Recently, world’s one of the most prominent investment bank, Barclays said that the sugar and soybeans are the markets facing the highest risk of a meaningful slowdown in exportable production growth. This will be owing to compelling underlying demand dynamics, partly linked to Brazil’s soaring energy needs, and slower output growth.
Brazil’s Sugar Story: After doubling between 2000-01 and 2008-09 marketing seasons, Brazilian sugarcane production has been sluggish over the past two years. Unfavorable weather was somewhat responsible for the poor outcome but falling investments in the sector in the aftermath of the financial crisis also played a crucial role, causing a sharp drop in the number of new mills entering the market. Although twenty-nine new plants were brought into operation in the 2007-08 and 2008-09 harvesting season, which was almost half the number to come on line over the preceding two years, the output never really took off. And now, UNICA (Brazil’s sugar industry association) projects that only five mills will come on line during the 2011-12 seasons.
The bank believes this weakness to improve as higher sugar and oil prices should help attract investments in the sector. Besides, the Brazilian government is also showing a strong commitment to the domestic ethanol industry, which should support stimulating growth. for instance, in early June, the government announced a $20bn package – equivalent to almost two-thirds of the industry’s annual output – to finance expansion in the sugarcane sector throughout 2014.
In our view, maintaining such a pace of expansion will prove difficult. Cost escalation and poor infrastructure are key challenges. UNICA estimates that there has been an increase in production costs of 38% over the past five years. Transportation, in particular, is seen as a weak link in the sugarcane supply chain (as noted above) and substantial investments to lower transport costs from mills to consumer centers and ports is needed. Moreover, rising environmental concerns about land clearing could also slow the pace at which new land is brought to cultivation. Estimates by the Food and Agriculture Organization, which run through 2018, point to a deceleration in the pace of sugarcane output growth in Brazil over the next eight years, estimated at 5.9% p.a. from 6.7% during the prior decade.
The deregulation of the Brazilian Sugar sector during the 1990s and the growing usage of flex-fuel cars have greatly benefitted sugarcane production, helping create new end-user markets and facilitating investments in the sector. As result, sugarcane output more than doubled throughout the past decade, driven by a threefold increase in productivity and sugarcane’s yield- per-acre since the early 1990s. This expansion led to an enormous growth in sugar output, sugar exports and Ethanol production over the period.
However, now lower sugarcane output would likely result in slower growth in sugar exports, as a more measured expansion in feedstock availability would limit the ability of the sugar and ethanol sector to grow unconstrained. Given such circumstances, should Brazil’s ethanol production growth return to pre-recession levels (about 10% p.a.), sugar exports would plunge well short of the expansion of the previous decade.