Itaú BBA - We Expect an Additional Drop in Sugar Prices

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We Expect an Additional Drop in Sugar Prices

November 1, 2013

The Itaú Commodity Index (ICI) was virtually unchanged in October.

• Fundamentals explain just some of the gains in sugar prices, so we expect prices to drop further ahead.

• WTI discount to Brent crude will probably remain wide until early 2014, as logistical bottlenecks in the Central U.S. show up again.

The Itaú Commodity Index (ICI) was virtually unchanged in October, falling just 0.4% during the month. The breakdown by component shows small changes in all sub-indexes: Agriculture (-1.8%), Metals (0.5%) and Energy (0.0%). In terms of products, the highlights were higher sugar prices and lower WTI crude prices. The fiscal uncertainty in the U.S. was resolved without a major impact on the growth outlook. The activity pick-up in China was confirmed in 3Q13, but we (and the market consensus) continue to see it as temporary. The partial shutdown of the U.S. government delayed data releases by several agencies – some numbers were made available later (and do not change the scenario), while other relevant reports were not published.

Agricultural commodities were affected the most by the interruption of data releases by U.S. government agencies. The absence of weekly reports from the Commodity Futures Trading Commission (CFTC) affected all commodity categories. Grains, soybeans and beef were further impacted by problems in the release of weekly and monthly data by the U.S. Department of Agriculture (USDA), which provides highly important information for the analysis of fundamentals. In particular, the cancellation of October’s World Agricultural Supply Demand Estimates (WASDE) and uncertainties surrounding the data-gathering process for the next report may be a source of volatility in coming months. The risk is a single report concentrating too many changes in the scenario.

Sharp rise in sugar prices partly explained by fundamentals. Sugar contracts in the futures market advanced sharply up to October 20, extending gains posted in September. Since then, the move was partly reversed. The increase in prices was partly consistent with the appreciation of the Brazilian currency in the period and with the global deficit in the second half of 2013. However, the outlook of a return to surpluses in the first half of 2014 and of Brazilian producers taking advantage of favorable prices to establish delivery prices for the next crop helps to explain the partial reversal by the end of the month and a additional drop ahead. The net effect is bullish for prices, and we are revising upward our forecasts for sugar prices. We now expect sugar prices at USD 18 per pound by the end of 2013 (previously: USD 17.65).

Better prospects for corn and soybean crops, with favorable weather for harvesting in the U.S. and for planting in Brazil. The weather has not changed our price forecasts for 2014, but reduced upside risks to prices for both commodities.

Energy: wider WTI discount to Brent in the short term. By the end of October, the Energy ICI stood at the same level observed in the end of September, as the increase in Brent prices was offset by the decline in WTI prices. The WTI discount to Brent widened from an average of USD 4.5/bbl in September to USD 12.0/bbl in late October. The drop in WTI crude is consistent with the return of oil surpluses in the Central U.S., which should last until the first half of next year. While there is a surplus, the discount should remain above USD 8.0/bbl. Brent prices continued to fluctuate between USD 106.0 and USD 110.0/bbl in October, in line with fundamentals. Due to a larger WTI discount expected by the end of 2013, we adjusted our short-term estimates for the Energy ICI. We now forecast a 5.8% year-over-year increase in 2013 (previously: 6.6%) and -0.1% year over year in 2014 (previously: -0.8%), meaning a lower level in the short term and the same level by the end of next year.

Grains: Favorable Conditions for Harvesting in the U.S. and for Planting in Brazil

Improved supply outlook in the U.S. The corn and soybean harvest is advancing in the U.S. under favorable weather conditions, and quality evaluations throughout the process suggest higher yields than suggested by preliminary estimates. Regarding corn, higher yields may partially or fully offset the impact of a smaller planted area, so that the U.S. crop should top our previous estimates of 340 million metric tons (current USDA scenario: 352 million). As for soybeans, improved conditions remove downside bias from the current USDA scenario, outlined by dry weather in late August (current scenario: 85.7 million metric tons).

