Commodities

Sugar Prices Reflect a Commodity Rife with Regulation


Editor's Note: After publication on Aug. 21, a representative of the U.S. sugar industry disagreed with our description of sugar price increases. He pointed out that the price U.S. food companies pay is for wholesale sugar, which has risen by 50% since January 2008, not world futures prices, which as we pointed out had doubled. This story has been updated to reflect that, along with additional comments from the sugar industry, the U.S. Agriculture Dept., and others.

Lufkin, Tex., a small city north of Houston, has been the home of family-owned Atkinson Candy since 1932. As sugar prices reach highs not seen in almost 30 years, that's about to change.

Sugar accounts for some 60% of the ingredients used to make Atkinson's candies, such as its signature Chick-O-Sticks and Long Boys, says Eric Atkinson, the company's president and the grandson of the founder. Because the U.S. Agriculture Dept. places quotas on the amount of sugar that can be imported (except those from Mexico, which are unlimited under NAFTA), the company has been forced at times to pay double what its international competitors pay. And with prices for U.S. wholesale refined sugar increasing by almost 50% since the beginning of 2008—from around 24¢ a pound in January to more than 35¢ a pound in July, according to the Agriculture Dept.—Atkinson has decided he has no choice but to shift some operations to Guatemala, where he can take advantage of lower sugar prices. According to a USDA commodity report published in March, the Guatemalan Sugar Assn. set wholesale refined sugar for 2009 at 26¢ a pound. To be sure, manufacturing candy in Guatemala is cheaper not just because of the lower price of sugar—labor and land, for example, are less expensive as well.

"There's still equity in 'Made in America,' but costs have been going up precipitously and customers have taken a hard line—they won't accept an increase in prices," says Atkinson. "If it was only about labor I could still be here—it's the price of sugar that we're having to leave for." Atkinson argues that "protectionist" measures intended to aid U.S. sugar growers and producers end up hurting domestic food and confectionery companies. At least 30 workers of his 225-member staff have lost their jobs, Atkinson estimates, as he's lost business to lower-cost competitors. "We've been between this rock and hard place for 25 years," he says. "When you don't let the market control the commodity, this is what happens."

American food companies have railed against the Agriculture Dept.'s quota policy for decades. In response to the recent prices and concern over "unprecedented shortages," a group of large U.S. food companies, most much larger than Atkinson Candy, sent a letter on Aug. 5 imploring Agriculture Secretary Thomas J. Vilsack to boost the sugar quotas. The companies, including Conagra Foods (CAG), General Mills (GIS), Hershey (HSY), and Kraft Foods (KFT), warned that failure to import more sugar, in order to secure future supply, could lead to higher consumer prices, job cuts, and "distorted" trade patterns.

The Agriculture Dept. contends the domestic market is not in danger of a shortage in the near future. "At the current time, it appears that the domestic market will be adequately supplied through the end of the marketing year, which ends Sept. 30, 2009, at which time both new domestic sugar production will be available and imports under the 2009-10 Tariff Rate Quota will begin," said Undersecretary Jim Miller in a statement.

American sugar lobbyists, meanwhile, insist that food manufacturers are simply playing politics to depress domestic farmers' prices. "Crying wolf is nothing new for food manufacturers' lobbyists," says Phillip Hayes, a spokesman for the American Sugar Alliance, which lobbies for the domestic sugar industry. "They've been preaching doom and gloom about sugar supplies for decades…in hopes of pressuring the USDA to increase imports so sugar prices will fall further and they can boost their already healthy profits." Nicholas Fereday, a senior economist at LMC International, an independent agribusiness consultancy and research firm, adds: "[The food companies] could simply be using the current trend in the market to leverage their position."

Governments Restrict Trade Distorted trade patterns on the world sugar market are also nothing new. Though it doesn't generate the headlines of oil and gold, sugar can be far more volatile. "Sugar is the commodity the most protected and the most meddled with by governments," says Mike McDougal, senior vice-president for the Brazil desk at Newedge, a global brokerage firm.

The Agriculture Dept. estimates the world market will produce some 160 million tons of sugar from 2009 to 2010. But many of the top-producing countries enforce trade barriers and quotas that skew prices, supply, and demand internally and globally. The price of the most active world raw sugar futures contract soared from $11.70 on Oct. 24, 2008, to $22.97 on Aug. 12, 2009. That 96% increase happened much faster than the time it took the price of gasoline in the U.S. to double to more than $4 a gallon last summer.

