combined with policy-induced production swings across Asian countries,
are the main sources of higher and more-volatile sugar prices.
By Michael McConnell, Erik Dohlman & Stephen Haley*
Affected Global Sugar Market in 2009/10
Policies fostering the industrial use of sugarcane also increased demand. Brazil, the world’s largest sugar producer
** Prices have increased again in recent months, with world raw sugar prices as of early November actually surpassing the January/February 2010 levels. While having fallen from those highs, they still remained in the 25-30 cent/pound range as of the time this issue went to press.
Brazil’s leading role as a sugar exporter was further heightened when the European Union (EU), which supplied as much as 20% of global exports in the 1990s, shifted from a net exporter to a net importer following sugar policy reforms in 2005. This shift removed a traditionally important supply source from global markets and has made sugar importers more reliant on Brazilian exports.
In addition to exposure to supply and price developments in Brazil, sugar prices have become more susceptible to increasingly volatile production cycles in Asia’s large sugar-consuming markets. Production swings in these countries are tied to policies that ultimately create large oscillations between their exports and imports from year to year.
With the full implementation of the North American Free Trade Agreement (NAFTA) in 2008, the United States now relies on Mexico to supply a significant share of U.S. sugar demand. However, after exporting 1.4 million tons of sugar to the United States in the 2009 marketing year, Mexico was forced toimport large amounts of sugar from the world market, thereby helping to support high world sugar prices. Despite the United States’ general isolation from the global market, developments within the United States still can affect world prices, albeit sometimes indirectly.
Sets the Tone for World Sugar Prices
Brazil — particularly the center-south region of the country — has a low cost of production, usually ranking first or second globally, with production costs of $265 per ton, compared with a world average of $353 per ton in 2008, according to LMC International.
Brazil also has the world’s largest land base committed to sugarcane, which contributed to its rapid growth as the dominant exporter. Over the past 20 years, Brazil more than doubled its cane production area, from nearly 3.6 million hectares to almost 7.5 million hectares, and it continues to increase area each year. Sugarcane area among other leading exporters has remained relatively stable — Australia with 350,000- 450,000 hectares and Thailand with 900,000-1.2 million hectares over the past 10 years.
Because Brazil is such a significant world supplier, both raw and refined world sugar prices are closely correlated with Brazilian production costs. A key factor affecting these costs is the exchange rate between the U.S. dollar and the Brazilian currency, the “real,” because sugar is traded in U.S. dollars in international markets. When the U.S. dollar is strong against the Brazilian real, Brazilian sugarcane producers’ costs are relatively lower, which makes exports more competitive. For instance, if Brazilian production costs remain constant in local currency terms and if the value of the U.S. dollar doubled, Brazilian production costs would fall by half when measured in U.S. dollars.
The real lost 50-70% of its value against major currencies between 1997 and 2003, which coincided with especially strong growth of Brazilian sugar exports and a decline in global sugar prices. However, the real began rebounding in 2003 and steadily strengthened through 2009. The real’s appreciation was modest enough to allow exports to continue increasing, but there was also a close correlation between the appreciating real and the increase in sugar prices after 2003 leading up to the 2009 price spike.
The real continued to strengthen through the first half of 2010, indicating that sugar prices could continue to remain elevated if the underlying relationship between exchange rates and world prices continues to hold.
Brazilian Sugarcane Area,
But Creates Tradeoffs
Increased production and use of ethanol has generated an additional revenue stream for sugarcane producers and processors, added flexibility to switch between sugar and ethanol production depending on market conditions, and allowed the Brazilian cane industry as a whole to grow.
Growth in the use of sugarcane for ethanol production dates to 1975, when the Brazilian government established a national program to regulate alcohol levels in fuel to mitigate the impacts of oil price shocks at a time when Brazil imported over 80% of its oil. The result was a large expansion in sugarcane production and the development of anhydrous alcohol, used for blending in gasoline, and hydrous alcohol, used in a pure form in specially equipped cars.
From 1998/99 to 2008/09, Brazilian ethanol production nearly doubled to 27.5 million liters. Increased vehicle sales have raised demand for fuel and ethanol. The Brazilian government mandates that all gasoline must be blended with 20-25% ethanol. Flexfuel vehicles (FFV), commercially available since 2003 and now in widespread use in Brazil, have the ability to use either blended gasoline or pure ethanol as fuel. Consumers can purchase the fuel that is most cost-effective given the energy differentials between the two, allowing for a greater ethanol capacity and improved substitutability for drivers. In addition, with sugar and ethanol production typically being made in the same facilities, producers can adjust the output mix substantially within each year in response to price movements in both markets, which provides flexibility in the supply of both goods.
