Destroy the books on economy. Forget what Adam Smith or Enrico Barone wrote about. The sugar-alcohol sector has created its own economic theory. In it, where there is a product shortage, prices fall. And when the product stock is high (as it happened with ethanol in October last year), prices reach their peak. This is not my assertion, but an experienced market trader’s when getting it off his chest. Today we are watching ethanol prices drop right in the middle of the off-season despite the perspective of better consumption and the fact that it is almost certain that the Center-South will crush less sugarcane than the market has foreseen.
The narrowing of the May/July spread is a sign that the participants of the futures market traded in NY have started to worry about the availability of sugar at this beginning of the crushing. The spread closed the week trading at 10 points. Mills that had pending pricing for sugar traded on the physical market maturing against the May contract have correctly decided to roll over the fixations until July, so winning additional 60 days and hoping to get better prices. As far as we see it, a right decision at a cost close to 5% per year.
It is evident that the decision implies that there are some risks. For instance, the political environment in Brazil is much worse than one could have imagined. Before President Jair Bolsonaro’s swearing-in, the companies were betting that the real would strongly appreciate against the American currency and that the approval of the necessary reforms to put the country back on track would occur in the first semester. The markets lost heart because of the lack of political practice of the President and the dollar came close to R$4.000. Hence, sugar in NY, pressured by a better settlement price in real per ton, traded within a restricted price range. This picture has limited any sugar price recovery in spite of the oil price improvement on the foreign market.
There are several reasons to believe in a sugar price recovery in NY. We believe that the crushing in the Center-South should stay between 560-570 million tons of sugarcane. It is hard to talk about sugarcane field expansion when the difficulties of the mills in renewing the current sugarcane field, in using pesticides and cultural treatments with so many cash flow problems affecting them are widely known.
The ATR for the next harvest will hardly be better than that of the previous harvest (138.36 per ton of sugarcane, according to UNICA last report). The reduction in sugar availability should occur because the ethanol arbitrage with sugar pays the former at least 100 points over the latter despite of the accumulated drop of 13% in the month.
It is also worth noting that the ethanol consumption should continue growing. In order to change the mix, that is, in order for the mills to decide to produce more sugar, the domestic and/or foreign markets will have to pay the price. Also, take into account that the start of the harvest should be more alcohol prone due to the need that mills have to turn product into money faster. Sugar availability will soon be compromised.
The uncertainties are huge. The number of possibilities together with price, currency, oil, climate, among other factors, creates a complex decision matrix. We like to use some data to better place the current moment of sugar in real per ton. Since 2014, therefore, a little over 5 years, in adjusted values to today, the sugar closing in NY together with the dollar closing by the Central Bank, 40% of the times has been above R$1,125 per FOB Santos ton with polarization premium (exactly the price of this Friday’s closing). Half of the times, it has been over R$1,024 per ton. In just 20% of the times, it has been R$1,366 per ton.
Given the possibility of change in the perception of the market as to sugar supply of the Center-South, it is reasonable to think that we will have better prices in real per ton pretty soon. Over the same five-year period, when NY reached the 9.83-cents-per-pound low in September last year, the adjusted value today corresponds to R$954.52 per ton. In just 38% of the times (Fibonacci?) has the market been below this value.
On a different note, after weeks of boring sessions in the sugar futures contract in NY, last Monday we were flabbergasted to watch the trading of a record volume of call options. More than 130,000 contracts were frenetically traded in just one session at what seemed to be a huge settlement of short positions in calls, probably by funds. As it always happens in such situations, when we have no clue what is going on, or who is operating, that is, whatever lies behind the events, several theories pop up.
Some traders explained that the huge traded volume was because of the funds that were changing the bullish vision they had about sugar, and for this reason they settled the call options they served – still according to them – as protection against an eventual climate problem in the Center-South. The fact is that the funds didn’t change their vision; they are heavily short in NY, according to a CFTC report, by about 114 thousand contracts. If this is bullish, I don’t know what being bearish means.
A futures broker in NY has alerted that no businesses done with options on Monday went through any trading company, but just straight through the Exchange, which leads us to conclude that they might have been “algorithmic trading” (an investment tool which trades financial assets or commodities automatically based on mathematical models and artificial intelligence)
Set aside the date on your calendar. The XXXII Intensive Course on Futures, Options and Derivatives – Agricultural Commodities will take place on August 27 (Tuesday), 28 (Wednesday) and 29 (Thursday), 2019 in São Paulo, SP at the Hotel Wall Street near Paulista.
You all have a great weekend.
Arnaldo Luiz Corrêa
