The European Sugar Sector

13 February 2019

PRESENTED BY:

Robin Shaw
Sugar Analyst
We Had a Dream…

In 2016 when EU sugar liberalisation was on the horizon, everything looked optimistic:

 World prices were high (24/c lb in New York).

 EU prices were high (600 Euros).

 EU processors’ capacity was unleashed. They could extend the campaign, and add 20% to their production while reducing costs.

So some of us had a dream:

 Being beet producers, EU producers would vary area sown so as to only produce ~ the tonnage of sugar consumed in the EU (17.5
million tons excluding ethanol), and would only plant to make additional sugar when world prices were high, and would hedge that
surplus tonnage and export it.

 As a result the EU would become a ‘regulator ‘ of the world market, producing less when prices were low; and this regulator
would keep world prices close to the level at which EU farmers/growers were willing to plant beet, i.e. a relatively ‘high’ world
price.

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Then we woke up to reality…

 In 2017 EU beet processors encouraged farmers to plant maximum beet’, yields were good and the EU produced 19.7 million tons of
sugar.
 Simultaneously world prices collapsed, and EU prices followed. EU domestic prices traded at close to export parity.
 EU beet processors lost money, and growers received poor prices for beet.

23¢ €650

21¢
€550

19¢
€450

17¢
€350
15¢

€250
13¢

€150
11¢

9¢ €50
1/11/2016 1/2/2017 1/5/2017 1/8/2017 1/11/2017 1/2/2018 1/5/2018 1/8/2018 1/11/2018
Source: Bloomberg; Marex Spectron
Sugar no.11 (NY) NW Euro Sugar Price Ex Works

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Processors could not control the market….

 Inevitably in a market without quotas, and with an exportable surplus, the EU domestic price fell towards the world price and stayed
there all through 2017 and most of 2018.
 Only by the accident of a very poor climate in 2018 (drought), and therefore of production falling by nearly 3 million tons on the same
beet area, did EU domestic prices rise at the end of 2018.
 Prices are now around 400 Euros per tonne, which is close to import parity.
 So the lesson learned the hard way is that when there is a large export surplus, domestic prices tend to fall towards export parity, and
when that exportable surplus is small or non-existent, they rise towards import parity.

 In theory export parity is around New York plus about 40 Euros per tonne, and import parity is around NY plus 140. But in
practice the difference is between NY plus about 70 and NY plus about 120 Euros. But those 50 Euros per ton make all the
difference between say 320 and 370 Euros, which is the difference, for a processor and grower, between life and death.

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What will happen in 2019/20?

Estimated balance sheets for EU sugar in 2018/19 and 2019/20 would look something like this:

2018/19 2019/20
Opening stocks 2.4 mmt wv 2.6
Production 17.2 17.5
Imports 2.0 2.0
Consumption 17.6 17.6
Exports 1.5 2.0
Ending stocks 2.6 2.5

So export surpluses are likely to remain in the 1.5/2.0 range. And will get bigger if imports increase, (which they will if the EU
prices stays at too big a premium to the world market).

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T h e E U w i l l s t i l l b e i n s u r p l u s ; w i l l p r i c e s g o b a c k To E x p o r t P a r i t y ?

 The EU will still have to export. If they do not, then ending stocks will grow, and processors will go back to competing to sell on the
domestic market.
 But it is asking a lot of processor A to export additional tonnage at today’s export price of 260 Euros, so that his competitor, processor B,
can sell that tonnage domestically at 400!
 And sellers cannot plan collectively to share the sacrífice of exporting.
 Processors successfully shared the burden of exports in 2017/18, but then the difference between the export price and the domestic price
was only about 40 euros per ton.
 This year they have exported about 600,000 tons so far, but a lot of those sales were booked before the EU price shot up.
 And now we expect more imports to come in, thus increasing the tonnage which processors have export (or store).

 So some kind of collective intelligent self-interest will only work on a sustainable basis when total EU sugar production is
relatively close to EU consumption, i.e. when the export surplus is small or nil.

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How Can EU Processors/Growers Limit EU Sugar Production?

 At first glance it may look impossible. EU processors will, in no circumstances, exchange information or much less, plans, with each
other.
 But they have some instruments at their disposal.
 There are only about 7 major processing groups.
 They have the ‘memory of quotas’.
 They have a huge interest in solving the problem (to return to 300 Euros, which will happen if they fail) would be suicide.
 They can export any tonnage they like.
 They can store any tonnage they like, and have invested in storage capacity.

 Above all the processors can discuss with their farmers, most of whom are in a cooperative relationship with the processors,
and decide what would be the optimum area to sow to beet in the then-existent circumstances.

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How Can Processors Work With Growers to Limit Beet Area?

