World Sugar Market – Weekly Comment – Episode 18

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Blame it on the mill owner

The sugar futures market in NY closed out Friday just about unchanged. October/2021, which expires next week, closed out at 19.16 cents per pound (just 2 points below last week’s close). March/2022 closed out at 10 points above last Friday’s – at 19.96 cents per pound. The other trading months slightly rose between 2 and 9 points. The dollar was trading at R$5.3384 at the end of the week – a 1% drop against last week.

Not surprisingly, the October/March spread opened up more, that is, increased the discount of the first month against the second, demonstrating that the holders of the long positions in October’s futures contract want to get rid of the sugar as soon as possible. Whatever the reason is – expensive freight in the short term, cash flow adjustment or lack of buyers at the final destination – the fact is that the discount has gone up over 10.5% per year equivalent. If we have a large delivery of sugar next Thursday when October expires, the futures market in NY (H22) can feel the pinch of the contagious anemia and move toward 19 cents per pound.

Just like what happened in Brazil, with mills putting off new sales and pricing of their export sugar, India is also coming aboard on this bet. Arguing that the drought, frost and fires that hit part of the sugarcane fields in the Center-South will reduce the availability of sugar in Brazil this and next crop, Indian exporters have decided to take a break. They believe the weather effects in Brazil should increase prices of the sugar futures contract in NY beyond 20 cents per pound.

For the first time in history, India closed sugar export contracts before starting the crop taking advantage of the high prices on the futures market. More than 1.2 million tons are fixed and sold. Now we see a slower rhythm and Indian exporters believe that they will be able to sell their sugar for about 21.50 cents per pound. Wishful thinking replaces the pragmatism that should run trade negotiations.

EverGrande, one of the major real estate groups in China, scares the market with a liability close to US$300 billion and doubts that the company will be able to honor its financial commitments. Because the Chinese government tries to control everything, what we see from outside might be different from what is going on inside the company. If the company’s meltdown really happens, considering that the real estate market and services related represent 29% of the Chinese GDP, one can expect that it will spread to the other sectors of the economy, and especially, to the commodities. Therefore, this can be a tail event strong enough to shake commodities prices. We must always remember Lehman Brothers in the 2008 financial crisis. Is it worth thinking about buying an out-of-the-money put option? The answer is a sounding yes.

Itaú Bank has reduced its GDP growth forecast for Brazil for 2022 to 0.5%, partly due to the increase in the basic interest rate. The bank predicts a benchmark SELIC base interest rate for late 2022 at about 9% per year. Other institutions place this threshold at 10%. As I have said here several times, 2022 will be an extremely damaging year for the Brazilian economy, made worse by the presidential elections.

The President of the Republic has declared that ethanol – go figure – is to be blamed for the high gas price because the 27% mix of ethanol in gas increases the product price at the pump. Therefore, shrinking this mix to 18% is all it takes: “the mill owners will protest, because they have a guaranteed market today”, said His Excellency. You can tell that, among so many other issues, the President also knows nothing about the tax structure related to each product and thinks that all it takes is to reduce the mix of the “bad guy” anhydrous to 18% (from the current 27%) to lower the gas price at the pump as if by magic. Being used to saying stupid things, this has been just another one.

Let’s stick to the facts: if the government changed the mix from 27% to 18% (minimum allowed by the current legislation), the gas price at the pump would decrease by only R$0.0100 per liter. So, it’s not the percentage of the mix that determines the high gas price, but the combination of the oil price on the world market and the exchange rate, not to mention – of course – the different tax charges on the products that are in it. Great part of the problem lies in the Brazilian real, which is one of the currencies that have devalued the most among the emerging countries since the pandemic started. And why does the Brazilian currency devalue? Because of loss of credibility of the country in the international scenario, insoluble fiscal crisis, energy crisis, caused by the government itself. But, for the President, the others are always to blame. And the next big thing now is the mill owner.

Based on the dollar and gas close this Friday, what we know is that Petrobras already has a gap of R$0.2775 per liter compared to the price currently charged by the refineries. That is, there is an even more explosive potential for an increase in fuel price which will feed into the inflation spiral with all its resulting harmful effects.

In a perfect storm for next year where we can see a combination of higher oil price because of the driving season (summer in the northern hemisphere), when the demand for gas is usually at its seasonal peak, and a more volatile real here due to the elections, the gas price at the pump can easily hit R$7.000 per liter in the state of São Paulo (which is the cheapest)

In the past, the sector paid a high price for the populist policies of the Workers’ Party (PT) governments that managed the fuel prices in such a way that there was cheap gas at the expense of the taxpayer (via Petrobras huge losses) and the mill owners (60% of the time these people were in power, hydrous was sold below the cost of production). Now with this government that said to be liberal and promised “more Brazil and less Brasília” and whose Minister of Economy is more like a host of a comedy TV program, you can be sure that the social networks fed by the hate will turn against the sector – until the government picks out another culprit. I hope I’m wrong.
You all have a great weekend.

You all have a great weekend.

To read the previous episodes of World Sugar Market – Weekly Comment, click here

To get in touch with Mr. Arnaldo, write on arnaldo@archerconsulting.com.br

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