Planting in Brazil advances under favorable weather. Overall, planting is being done earlier than last year. The main surprise was in Mato Grosso state, the largest producer of soybeans in the nation. Weather forecasts suggested unstable rainfall until late October, delaying planting. However, rainfall was more frequent than anticipated, ensuring fast advance in planting in the second half of the month. Late planting of soybeans in Mato Grosso would also hinder the winter corn crop, which is planted right after the summer soybean crop is harvested, so that the earlier soybean planting in Mato Grosso improves the supply outlook for both commodities.

Delayed data releases and favorable weather are behind the small change in prices. October was marked by the interruption of report releases by several government agencies in the U.S. Among major commodities, corn, soybeans and wheat were affected the most. The monthly USDA report which was to be published in October was canceled and there are questions surrounding data-gathering for the November report. Given the delay in data releases and good conditions for harvesting in the U.S. and for planting in Brazil, there was no sharp movement in prices during the month - corn, soybeans and wheat fell 3.0%, 1.6% and 0.2%, respectively. Delays in updating crop balances may represent a source of volatility for prices in coming months, with potentially intense revisions in USDA estimates in a single report.

Stable forecasts and the scenario for 2014. We maintain our year-end price forecasts for 2014 at USD 5.0/bushel for corn, USD 12.2/bushel for soybeans and USD 6.8/bushel for wheat. Our forecasts are based on a scenario of corn and soybean surpluses (especially for corn) and equilibrium in the global wheat balance, while adjustments in relative prices of corn and soybeans are pushed forward to the next crop in the Northern Hemisphere.

Cotton: Prices Should Remain Stable, Despite Higher Global Inventories

Prices fall in October due to expectation of larger output in India and harvest acceleration in the U.S. In the first nine months of the year, cotton prices climbed 7.9% in the IntercontinentalExchange (ICE). However, the prices dropped 10.4% in October. The decline was driven by two factors. First, the announcement from Cotton Corporation of India (CCI), the largest global producer, that the 2013-2014 crop should reach 38.1 million bales, up from an earlier forecast of 37.5 million, and up from 35.7 million in the previous crop. Second, favorable weather conditions led to a strong harvest pace in the U.S.

Global inventories continue to expand. According to the USDA, the global 2013-2014 crop should cause another increase in inventories. After a 30% increase in the previous crop, the USDA expects end-stocks to rise 10% in the 2013-2014 crop, reaching 94.7 million bales, because of weaker global consumption. As for production, the crop should total 116.4 million bales (down by 3.8% from the previous crop), with lower output in the U.S. and China, which are major producers.

Inventory policy in China should prevent further price drops. An important factor in the cotton market in recent years is China’s economic policy. Since 2011, the nation has adopted an agricultural policy of inventory accumulation, aiming to protect local farmers. The Chinese government has announced that purchases will be maintained throughout the year despite rising global inventories, so that part of global output will stay outside of the market. Hence, even with a looser balance in the 2013-2014 crop, China’s stance should help to support cotton prices, preventing further declines in coming months. We expect prices in the range of 78-80 cents/lb.

Brazil: increased planted area in the next crop. According to food-supply agency CONAB, the planted area should expand once again in the 2013-2014 cotton crop, as cotton becomes more profitable than soybeans and corn. Unlike the previous crop, when grain prices were more favorable to soybean and corn planting, cotton came back in the 2013-14 crop. According to a study by CONAB on profitability and substitution, cotton is the second more profitable crop in Mato Grosso, with a rate of return of 29% (only behind soybeans, which are returning 81%). In Western Bahia, cotton is the most profitable crop, returning 87%. Hence, the agency estimates that the area planted with cotton in the 2013-2014 crop will be 23% larger than in the previous crop, increasing output by 30%.

Sugar: Brazil To Smooth Out International Price Cycles

Following a long period of declines, international sugar prices increased sharply. Between early September and October 21, raw sugar for delivery in March 2014 climbed 15.5%.

Rising prices are explained by the appreciation of the Brazilian currency, a tight global balance in the second half and by a fire in the Santos Port. The hike may be attributed to: i) the exchange-rate move to BRL 2.18/USD from BRL 2.39/USD in the period; ii) the deficit in the global sugar balance in the second half of 2013, according to our seasonally adjusted estimates for global production and consumption; and iii) the blaze in sugar warehouses in the Santos Port, which destroyed 180 thousand tons of sugar, and with the potential to affect export logistics in the next months.

