Sugar deficit bulls loom large in Big Apple

The dust has settled on another New York Sugar Week.

This annual gathering of the movers and shakers of the sugar world is the latest stop in a packed conference calendar, which begins in Dubai at the end of January and will culminate November in London -- with plenty of events in between in other exotic locations to keep the most committed air-miles collector hosted in the finest airport lounges well into retirement.

Many will have departed New York cautiously optimistic about the months ahead. There is widespread agreement that the global sugar market will experience a structural deficit for a second successive season for the upcoming 2016-17 campaign, even considering the expected bumper crop in Central-South Brazil.

After five years of surplus and record low returns this shift in the balance sheet is promising price-wise. But the unpredictable factor of weather, in particular in India, Thailand and indeed Brazil, promises to keep that optimism in check.

Interestingly enough was the mixed sentiment over dominant player Brazil. On the one hand, were the Brazilian bears betting on another record harvest of more than 640 million mt of cane crushed.

On the other hand were the bulls, mainly producers, betting on a smaller crop than 2015-16 season.

The dry weather, a possible La Nina, flowering cane, frost, a sudden halt to the crush and aging cane due to poor renovation, are the most important factors alongside the bulls.

The lowest expectation was pointed by a local producer at 585 million mt. Even with this large range of 55 million mt of cane, the consensus for sugar production is around 35 million mt.

CS Brazil has lost roughly 1.5 million mt of crystallization capacity over the past years after more than sixty mills shut down.

The current estimated crystallization capacity is around 36 million-38 million mt, with crushing set to be at a good pace until mid-December.

Total recoverable sugar (ATR according to its Portuguese acronym) is another tricky question.

Almost all the leftover cane (cana bisada) has been quickly crushed and mills are now crushing very young cane (10-11 months old). As consequence, the ATR could be lower than current average expectation for this season of roughly 134 kg/mt of cane.

Nonetheless, the mix would be mainly a function of the ethanol/sugar arbitrage (currently above 400 points). The need for cash by the more-financially weak mills, would also be considered.

Another factor is if the government increases the CIDE tax on gasoline. Ethanol prices will have room to increase and this could be an incentive for millers to divert more cane to such production.

But how much more ethanol is needed to supply demand?

The current estimate of roughly 28 billion liters of ethanol production would be enough to meet current demand, which seems unlikely to increase due to Brazil's economic recession.

Plugging the supply gap in Asia

As a deficit region, Asia provides a myriad of arbitrage routes for traders to track and exploit and of nuances for analysts to factor into the balance sheet -- and that's in a good production year.

It's increasingly clear that unfavorable weather conditions and regional economic and trade factors over the next 18 months will pose additional challenges for local producers and leave suppliers poised to capitalize on what could be a rapidly changing picture.

In India, drought conditions in a second successive year of severe monsoon caused the ground to crack and cake, making it nigh on impossible to plant in some regions.

In one forum, a whites trader said acreage in Maharashtra state has been cut 35% for 2016-17, leaving food for thought: if replicated in India as a whole, this could remove 10 million mt from its sugar production.

From our perspective, if the monsoon is above average, production could be 500,000 mt higher at 24 million mt and the positive impact would be bigger for 2017-18.

But if the monsoon fails again, production could fall to 21 million mt and below 20 million mt in 2017-18.

There appears to be a majority expectation for production next season (16-17) to come in between 21 million-23.5 million mtwv.

As the region's dominant exporter, Thailand could be the big beneficiary of the opening up of sugar markets under the Association of Southeast Asian Nations bloc by 2018.

But in the short term Thailand's crop too is threatened by dry weather conditions, with a prevailing market view emerging its sugar output for 2016-17 crop could fall below 10 million mt tel quel and even 9 million mttq depending on rainfall during the intercrop period.

If that were to happen, new mills due for completion in time for the new season could come online before they cannot be fully utilized.

China poses one of the bigger conundrums to digest. Its rapid economic expansion has for many years been influencing global commodity markets, particularly oil and metals.

News around the import policy has been a sporadic and seasonal factor in driving world sugar prices, with whites demand one factor supporting the white premium so far this year.

Look closely and the signs are there for China's role in sugar to grow and grow. A rising population and increasing urbanization of the masses should drive demand up.

But the trend for migration from countryside to towns is also affecting local production, with farmers disinterested in the hard manual graft required to maintain a crop year after year and instead lured by the prospect of higher wages in the cities.

Unless efforts are made to back the local sugar industry (and there is little sign the government wants to do this), China's consumption will rise as its domestic supply falls, leaving it increasingly reliant on the world market to make up the shortfall.

In the meantime, it's a challenge to settle on a figure for its import requirement (via official and unofficial channels) for the coming year.

It is an area with a clear lack of consensus of opinion, with views ranging from sub-4 million mtwv to upwards of 6 million mtwv.

Funds challenge masters of the sugar universe

How much longer the "specs" could go is the question everybody is asking, considering we are in unknown territory: the net long position, the gross longs and the percentage of the total open interest are all at historical record levels.

The funds are not only reluctant to get rid of their longs, they continue adding more. Their bullish strategy seems to be part of a wider one for all commodities: while alternative investment returns are poor, the market is also betting on not-so-poor Chinese economic performance.

Looking ahead

Navigating through the views on fundamentals, the weather, the macros and the funds position brings us to the conclusion that uncertainty remains of the exact point at which the anticipated two years of deficit current forecast in the balance sheet will actually hit the market.

On one side, the raws tradeflows are in a quarterly surplus at least up to Q4 2016, with the first deficit estimated only for Q1 2017.

On the other side, we have a different situation on the whites market with net tradeflows showing a tight situation up to Q4 2016 when a deficit could take place.

How long will the record speculative net-long position last, and will it grow yet larger -- potentially reaching 300,000-350,000 lots -- before positions are liquidated?

It's also worth noting the sugar and ethanol parity in Brazil, where sugar pays more than 400 points (4 cents/lb) more than ethanol.

The potential is there for a price drop in the immediate short term.

Platts Kingsman modeling sees a low of 14 cents/lb possible for NY#11 sometime in August, when peak Brazilian output for this season and ahead of the summer vacations could see the funds liquidate positions.

But when the deficit finally takes hold, bulls should put prices on a decisively upward trend.

Since leaving New York, the Sugar No. 11 contract has broken through the 17 cents/lb mark and the latest Commitments of Traders report showed the specs have extended their net-long positions to 284,210 lots as of May 24, an increase of 5,165 lots on the week.

The bullish story has further to run.