While oil and gold get all the press, the sugar market has quietly been experiencing a steady bull market for almost 18 months
Bull Market in Sugar: Why This is Only the Beginning
As much press as the bull markets in Crude Oil, Silver and Gold are getting in recent months, there are other, less headline grabbing markets that are not only benefiting from the overall bull market in commodities, but may be offering better opportunities due to lower volatility and less speculator led price swings. While prices in energies and precious metals are most certainly being driven higher by strong fundamentals, they are also vulnerable sharp rallies and deep sell off’s. This roller coaster ride is due in no small part to the wide press coverage these markets receive, often causing a “spook the herd” effect among heavily positioned (and often fickle) speculators.
While oil and gold get all the press, the sugar market has quietly been experiencing a steady bull market for almost 18 months. While sugar’s most impressive gains have come since last July, sugar prices started moving higher in early 2004 and have remained in an impressive trend since. While prices have been consolidating over the last few months, the fundamentals for the sugar market remain bright. In short, as long as the world deals with higher energy prices or fears of oil supply disruption, demand for sugar will continue to gain ground
Why? The answer comes in one word: Ethanol. Or as is might be known in the near future, “White Gold.”
Granted, this is not a groundbreaking observation. Ethanol is not a brand new buzzword in the commodities trading industry. Corn and Sugar bulls from 10 years ago talked up ethanol every Spring proclaiming “this will be the year” that the ethanol industry finally has a major impact on these markets. Until last year, they were wrong. But they were not working with $70 per barrel oil in those days.
Times have changed. Crude Oil above $55-$60 a barrel finally makes ethanol a practical choice, not only for consumers, but producers and refiners of this alternative fuel. Ethanol as a more “environmentally friendly” choice was a hard sell to the mainstream consumer. Ethanol as a cheaper choice is a pretty easy pitch. Now that a gallon of ethanol can be produced cheaper than a gallon of gasoline, it makes sense for consumers to begin substituting the fuel. Thus, more refiners, distributors and auto manufacturers are stepping up to meet the new demand. And this has meant higher demand for the raw materials that ethanol derives from. In many countries, this means sugar.
About 60% of the world’s ethanol production comes from sugar. A leader in the switch to ethanol as fuel is, not ironically, the world’s leader in sugar production, Brazil.
In Brazil, the world largest producer of sugar, sales of the popular “flex-fuel” car, an auto than can run on up to 100% ethanol, reached 62% of all new car sales in 2005. With this new market in domestic demand, Brazil has shifted a considerable portion of it’s exportable sugar supply into domestic ethanol production. This takes supply off of the world market and thus, increases price. With ethanol prices running about 50% less than gasoline prices in Brazil, it seems only logical to expect a continued expansion into ethanol fueled vehicles.
In the US and Europe, Bio-Diesel is gaining a foothold as a legitimate substitute for diesel engines. An even larger impact will be felt over the next few months as US refiners phase out methyl tertiary butyl ether (MTBE) in gasoline blending. What will they replace it with? You guessed it. Ethanol.
US ethanol demand is expected to increase 25% this year as a result of this switch. Every major US oil refinery plans to have MTBE phased out and replaced with Ethanol by June 2006. It will take 130,000 barrels of ethanol daily to replace MTBE. Each barrel contains 50 gallons of ethanol. It takes about 14.45 pounds of sugar to produce 1 gallon of ethanol.
Where is all of this additional ethanol going to come from? The US is a top producer of corn based ethanol but does not have the capacity to meet it’s domestic demand. Therefore, as with much of it’s energy needs, the US relies on imports. And this generally means sugar based ethanol.
The US imports much of this sugar based ethanol duty free from nations included in the Caribbean Basin Initiative (CBI). Yet the US slaps a 54 cent a gallon tariff on imported sugar ethanol from countries outside of the CBI. This includes Brazil. The CBI does not produce enough sugar to meet the increased demand and thus, the US will almost certainly be forced to turn to Brazil for much of the additional supply. But tariffs will make ethanol based fuels more expensive to produce and thus, more expensive for consumers to buy.
Under substantial pressure to “do something” about higher energy prices, the Bush administration may be ready to make a move to abolish the tariff. Energy secretary Samuel Bodman announced this week that President Bush was prepared to speak with members of congress about lifting the tariff. This is a key fundamental that should be monitored closely by sugar traders.
The US imported 118.4 million liters of cane ethanol from Brazil in 2005. This figure is expected to double in 2006. This alone is one factor that should keep sugar prices firm through year’s end. Yet, if US tariffs are lifted, demand for Brazilian cane ethanol could burst higher. The problem is, the supply to meet this demand may not be there.
Brazil’s ethanol shipments to all locations last year totaled 2 billion liters. The country is expected to harvest a record sugar cane crop in 2006, about half of which will go towards ethanol production. After demand for raw sugar and domestic ethanol is met, Brazil expects it will not be able to export any more cane ethanol than it did last year. Although the Brazilians have indicated they could shift more raw sugar into ethanol production, the net result is the same for sugar demand. If ethanol production increases, production of raw sugar slows.
This all comes at a time when the world sugar market is in it’s third strait deficit season. While the world market saw a sharp rise in production from Brazil, India and Thailand, it was more than offset by spiraling global demand and a steep drop in European production.
While fluctuations in energy prices or overbought technical conditions could cause setbacks in sugar over the near term, we think the cat is already out of the bag for global ethanol production and expect it to continue to increase in the future.
The NYBOT’s launching of a sugar cane based ethanol contract to bouy the sugar market as well. It is likely that ethanol prices will loosely correlate to sugar prices, much the way unleaded gas prices correlate to crude oil.
It is our opinion that sugar prices will not only remain firm, they are only in the beginning stages of a long term, world demand driven bull market.
As corrections can be expected in any bull market, we see selling put options in sugar as the most consistent way to profit from steady to higher sugar prices in the coming months. As sellers of puts, we don’t necessarily need the market to move higher. We only require that the market not move substantially lower.
While another spike in energy prices or a lifting of US import tariffs on cane ethanol would almost certainly ignite the next leg higher in sugar prices, a seller of puts should do well even if these events do not come about.
We will be working closely with clients in over the next 7-14 days in positioning in this market.
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