 The processor is in fact NOT the producer. The processor is a laundry which takes in beet and converts it into sugar. So the processor
does not materially suffer if prices of sugar and beet are high or low. The farmer of course feels the pain or the gain.
 And the farmer has a choice; he can plant alternative crops, like wheat or rapeseed.
 But it is the processor who coordinates planting intentions with all ‘his’ farmers.
 The processor has had an interest in encouraging farmers to plant more, rather than less, beet, since by increasing throughput he
reduces processing costs. But what really interests the processor is the processing margin.
 It looks likely that in the near future farmers will want to fix their price against world futures. That will involve an agreed processing
margin. It would not be impossible for processors to agree with farmers a profit sharing whereby the processors’ margin,
counterintuitively, is increased when beet tonnage is low.
 This would leave the processor free to concentrate on trying to achieve the best remuneration for ‘his’ farmers.
 The processor would become like the conductor of an orchestra, using his judgment and skill, and the various instruments at his
disposal, to achieve a higher price, rather than higher volume.

 But it would be like an orchestra where the players were not allowed to speak to each other!

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Prisoners’ Dilemma

 Such a market would be reminiscent of ‘Prisoners’ dilemma’. Each producer has a its own individual interest, but they all share a
common collective interest.
 And they cannot collude.
 So how to prevent one group taking advantage of the ‘sacrífice’ of the other groups?
 You cannot. But if you think about it, all free markets are like this; all producers in a free market want a higher price; but each of them will
look after his own interests first. They cannot collude with each other because in a free world market, there are millions of individuals so
communication is impossible.
 But the stakes are high. If EU producers could achieve this they would have restored the ‘dream’ we talked about at the beginning: - a
world in which the EU being beet, could limit production when prices are low and expand substantially (by 5 or 6 million tons) when
world forward prices are high, and hedge that exportable surplus.

 So the EU would become, for the world market, a regulatory factor of some 5 or 6 million tons, pivoting around the price at
which EU growers make money. And the EU beet industry would be on a solid foundation, producing less when prices are low
(but achieving a higher premium over the world price), and ready to take advantage of those occasions when the world price
offers a profitable return to EU exports.

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A Possible Solution

 But that happy ending can only be achieved if all partiers – farmers, processors, consumers and traders – are able to take informed
decisions.
 At present no one can knows with confidence the essential factors which make a market – sugar prices; the calculation for converting
those prices to beet prices; the area which farmers intend to plant to beet.
 If the market knew these elements, then all parties would be able to take informed decisions in their own best interests, and the sum of
those decisions would enable the market to find its own equilibrium.
 In addition EU processors have several advantages which we mentioned before; few players, the capacity to export, the capacity to
store, and the memory of quotas, to serve as a basis for estimating production figures.
 In addition the EU has the unique advantage of being beet, which means that production can be varied each season.

 If ‘everyone knew everything’ these advantages would be achieved, not only from intelligent and informed decisions made by
processing groups, but by the ‘invisible hand’ of Adam Smith operating to enhance the comparative advantage of each party.

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W h a t Wo u l d Tr a n s p a r en cy M e a n In Pr a c ti c e ?

 Sugar prices. Prices are at present very opaque. Transparency would enable consumers to buy forward if prices go too low, farmers to
decide what areas they plan to plant next year, (and to hedge the equivalent sugar tonnage), and processors to play their role as
conductors of the orchestra.
 Beet prices. Again, these are fairly opaque at present. Transparent formulae for deriving the price of beet from a given sugar price, would
enable farmers and traders to make intelligent judgments on what world futures prices would translate to in terms of EU sugar prices and
then in terms of beet area.
 Beet areas. These become known after sowings are complete, i.e. too late. The regular and timely publication of planting intentions would
enable all parties to gravitate towards the optimum beet area.

 Those judgments will always be an art rather than a science since the EU sugar industry has a huge number of moving parts –
ethanol, HFCS, climate, and above all prices of alternative crops – too many for anyone to claim to be able to predict, much less
control it. Only a free and open market can bring all those factors into equilibrium.

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Pricing of Domestic Sugar Against The World Market

 It follows that, if transparency will one day prevail, this would almost inevitably require that a large proportion
of EU sugar would be priced against world futures.
 This would enable farmers and buyers to price in advance, while processors would be able to hedge their
margins.
 It is already happening to a growing extent, since it is much more convenient for buyers to price against a
clear and visible benchmark such as futures, rather than complex negotiations every time a buyer wants to
fix a few tons.
 It also allows for OTC structured products which offer ‘insurance’ to both buyers and sellers.
 Above all it would enable growers/processors to adjust the processing margin so as to achieve the essential
purpose, which is to ensure that the factories have a stable throughput, and a sustainable margin, even when
sugar prices are low, and farmers have the temptation to plant other crops.

 Pricing against world futures literally works to the advantage of all parties.

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