Sugar costs more; latest catalyst is ethanol push

Thursday, February 09, 2006

By Patrick Barta, The Wall Street Journal


BANGKOK, Thailand -- Call it a different kind of sugar high.

Many people think of sugar as little more than an ingredient in foods like pies and candy bars. But hedge funds and other investors are betting that more sugar will soon be needed for another reason: to produce ethanol.

That is the increasingly popular fuel substitute that can be mixed with gasoline to power cars. As oil prices go higher, traders believe, demand for ethanol -- and sugar -- could soar.

Sugar futures prices are at their loftiest levels in a quarter century. After trading below 10 cents a pound for much of the past decade, sugar-futures prices have risen on the New York Board of Trade, zooming past 19 cents a pound earlier this month. Wednesday, they settled at 18.80 cents.

"Everybody and his mother is buying white sugar right now," says Michael Overlander, managing director of Sucden U.K., a London commodity broker.

In his State of the Union speech, President Bush called for more ethanol investment to help reduce oil imports from the Middle East, though his plan focused primarily on using agricultural waste (such as plant stalks and wheat straw) in the production process, rather than commodities such as sugar or corn.

The market's sugar high raises a dilemma that could apply to other commodities such as corn and palm oil -- even tapioca, a root starch perhaps more familiar to pudding lovers. All of these can be used to produce ethanol or other alternative fuels, such as biodiesel (a fuel made from vegetable-oil derivatives). Farmers world-wide are rushing to increase production in anticipation of a bigger global appetite for such alternative fuels.

In one major global market, sugar's role as a foodstuff plays second fiddle to ethanol production.

Brazil, the largest sugar exporter and the world leader in ethanol production, is diverting about 52 percent of its sugar-cane crop to ethanol, up from about 48 percent in 2003, according to the International Sugar Organization. Sugar cane "has slowly moved from being a food crop to being an energy crop," says Pichai Kanivichaporn, director of Thai Sugar Millers Corp., a sugar producer in Thailand, another country that ranks among the world's top exporters.

Big sugar users are getting caught in the crossfire. In a conference call last month, Hershey Co. said it anticipates "substantial input cost increases" in 2006, and shares in the Hershey, Pa., company, which sells Hershey's Kisses and Kit Kat candy bars, fell by more than 3 percent. General Mills Inc., of Minneapolis, whose brands include Haagen Dazs ice cream, said it expects costs for agricultural commodities, including sugar, to be some $25 million higher than originally expected in its fiscal year ending May 31.

Since the market for ethanol is somewhat untested, it is tough to know how long-lasting the demand will be, especially if oil prices level off. During the past year, oil prices have risen about 40 percent.

As sugar and ethanol-producing capacity come online, there is a sense that we are seeing a sugar "bubble," says Leonardo Bichara Rocha, an economist at the International Sugar Organization in London, an organization of sugar-producing states. Some price increases have been justified, since demand has been growing faster than supply this year. However, "I don't think (sugar) prices at this level ... are justified" in the long run, Mr. Rocha says. That is partly because overall production this year has been lower than usual in some countries, partly due to bad weather. If that bounces back, prices could be pushed back into balance, he says.

Ethanol is an alcohol that can be derived from a variety of commodities, including corn, cane sugar and sugar beets. When mixed with gasoline, it produces a fuel that is relatively more clean-burning. (Biodiesel is made from vegetable oils such as processed palm oil.)

Despite the allure of ethanol to cut reliance on oil, it still makes up only a tiny part of the world's energy picture. Last year, about 3 percent of U.S. gasoline was made from ethanol, according to F.O. Licht, a commodity-analysis firm in Ratzeburg, Germany. But consumption is rising rapidly. In 2005, the world made about 36 billion liters of ethanol fuel, an increase of nearly 20 percent from the year before.

Ethanol isn't the only reason sugar prices have climbed. Dry weather in Brazil and Thailand hurt production for two of the world's top exporters. And last year's hurricanes ruined some of the U.S. crop, primarily in the Southeast.

Some analysts think those and other factors can only justify sugar prices in the range of 12 to 13 cents a pound. Much of the remaining demand, analysts say, is coming from hedge funds and other speculative investors who made lots of money on oil and other raw materials in 2004 and 2005 and believe ethanol is going to make sugar the next hot commodity.

The world's four biggest sugar exporters -- Brazil, the European Union, Australia and Thailand -- have plans to increase production of ethanol and other alternative fuels during the next several years.

Although sugar is one of the world's most important agricultural crops, its price has languished in recent years, in part because of soaring production in places like Brazil. Prices dropped below six cents a pound as recently as 2003.

Another reason to be bullish, some traders say, is that sugar prices are a far cry from the early 1980s, when they soared as high as 45 cents a pound, according to Informa Economics Inc., a Memphis, Tenn., commodity-research firm. Although Informa's analysts believe the "fundamental" price of sugar is lower than current levels, they say speculative buying could drive market prices higher.

Yet many energy-market analysts remain skeptical about the long-term demand for ethanol. If they are right -- and ethanol fails to live up to the most bullish expectations -- the sharp rise in sugar prices could reverse, burning some of the hedge funds entering the market.

Most countries lack the basic infrastructure to use ethanol. Even at today's high oil prices, the finished product often requires big government subsidies to compete with more traditional fuels. As sugar prices rise, some producers might decide to divert their sugar cane back to making sugar instead of ethanol -- a move that could bring sugar prices back down.

It is also unclear whether sugar will necessarily be the most important source for ethanol in all the countries with large sugar industries.

In Thailand, the world's fourth-largest sugar exporter, government officials aim to replace some types of regular gasoline with ethanol-based blends by 2007. Local sugar-industry leaders are calling on farmers to increase cane production to about 80 million tons or more a year by the end of the decade from about 45 million tons or less in the most recent, drought-impaired season.

"I think the sugar price will keep rising," says Chaiwat Kamkeankoon, a sugar-cane farmer in the town of Nampong in northeast Thailand, several hours north of Bangkok. "As long as the oil price in the world keeps increasing, the demand for an alternative fuel like ethanol will also be higher."

But many of the new ethanol plants envisioned in Thailand are designed to run on tapioca, not sugar. And only a few have progressed beyond the planning stages.

The economics of the industry aren't settled yet, either. A plant in the central Thai city of Khon Kaen, for instance, is still unprofitable, say its owners, Khon Kaen Sugar Industry Public Co. The company decided to build the plant two years ago at a cost of $15 million because it saw a rising need for ethanol. Demand has indeed surged. But the oil and gas companies that buy ethanol in Thailand aren't paying a high enough price to make it a profitable business, says Pornsin Thaemsirichai, a vice president at Khon Kaen Sugar.

At times, he says, "we've been wondering, why are we doing this?" But he is optimistic the investment will work out in the long run. "The world is crying for ethanol," he says.




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(Lisa Yuriko Thomas contributed to this article.)