Sugar is ascending.
Reasons are varied and include the effects of a weaker dollar, stronger oil prices and increasing demand for ethanol.
But the key bullish factor has been a much larger than expected seasonal production deficit due to growing crop shortfalls from the world’s two top producers Brazil and India - and that’s down to the weather.
As Standard Chartered noted back in March, the situation in India was already looking tight:
India is now expected to produce up to 11mt less sugar (-42% y/y) than it did during the previous season, compared to the 8.5mt decline initially forecast. This is bullish for the market given India’s strategic position as the largest sugar consumer globally.
One of the key policy challenges in India is to keep inflation contained, especially in 2009, an election year. Given its potential impact on inflation, the steep drop expected in sugar output will make this objective even more challenging. Over the last six months, sugar prices in Maharashtra state have risen by more than 30%. In response to the threat of inflation, the government has imposed stock limits on processors in an attempt to tap last year’s surpluses. The government has also allowed duty-free imports of raw sugar under the ‘tonne-tonne’ agreement provided that importers ship out the equivalent amount of refined sugar in two years.
Our understanding is that by providing a two-year window, the government aims to encourage processors to buy now and service the local market in anticipation of excise-free access to international markets when output in India recovers. The main weakness with this policy is that it assumes that processors will make their processing decisions based on future expectations about prices and output. We do not find this credible given price and output volatility, current risk aversion in the industry, and high processing costs for raw sugar relative to market prices.
Since that time, deficient monsoon rains have stalled further production in India. In Brazil, meanwhile, increased rain interruptions, put down to El Nino effects, as well as lower sucrose levels — on account of earlier over-production — further threaten downward revisions to global 2009-2010 harvest forecasts.
As Barclays Capital explained in a note to clients this week, global sugar stocks have now halved in the past 12 months. As they forecast:
Given the forecasts are for the wet weather to continue into August and the El Nino effect likely to mitigate prospects for a dry end to the harvest, our original forecast for Brazilian output of 37.5Mt now appears to be too high, as such the 09/10 projected market deficit is growing by the day. Our current target on the March 2010 contract is 22 cents/lb, but this may prove conservative if El Nino lives up to its reputation
All of which continues to present a pretty bullish case for sugar prices.
