With all of the recent news of a depressed market in the commodity sector, agricultural commodity analysts have been presented with a cause for concern as three major meteorological agencies (Australia’s Bureau of Meteorology, NOAA and the Japan Meteorological Agency) all confirmed that the El Nino that has been in a weak phase for the better part of the past year is finally showing signs of strengthening.
Some are suggesting a strong year 1 phase of the El Nino Southern Oscillation (ENSO). These releases were quickly followed by similar statements from a host of academic institutes as well as private and public weather service providers. So with a potentially strong El Nino upon us and the Indian Monsoon onset just around the corner, what should the agricultural risk manager be preparing for in 2015 and 2016?
Let’s look at the potential impact on a commodity that nearly everyone consumes, but one in which we rarely consider the price: sugar. The price of a 5-pound bag of sugar in the US is roughly the same as it was 10 years ago. Even when extreme weather events have caused havoc for producers, and at the same time eating into the profit margins of consumer goods companies that purchase the refined sweetener, the change in price to the end user barely registers. The food and beverage industry cannot pass along price increases to consumers of low cost candy and soft drink items every time Mother Nature decides to throw a curve.
The 2015-16 period may see one of these curves with an ENSO event timed with relatively low commodity prices for many agricultural and soft commodities. As of Tuesday’s close, world sugar futures were 12.97 cents per pound, and forward contracts are currently in a contango situation, where the prices for forward contracts are higher than the nearby price. The October chart for #11 futures is shown below. As sugar has been generally rangebound for the last few months, the coming ENSO could serve as a catalyst for price movement to the upside. Some of the market’s concern about the potential impact of this El Nino seems to be already priced in; however, what is the ‘fair value’ for the widely used commodity in light of the weather and crop uncertainty?
ENSO events, despite all of the negative attention, are not bad for producers everywhere. For Brazil, the world’s largest producer of sugarcane, a moderate to strong ENSO can be a good thing. Typically, as moisture moves away from the Asia Pacific origins with the shifting tradewinds, additional moisture makes its way into South America. Given the exceedingly dry conditions that Brazil’s Centre-South region has seen over the last two years, a transition to a positive El Nino phase is good news. However, when it comes to sugar, we need to balance Brazil’s optimism with potentially negative conditions in other key origins.
India is the second largest producer of sugar by volume, and with a historically fickle Monsoon during ENSO events, and tight supply stockpiles, this year’s Monsoon will carry special significance. In addition, year 1 of an ENSO cycle tends to correlate with dryness in Thailand, Australia and Southern China – all key production regions which, in aggregate, can tip the global scales from surplus to deficit.
Please continue to follow aWhere as we will be launching a series of tools in the coming months to help agricultural practitioners and risk managers plan and respond to whatever Mother Nature decides to throw their way.