The Mexican and U.S. sugar markets are going through a structural change as a result of a new trade agreement between the two countries. The agreement suspends the antidumping (AD) and countervailing (CVD) duties imposed on Mexican sugar exports to the U.S. in 2014.
This deal shifts the U.S. and Mexican sugar markets from free trade to regulated trade, as provisions in the North American Free Trade Agreement (NAFTA) have been deferred. Currently, Mexican exports to the U.S. are limited through quotas and minimum prices. There are processes in place regulating how Mexican exports to the U.S. must flow.
In analyzing the mechanics of the U.S. and Mexico sugar market—and quantifying the implications of the new trade agreement moving forward—we found that the agreement brings more stability to the U.S. market through its supply side, while the U.S. sugar policy recovers its muscle. On the other hand, we believe that Mexican producers can operate successfully under the agreement, as long as they adjust their strategy. Traders and U.S. refiners (non-vertically integrated) will have a challenging road ahead.
Understanding the U.S. and Mexican Sugar Sector
The U.S. and Mexican sugar markets are very unique. Although they rank among the top 10 largest sugar producers and consumers in the world, they operate differently than most major markets. The free trade policies of these two countries do not apply to sugar. Both markets are highly driven by policy that ultimately supports domestic prices above global prices (see Figure 1).
Historically, sugar has been an important and powerful industry and a major part of the economy for both the U.S. and Mexico. Today, the relevance of the sector remains unquestionable. The U.S. is the sixth-largest sugar producer in the world. It generates an economic impact of over $21 billion per year and creates around 150,000 jobs. Mexico is the seventh-largest global sugar producer. It is the largest exporter of standard sugar and the fifth-largest exporter of refined sugar.
Policies Support Sugar Prices
The U.S. policy’s main objective is to support sugar prices by influencing the amount of sugar available in the market, while at the same time avoiding costs to the federal government.
In order to achieve that, the 2014 farm bill established different programs and tools. For example, the USDA provides nonrecourse loans to sugar producers. That is, when those loans mature, the USDA may accept sugar pledged as collateral as payment if prices drop below the established loan rates (forfeiture levels). In the end, if market fundamentals and the tools don’t work to keep prices above forfeiture levels, the USDA can trigger the Feedstock Flexible Program (FFP). That program diverts sugar from human consumption to ethanol production.
In Mexico, the goal of the domestic policy is to support cane growers’ income without direct payments from the government. In order to do that, the policy links cane prices to a reference sugar price set in the Cane Law. That price is determined at the beginning of each cycle, following negotiations between the Mexican government, industry and the cane farmers. The reference price at that time is an estimation of the prices that the mills will receive in the domestic and export markets during the current cycle. At the end of the cycle, the reference price is adjusted, depending on the prices received by the mills. Cane prices are calculated as 57 percent of the reference sugar prices plus/minus some other quality premiums/discounts.
When the campaign begins in October, cane growers get a down-payment of 80 percent for the value of the expected crop that will be delivered to the mill, using the estimated reference price. At the end of the campaign, the pending payment is adjusted to the final reference price.
Before and after NAFTA
In 1994, NAFTA was implemented in the U.S., Canada, and Mexico. However, sugar was one of the exceptions. It was not until 2008 that the free trade of sugar between the U.S. and Mexico was fully in place.
Interestingly, Canada was excluded from the deal, as its sugar sector is fundamentally different from those in the U.S. and Mexico. Canada is highly import-dependent and is a much less protected market than the U.S. and Mexico. Not surprisingly, NAFTA created a structural change in the structure of the Mexican and U.S. sugar markets.
Before NAFTA, the Mexican sugar sector operated in a closed market. Imports were restricted, and were only allowed and allocated when the market ran into a shortage. Exports were low and sporadic, as Mexican prices were higher than those of most markets abroad. Back then, production was intended to fulfill domestic consumption and avoid surpluses that could exert downward pressure on domestic sugar prices.
