As we begin 2019, Brazilian sugar markets might be adopting a new motto for the new year: “Fasten your seatbelts”.
We have seen a great deal of volatility come back into the market in recent months. Brazil’s elections drove some of this, combined with corresponding fluctuations in the real’s value against the dollar. Less visible to mills has been the move toward daily pricing of gasoline by Petrobras, which has affected spread prices for sugarcane-based ethanol. Stronger ethanol pricing has pushed many mills to allocate much higher percentages of their production capacity toward ethanol and away from sugar. This has been exacerbated by the very strong crop out of India, which dragged down global sugar prices.
Now we are entering the intercrop period between the harvest in Brazil and the beginning of the crop season for those in other major growing regions for sugarcane and sugar beets. It may seem like the start of a new quiet period to some, but in reality it is likely to be a short stretch of smooth road before a bumpy 2019.
There are several reasons to expect volatility to continue going up after the new year.
First, let’s consider politics. There could continue to be a shakeout domestically as the new administration takes office in Brazil. Significant uncertainty remains as to how government policies will change with regard to agriculture, energy and trade. Yet Brazil is not the only country holding elections. India, the world’s second-largest producer of sugar, also will be holding key elections in April and May, which could impact the world market.
Second, there are questions about the health of upcoming crops, potentially limiting supply after a long period of heavy oversupply relative to demand. Crops of sugarcane in India and sugar beets in Europe are grabbing analysts’ attention. Various reports are stating that the effects of El Nino could be quite impactful, leading trading houses to examine next year’s crop in Brazil, too.
Third, there is the mix between sugar and ethanol within Brazil’s milling industry. Ethanol demand in Brazil is currently breaking all records. This combined with weather-driven supply limitations could force prices upward. Or, with the recent sag in global oil prices, ethanol could be pulled down, incentivizing some mills to switch more production back to sugar. Because ethanol is denominated in reais and sugar in dollars, the foreign exchange rate will have an impact, as well.
In other words, there are many variables that could send the sugar market in either direction. With that in mind, now is the time for mills to look at the things they can control. This includes implementing a risk management strategy that provides needed protection of margins.
Market signals point to uncertainty
Of course, mills always want to lock in the best price possible. Yet with the uncertainty in front of the market, this might not be the best environment to try and secure every last penny. A conservative hedging approach may be best to preserve a floor price and protect margins. This would help ensure vital cash flow needed to run operations.
Your debt levels – and their currency denomination – will play a role in your strategy, too. For instance, mills with debt or operating costs in reais could benefit from certain structured products that hedge against both the price of crude oil and the foreign exchange rate with the dollar.
No matter your situation – including your allocation of production between ethanol and sugar –2019 is likely to contain more volatility and a number of unpredictable variables coming into play.
Cars have seatbelts for when the unexpected happens. Likewise, a good risk management strategy is essential when volatility is on the horizon. Be safe, and buckle up!