The sugar market closed at 19.71 cents per pound for October/2016 this week, with a 64-point fall against the previous week and a lot of pressure on the October/March spread probably due to the position rolling by the funds, which still carry a long position of 330 thousand lots.
Regardless of the huge position kept by the funds, the profit-taking on the futures market, the trajectory of the real against the dollar, the sugarcane volume to be crushed this harvest or the amount of sugar to be delivered against October/2016, the worrying act is that those poring over the sugar and ethanol supply and demand analysis in Brazil are astounded by the numbers.
We decided to make the following exercise, which we would like to share with you. There is consensus among the top market analysts – and we can include executives in charge of the most important companies of the sector there – that it will be hard for the sugar field expansion to go beyond a 2.5-3.0 % growth per year over the next 5 crops. Our pretentious futurology exercise covers the 2017/2018 up until the 2021/2022 harvests.
First, in order to analyze the potential consumption of both ethanol and sugar in Brazil, we estimate the ethanol mixture in gas will stay at 27%, though we know this number – as will be shown next – will hardly resist and Brazil will continue favoring the production of sugar since it has a better return for the producers/mills.
With the likely Brazilian economic recovery from 2017 on, and conservatively assuming the GDP’s growth for the next years, it’s feasible for the Brazilian light vehicle fleet to go from the current 35.8 million units over to 46.2 million units by mid-2022 along with the consumption growth of Otto Cycle fuel. We would arrive at the end of the analyzed period consuming 63.4 billion liters. Well, this increment corresponds to the need that in 2021/2022 we will be crushing another 126 million tons of sugarcane compared to the ongoing harvest year.
Still part of the same exercise, we assume Brazil will keep its participation in the world sugar market and the domestic consumption will follow the vegetative growth. It turns out that unless we have huge expansions on the part of producing countries which compete with Brazil in the current context, if we analyze world sugar supply and demand without taking Brazil into account, we will have a 33.5-million-ton deficit for the 2017/2018 harvest. Since Brazil should produce 40 million tons next year and consume about 11.6 million tons, it will make 28.4 million tons available to the world, not enough to meet the abovementioned 33.5 million tons.
We can see the number doesn’t match, for on the side of the supply, we have a sector which can’t expand beyond 2.5% per year, and on the side of the demand, we have the perspective of a recovering economy and the world sugar consumption incapable of meeting the required volume.
The alternatives are: a) the expansion of the sugar field, already dismissed because we have assumed the small growth of 2.5-3.0%; b) the recovery of the investments in the sector which, due to the lack of transparency in fuel pricing formation and its impact on hydrous price, has driven away any investor who knows how to use the four arithmetic operations; c) gas and corn ethanol import to meet the demand which cannot be met by brazilian ethanol; d) substantial increase in gas price to bring the consumption to levels that can be met by the supply.
Based on the simulation test we have done, ethanol supply in Brazil will have to be reduced by between 14 and 16%, affecting the current ethanol mixture in gas by 27% proportionally. As the possible investments in the sector point to an increase in the capacity of crystallization (sugar production), ethanol supply can be affected even further while the difference between sugar and hydrous stays in the high premiums of the first in relation to the second.
In order to null this tight situation between supply and demand both for ethanol and sugar, the perfect world would be for Brazil to produce an additional 214 million tons of sugarcane in 2021/2022 over the current production level of 660-670 million (Center-South and North/Northeast), that is, an unlikely task if not impossible.
The solution, if we look in economy 101 books, is fuel price increase. We find it unlikely that importing 6.7 billion liters per year, which is the deficit shown by the analysis, starting in 2017/2018 will happen. Meanwhile, lots of people are betting the 2017/2018 harvest will reach 600 million tons of sugarcane.
Therefore, like from 2010/2011 to 2014/2015 when we had five years of world surplus, we might have the same thing happen deficit-wise. We have no doubts we are just at the beginning of a volatility-filled period. Buckle up because we are in for a bumpy trip.
How about Lula, huh? I wonder when he will be arrested.
We are making the book “Agricultural Derivatives”, written by journalist Carlos Raíces and me, available to all our readers. Download it in PDF by clicking on https://archerconsulting.com.br/livro/. We hope the book will help you understand this market better. Sorry, only in portuguese.
There are still spots for the 26th Intensive Course on Futures, Options and Agricultural Derivatives to be held on September 27, 28 and 29 from 9:00 am to 5:00 pm in São Paulo, SP. For further information contact priscilla@archerconsulting.com.br
If you want to get our weekly comments on sugar straight through you email, just register on our site by logging onto https://archerconsulting.com.br/cadastro/.
Have a nice weekend.
Arnaldo Luiz Corrêa
