After a brief relief rally, the sugar market (NYBOT:SBV13) has returned to its bearish ways. Over the past year, the market has rallied leading up to — and sometimes after — the expiry of the front-month contract, as seen in Chart 1. In all likelihood, the rallies were the result of covering by shorts who wanted to book their profits and did not wish to roll over their positions. The expiry of the July 2013 contract on June 28 was certainly due to short covering, as evidenced by the over-100,000-contract drop in open interest and the contraction in the net-short position held by funds (Chart 2).
There have been some developments on the fundamentals front.
Wet weather in Brazil during the first half of June hampered sugar crushing, prompting larger-than-expected ethanol production. It’s been drier over the past few weeks, but sugar output was down enough for analysts to revise their sugar output forecasts. Some estimates for 2013-14 output have fallen by more than 2 million tonnes.
Unless there is an unexpected shift in the ethanol/sugar ratio as the crushing season develops, we are no longer looking at record sugar production. Original estimates called for over 35 million tonnes, but the tally now looks to be closer to last year’s output of about 34 million tonnes.
The government incentives for ethanol producers – not to mention competitiveness spurred by the fact that crude oil is trading over $100 per barrel – have been effective. Output in the center south region, where 90% of Brazilian cane is grown, will be 25.7 billion liters, up from an earlier forecast of 24.5 billion liters, and compared with only 21.4 billion liters for the 2012-13 season.
The ethanol/sugar ratio is estimated at 55.2%/44.8%, above a previous forecast for 53.5%/46.5%, and compared with 50.5%/49.5% in 2012-13.
Last season we saw wild swings in the estimates for Brazilian sugar production because of alternating favorable and unfavorable weather systems, and there is no reason not to expect the same this year. So while the change in the outlook for Brazil is clearly bullish at the moment, it is not carved in stone. Certainly this is the view of traders who have pushed front-month October to new lows in recent days.
Another potentially bullish factor down the road – also, which has made no impression at all on bears – is early forecasts for 2013-14 Indian production. Fears of a poor monsoon have passed. The monsoon arrived on time in early June, and the rains have been at above-average levels in cane-growing regions. Still, Maharashtra province, the largest-producing region in India, continued to suffer from last year’s drought, and cultivated area fell by 25%. That would draw down Maharashtra province output by about 2 million tonnes, to 6 million tonnes.
Overall, Indian sugar output is estimated to fall to about 22 million tonnes in 2013-14, down from 24.6 million tonnes in 2012-13. Last year’s consumption was 23.6 million tonnes, and with a growing population, it is inconceivable that usage will not be at least as much. This will leave India with a production/consumption deficit and the need to tap into inventories.
The government’s liberal export policy facilitated exports of over 3 million tonnes in 2011-12 and 2012-13. For this coming season, however , analysts have acknowledged that new supplies will be much tighter than in recent years. Exports are estimated to be negligible, at about 500,000 tonnes in 2013-14.
At this point, the global balance sheet is still expected to show a production/consumption surplus for 2013-14, but all the major sugar analysts have been inching their forecasts down. The average estimate calls for a surplus of about 4 million tonnes, compared with close to 10 million tonnes for 2012-13.
Finally, as we’ve mentioned many times in these pages, the cost of production has moved up substantially over the past few years. If the world sugar price at 20¢ per pound proved to be a disincentive to sugar cultivation, it has certainly become a much larger factor at 17¢ per pound.
We continue to believe that the purchase of out-of-the money calls will prove to be rewarding, even if repeated several times.