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Sugar

WHAT TO EXPECT AFTER THE UNEXPECTED?
20/03/2020

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If you are reading this comment, dear reader, it means you have made it through, even the hard way, the whirlwind that has come over the world and which – there is every reason for us to believe so- is far from over.

If someone says he has any clue of what can happen over the next week (over the next 24 hours, anybody?) to the markets, is surely speculating or prematurely suffering from the hallucinogenic effects of the quarantine imposed on all of us. Nobody knows.

At these times the best thing to do is to stress the scenario as far as our imagination goes and try to exceed what such a scenario can impact the result of the company. And let’s face it, even stressing, we aren’t that good at it. If just 30 days ago someone in a circle of his sugar market partners said that NY would trade below 11 cents per pound and the dollar would be worth more than R$5, he would get resoundingly booed or sardonically laughed at; well, we have difficulty dealing with randomness.

The lessons we have been learning in this troubled moment will be extremely invaluable, particularly if they are taken in. As we said here last week, we have to train our minds regularly in order to see the market in a comprehensive way and not restricting ourselves just to our views, which a lot of times are fed by strict biases.

When we deal with risks, there are several methodologies to quantify and mitigate them, be it by options, insurance or other derivatives structured to this end. In difficult times, such as the ones we are going through now, even simpler protection ends up becoming extremely expensive due to the high endemic risk perception of the market which causes a substantial increase in volatility making the protection we are looking for financially speaking impossible. Try, for example, to buy a call or a put from banks at this moment. Huge volatility embedded in pricing due to the demand for this type of structure and the risk perception on the part of the financial agent.

The thing is more complex when we deal with uncertainty. There is no way we can protect ourselves from uncertainties. We can only think proactively and avoid making decisions based on panic. As Warren Buffet put it, “the market is a money-transferring machine from the impatient to the patient ones”. We could add that the market is a vanity-crushing machine.

Getting back to the sugar market – it’s stunning how things change at the drop of a hat. 2020 foresaw a more optimistic tone for the sugar-alcohol market. Oil at about 50 dollars per barrel assured great competitiveness for hydrous ethanol and pro-sugar mix production would be slightly increased in line with the strengthening of the American currency. Brazilian economy would have, under the market view, a market growth around 2.0-2.4% which projected (our number) a Ciclo Otto consumption increase by 5% for 2020. Coronavirus and the spat between Saudi Arabia and Russia have turned this rosy picture upside down.

The Brazilian government has declared a state of national disaster, approved by the Congress, until December 31. Stores, shopping malls, movie theaters, bars and restaurants, services, and so on are closed in just about every main city of the country. The consumption of fuel, some dare estimate, can melt by 50% over this quarantine period which, at first, should last until late April. Airlines are having huge losses and have canceled 70% of their domestic and international flights. Oil, at the moment this comment is being written, is trading below 20 dollars per barrel. What picture can possibly be outlined under this condition except pretty drastic?

The mills that fixed their sugar before this bloodbath are relieved. I hope they aren’t stung by the speculation bug and repurchase their futures positions and then think they can sell it again at a higher price (some did that in 2016 and feel sorry today).

This picture of uncertainties and continuous scare points to a huge sugar mix growth for this 2020/2021 harvest. There is no doubt that organized and capitalized mills, which run their own futures and option desk, will prioritize sugar. Our preliminary estimate is that the sugar mix for the 2020/2021 harvest can reach 44% (against 34.5% for the 2019/2020 harvest). More Center-South sugar will be produced at a moment when it is estimated that less sugar will be consumed in the world due to the recession we will see throughout the year.

Few world producers are able to survive without government subsidy. The closing of NY this week at 10.90 cents per pound along with the dollar at R$5.0267 is R$1,259 per FOB Santos ton, a value which befittingly pays a good part of the mills in the Center-South. To have an idea of this value, in 2017 the NY average was R$1,155 per ton; in 2018 it was R$1,023 and in 2019 it was R$1,118 per ton.

What will negatively impact the result of the companies of the sector is hydrous ethanol which will be hit by the gas price reduction at the pump (Petrobras still has room to reduce R$0.30 per liter) and the huge consumption contraction of fuels. What seemed like a promising year for the sector has turned into a year that will demand enormous management capacity, a lot of inventiveness, patience and determination.

The sector should look for government help to postpone taxes to be paid and creation of emergency line so it can make it through a rough sea in a scenario where everything seems to go wrong.

It is commented backstage that a renowned trading company is having great difficulty getting the letter of credit opened by the buyer.

Due to the Covid-19 pandemic, the XXXIII Course on Futures, Options and Derivatives – Agricultural Commodities held by Archer Consulting has been postponed to a date to be set as soon as this critical moment goes away.

Have a good weekend and stay home!!!

 

Arnaldo Luiz Corrêa

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