With NAFTA in place, Mexico went through a structural change. It modified its production and export platform as it gained full and unrestricted access to the U.S. Market conditions allowed Mexican producers to increase scale through rising production and diminishing average production costs. The challenge for Mexico was to maximize revenues, as U.S. prices have traditionally been lower than Mexican prices. As long as Mexico cleared its domestic market, local prices could be sustained at levels high enough to compensate for the lower prices received from exports to the U.S.
As expected, Mexico’s exports to the U.S. began to grow sharply. From 2006/07 to 2008/09, exports rose, from 54,000 metric tons to over 1.2 million metric tons, reaching over 2 million metric tons in 2012/13. In addition, the cane area planted increased. Mills began to buy and lease land (on top of the land owned by independent farmers) to improve their cane procurement and scale. By 2012/13, sugar production reached almost 7 million metric tons, while the next two cycles posted an average production of 6 million metric tons. Clearly, those volumes were higher than the average production of 5 million metric tons prior to NAFTA
(see Figure 2).
NAFTA also changed the structure of the U.S. sugar market. Before NAFTA, from 2000/01 to 2006/07, U.S. total imports averaged 1.8 million metric tons. Then, from 2007/08 to 2014/15, imports were around 3.1 million metric tons a year. That—in combination with an increase in domestic production during the 2011/12 and 2012/13 cycles—meant supplies rose sharply (see Figure 2). As U.S. supplies increased, the effectiveness of U.S. policy diminished. During the second quarter of 2013, domestic prices began to approach forfeiture levels.
Another relevant shift came after NAFTA, as high fructose corn syrup (HFCS) became more important in the U.S. and Mexican sweetener markets. In mid-2006, Mexico lost a decade-long bilateral trade dispute to constrain the use and import of non-sugar sweeteners, particularly HFCS. As a result, Mexican imports of HFCS from the U.S. rose sharply. Between 2000 and 2006, imports averaged 124,000 metric tons and reached a peak of 1.2 million metric tons in 2011/12. The penetration of HFCS grew rapidly in sugary soft drinks, displacing domestic sugar consumption (see Figure 3).
In Mexico, the use of HFCS has matured, as one of its main drivers—carbonated soft drinks—struggles to grow. Obesity and health awareness have become a major concern, and consumers are looking for more “natural” ingredients, such as cane sugar and alternatives with fewer calories, including teas and bottled water—a similar pattern to that seen in the U.S. (see Figure 3). However, HFCS remains an important component in the U.S. and Mexican sweetener markets, due to its price competitiveness and ease of use.
The Dispute
Despite the U.S. policies in place, U.S. sugar prices dropped below the forfeiture threshold in mid-2013, driven by large sugar supplies. That year, ideal weather boosted U.S. sugar production, while imports from Mexico rose sharply.
On March 28, 2014, the American Sugar Alliance, a U.S. sugar industry group, filed a petition with the International Trade Commission and the U.S. Department of Commerce, requesting the imposition of countervailing duties (CVDs) and anti-dumping duties (AD) on sugar imports from Mexico.
Subsequently, on August 26, 2014, the DoC pronounced its affirmative preliminary determination in the CVD duty of Mexican sugar imports. On Oct. 27, 2014, the DoC announced its affirmative preliminary verdict in the AD duty investigation of imports of sugar from Mexico.
The final AD rates were set between 40.48 percent and 42.12 percent, with CVD rates between 5.78 percent and 43.93 percent, depending on the exporter. Clearly, those duties would have reduced Mexican exports to the U.S. However, the U.S. and Mexico reached a trade deal that suspends those duties regardless of the positive final determination by U.S. trade officials back in October.
