Is Sugar Still Sweet

Hits 25-Year High, Then Corrects

Sugar futures at the New York Board of Trade recently reached their loftiest levels in a quarter century, but recently have traded lower, as commodity funds closed out profitable long positions and sold ahead of today’s March Sugar expiration.

Let’s be careful not to lose sight of the bigger picture. Sugar has been in the midst of a powerful bull market since early 2004, and there are a number of factors supporting prices and driving the market higher, not least of which is a growing recognition that Sugar is becoming an energy crop, and not simply a food crop.

Will Sugar futures move higher or lower in the months ahead? That’s for individual traders to decide, after considering all available technical and fundamental information, but it’s important to be aware of the new relationship between energy prices and Sugar futures. More and more traders are coming to see a direct linkage between the price of Crude Oil and the price of Sugar.

Sugar and the Rise of Ethanol

Call it a different kind of sugar high, said a recent Wall Street Journal article. Many people think of sugar as little more than an ingredient in foods like pies and candy bars. But many savvy traders and investors, like hedge funds, are betting that more sugar will soon be needed for another reason: To produce ethanol, the increasingly popular fuel substitute that can be mixed with gasoline to power automobiles. As oil prices continue to climb higher, many traders believe, demand for ethanol could soar, and sugar, as an important component in ethanol production, could benefit, too.

Ethanol is an alcohol that can be derived from a variety of commodities, including corn, cane sugar, and sugar beets. It’s attractive for reasons that go beyond the high price of oil. Environmental concerns, for example, make ethanol an interesting option, because when mixed with gasoline, it produces a fuel that is relatively more clan burning (biodiesel is a different but related fuel, and is made from vegetable oils such as processed palm oil.)

Geopolitical issues also have put ethanol in the spotlight. For instance, in his State of the Union speech, President Bush called for more ethanol investment to help reduce oil imports from the Middle East, though his plan focused primarily on using agricultural waste (such as plant stalks and wheat straw) in the production process, rather than commodities such as sugar or corn. The goal is to reduce the U.S.’ reliance on Middle East countries that supply oil but which do not share U.S. values, interests, or strategic goals and which, in some cases, are openly adversarial toward the U.S.

The Brazilian Example

Brazil, the largest sugar exporter and the world leader in ethanol production, is diverting about 52% of its sugar-cane crop to ethanol, up from about 48% in 2003, according to the International Sugar Organization. In Thailand, the world’s fourth-largest sugar exporter, government officials aim to replace some types of regular gasoline with ethanol-based blends by 2007. Local sugar-industry leaders are calling on farmers to increase cane production to about 80 million tons or more a year by the end of the decade from about 45 million tons or less in the most recent, drought-impaired season.

According to the Wall Street Journal, Sugar still makes up just small fraction of the world’s energy picture, despite its potential to help ease reliance on Crude Oil. Last year, only about 3% of U.S. gasoline contained ethanol. But consumption is forecast to rise, and in 2005, estimates are that 36 billion liters of ethanol fuel were produced, representing an increase of roughly 20% from the previous year.

Where Can the Market Go from Here?

Some analysts in the bearish camp suggest that Sugar prices only in the range of 12 to 13 cents per pound are warranted. Much of the remaining demand, they say, is coming from hedge funds and other speculative investors who realized substantial profits in Crude Oil and other raw materials in 2004 and 2005 and believe ethanol is going to make sugar the next hot commodity. Bearish market observers also point to the fact that the world’s four biggest sugar exporters Brazil, the European Union, Australia and Thailand all have plans to increase production of ethanol and other alternative fuels during the next several years. Although sugar is one of the world’s most important agricultural crops, its prices has languished in recent years, in part because of soaring production in places like Brazil. Prices dropped below six cents a pound as recently as 2003.

Bullish Sugar traders, however, correctly point out that even at today’s lofty levels, Sugar prices are a far cry from the early 1980s, when they soared as high as 45 cents per pound. Most countries lack the basic infrastructure to use ethanol at this point in time, and ethanol production often requires big government subsidies to compete with more traditional fuels. But if Crude Oil prices remain high, the incentives to make ethanol work grow. Even small steps toward increased ethanol consumption, they say, could drive long-term demand for Sugar higher.

It’s up to individual traders to draw their own conclusions as to where Sugar futures will head as 2006 unfolds. But one thing’s for certain: Futures and options on the “universal commodity” will be active, and there should be plenty of trading opportunities for those with both bullish and bearish perspectives.