Prepared by Prudential Securities

World sugar prices have held relatively steady this year, with July futures trading above 10.50 cents per pound since mid-February. Several factors have contributed to the market's firmer tone, including: (1) progressively lower trade expectations of world 1996/1997 production; (2) initial expectations that global end-1997/1998 stocks may decline relative to the previous sugar year; (3) Cuba's failure (at least for the time being) to keep its production recovery program on track; (4) India's faltering export performance, combined with the realization that it could become a net importer; and (5) Brazil's apparently restrained export posture, despite the country's obvious capacity to boost exports sharply.

Futures weakened in early May, partly on news a large tonnage of Brazilian sugar was being tendered against the now- expired May contract, which led to much interest concerning the sugar's quality and destination. With the market apparently believing the sugar had found a home in Russia, futures found support, although upside progress was labored given steady origin selling.

We look for world sugar futures to advance to the 12.50- cent area, basis nearest futures, over the next quarter. We also anticipate that the October/March spread will remain firm, widening to about 25-30 points.

Update

Table 1 shows the annual global supply/use balance for the decade, including 1996/1997 production estimates from the USDA's May report. The USDA's latest production estimate of 122.3 million tonnes was a surprisingly large 1.7 million tonnes below the March forecast; the USDA explained the difference was due to faltering production in Cuba, India, Indonesia and Pakistan. Note that this latest estimate is about 3 million tonnes lower than last November's estimate of 125 million tonnes. Reduced production expectations have contributed to the relatively steady tone of #11 futures prices in the first five months of this year.

1--Forecast.

Source-- USDA.

The London-based trade house Czarnikow also released revised 1996/1997 global sugar statistics in May. The firm foresees world production at 122.8 million tonnes, about 500,000 less than it forecast in February. Consumption, which Czarnikow projects on a calendar-year basis, was lowered to 120.4 million tonnes from February's level of 121.0 million, diluting the potentially constructive price implications of the revised output number. Czarnikow's data point to an end-season stocks increase of about 1.6 million tonnes, compared to an increase of 4.4 million at the end of 1995/1996.

The USDA's initial forecast of world 1997/1998 sugar output is 122.4 million tonnes, virtually unchanged from the previous year; global consumption is projected at 125.0 million tonnes. These numbers indicate that end-1997/1998 stocks could fall to about 21.3 million tonnes from 23.5 million the year before. While forecasts made this early in the year obviously are subject to revision, the USDA's initial figures are potentially price-supportive.

A production breakdown for the world's 12 leading origins (accounting for about 75% of global output) is shown in Table 2. The largest producer by far is the European Union (with roughly 14% of world output), and the USDA is forecasting 1997/1998 production there to increase nominally relative to 1996/1997. India and Ukraine are two producer nations for which a production decline is foreseen. The other nine producer countries are expected to see sugar output rise in the upcoming season, with the largest increases forecast for Pakistan, the United States and Brazil

1--Ranked according to 1997/98 forecasts.

2--Forecast

Source--USDA.

1--Ranked according to 1997/98 forecasts.

2--Forecast

Source--USDA.

Table 3 shows the world's 12 leading sugar consumer markets, which account for about 65% of global intake. The table includes the USDA's initial forecasts for 1997/1998. Of the markets shown, only Russia, Pakistan and Japan are expected to see consumption drop in 1997/1998. The largest year-over-year consumption increases are forecast for India (up 500,000 tonnes), Indonesia (up 400,000 tonnes) and Brazil (up 300,000 tonnes).

Weather specialists are generally agreed that an El Nino is underway, although there is no consensus as to its likely intensity and duration. The El Nino phenomenon has the potential to adversely affect crop production in a number of countries, and thus will be of great relevance to the market as the year progresses. Here is how the El Nino may impact various major sugar origins:

–Unusually dry conditions: Australia, southern Africa, India, Indonesia, Philippines, Central America, Venezuela and Brazil.

–Above-average temperatures: Southern and eastern Africa, India, Southeast Asia, Central America, Venezuela, Brazil and Peru.