Add a Volatile Dimension
Sugar production in India, China and Pakistan fell by a combined 15.9 million tons (33%) between 2007/08 and 2008/09, contributing to an unprecedented decline in global sugar stocks. This decline altered trade flows and led to higher prices around the world. Brazil increased its exports in response to the higher prices and greater returns for sugar, but could not fully compensate for the production shortfalls elsewhere, particularly since production in Brazil was held stagnant in 2008/09 by weather problems.
Weather played a role in Asia’s decline in production; but policies also influenced the outcome, and global markets were highly susceptible to perceptions about how production would respond to the economic and policy levers affecting output from this region. China, Pakistan and India together account for over 25% of global sugar consumption — a share that has been growing since 2005. India is the largest consumer, with sugar consumption totaling an estimated 23.5 million metric tons in the 2009/10 marketing year, more than twice the projected U.S. consumption of 9.2 million metric tons. China consumes 14.9 million metric tons of sugar and Pakistan, 4.2 million metric tons.
These countries also account for 20 to 30% of global sugar production, depending on the year, but are subject to volatile production cycles. Over the past 10 years, Indian sugar production has ranged from 14.1 to 30.8 million metric tons. Production variability has also increased in China and Pakistan over the past decade, although the cycles are not as large as in India.
The result of steadily growing consumption but volatile production has been large swings in net trade for the region as these countries, particularly India, shift from net exporter to net importer and back again. The magnitude of these shifts has increased as production cycles have become more exaggerated. Most recently, India switched from a net exporter of 5.8 million metric tons in 2007/08 to a net importer of nearly 4.5 million tons in 2009/10, representing about 11 and 9% of global trade, respectively.
Asian production is expected to increase 23% in 2010/11, and pressures on price due to tight supplies are already beginning to wane. However, continued cyclical production patterns will mean ongoing risks of sudden world sugar price increases — particularly if global demand growth and Brazil’s exchange rate remain strong and if sugarcane for ethanol becomes more lucrative.
Exacerbate Cyclical Patterns
Both the central and state governments of India have policies that affect sugar storage, pricing and trade. The Indian Agriculture Ministry recommends annual support prices funded by the central government. State governments then set a price, known as the State Advised Prices (SAP), which sugar millers pay sugarcane growers for their cane. The government also regulates the price of sugar for consumers by using marketing quotas and centrally managed stocks.
The relationship between changes in SAP levels and harvested area is clear: reductions in SAPs generally correspond with decreases in sugarcane area harvested, while increased SAPs tend to bring more land into production.
However, there is a lag in this relationship due to yield patterns that vary over time. In India, a sugarcane plant is typically harvested for three years — rather than for five or six as in many producing countries — with the first year of growth providing the highest yields. Production depends not only on sugarcane area harvested but on how much of that area is in its first year of growth.
Acreage responses are typically stronger in the years following a change in the SAP than in the first year. The result is that price signals affect consumers and producers at different times. For example, in 2005/06, the Indian government began decreasing the SAP for sugar and increasing the support prices for rice and wheat. However, harvested sugar area did not decrease until 2007/08.
These policies, designed to support growers and consumers, have caused financial stress for India’s sugar mills, particularly when sugarcane prices are kept high and sugar prices low. The market factors that affect the cost of sugarcane and the price of refined sugar are not aligned. In surpluses, mills face weakening sugar prices but fixed costs based on the SAP. Mills have to defer or default on payments to sugarcane growers. In response, growers will divert sugarcane to the production of alternative sweeteners, such as khandsari and gur, which are not subject to government restrictions. When producers divert land away from sugarcane, the loss of production is exacerbated by the decrease in yields that results from fewer first-year plantings. The central government, in turn, often modifies its trade policies to encourage exports in surplus years and imports in deficit years.
Affect U.S. Sugar Market
attempting to increase their export potential, such as Colombia.
Although many countries attempt to insulate their domestic markets from dramatic price fluctuations like those in the past two years, any country that imports sugar is in some way influenced by global price swings. The U.S., for example, supports domestic prices at or above 20 cents a pound through domestic marketing allotment quotas and through tariff-rate import quotas.
The U.S. is still heavily reliant on these imports even though it now imports duty-free sugar from Mexico under the North American Free Trade Agreement. When world sugar prices are close to or above the U.S. base support price, U.S. sugar prices have to be, at minimum, slightly higher than world prices to cover marketing expenses involved with importing tariff- rate quota sugar. Therefore, U.S. sugar prices react to changes in world prices, although not necessarily on a one-to-one basis.
So what are the implications of changing world prices for the United States? World prices appear poised to remain at a higher plateau than in the past. Consistently high prices could undermine the rationale for policies that support domestic producers, as well as lower the opportunity cost of government support policies. However, volatility in the global market, such as that caused by Asian production cycles, would still leave U.S. sugar producers vulnerable to low prices without the domestic programs currently in place.