The futures sugar market in NY closed the week with March/2019 at 13.42 cents per pound, clearly showing the difficulty sugar faces setting above 14 cents per pound.
The funds are apparently zeroed out, or slightly long, and, therefore, can choose which side of the boat they would rather be on. Although the current discussions about sugar fundamentals are more constructive, especially when people talk about reduction in the much-vaunted surplus and some consensus that the Indian sugar crop will be smaller than the 32.8 million tons of sugar heralded before (today a lot of traders are taking less than 2 million tons of sugar for granted), we cannot forget that the movement of the long-short funds has been synchronized.
Well, sugar and coffee have gone up 11% in a month (due to the fund’s liquidation, at least in sugar) while oil and gas dropped 15% and 20%, respectively. Should there be any issue in the Middle East which can trigger an increase in oil and non-indexed funds decide to redo their long positions, will it make sense for them to destroy the futures sugar markets again and aggressively sell both of them again?
Oil market analysts have alerted in the first week of October that the funds were changing the bullish feeling they had been showing until then against the commodity and, therefore, started a profit-taking process of these long positions, practically returning to the market all the high trend seen since mid-August, when the WTI oil went from 65 dollars per barrel to about 77 dollars per barrel. This Friday it closed at 63 dollars per barrel.
In early October we saw the price of the oil barrel reach its highest price level equivalent in real, combining the pressured real at 4.0200 and the oil on the international market hitting 84.98 dollars per barrel. So, in reals, we had 341.62 per barrel. This Friday Brent oil closed near 270 real per barrel – a 21% drop from the peak seen a month ago.
This substantial reduction in the oil price will reach Petrobras trading value, that is, the origin price of the refinery set by the Brazilian state-owned oil company. If we just compare the average fuel consumer price based on more than 100 countries, we will see that today gas should be at R$3.9690 per liter at the pump. Last week the average price in São Paulo, according to Novacana, was R$4.8670 per liter. That is, theoretically, there is room for an 18% reduction.
The change in fuel consumer prices, especially when there is room for reduction, is usually slow, but it will come along. Likewise, the gain obtained by hydrous ethanol from an important market share that used to belong to gas when it was very expensive for the consumer will only be lost if oil plummets even further on the world market so as to make hydrous lose competitiveness to gas. But oil plummets…
The thing is we cannot say the market has consolidated. Heavy clouds can darken the sugar-alcohol scenario again. Steady real and declining oil are a combination that would affect the willingness of the mills to keep the current mix of products for the next harvest, that is, the key turns to sugar, increasing the supply of this product once ethanol loses competitiveness with cheaper oil import in real. Steady real with increasing oil would keep us safer in the current price interval of 13 and 14 cents per pound.
In order to reach higher market price levels, the market needs substantial change in the fundamentalist scenario (Indian harvest, perception of harvest in the Center-South below this year’s volume, extraordinary increase in domestic demand of sugar and fuel in Brazil) or alterations in the oil supply around the world, or also weather-related issues. Or, the best of both worlds, an adequate combination of all these factors.
While this doesn’t occur, it’s advisable not to miss opportunities of pricing for the 2019/2020 harvest, seeking the convenient level of price according to your risk appetite and in line with the shareholder’s compensation. The purchase of a put at a strike price below that of the market and the concomitant sale of a call at a strike price above that of the market, structure known as fence, can also be suitable.
Be very careful about more complex structures painstakingly designed to rip money out of your pocket disguised as zero cost operations. Remember that there is no free lunch. Responsible risk management is halfway through to success.
Registrations for the XXXI Intensive Course on Futures, Options and Derivatives in Agricultural Commodities, which will take place on March 19 (Tuesday), March 20 (Wednesday) and March 21 (Thursday), 2019 at the Hotel Paulista Wall Street, in Bela Vista, in São Paulo (SP), are open. For further information, send an email to priscilla@archerconsulting.com.br. We recommend that the participant read the book Derivativos Agrícolas, which can be found at iTunes, Amazon, Livraria Cultura or www.estantevirtual.com.br, before attending the course.
Have a nice weekend.
Arnaldo Luiz Corrêa