Fundamentals explain the recent price reversal and suggest lower prices by the end of June. Sugar and hydrous ethanol relative prices favor sugar output, so the production mix in Brazil should be heavier on sugar next year. The price advantage would not be affected by a possible increase in gasoline prices in Brazil this year, because the magnitude of the increase would be around 5%, while the sugar-equivalent price of hydrous ethanol is about 15% lower. Additionally, our base-case scenario contemplates the Brazilian currency at a weaker level, fueling the advantage of sugar prices. With larger production in Brazil and good weather conditions in India and Thailand, we expect the global sugar balance to become looser again in the first half of next year, consistent with lower prices.

Production adjustments in Brazil smooth out the transition from surplus to deficit in the global sugar balance. In 2013, the Center-South region of Brazil is expected to funnel approximately 45% of sugarcane output to producing sugar, a much narrower share than in the previous year (50%). This adjustment reduced global surplus and prevented an even sharper slide in international prices. In 2014, the Center-South region will probably increase the share used to produce sugar, preventing a deficit throughout the year. Hence, Brazil’s ability to adjust sugarcane usage between sugar and ethanol cushions the transition between surplus and deficit periods in the global sugar balance.

Warehouse fires in the Santos Port created uncertainties for 2014. Following the blaze, will Brazil be able to export up to 2 million tons of sugar more than in 2013? Exports may be more concentrated in the second half, but we believe that it will be possible to increase exports. According to the company affected by the fire, shiploading equipment was not damaged, so that the company will still have some exporting capacity in that location. Additionally, with the outlook for a smaller winter corn crop, there will be spare capacity for shipments through Paranaguá Port in the second half.

We forecast a further decline in sugar prices in the short term, with a rebound starting in the second half of 2014. Due to the recent evolution in prices, we changed our year-end forecast for 2013 to 18 cents/lb. from 17.65 cents/lb. (sugar Nº 11, first due date), representing a 1.7% decline from the end of October. We expect prices to recover starting in the second half of 2014, reaching 18.4 cents/lb. by year-end.

Crude Oil: Talks with Iran Resume

The WTI discount to Brent widened again. Brent crude prices remained in the range of USD 106.0 to USD 110.0/bbl in October, without significant adjustments in current supply and demand conditions outside of the U.S. WTI crude slid 5.2% during the month, reflecting once again excess supply in the Central U.S. Hence, the WTI discount to Brent widened from an average of USD 4.5/bbl in September to USD 12.0/bbl in late October.

Downward revision in year-end forecasts for WTI. The drop in WTI crude is consistent with the return of oil surpluses in the Central U.S., meaning that the oil inflow is again larger than the sum of local use and transportation to coastal regions, due to infrastructure constraints. This scenario is expected to last until 1Q14, when the outflow capacity in the region increase again, prompting a decline in crude inventories in the region. The resumption of inventory accumulation in the short term is consistent with a wider discount than forecasted in our previous scenario. We thus revised our 2013 year-end forecast for WTI to USD 102.0/bbl from USD 105.0/bbl.

Brent forecasts are unchanged; downside risks with the resumption of talks with Iran. With the absence of changes in fundamentals, we maintain our year-end forecasts for Brent crude at USD 110.0/bbl in 2013 and USD 108.0/bbl in 2014. However, resumed talks between P5+1[1] and Iran created downside risks to prices if sanctions against the country are reduced.

Artur Manoel Passos

Verena Paiva



* The Itaú Commodity Index is a proprietary index composed of commodity prices, measured in U.S. dollars and traded in international exchanges, which are relevant to global production. Its sub-indexes are Metals, Energy and Agriculture

**The ICI-Inflation is a proprietary index composed of commodity prices, measured in U.S. dollars and traded in international exchanges, which are relevant to inflation in Brazil (IPCA). Its sub-indexes are Food, Industrial and Energy


[1] The five permanent members of the U.S. Security Council plus Germany.



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