Lessons for the future: The myth of no relation between the world free market sugar price and its co
Guyana and the wider world
By Dr. Clive Thomas
Stabroek News
July 18, 2004
Several features of the world sugar market were highlighted last week as I continued to assess the future of the industry in Guyana and the wider Caricom region. Among the features stressed were the volatility of the world free market price for sugar; its long-run downward trend; the wide range of existing competitors to sugar in the broader sweetener market; and, the huge volume of by-products generated from sugar production. In regard to the last observation, I take the opportunity to correct a typo from last week, which a kind reader has drawn to my attention. It requires 10-14 metric tonnes of the sugar cane plant (not lbs as the article indicated) to produce one metric tonne of sugar.
Arising from all these observations perhaps the central feature of the world market is its "residual" nature. By this is meant that a small proportion of global sugar production is exported and a smaller proportion exported for sale outside of the framework of some special trading arrangement directly onto the world free market for sugar.
Myth and unsubstantiated assertions
This occurrence has led to a number of unsubstantiated, but authoritative-sounding statements about the so-called unrelatedness of the world free market price for sugar to its cost of production anywhere. I had in fact addressed this issue two years ago almost to the date in this series, when I carried a number of articles on sugar, but it still keeps being reported in public discussion locally and some parts of the region as if this were undisputed fact. I believe that one of the reasons why persons hold this view is that it seems counter-intuitive that a market so segmented because of highly protected and administered production arrangements could have any significant relation or correlation with the cost of producing the product. In a normal market there will certainly be a relationship between price and cost of production, but to many in a "residual" market this outcome is inconceivable.
The question however, is whether this is true or not. Is it supported by factual data or is it a reproduced myth? In a number of academic articles dealing with sugar I have made the point that there is a way to test the validity of this claim. That is, to compare prices in the world free sugar market with average costs over time for a number of producers around the world. The issue is that access to such cost data is available only to a very few agencies and firms. One of these is LMC International Ltd, the specialist sugar advisory firm. Its credentials are strong. In the Caricom region it has been able, through its work for governments, sugar companies, and agencies like the World Bank, to have greater access to, and information about, production costs in the regional sugar industry than any other body, whether it be government, universities or private firms. Its impact on policy assessment and choice is equally formidable. Over the past few years it has been the leading consultancy /research firm in designing the future of Guyana's sugar industry. Of greatest significance the firm has a similar track record in every sugar-producing region worldwide.
Cost of production and the free market price
I mention all this in order to indicate that its claims cannot be summarily dismissed. Undoubtedly it has unique access to cost of production data for sugar worldwide. Based on regular cost surveys, which the firm has undertaken around the world for both sugar and the second leading sweetener high fructose corn syrup (HFCS), going as far back as the 1970s, the firm has plotted these costs alongside that of the world raw sugar price adjusted for inflation. It found that sugar costs pattern the long run trend of real sugar prices in the world market. The relationship is striking. As I have stated elsewhere, LMC International consequently postulates that despite the highly segmented nature of the world sugar market and the strong influence of non-market factors on price "the long run trend in world free market prices represents a fairly accurate guide to the long run cost of production required for a sugar industry (beet or cane) to be competitive".
Until statistical data on costs prove otherwise, it would be playing ostrich to ignore this finding and its brutal implications for us. Why brutal? The reality is that in 1999 the nominal world sugar price fell to 3.93 cents per lb. Three years later in mid 2002, as we saw last week, it fell below 5 cents per lb. While it is true that as far back as 1985 it had also fallen to 4.2 cents per lb. However, if that price were adjusted for inflation (base year 1990) it would be the equivalent of 7.2 cents per lb.
This sort of analysis can be taken one step further by taking a closer look at the price data in the residual world free market for sugar. Statistical and econometric analysis of sugar prices usually adjust the nominal market price to take into account inflation (that is, the rise in the general level of all prices) and the behaviour of the exchange rate in which sugar is priced - the US dollar. The latter is important, since if for example other exchange rates are appreciating or rising relative to the US dollar, the amount earned from a dollar of sugar sales would result in fewer purchases in other currencies. Thus in the example I gave above when the 1985 price of 4.2 cents per lb of sugar was adjusted for inflation, based on 1990 prices, its value became 7.2 cents per lb. But if it were adjusted for both inflation and the behaviour of the US currency relative to others it would become 9.1 cents per lb.
Other considerations
From Guyana and Caricom's standpoint therefore changes in the US dollar relative to other currencies is a major consideration when assessing the significance of the world free market price for sugar. By parity of reasoning we can also state that movement of domestic currencies relative to the US currency will similarly play a major role, as this determines the amount of domestic income generated from sugar sales to this market. The sequence of course does not end here, but we shall have to return to this issue later after I commence the assessment of the local circumstances of the Guyana and CARICOM sugar industry next week.
Using sugar prices that have been adjusted for both inflation and exchange rate changes, analyses have shown that the combined effect of three variables explains the behaviour of the price of sugar on the world free market. One is the ratio of stocks to consumption. Another is the rate of interest, which affects the cost of financing for the industry. And, the third is world oil prices. LMC International has a model that combines all three variables. When combined they explain 75 percent of the movement of sugar prices.
There is a saying among sugar people that "world production closely tracks world consumption". This appears to have validity empirically. It however flags the concern that the rate of global growth of sugar demand has been secularly declining. In the 1950s it was about five percent per annum. In the 1960s, it was about four percent per annum. In recent times it has been fewer than two percent per annum.
Readers need to bear these factors in mind for next week, when I use them as building blocks in the evaluation of the future of Guyana and Caricom's sugar industry.