an active fleet of motorcycles at 14 million units. Changes in these numbers due to an eventual improvement in the economy after 2018 will obviously reflect upon the abovementioned deficit.
As for the estimate of RenovaBio, object of our comment last week, that Brazil should consume in 2030 about 50 billion liters, Archer’s numbers show that in that year the total fuel consumption should be 75.7 billion liters, of which 40.1 billion liters of gas A (without mix) and 35.6 billion of liters of ethanol (14.8 of anhydrous and 20.8 of hydrous)
Archer Consulting 28th Intensive Course on Futures, Options and Derivatives – Agricultural Commodities (in Portuguese) will be held on September 19 (Tuesday), 20 (Wednesday) and 21 (Thursday) from 9:00 am to 5:00 pm in São Paulo, SP at the Hotel Paulista Wall Street. Don’t leave it to the last minute and enjoy the discounts.
If you want to get our weekly comments on sugar straight through your e-mail, just sign up on our site by logging onto https://archerconsulting.com.br/cadastro/.
For those who are going to New York to attend the Sugar Dinner, have a nice trip and good businesses.
Have a nice weekend.
Arnaldo Luiz Corrêa
