Agri-commodities can have peculiar supply-demand patterns. These goods are often in semi-continuous production so, there will be periods when traders are speculating on the next production cycle. |
That can mean excessive volatility with every change in expectations. Demand also changes slowly for most agri-commodities so small changes in supply can cause relatively large price-swings. |
In addition, agri-goods are politically sensitive. Farmers are a powerful lobby even in the most highly industrialised places where they form a small section of the population. Japan has its rice-price protection fanatics; the Euro Union builds its butter mountains; the US has non-tariff barriers to protect its own farmers. |
A decision to import or export farm goods always causes more debate than a similar decision involving cars or iron ore. India has even more policy distortions related to the agro-sector than most nations. And among Indian agro-industries, sugar has one of the messiest profiles in terms of policy distortions. |
Sugar stocks have seen a sell off in the past month or so because the supply-demand position seems to have changed. Brazil will deliver higher than expected production and India is also set for a good harvest. Prices of sugar may thus soften and that could mean the end of a three-year sugar boom cycle. Of course, it may take several more months to play out even if this is the case. |
Does this offer an opportunity to enter sugar stocks with a long-term view as a petro-substitution play? This is how the logic goes. Cane is the major alcohol-source. |
Ethyl alcohol is an alternative fuel for automobiles "" it can replace petrol or be mixed with petrol to run in normal engines. Other bio-fuels (bagasse) can be generated from cane. |
Crude prices are slated to remain high through the foreseeable future though they are coming down off the highs triggered by the Lebanon crisis. The Indian government has major incentives to encourage crude substitution. |
This could create an alternative market and guarantee that supply overhangs will no longer pull down prices. Most sugar producers would be frontline alcohol producers in such a scenario and that would create alternative revenue streams that led to a re-rating as the demand for alcohol shot up. |
These fine thoughts have already led to high valuations for the Praj Industries of the world. The Brazilian example is often cited. The Latin American giant went in for massive crude substitution in the 1970s itself. |
Brazil's alcohol fuels are competitive with global crude prices at the $25-30/barrel range and the policy saves huge quantities of forex for Brazil. India has similar acreages under cane, and scope to considerably improve yields to pull off a similar feat. |
However, it took some 20 years of policy commitment for the Brazilian industry to mature. That included mandatory blending, tax breaks for alcohol fuel producers, breaks for cane producers, etc. India may be able to create and implement policy with somewhat greater efficiency. But it would take quite a while. |
Looking at timelines, logic suggests that the next sugar cycle is also likely to play out without ethanol making a serious difference to the sector's dynamics. |
But investments into this area will increase for sure. Any sign of a crude-substitution drive in policy could lead to a sudden surge in sugar shareprices. |