Four Unknowns Threatening the Margins of Brazilian Sugar Mills
Is now the time? That’s what sugar mill operators in Brazil should be asking themselves.
In a domestic environment that has seen a large devaluation in the local currency this year, strong expectations for ethanol production and good futures prices for sugar at the moment, margins are historically high for most of these operators. In some cases, those margins may be approaching 100%. This may leave them inclined to see if margins will go even higher because, after all, thanks to the situation today, they are not in danger of running out of cash.
But there are several reasons why next year may look different. These looming uncertainties should cause mill operators to ask whether it’s a good time to lock in margins further into the future. On balance, the unknowns may indicate it’s more likely that margins contract next year than expand. Let’s look at them one by one …
Demand uncertainties due to COVID-19
The biggest unknown out there is what happens next with the pandemic and how it impacts consumer demand for both food and fuel. This matters in Brazil, of course, given high rates of domestic usage – and COVID-19 has continued to spread in that country. But it also matters for exports.
China is the largest buyer of Brazilian sugar. Although many agree that its economy has stabilized and is recovering, that economy is dependent on the health of its own trading partners, too. If the global picture does not improve, China could experience a slower than expected return to normal.
So robust export demand is also far from a sure thing, potentially putting margins at risk.
Government actions in India
On the supply side of the ledger, one of the biggest questions marks comes from the second-largest sugar producer, India. COVID-19 has taken a staggering economic toll on the country, and most experts anticipate further government stimulus after the November elections to stave off even greater unemployment.
It becomes more profitable for India’s mills to export as opposed to selling sugar domestically when the export price hits approximately 18 cents a pound on a New York basis. Right now, it’s not that high, but government subsidies could push it up above that mark to encourage employment through mill activity and exports. If that happens, Indian sugar will flood into the global market, weighing on prices and depressing margins in Brazil.
Sugarcane-growing regions in Brazil experienced very dry weather early in this season, potentially limiting the upcoming crop. But that changed in the latter part of October, with heavy rains arriving.
As all producers know, sugarcane does not need prolonged rain throughout the season to prosper – even a short burst goes a long way. Although rains in total have been below average, we could already be well on our way to a big supply that would weigh on sugar futures prices in 2021. With many mill operators already having fixed costs for next year, that price decline would flatten their margins further.
Hedge fund positions
Then there is the question of what hedge funds will do. Right now, they hold a very large long position in aggregate. That has helped keep prices high, but what happens if they decide to exit those positions? We could see a Brazilian domestic price that drops from the current 15 cents a pound down into the single digits. If the funds do reach a triggering point for whatever reason and pivot to sell, margins for mill operators will come under heavy pressure.
Time for discipline
No one knows the future for certain. But right now, high margins may have made some mill operators too comfortable with high levels of risk. At moments like this, a disciplined risk management strategy is key. Depending on individual variables like credit, cost structure and optionality to switch between sugar and ethanol production, it may be desirable for some mills to lock in margins further into the future.
That’s where Cargill Risk Management can help. Our team can work with you to identify tailored hedging solutions that meet your specific needs in an environment with a lot of unknowns. Protecting historically high margins can help you avoid that queasy feeling of missing out on a big opportunity.
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