Unfavorable weather conditions in June and part of July in the world’s two largest sugar producers – Brazil and India – threatened to compromise 2012-13 production. In Brazil, excessive rains hampered the harvest and lowered sucrose content. In India, the monsoon season got off to a slow start, leaving cane crops with insufficient moisture. Prices responded accordingly, with a strong rally up to 24¢ per pound.
Improved weather in both countries, however, stabilized the situation, ending fears of a global deficit. In Brazil, drier weather prevailed, allowing the harvest to advance. The Indian monsoon picked up some steam, and a disaster was avoided. The market has since erased the entire rally.
The rally was an accurate reflection of bullish supply-side fundamentals. Had the weather not cooperated, we would be looking at crop losses of several million tonnes in each of the two countries. The resulting global production/consumption deficit would have drawn stocks down enough to tighten supplies available for world trade. Conversely, the selloff back below the 20¢-per-bushel level has, we believe, been exaggerated to a degree.
To be sure, there were enough bearish developments on both the supply and demand sides to warrant the downdraft. The seasonal demand period in the Middle East and Asia had ended. As recently as July, Chinese customs data showed large increases in sugar imports, which seemed to indicate strong demand down the road. Now, analysts are saying that 2012-13 imports will fall to 2 million tonnes, down from 3.5 million tonnes in 2011-12.
Finally, the sugar/ethanol ratio in Brazil has been favoring sugar. Even with falling sugar prices, sugar provides a higher profit margin. Recent estimates say that 48.7% of the cane crop was used for sugar, up from 47.1% in the 2011-12 season.
With dry weather through the balance of the harvest period, the Brazilian 2012-13 cane harvest could equal or exceed last season’s production. If all goes well, export availability of 22 million tonnes will equal last year’s. To put this in perspective, though, 2011-12 was an off year for production, with sugar production down about 2 million tonnes from the previous season. So while the worst-case scenario of export availability of below 20 million tonnes has been averted, it is still not a bountiful situation. In addition, analysts point out that although the cane harvest will probably be over 500 million tonnes, the sucrose content level is still suspect.
Falling ethanol production may be bearish for sugar prices in the short run, but the dynamics of the ethanol market in Brazil will eventually swing the pendulum in the other direction. The minimum government-mandated 20% ethanol blend for vehicles will not change. Demand for Brazilian ethanol for export is strong and growing. Total Brazilian exports in the 2011-12 marketing year were 1.9 billion litres, and are expected to increase by at least 15%, to between 2.2 and 2.5 billion litres.
The soon-to-be-harvested US 2012-13 corn crop was devastated by drought and will be at least 12% smaller than the previous season’s crop. The USDA slashed its estimate for ethanol consumption to the corn equivalent of 4.5 billion bushels, or 10% below the previous season. However, a good deal of usage is entrenched in the system.
One private analyst estimates that US exports will fall dramatically, but that only represents less than 10% of US usage. Domestic consumption, on the other hand, will fall by only 2%. The total drop in demand would be about 5%, much smaller than the USDA estimate. A political debate has commenced regarding the wisdom of maintaining the current mandated ethanol blend requirements, but we do not believe the mandate is likely to change.
This brings us back to Brazil where US imports of Brazilian ethanol are expected to jump significantly to compensate for the shortfall created by the smaller corn crop.
We’ll muddle through the early part of the marketing year, when corn supplies are ample and the US will not need to rely on Brazil. However, if Brazilian cane processors continue to favor sugar over ethanol production at the current rate, tightness in ethanol should emerge. Ultimately, the sugar/ethanol ratio will shift back to the levels we saw several years ago, tightening sugar supplies available for export.
Private industry analysts in India lowered their estimate for Indian output by 1 million tonnes, to 25 million tonnes. Some areas did indeed receive much better moisture as the monsoon improved. Other key areas did not. We’re skeptical about this estimate, because a good part of the growing season was dry. One Brazilian analyst puts the Indian crop at 23.8 million tonnes, much closer to Indian domestic consumption, which of course means that India’s ability to export is crimped. We expect to see final estimates for India to be a fair bit lower than 25 million tonnes.
Some analysts have raised their forecasts for the global surplus to reflect the recent crop recoveries in Brazil and India. Other’s share our view and have lowered their estimates. The range of estimates is between 3 and 9 million tonnes, a rather significant divergence.
We were stopped out of our long position in October sugar at 22¢ per pound. Re-enter the long side. Buy March sugar, currently just above 20¢ per pound and place initial stops at 18.50¢ per pound, close only.
