Markets unPACKed: Is a Commodities “Sweet” Super Cycle Coming?
Is a Commodities Sweet Super Cycle Coming?
In these weekly articles, we have been focused on corn and beans, given the extraordinary market we have these days. While there is still so much to be said about this week’s price action, I wanted to shift over to ethanol, then to sugar.
This week, my email was abuzz with the headline “J.P. Morgan says commodities may have begun a new super cycle!” The article on Bloomberg goes on to state that other banks such as Goldman Sachs and Bank of America have also published analyst expectations of a bullish commodity cycle as traders hedge against inflation and strong economic recovery as the Biden administration works to roll out vaccines. The end of this article is vague, as they mention the nice turnaround we have seen in oil from negative prices to March crude futures trading at $58/barrel.
I am curious as to whether this super cycle includes ethanol. Now, I do not have the full analysis from J.P. Morgan, but ethanol is treated like an annoying little stepbrother by the oil industry; it is the underdog to farmers, as ethanol is marketed as a cleaner-burning fuel. In case our readers are a little unfamiliar with the role of ethanol in the U.S., let us break it down: The Renewable Fuel Standard (RFS) (established by Bush Jr. administration) sets quotas to blend ethanol and biodiesel for transportation fuels. It is a government mandate. Those refiners who are unable to meet any given year’s quota must fulfill this requirement by buying Renewable Identification Numbers (RINs) in the open market from those refiners who have blended gallons to spare. The Environmental Protection Agency will issue exemptions to smaller refiners to avoid the financial burden of purchasing RINs, as they can be expensive. Now, blending exemptions were more abundant with the Trump administration than the Obama administration…as this comes down to big oil versus big corn and the environmental lobby.
So, if hedge funds and banks are bullish on oil consumption as the globe starts moving again, are they bullish on ethanol? What implications are there on prices if the Biden administration is even more stringent on blending exemptions?
At the end of the day, ethanol will not hold back oil prices to the severity of other global events. However, ethanol is worth keeping an eye on. It is also worth noting that China is building ethanol plants as quickly as possible as they have implemented a 10% blending requirement as well. RBOB (gasoline) and WTI futures prices are back to pre-COVID-19 levels. Ethanol cash traded at $1.485/gallon; this time last year it was $1.35/gallon. To have an active position in ethanol, focus on RBOB.
While we wonder if ethanol is going to be included the super cycle, we cannot ignore sugar’s price action when energy receives positive news. Sugar is the main source of South American ethanol and sugar moves with energy markets for this reason.
Here’s the sugar picture: India is the world’s second-largest sugar exporter in the world, and production there is increasing — up 9% from this time last year. Last Tuesday, the Indian Sugar Mills Association (ISMA) reported that India’s Oct-Jan sugar production was already up +25% y/y to 17.68 MMT. Unica reported Wednesday that Brazil’s Center-South sugar production through January was up +44% y/y to 38.195 MMT.
However, my colleague pointed out to me that sugar prices are outpacing ethanol prices in Brazil, ever so slightly. This suggests it is a better economic decision for sugar mills to produce (and export) sugar than it is for them to produce ethanol.
Keep in mind that when oil prices increase, it drives the parity price. The price of sugar must justify further production over ethanol production. As oil prices have increased, so have sugar prices. Strength in sugar could be that money managers are holding a record net long position in the March contract. As option expiration in March approaches, we will see if the funds roll their record long to the May contract and cause it to rally as well.
Speaking of exports, there is a known global shipping container crisis, with headlines highlighting that India cannot afford to export its sugar. Why are countries being priced out of shipping? The core issue is that China, which has recovered faster from COVID-19, has revved up its export economy and is paying huge premiums for containers. With more economies coming online, this will continue to be a bullish factor for sugar.
The option skew is showing much more action on the call side than the put side. With the call skew reaching 45% implied volatility, it seems as though those reading about upward momentum in oil are positioning themselves in sugar as well. If you have not thought about sugar as an energy play, we remind you to do so.
The chart below shows ethanol cash prices in black, WTI crude march contract in red, and Sugar #11 March contract in purple.
(source: Barchart.com)
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