Industry Trend Analysis - Sugar: Recent Rally To Prove Temporary - JAN 2018


BMI View: Sugar prices have approached USc16/lb in recent weeks, in response to news that Brazilian mills will increase the share of cane diverted to ethanol in the upcoming 2018/2019 harvest. We maintain our forecast for sugar prices to fall to an average of USc13.50/lb in 2018, as the 2018/2019 surplus begins to weigh on sentiment and bullishness in the Brazilian ethanol market fades over H118.

Sugar prices have been rallying from a low of USc12.5/lb in June 2017 to near USc16.0/lb as we reach the end of November. Traders have been reacting to predictions that Brazilian mills will choose to crush cane into ethanol rather than sugar, as domestic ethanol prices improve. Sales of hydrous ethanol have been responding positively to the recent increase in gasoline prices, following the Brazilian government's decision to increase the national fuel tax, which almost doubled in July 2017. Brazilian mills have therefore stated their intention to direct more of their cane to ethanol production, surprising market participants and spurring the rally in sugar prices.

Temporary Rally In Sugar Prices
Front-Month ICE Sugar No. 11, USc/lb (daily chart)
Source: Bloomberg, BMI

We believe that the sugar price rally is running ahead of fundamentals, and that prices will be in for a correction over Q118, dropping back into line with our most recent forecast, which predicts an average price of USc13.50/lb over 2018. The most recent USDA WASDE corroborates our forecast for a production surplus of about 10mn tonnes in the 2018/2019 Marketing Year. The ISO has also upgraded its estimate of overproduction in 2018/2019 by 0.4mn tonnes, to 5.0mn tonnes. The production outlook is positive for all three major producers - Brazil, India and the European Union - and global import demand is expected to fall, following China's decision to double its import tariffs and incentivise domestic production to make up for the shortfall.

Global Surplus Expected In 2018/2019
Global - Sugar Production Balance (mn tonnes, LHS) And Stocks-To-Use (%, RHS)
e/f = forecast/estimate. Source: USDA, National Sources, BMI

We are indeed expecting Brazilian ethanol prices to regain the upper hand over sugar, but this will only happen towards H218, once the 2018/2019 harvest has been completed. Our view is based on the following factors: First, we are bearish from spot on crude oil prices over a three-to-six-month horizon, as we expect strong OPEC and non-OPEC supply to keep price appreciation in check over 2018, thus putting a cap on the price competitiveness of ethanol on the Brazilian market (see 'Brent: Over Run Short Term, Under Done Long Term', November 2 2017). Second, recent developments in the Brazilian Congress indicate that the government's ambitious biofuel support programme - known as RenovaBio - will come into effect in July 2017 at the earliest, which would be too late to impact crushing decisions during the upcoming harvest. We therefore maintain our forecast for millers to continue demonstrating a preference for sugar over ethanol until the 2019/2020 season, at which point we expect a large shift towards ethanol, as environmental incentives associated with the new programme come into effect.

Ethanol Prices Temporarily Pulling Up Sugar
Brazil - CEPEA/ESALQ Sao Paulo Sugar Prices (BRL/50 kg bag, RHS) & Ethanol Prices (BRL/litre, LHS), weekly average.
Source: CEPEA/ESALQ, BMI

Brazilian motorists, a majority of whom drive 'flex-fuel' vehicles that can run on either ethanol or gasoline, tend to switch to the biofuel when the price at the pump is less than 70% of the price of the fossil-fuel alternative. Low oil prices have been preventing this substitution effect from being realised, and millers have been increasing the share of cane diverted to sugar production for two seasons now, beginning in 2016/2017. This has led to a surge in imports of ethanol from the United States, and spurred the Brazilian government into introducing a range of measures to protect the domestic ethanol industry, including a 20% import tariff on ethanol and the increase in the fuel tax.

Surge In Ethanol Imports In 2017/2018
Brazil - Ethanol Import Volume (mn litres) & Value (mn USD)
Source: CONAB, BMI

The proposed biofuel support policy, RenovaBio goes even further, increasing the biofuel blending mandate to 10% and obliging distributors of fossil fuels to offset the carbon content of their sales by purchasing carbon credits from ethanol producers. The policy has been introduced as an urgent measure in the Brazilian Congress ( regime de urgencia), with 299 votes in favour to 9 against, and we believe the Bill will be passed as soon as other priorities on the legislative agenda are dealt with, namely pension reform and tax reform.

Ethanol To Regain Attractiveness With RenovaBio Biofuel Support Policy
Share Of Cane Diverted To Sugar & Ethanol Production (% Of Total Cane Production)
Sources: CONAB, BMI
BMI Sugar Forecasts
Global Sugar Indicators 2013 2014 2015 2016 2017f 2018f 2019f 2020f 2021f
f = forecast. Sources: USDA, National Sources, BMI
Sugar #11 Price, Usc/lb, ave 17.47 16.34 13.12 18.20 15.60 13.50 15.00 15.75 14.80
Production, mn tonnes 177 176 177 165 171 185 185 185 189
Consumption, mn tonnes 165 167 170 172 173 175 179 183 187