Sugar Games: A Behind-the-Scenes Look at a High-Stakes Investing Gamble

By David Brough

LONDON -- A handful of the world's biggest merchants play a tense, high stakes game every few weeks and a well-connected newcomer from Asia just sat down at the table.

The stakes are in sugar often worth hundreds of millions of dollars; the occasion is the expiry of futures contracts.

Five leading American and European trade houses -- Cargill, Louis Dreyfus, ED&F Man, Sucden, and Bunge -- have typically jockeyed for the best position ahead of the delivery and receipt of sugar when futures contracts expire, which happens nine times a year.

At the latest raw sugar futures expiry last week, the exclusive club was joined by Singapore-based Wilmar International Ltd., sole receiver of 152,762 tonnes of Central American and Brazilian sugars worth around $61 million.

The expiries are risky because a bet that leaves a player holding large amounts of physical sugar can reap huge rewards when supplies are tight and prices are rising, but a trade house can face eye-watering losses if the harvest's outlook improves or demand is dented at the last moment.

Wilmar is taking delivery through a sugar futures expiry for the first time since entering the market three years ago.

Need to Move Fast

This delivery is barely more than a quarter of the size of the previous raw sugar expiry, for the October 2012 contract, which saw Bunge receive almost 600,000 tonnes, valued at roughly $240 million.

Analyst Jonathan Kingsman said Wilmar will have to be nimble to sell the Brazilian sugar that it acquired through the expiry ahead of the country's coming crop, which starts around April and is expected to be abundant -- potentially weighing on prices.

"People [traders] were wary of taking delivery of Brazilian sugar with a big new Brazilian crop expected to start early -- you would have to move quickly to get it out if values come down," said Kingsman, head of agriculture at data and information provider Platts.

Much futures business is done by financial investors who trade promises involving sugar but close out the bets before they risk taking actual delivery of the raw sugar traded on InterContinental Exchange (ICE) or white sugar from NYSE Liffe.

As the expiry draws closer for a contract such as the ICE current front month futures, only those players with a real interest in the physical commodity remain.

Trade sources said Wilmar fits the bill, with strong business ties in Central America, and would have no difficulty finding customers for Central American sugars within that region or in big importers China or Indonesia.

Cargill Setback

U.S. agribusiness Cargill was often in the past a major receiver of sugar but has been keeping a lower profile after an aggressive bullish bet misfired.

In January last year Cargill reported its worst quarterly earnings since 2001 and noted that "our performance in the sugar market was poor."

A month earlier the company had replaced its head of sugar, Jonathan Drake.

Cargill took delivery of almost one million tonnes of sugar at the expiry of the March 2011 raw sugar contract on ICE just days after the market had risen to a 30-year high of 36.08 cents per lb on concerns about tight global supplies.

The worries over scarcity proved unfounded, however, and the price had fallen by more than one-third by the end of the year.

A Cargill spokesperson said that while 2011 was a tough year, this was not all down to aggressive trading strategies.

"Cargill's sugar business has undergone a number of changes and we made a significant turnaround in 2012," the Cargill spokesperson said.

Provided the parties play by the rules, regulators leave them to it and sit on the sidelines.

"As long as people stick with the guidelines -- and there are no exceptional delays in sugar deliveries -- no one gets concerned," a senior London broker said.

Deliverer Can Make Life Tough

Adding to the fraught nature of expiries, buyers face various dangers and sellers have money making opportunities.

The 'long' [receiver of sugar] holds the cards," one senior trade source said. "But the deliverers have options to make money from the receiver."

The trade house receiving the sugar will try to line up customers and will have built futures strategies against its physical trading book. But these strategies are complicated by uncertainty over where the sugar will be delivered.

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On Liffe's white sugar contract, the company delivering can nominate several ports at which to provide sugar, as long as they comply with a minimum delivery per port of 80 lots, or 4,000 tonnes.

The receiver is obliged to collect all the sugar from ports nominated by the deliverer, within the set time frame allowed.

Sometimes the deliverer has nominated several ports knowing that it would not make financial sense for the receiver to charter vessels to load at each nominated port.

In these cases, the delivery can be settled privately with the receiver agreeing to pay to cancel or "wash out" the contract.

"The deliverer likes to make life difficult for the receiver," said one senior European sugar broker, who asked not to be identified.

"It's a game of poker."

Photo Credit: Prashanth Vishwanathan/Bloomberg via Getty Images