The price of raw sugar futures may not directly affect American markets right away, but a tightening in the world markets makes it that much more difficult to procure sugar should the domestic supply be insufficient to meet future demand, as the food companies fear. And the fact that open-market prices are lower than U.S. prices continues to attract domestic companies that could boost their profit margins should they migrate overseas.

The U.S. restricts the amount of imported sugar to keep domestic prices high and, through a loan program to U.S. producers, effectively establishes a floor price. The government of India restricts how long and how much of the commodity sugar traders can hold, to prevent hoarding. It also establishes price floors and requires sugar mills to sell 10% of their product to the government so it can be sold at a discount to the poor. In Thailand, the government controls domestic prices and places heavy tariffs on imported sugar. Provincial governments in China also set minimum prices, and the Chinese National Development & Reform Commission has provided industry loans in concert with the People's Bank of China and purchased thousands of tons of sugar along with the Finance and Commerce ministries.

"The quotas make no sense because the reasons for them being there have been so [subverted] by interested parties," says Philip Corzine, an agricultural consultant. "Most people have no idea that sugar is this regulated." Among those interested parties are rural farmers, makers of alternative sweeteners (such as high-fructose corn syrup, the price of which often moves in tandem with sugar), sugar processors, the food companies, and of course politicians chasing campaign contributions.

Weather's Impact Like many agricultural products, the world's sugar supply is heavily reliant on the weather. Sugarcane and sugar beets are used to produce most of what the world thinks of as table sugar, while high-fructose corn syrup, another sweetener in liquid form, is derived from corn. Heavy rains in Brazil, the world's largest producer and exporter, have caused yields to fall this year (too much water in the cane causes it to gain weight and vegetate, resulting in decreased sucrose levels). India faces the opposite problem—there hasn't been enough rainfall to properly cultivate crops during its current drier-than-expected monsoon season. Drought in Mexico has also resulted in lower-than-expected crop yields.

The land devoted to sugarcane also began to drop off in recent years in both Brazil and India after lower prices forced Indian farmers to diversify into other, more profitable crops and Brazil ramped up sugarcane production to be used for ethanol, a gasoline substitute that became more profitable as the trend toward alternative fuels gathered steam.

Demand for sugar has risen in recent years, partly reflecting rising incomes in developing nations. The Agriculture Dept. projects worldwide consumption will climb by 1.5 million tons in 2009-2010 from the previous year.

Farmers are responding by shifting production back to sugar from some alternative crops and uses. About 42% of Brazil's sugarcane will be destined for use as sugar this year, up 2% from last year. But unlike corn, sugarcane takes years to harvest, so switching to that crop takes time and money. The global financial crisis made that transition even more tenuous. As Brazil tries to update its factories and build new ones, "it's taking longer for production to react, particularly because of the credit crisis," says McDougal. "Brazil had been on a tear increasing production, but now they've come to a screeching halt." The Agriculture Dept. says 40% of the Brazilian mills that were to come on stream in 2009 have been postponed until 2010. India, meanwhile, went from exporting 5.8 million tons (No. 2 in the world) to importing 1.8 million tons (No. 2 in the world) within a year.

Producers Benefiting Sugar producers are reaping the benefits of high prices. Cosan (CZZ), Brazil's largest sugar producer, with 21 sugar and ethanol plants, swung from a net loss of $64.6 million for the quarter that ended in January to a net profit of $184 million in the spring quarter, as sugar prices increased about 33%. Cosan Finance Director Marcelo Martins said in an earnings conference call that he expects prices to remain steady for at least one more growing season.

Other companies that are benefiting from the price spike include producers and traders such as Tate & Lyle (TATE.L) and ED&F Man, said Gary Drimmer, president of agribusiness consultancy Drimmer & Associates International; high-fructose corn syrup producers Archer Daniels Midland (ADM), Cargill Foods, and Corn Products International (CPO); and fertilizer manufacturers Agrium (AGU), Terra Industries (TRA), and CF Industries Holdings (CF).

"Typically with a commodity, as long as you can maintain adequate carryover stocks, the market functions well," says consultant Corzine. Due to the supply disruptions in Brazil and India, he says, "you ended up with lower stocks. As the price of sugar rises, people will have to seek alternative sweeteners" and eventually the world market should correct.

Still, warns McDougal, "if the Indian harvest comes in, you should see prices moderate. But if the monsoon season continues to be sporadic, or El Niño causes other problems in Asia, or Brazil is affected further, you could see higher prices. The markets are very sensitive right now."
Deprez is a reporter for Bloomberg News in New York. Follow her on Twitter @esmedeprez.

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