Estimates for the 2012-13 global sugar surplus keep rising. Most recently, the International Sugar Organization (ISO) raised its surplus estimate to 8.5 million tonnes, up from 6.5 million tonnes for 2011-12. More significantly, this estimate is 2.3 million tonnes higher than the ISO’s November estimate. The main reason for the expanding surplus is the unexpected surge in Brazilian output. What lies ahead?
Brazil’s 2013-14 marketing year begins in April, and early estimates call for a 1.8-million-tonne, or 5.2%, increase in the center-south crop. While that sounds quite bearish, the estimates could change as demand for ethanol increases. Ethanol demand in Brazil fluctuates. At present, it is more economical for motorists to fill their cars with ethanol than it is with petroleum-based gasoline.
The big issue from the production side is that sugar prices are now well below the cost of production. The estimate for the sugar/ethanol output ratio is for an increase from 49/51 to 46/54. We believe that this forecast is outdated because of ethanol’s higher relative profitability. We expect the ratio to move back to where it was several years ago, in the 40/60 range.
This is all old news, though, and has failed to halt the slide in prices. More recent developments in India, however, are very bullish and are being completely ignored by the market. Severe drought will affect the 2013-14 crop to the extent that the key growing regions will see acreage fall by 20% to 25% below 2012-13 area!
Last year’s output reached 24.3 million tonnes. A drop in output of even 10% would see production fall below domestic consumption. The Indians might draw on ending stocks, but it is far more likely that the government will protect a comfortable inventory level by removing tariff barriers to promote imports.
This will be the first time in four years that India will experience a production/consumption deficit. Back in 2010, two consecutive crop failures — just about singlehandedly — drove sugar prices to 35¢ per pound (Chart 1). It is impossible to estimate the size of the coming crop at this juncture. There are many variables that could either exacerbate or mitigate the situation, for example, the quality of the June-through-September monsoon and the amount of cane used for cattle feed.
Early forecasts for the 2013-14 global sugar balance call for a surplus, albeit a smaller one than in the current marketing year. Farmers in some Northern Hemisphere beet producing countries, such as Russia, the Ukraine, and the US, are expected to divert sugar area to more profitable crops. Grain and oilseed prices, for example, have fallen from lofty bull market levels, but are still far above their historical norms, leaving farmers with much more potential for profits.
We believe that these projections for 2013-14 do not include the recent developments in India. Nor do they take into account the high probability that the sugar/ethanol ratio in Brazil is being overestimated, as we discussed above.
Commodity fund managers have been increasing their bets on the short side – even now, at the 18¢-per-pound level, which would seem to be counterintuitive, were they to consider that they are selling sugar short at prices that are well below the cost of production. The net-short position is at a multi-year high (Chart 2).
Our January 31 recommendation, to avoid jumping on the long side just yet, stands. We do, however, continue to advise buying call options. Implied volatility levels have jumped a bit, but are still near historic lows and present the best opportunity for bulls. Buy July 19 or October 20 calls.
