Weekly Comment – October 2nd to 6th, 2017

We said on our comment last June 2, that is, a little over four months ago, that some hidden risks can come out of hiding at any time bringing, even more, devastation to the prices…hedge repurchasing on the part of the mills to create cash flow will press the market sooner or later.

Well, the check has come. There is no doubt that one of the most inhibiting points of a recovery in the sugar price at the NY exchange was the repurchase (which makes the mill have to fix later) and also the roll-over (which transfers the hedge of a month to the next in the hope for better prices).

It is estimated that 20% of the fixation percentage for October (between 37-42% of the yearly volume of the sugar exported by Brazil) has been rolled over to March. And that the fixation for March, because it is the last trading month of the Center-South harvest, has reached at most 50% of the expected volume to be fixed against that month, because the mills hold out for the production rhythm before making the hedge in its entire expected volume.

Hence, we might still have no less than 4.8 million tons of sugar to be fixed, or about 95,000 lots, volume close to the 106,000 lots which the funds are shorts at. The turbulences continue. As an implacable executive recently put it to a bunch of friends, “the market is full of Supermen who jumped off buildings and found out they cannot fly”. The mills that repurchased hedge or kept looking at the screen in the hope that the price would go up again found out they cannot fly.

The sugar market closed Friday with March/2018 traded at 13.98 cents per pound, a 12-point fall against the previous Friday. The pressure on the other months was smaller, strengthening the thesis that the market has a ceiling as long as the need to close the books (mills fixing) lasts.

Last week we released the first sugar production estimate of the Center-South for 2018/2019. It is 591 million tons of sugarcane, split between a production of 35.5 million tons of sugar and 24.6 billion liters of ethanol, out of which 13.6 billion liters of hydrous and 11 billion liters of anhydrous. The estimate is based on sampling and it took into account limited expansion of the cane field. We have preserved the same product mix and reduced the production of ATR per ton of sugarcane. We still find it premature to make changes in the mix and only focus on the production of sugarcane.

The next sugarcane harvest in the Center-South will be the first to have a new and important component in sugar pricing which should introduce a little bit more of volatility to the market: the oil price on the foreign market. The fuel pricing policy introduced by Petrobras taking as a basis the oil price fluctuations on the foreign market and with daily changes in the gas price at the refinery add a component which the sugar market will have to learn to live with.

In the recent past, under the PT’s (Workers’ Party) government of Lula and Dilma, substantial changes in the oil price on the foreign market did not change the gas price at the refinery. At the time of high oil prices on the foreign market, the sugar-alcohol sector was left in the lurch and did not make a single cent out of the bullish trajectory of the black gold. The administered prices by PT’s (Workers’ Party) populist government, stole hundreds of millions of real from the mills through the gas price freeze. That is, the changes in the oil prices didn’t matter much because their internal effect was close to zero. This has been changing. 

There are doubts whether the risk policy of Petrobras would set a maximum ceiling of fluctuation to be passed on to the refinery. But, if so, there are no doubts that oil or gas price fluctuations abroad will have an immediate impact on the fuel prices at the pump making the ethanol incorporate this change and thus affecting the sugar price.

Thus, what we will certainly see is the sugar price in NY starting to reflect not only the supply and demand of the product but also that of the energy market. The mills go through decades producing a commodity whose price can be hedged at the exchange, and a by-product whose selling price was unknown because it depends on the government fiscal policy of the moment – an unfair business which partially explains the size of the debt of the sector.  

Now the participants of the futures sugar market will have to learn how to treat sugar and energy as components of a single matrix. The intercommunicability of the oil prices with ethanol and ethanol with sugar, in the medium and long terms, should improve the profitability of the mills by means of financial instruments that provide price protection and/or minimum return.

Other components should strongly play into the trajectory of the prices over the next year. And they are what we could call hidden risks. For example, the market and the bears ignore that the fuel consumption is on a slightly rising trajectory. The sensible improvement of the economy will boost the fuel consumption. If with a negative GDP of 3.7% we grow zero, how much can we grow with a positive GDP of 2% – keeping in mind that over the last ten years, the fuel consumption growth (equivalent gas) was 6% per year and that over the last five years it has been 3.4%? Are we ready to grow by this percentage? 

Some traders argue that the minimum production of hydrous necessary for 2018/2019 in case of a possible recovery of the economy would be 15 billion liters. So that we can reach this number, the maximum production of sugar in the Center-South would have a decrease of 4 million tons. But of course, these risks are still hidden.

We have hardly opened registrations for the XXIX Course on Futures, Options and Derivatives in Agricultural Commodities which will take place on March 6, 7 and 8, 2018, in São Paulo, SP at the Hotel Wall Street and 20% of the spots have already been filled with the course still 6 months out. Don’t leave it to the last minute. For further information:

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Have a nice weekend.

Arnaldo Luiz Corrêa

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