Sugar Prices Reflect a Commodity Rife with Regulation

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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 BusinessWeek.

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