Global Sugar View by Michael McDougall – Episode 3

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Food or fuel?
In 2005, the United States prohibited the use of MTBE as an oxygenate due to the lead in the formula being detected in the groundwater. MTBE was replaced by corn ethanol. US ethanol production was already beginning to rise in anticipation of the changeover, but by 2002, production of US ethanol was 2.130 billion gallons, and by 2010, we were up to 13.230 billion gallons, a jump of 620%. These days, corn used in ethanol production represents nearly 35% of US corn production. This is with a 10% mix in the gasoline, far short of the 27% Brazil is using with their gasoline/ethanol mix. There has been a push for E-15 for some years, but there has been pushback from auto manufacturers and honestly fuel distributors who prefer to hold ethanol use to a minimum.

The US ethanol program was a big boost for US farmers, but when grain prices jumped in 2007-2008 and 2010, immediately the argument started that, should we produce fuel with a food crop? The US corn ethanol program actually began in earnest back in the early 70’s after the OPEC oil embargo in 1973. Back then, there was a certain amount of desperation with the US oil production not covering consumption and the US very dependent on oil imports. Brazil was in the same situation and they started their ethanol program. Their ethanol program would go through many ups and downs, but once the flex fuel car was introduced in Brazil (from the United States) back in 2003, ethanol consumption really took off.

However, along with the food or fuel argument back in 2008, there was also a surge in investment in commodities on the part of investors through an instrument known as an index fund. This new channel for investors was, at the time, a blunt instrument and only 5% of the positions held by index funds at the end of 2007 were short positions. The increase in investment and the food for fuel argument led a wave of criticism as rising food prices provoked actual regime change in several countries and US Congress began to get involved and “suggested” investors should be reined in. Well it took some time, but the CFTC this year announced a contract limit that speculators could hold in agricultural futures markets.

Interestingly enough, this year we have seen a similar situation, but with an unfamiliar commodity, vegetable oil. Palm oil over the last year has jumped 139%. Soybean oil has performed even better, rallying some 177%. Both markets, interestingly enough, have eclipsed their historical high prices. The previous high prices were set back in, yes you guessed it, 2007. The jump in price came about partially because human consumption surged as the pandemic  has begun to ease, particularly in China. However there has also been an increase in demand for biofuel. Malaysia and Thailand, neither large producers of crude oil have been boosting or planning to boost their biofuel mix. The United States as well is also boosting their biofuel production in anticipation of a potential “Green Deal” as President Biden wants to push the country to a renewable energy future. Once again, there have been some complaints by those consumers of veg oil and have seen prices explode. At least speculators can’t be blamed as the net fund long is only currently 30% of its previous high set back in 2016.

That brings us back to sugarcane ethanol and an interesting development. Some countries are actually looking to boost ethanol production in order to cut back on food (sugar) production. India is at the forefront of this reverse shift as it deals with overproduction of sugar and the need for a subsidy to export the excess. The subsidy amount (with the reduction announced last week would be about $483 million taken at Friday’s exchange rate) The Indian sugar industry claims the subsidies are compliant with WTO rules. Other sugar producers, like Brazil, Australia and Thailand don’t agree. Ethanol production, which should be a natural for India, given their production accounts for only 12% of their refining capacity, has struggled to gain traction, at least until this year.

This year, however, the demand from Oil Marketing Companies (OMCs) totaled 4.57 billion liters. Sugar companies have finalized bids of only 3.25 billion liters. Of that, only 800 million liters are from either Molasses B or sugarcane juice. That amount would signal a reduction of only 700,000 tons of sugar. The industry is hoping this amount would be closer to 1.5 MMT. (This data from April 6th) The mix of ethanol in the fuel this year looks to be around 7.2%. The target for 2022 is for 10%, and then 20% by 2025. Praj, a well-known sugar mill/distillery builder announced a new sugarcane juice plant that would increase its plant’s capacity by 30%, so there is investment. Despite the crippling impact on the Indian economy of the recent virus surge, sugar mills have certainly been boosted by the government subsidy, given the positive margin for export sugar after the price rise. This should help boost investment in more ethanol, particularly if the government makes it clear that subsidies were only a stop gap measure, and not “business as usual”.

The danger of course is that the ability to expand ethanol production will be crippled by the rise in raw material prices, like steel and aluminum, as well as semiconductor chips and copper. Will ethanol margins be strong enough to provide incentive to battle those headwinds, or will we see later this year, sugar mills, head back to the government with hat in hand for another handout?

The food or fuel argument will continue, but ethanol can provide an excellent bridge to a transition to EV (Electric vehicles) as it uses existing fuel distribution logistics, and it is more clean burning and carbon positive than fossil fuels. It is also an alternative for declining sugar consumption due to health concerns and declining demographics. But in India’s case, it would also put it back in the good graces of the world’s sugar producers. The question is, How long will that take?

Click here to read Episode 1
Click here to read Episode 2

Mr. Michael McDougall is Managing Director at Paragon Global Markets, LLC, New York, USA. He has been active in commodity futures for 35 years.

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