Sugar - short-term risks and long-term opportunities

Summary:
- Sugar prices moved higher as concerns over output in India and Brazil mounted
- Brazilian real does not support sugar prices
- Significant increase in ethanol prices can be seen as negative factor for sugar prices over the short term
- Fundamental situation looks promising over the medium term

Supply side risks

Concerns over the output in the current season triggered a rally on the sugar market at the end of December. Weather is once again a factor said to play a key role in developing these concerns. High temperatures and scarce rainfalls could have hit sugar industry in India, one of the world’s biggest sugar producers and consumers. India barely had any international trade in sugar in the past few years as the country needed major part of what it produced. However, subsidizing farmers caused acreage to increase and output to surge - India became a significant sugar exporter in the aftermath.

Apart from limited Indian output, situation in Brazil does not bode well either. Brazil, longtime sugar production leader, experienced another decline in production. Price of sugar is to huge extent dependant on the situation on the oil market. High oil prices cause demand for biofuels to increase. In turn Brazilian farmers are more likely to sell sugar cane to ethanol industry as they can get better prices. Less sugar sold to mills results in smaller output and in theory is a positive factor for sugar prices. However, one can see on the chart below that ethanol price reached extreme levels recently and this can be treated as the warning sign for sugar as reaching such levels preceded a drop in the previous years.

Extreme ethanol prices in Brazil can be seen as warning sign for sugar. This is especially true given that we are observing consolidation on the oil market as it may fend consumers off the biofuels. Source: Bloomberg

Do fundamentals justify more price declines?

In the 2018 season we have experienced a drop in the sugar production and pick-up in consumption. Overall drop in production was mainly caused by issues in Brazil and by the European Union to smaller extent. Removing production limits by the EU caused bloc to play key role in developing sugar oversupply. On the other hand, India was the main cause behind increase in consumption. A plunge in the Brazilian production resulted in the biggest drop in exports in decades. Nevertheless, India may dethrone Brazil as world’s biggest sugar export thanks to subsidies. This very same factor may provide to be a cap for sugar price increase over the next years. Oversupply on the sugar market was present in previous years and is likely to be maintained in 2019.

Sugar fundamentals do not look too bad but they also do not warrant major price gains. Source: Bloomberg

Demand begins to increase in world’s biggest economies

However, it turns out that sugar stockpiles declined significantly in China and the US. At the same time consumption kept increasing in both countries. There is a scope that elevated demand for sugar will persists in the upcoming years what may help limit commodity surplus. India holds around 15% share in the global production - similarly to China and the US combined.

It turns out that the Chinese sugar stockpile are really low in comparison with consumption what implies way higher price levels for the commodity (yellow line, inverted axis). On the other hand, divergence surfaced two years ago and kept widening since. Source: Bloomberg

Similar situation can be observed in the United States. Sugar stocks-to-use plunged significantly (yellow line, inverted axis) what suggest price increases are looming. Source: Bloomberg

What to expect ahead?

Brazilian real is likely to have significant impact on the sugar price. Low valuations of BRL should encourage sugar mills to boost output and increase exports. According to Safras & Mercado, Brazilian sugar production should rebound around 5.7% this year. On the other hand, production in Europe may experience 5-10% drop compared to the previous season.

Brazilian real is underperforming right now what may drag sugar prices lower as well over the short term. Moreover, seasonal pattern suggests that sugar price may be poised to keep falling until mid-Q2. However, we do not expect price to drop below 11 cents per pound. Last but not least, Brazil and Australia submitted complaints to WTO over extensive subsidies for Indian farmers what causes crop from the other parts of the world to be less competitive. Nevertheless, if WTO is to take any action it is likely to happen in the second part of the year therefore there is little scope for sugar price rebound in the nearby future.

Over the past 10 years, March and April were months that saw the biggest price declines on the sugar market. Source: Bloomberg

Downward waves on the sugar market seldom last longer than 2 weeks but one cannot rule out occurance of the corrective movement with limited price volatility. Source: xStation5