Barclays - Sugar, how sweet will it get?

The sugar market has offered one of the most seductively bullish stories in early 2009. The drastic underperformance of the 2008/09 Indian harvest (which ran from October 2008 and ends in September 2009) alongside those in several other Northern Hemisphere locations has laid the way for a global deficit of historic proportion, thus offering a seemingly irrefutable fundamental case for strong price performance. That the frontmonth ICE no. 11 sugar contract traded for most of February and April in a range between 12.2 and 13.7 cent/lb, in spite of worsening estimates for harvests around the globe, was undoubtedly frustrating. This was particularly true given the widely held view that the onset of Brazilian harvest supply from May would help to douse the bullish dynamic sparked by the Indian shortfall. Such concerns were misplaced, though, as prices finally took off in the last few days of April, breaking out of their earlier range, with the July 2009 contract surging as high as 16 cents/lb. This represented a near-30% appreciation from January’s low point and largely confirmed the promise that had been predicted on a fundamental basis from the beginning of the year.

The question that faces investors now is whether that was the sum gain of the market deficit expressing itself, or whether there is more value to be extracted, and in that vein, how the influential variables affecting the 2009/10 market balance are evolving. The publishing of various major Brazilian cane crush estimates in line with the beginning of the Centre-South harvest (UNICA, CONAB and USDA attaché) offer a good platform from which to survey these key issues. We believe that the “bull” run for sugar is by no means complete even if prices consolidate in the short term round 15 cents/lb. India will remain a supportive dynamic, in our view, given the level of imports necessary over the rest of the year, while its next harvest will by no means offer a sizeable enough recovery in production levels to alleviate future import needs beyond that time frame. At the same time, a strong Brazilian harvest this year seems inevitable. This has been supported by the relative strength of sugar versus ethanol prices over the past year as well as the amount of cane leftover from the previous harvest. However, the impact of substitution into sugar production from ethanol is limited by available crystallisation capacity, with close to 40% of planned new mills failing to open in 2009 due to funding issues.

Moreover, given the run down of global stocks in 2009 and a projected mild market deficit in the 2009/10 harvesting year, alongside higher crude oil prices and improving macroeconomic sentiment, we would expect prices to remain well supported at current levels for the rest of the year. The potential exists, however, for considerable upside given the possibility of supportive developments in either India or Brazil – events or dataflow – which could tighten market dynamics.