The World Has a Sweet Tooth

The world has a sweet tooth. World consumption of sugar is 24 kilos per person - that's over 50 pounds of sugar for each man, woman and child on the planet. For something that has essentially no nutritional value, we sure do use a lot of it.

First, a quick review of some basic facts:

A crop year for sugar runs October to September. For example, the 2008-2009 season is October 1, 2008 to September 30, 2009. It's always good to get your crop seasons straight when you're talking about an agricultural commodity - you'll see why in a bit.

About 70% of sugar comes from sugar cane; the remaining 30% comes from sugar beets.

Countries such as Brazil, India, China, Thailand, Pakistan and Mexico grow sugar cane. France, Germany, the U.S., Russia, Ukraine and Turkey grow sugar beets. Once it is refined, sugar from cane and sugar from beets are very difficult to tell apart without a chemistry set far more complex than the ones behind the checkout stands at Wal-Mart. So rather than distinguish what it is made from, the commodity markets differentiate sugar by where it is delivered. Sugar #11 is traded on NYBOT and refers to sugar delivered to ports in the Caribbean. Sugar #5 is traded in London and refers to sugar at European ports.

For the 2007-2008 crop season, the top sugar producers looked something like this:
Brazil--35 M.ton
India--26 M.ton
European Union--16 M.ton
China--12 M.ton
Thailand--7 M.ton
Mexico--6 M.ton
Australia--5 M.ton
Pakistan--4 M.ton
Russia--3 M.ton
Cuba--2 M.ton

Total global production was 166.6 million tonnes in 2007-2008, well ahead of consumption at 157.1 million tonnes. Brazil was the clear leader, with India in second place. The European Union was thought to be oversupplied for domestic use, with 16.5 million tones produced. Of Thailand's 7 million tones, almost half was destined for export, as was almost a full three-fourths of Australia's crop.

And now for the current crop year - 2008-2009. India had fewer acres of sugar cane planted due to low prices coming off the high production in 2007-2008. Add to that some bad weather, and the picture for India changes dramatically. Production is forecast to drop 45% - with only 14.5 million tons forecasted for 2008-2009. A drop of that magnitude in the world's No. 2 sugar producer is bound to have some serious repercussions around the world, and global production is expected to drop 4.7% from the previous year down to 158.8 million tones, while consumption is expected to rise 3.2% to 162.1 million tonnes.

A classic commodities supply squeeze. By definition, that 3-million-tonne gap has to be closed, either through mysterious arrivals of new supply from storage or crop yields, or consumption has to fall. In either case, higher prices are the mediator.

First, At India
With India currently consuming around 22.5 million tones of sugar each year, a crop of 14.5 million tons means that India goes from being a net exporter to a net importer in one fell swoop.

There have been a couple of consequences from the small crop. Sugar mills that usually run at least into April closed in March this year due to a lack of cane to process. In response, the government instituted a program that allows cane mills to import raw sugar duty free, as long as they export a similar amount of refined sugar within the next two years.

There have even been suggestions that India may drop import tariffs on refined sugar, tariffs that currently stand at 60%. Of course, there are general elections coming in April and May, so it could be political positioning. But as of now, there has been no official action on the proposal, and according to the commerce secretary, G. K. Pillai, there won't be.

The sugar deficit in India has also affected Indian plans to increase ethanol use. An original goal of 10% ethanol blending was delayed because of the recent decline in fuel prices. In a time-honored tradition (not in India, everywhere), they made up for their immediate failure by doubling down: They announced the goal of having a 20% blending rate by 2017. Currently, India has the capacity to make around 2,200 million liters of ethanol. Of that, 750 million liters goes to the liquor industry, and 650 million liters goes to the chemical industry. The remainder is used for fuel blending. Those industries are paying 27 to 28 rupees per liter, while the fuel industry pays a fixed 21.50 rupees. If the Indian government wants to increase the amount blended for fuel, it will need to change the financial incentives.

Outside India
With India's production so low and global production forecast to be in deficit for the first time in four years, sugar prices have been remarkably steady, actually falling about 10% since October 1 (when the crop year started). Of course, back then, these deficits weren't expected, or more sugar cane would have been planted. On a year-to-date basis, prices have risen around 7%.

At the end of March, some analysts said the price increase was only the beginning, and analysts such as the Standard Chartered Group were forecasting sugar futures to rise as high as 15 cents a pound, with global demand exceeding production. Additionally, Bloomberg reported that Tom McNeil, a senior analyst with Kingsman SA, suggested that production may continue to be in deficit for 2009-2010.

"If that eventuates, a second year of deficit, certainly supply to the market will be tested and under those circumstances prices become very volatile," McNeill said. He declined to give a specific price forecast. "Sugar is probably one of the commodities with a slightly better story than most other commodities."
Additionally, on Friday, an Inside Futures article said that the Czarnikow Group is predicting that Brazil's producers will see a reduction in the amount of cane crushed from now through March 2011 because of halted mill expansions due to the financial crisis. Of course, ethanol demand in Brazil could be partially offset by low crude prices putting downward pressure on ethanol prices.

But either way, it sounds like sugar is set to rise, right?

Well, maybe.

Here's the crazy thing - the market may already be looking ahead to the 2009-2010 crop year; remember, the crop year starts October 1 when planting begins. But according to Bloomberg's headline from Friday, "Sugar Drops Most in Month on Concern Indian Output May Rebound," the market is already prepared for Indian farmers to plant like crazy.

So if the market is already looking ahead to next year, can the analysts be right that sugar will reach 15 cents a pound? Or has that ship already sailed, with the year's comparatively stellar 7% growth being the full extent of the bull market in tooth decay. In other words, maybe next year's crop is already priced in even before the first plant is in the ground.

On a more local level, April 1 marked the statutory date under the Farm Bill that the U.S. could start mucking with import quotas on sugar. This has caused a flurry of lobbying by food manufacturers who could profit from access to even-cheaper foreign sugar (right now, sugar imports are capped at 1.3 million tonnes for 2009). On the other side of the equation is the American Cane Sugar Refiners' Association and American Sugar Alliance, which state that an increase in imports of foreign sugar would be detrimental for the domestic sugar refiners and beet processors, and that the domestic market is well-supplied, with prices on the low side and that manufacturers able to get the sugar they need.

I don't believe that the government will decide to import more sugar, if for no other reason that any activity on sugar draws attention to what are fundamentally protectionist policies - but I've been known to be wrong before.