The sugar market in NY is still like water coming downhill, sweeping away everything on its way. Many mills are paying the price for waiting on better days which ended up not coming and then a volume of fixations yet to be made ended up accumulating against March/2018. Getting out of this maze is a hard equation to work out. However, maybe we have already seen the worst when it comes to prices for the producers.
The futures sugar contract for March/2018, which expires late this month, closed Friday trading at 13.63 cents per pound, a 26-point high against the previous day, but basically unchanged against Friday last week. The week has been tense when March came to close to 13 cents per pound. There were a lot of people biting their fingernails.
Several executives and market professionals are on their way to Dubai where, starting this Saturday, the Annual Sugar Conference will be held. For obvious reasons the discussions there usually have a bearish tone; after all, the organizer of the event is a great buyer. The impact has been neutral most of the times except for last year when the prices plummeted, not because of the Conference, but because they were just inflated.
A concern we have felt when talking to several executives from the sector has its roots in the size of the next harvest. There are no doubts that we will have a year with less sugarcane to crush, lower productivity (given that the production in 2017/2918 was amazing) and much less sugar.
Our third estimate for the 2018/2019 harvest of the Center-South predicts a crushing of 580 million tons of sugarcane, with a production of 30.5 million tons of sugar (a decrease of 5.3 million tons against the UNICA number for 2017/2018) and 26.5 billion liters of ethanol (an increase of 1.3 billion liters). This number was obtained considering a mix of 41.4% of sugar, which is slightly above the expectations of some executives who bet on a 40% mix. If they turn out to be right, you can cut another million tons of sugar out of this calculation. Can you imagine that?
A year ago when the market was trading at 20.42 cents per pound, I commented here that I smelled a black swan in the air, affected by a week of the course I attended given by Professor Nassim Taleb, of course. The market was ready for a turning point. The funds were heavily long. And today they are heavily short. The story is the same, but with plus and minus signs swapped over.
Today we know that the funds set up a strategy called long-short which consists of short selling some asset and buying another asset they believe will go up, using the same notional value, that is, they sell some equivalent value in sugar and buy the same equivalent value in oil, for instance. Therefore, they are heavily short in soft commodities (mainly coffee and sugar) and heavily long in energy (oil). While sugar and coffee dropped by 10% and 4.5%, respectively, in the accumulated of the year, oil went up by 8.5%. That is, the funds are making hundreds of millions of dollars off of widening up this spread.
The funds are in no hurry to come out of their short positions in sugar for several reasons: one, they are profiting; two, technically the market continues pointing down; three, oil is hanging on there and gives support to the position which keeps the sugar; four, whenever the market moves, the mills that are late in fixations take advantage of the increase and fix prices. That is, the funds do not need to rush. And the last mentioned factor is what has made the difference.
The concern is whether they will come out of the two positions simultaneously (and that is not rare). The possible increase that sugar would have from the repurchase of the short position on the part of the funds could eventually be neutralized by the oil drop which would affect the gas value at the pump and then the hydrous. That is, this difference between the two markets would narrow to a fairer value. I will explain it better.
The oil price curve for the next three months, assuming that Petrobras will keep its transparency policy in pricing and that the dollar will stay between R$3.1600 and R$3.200, shows an average gas price at the pump at R$4.0000 per liter.
Let’s admit two hypotheses: first, assuming that 70% of this value is the most that the hydrous can be traded at the pump keeping its competitiveness. Second, let’s imagine that at the start of the harvest, the mills press the sale of the hydrous so that its parity with gas comes to 65%.
Therefore, we have set R$2.8000 per liter as the maximum price and R$2.6000 as the minimum price at the pump. These values correspond to R$1.7434 and R$1.5434 per liter, respectively, at the mill, tax-free. The first one would demand that sugar in NY trade at 16.42 cents per pound to even out while the second one puts NY at 14.74 cents per pound. Therefore, this would be the fair price range for the period of March/April/May.
Ah, but what happens if the Brent drops to 55 dollars per barrel and the real appreciates to R$3.000? The NY fair price should be 14.88 cents per pound.
A good bet for those who like black swans: buy an 18 cent call and sell an 11 cent put, both expiring in October/2018.
There are only four spots available for the XXIX Course about Futures, Options and Derivatives on Agricultural Commodities which will take place on March 6, 7 and 8, 2018 in São Paulo, SP at the Hotel Wall Street. The next course should only be held in August/2018. For further information: priscilla@archerconsulting.com.br
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Have a nice weekend.
Arnaldo Luiz Corrêa