The Deal
The deal, signed in late 2014, is supported by two suspension agreements: the CVD and the AD suspension agreement. Both agreements seek to find a better balance in the U.S. sugar market by preventing stocks from increasing as a result of Mexican exports. The objective is to prevent prices dropping below forfeiture levels again. In addition, if that is achieved, the threat to the effectiveness of U.S. sugar domestic policy will have been neutralized.
The first agreement has the objective to regulate U.S. stocks, forcing stocks-to-use at 13.5 percent. In the agreement, Mexican exports are limited in volume and timing throughout the year. In addition, the agreement limits sugar imports during certain times of the year and restricts the amount of refined sugar imports (up to 53 percent of total sugar exports).
The second agreement establishes a minimum price, which is designed to avoid U.S. prices falling below forfeiture levels. This also discourages imports from Mexico when U.S. domestic prices are low.
The export limit quota will be calculated based on the total U.S. “sugar needs.” The limit will be set at the beginning of the cycle, and it will be revised several times throughout each marketing year. The export limit is based on the information provided in the World Agriculture Supply and Demand Estimates (WASDE) reports produced by the USDA.
Floor prices established on the AD suspension agreement are set at USc 22.25/lb and USc 26/lb for raw and refined, respectively. Both of those prices, including shipping costs, are far above the loan rates set in the U.S. sugar program.
Implications of the Deal
The new deal has various implications for the market and the industry. In order to capture the market impact, supply-and-demand prospects for Mexico and the U.S. were estimated to 2020, using the mechanics and provisions in the new agreement. Those estimates were then compared to projections as if NAFTA were Mexico’s sugar use is expected to grow, from 4.3 million metric tons in 2014/15 to 4.6 million metric tons by the end of the period.
If the U.S. stocks-to-use ratio stays at around 13.5 percent, U.S. cane and beet sugar prices are anticipated to be at around USc 25/lb and over USc 30/lb, respectively. If—and only if—Mexican production remains close to 6 million metric tons, the Mexican wholesale price can be sustained over MXN 420/bag.
Given those prices and the expectation of an average exchange rate of MXN 17.1/USD, Mexican export prices will be above the minimum prices set in the agreement. In addition, Mexican export prices will be competitive enough in the U.S. market.
Under the current deal, U.S. sugar prices, along with prices and margins for refiners, are higher than in the NAFTA scenario, due to lower exports and stocks. However, for the Mexican industry, margins will be positive, as long as they are able to manage low and stable domestic supplies and costs. Mexican prices can drop below our average expectation if domestic supplies increase. If some mills seek to increase revenue through volume, domestic prices will decline, along with margins.
As a result, the strategy for Mexican mills has to change in order to secure and increase profitability in the years to come. One possible solution is to increase market share through horizontal acquisitions, while improving efficiency in each mill. In addition, value creation through the development of new products (i.e. branding at retail) is imperative. That can even lead to Mexican companies conquering other markets abroad.
However, not everything will be sweet for the U.S. sugar sector. It will have some negative impact on some players. For example, the mechanics of the deal do not only limit sugar imports from Mexico, but also restrict trade from non-producers (i.e. traders). As a result, traders who used to export Mexican sugar to the U.S. will have a difficult time sourcing sugar from Mexican mills. This will get even more challenging when minimum prices are close to, or below, prices in the U.S. Logistically, it may make sense for some U.S. traders to partner with Mexican mills.
Conclusion
The sugar markets in the U.S. and Mexico will remain highly driven by domestic policy. They will continue to be more inward-looking than countries less insulated from the world market. The new trade deal means that U.S. policy is better equipped to keep prices above forfeiture levels.
What’s more, we believe sugar stocks in the U.S. will be more balanced in the years to come, and prices in the U.S. will be relatively higher and more stable than those experienced in the market in 2013. A similar scenario will occur in Mexico, as long as production remains near 6 million metric tons.
Meanwhile, the Mexican industry has lost its ability to increase profitability through economies of scale, but growth will come through increasing market share. In the years to come, it is likely that we will see a concentration in the industry.