This is the start of a series of articles looking at the top 10 most important drivers behind some of the main commodity futures prices. Episode 1 looks at sugar.
1) The Brazilian Real
Brazil is the largest producer of sugarcane, producing around 740 Mt in 2013, almost 40% of global output. A decline in the value of the Brazilian currency, the real increases the incentive for Brazilian farmers to increase output for export while at the same time reducing their production costs.
Millers in Brazil can crush sugarcane to make ethanol for the domestic fuel market, priced in reals, or sugar for export, priced in dollars. A decline in the value of the real versus the dollar encourages Brazilian producers to divert more to the export market.
2) Long supply cycle
Key to understanding sugar prices is its long agricultural supply cycle. The agricultural supply cycle describes the process of activities relating to the growth and harvest of the crop. These include loosening the soil, seeding, watering and harvesting etc. The typical cycle from planting to harvest for sugar takes 12-18 months. This means that farmers price expectations (i.e. whether they expect high or low prices to continue) are vitally important in determining future supply and prices for sugar.
3) Ethanol demand
Brazilian sugar cane growers can crush the cane they harvest to produce sugar or for ethanol. As ethanol also competes with gasoline as a transport fuel, a drop in the price of gasoline (as a result of lower oil prices) will tend to lead to lower ethanol prices and hence less demand for sugar to produce ethanol. The origins of Brazil’s use of ethanol as a fuel date back to the late 1920’s but it was the first oil crisis of the 1970’s that highlighted the dangers of oil dependence.
4) Government intervention
Subsidies and import tariffs have distorted sugar markets resulting in sugar producing countries making more sugar cane than would be the case in a normal competitive market. Many of these distortions have a historical legacy. In Europe for example difficulties sourcing sugar from the colonies in the early 1800’s prompted planting of sugar beet. Today the EU is the second largest exporter of sugar in the world. In the US import tariffs designed to protect domestic farmers have raised prices for US consumers, prompting them to look for alternatives such as high-fructose corn syrup.
The consumption of added sugar (sugar not contained in natural products like fruit or milk) or high-fructose corn syrup has increased dramatically over the last few decades, yet consumption varies considerably from country to country. At the top, we find the USA, Brazil, Argentina, Australia and Mexico, all at more than double the world average; ranging from 40 teaspoons for the USA to 35 for Mexico. At the other end, we find China with 7 teaspoons. Growth in demand for sugar is strongest in emerging economies, particularly South America and Asia.
6) Health concerns
Sugar is thought to be a leading cause of obesity, diabetes and tooth decay. With governments and consumers more aware of the risks of sugar over-consumption the growth in sugar demand could slow in the years ahead.
Related article: Excess sugar consumption leaves a bitter aftertaste
Sugar accounts for about 70% of world demand for sweeteners with chemical sweeteners, such as saccharin and aspartame, as well as an expanding number of synthetic chemical products accounting for the rest. High-fructose corn syrup is a more natural alternative to sugar that has been widely adopted in the United States.
While warm dry weather is important for the growth of sugar cane, drought in Brazil can be especially damaging for sugarcane farmers. Meanwhile, wet weather presents an obstacle to harvesting the sugarcane, delaying getting the sugar to market and risking damage to the crop. Wet weather also reduces the sugar content of the cane, especially if it occurs late in the crushing season, i.e. when mills are processing the cane.
9) Stock levels
As with all commodities, low levels of stocks indicate strong demand, weak supply or a combination of the two. In addition, low stocks provide very little in the way of a buffer in case of disruption to future harvests.
Unlike oil or copper, where the well or mine can be shut down when prices slide below production costs, sugar-cane mills can’t just leave the cane in the fields, nor do they have the capacity to store the sugar they make until prices rise. With such a long supply cycle, if problems occur on the way to or at storage (e.g. due to fire or transport delays) then this can significantly affect the price.
10) The US dollar
Like most internationally traded commodities sugar is priced in US dollar. At its most basic a decrease in the value of the US dollar relative to a commodity buyer’s currency means that the purchaser will need to spend less of their own currency to buy a given amount of the commodity. As the commodity becomes less expensive demand for the commodity rises, resulting in an increase in the price and vice versa. Unlike many other commodities sugar only has a small inverse correlation against the dollar of around -0.15 with the previous nine factors appearing to be much more important in determining sugar prices.
Related article: No sugar high in sight
The next article in the series looks at the top 10 most important drivers of livestock prices.