The USDA's initial forecast of the domestic 1997/1998 (October-September) supply/use profile was released in May. Production is forecast at 7.5 million tons, up 300,000 tons from the previous season's output; the entire increase is attributed to the beet sector, with cane-derived sugar production expected to remain unchanged. (It should be emphasized that the data presented in Table 4 are expressed in short tons, whereas international sugar statistics, such as those shown in Table 1, are given in metric tons.)

Domestic sugar deliveries are projected to reach 9.8 million tons in 1997/1998 versus 9.7 million in 1996/1997. Over the last 10 years, U.S. consumption has trended higher by about 160,000 tonnes annually. Although the USDA anticipates continued consumption growth for the next several years, it expects the growth rate will fall below the recent trend.

As of May 12, the USDA's calculation of the domestic stocks-to-use ratio for 1996/1997 was 15.4%. The ratio is significant in that it not only measures overall sugar availability (the lower the ratio, the tighter the supplies) but also forms the basis for changes in the USDA's import quota allocations. Thus, while the USDA, in conjunction with the U.S. Trade Representative's Office, initially set an overall import quota of 2.31 million tons (2.1 million metric tons) for the 1996/1997 fiscal year, only 1.7 million tons actually were allocated. The remaining 600,000 tons were available for allocation in 200,000-ton blocks if subsequent reviews of the U.S. supply/use situation showed the stocks/use ratio at 15.5% or less; allocations were authorized in March and May. A USDA official recently noted no further allocation was likely for 1996/1997 unless domestic consumption staged a sharp, near-term surge. The USDA will solicit public comments on whether to extend this method of managing the import quota system into the next fiscal year.

Rep. Dan Miller (R-Fla.) and Rep. Charles Schumer (D-N.Y.) have cosponsored a bill designed to phase out the U.S. sugar program, and believe a "reasonable chance" exists that their proposal will be adopted by the House of Representatives this year. (The House rejected a similar proposal by five votes during the debate of the 1996 farm bill). Under the proposal, the USDA sugar loan rate of 18 cents per pound would be lowered to 14 cents by 2002 and terminated in 2003. The bill also seeks the prompt elimination of price supports via non-recourse loans by stripping the USDA of its authority to offer such loans to processors during periods of stepped-up sugar imports.

The position of at least some U.S. sugar producers is that they would accept termination of the U.S. sugar program, including the existing import provisions, provided the United States were to convince governments of other sugar-producing countries to remove their protective trade measures, an item that could come up for discussion in the next round of global farm trade negotiations in 1999. U.S. sugar producers are far more efficient than most of their competitors, giving them a built-in advantage as long as they can face foreign competition on a level playing field.

Sugar Markets

Following the practice we have adopted in our earlier sugar quarterly surveys, we are highlighting several regional sugar markets whose supply/use statistics are expected to be especially significant in terms of their potential impact on the world sugar market over the next three to four months.

European Union

Accounting for roughly 14% of the world's sugar output, the European Union is the leading sugar origin, and any change in its production, export and import profile can be expected to have an impact on the global market. The USDA's initial forecast of 1997/1998 output is 17.4 million tonnes, little changed from the year-ago level. Following crop optimism based on favorable early sowings, forecasters have scaled back their production expectations after weather conditions that initially were overly warm and dry became too wet and cold in some areas. The area planted to beets has held steady, and the latest production forecasts are based on reduced yield data. (The European Commission recently forecast 1997/1998 yield at 7.82 tonnes per hectare, down from 8.18 tonnes for 1996/1997.)

Ending stocks for 1997/1998 are foreseen at about 1.8 million tonnes. The sharp export decline forecast for 1997/1998 will lower the region's exports to their lowest level since 1995/1996, reinforcing the European Union's overwhelming role in the quality whites market.

Russia And Ukraine

Like the entire Russian economy, the country's sugar sector faces another difficult year. Industrial inefficiency (due in part to out-of-date machinery and equipment), poorly developed transportation and distribution networks, and inadequate use of economic inputs rule out any significant upswing in sugar output for the time being. Other factors hampering output are the long-term decline in beet acreage (down roughly 27% from 1990 to 1996) and the tendency of growers to utilize marginal farm land, which tends to cause a drop in average yields.

The U.S. agricultural attache's initial forecast of 1997/1998 production is 1.9 million tonnes, versus 1.65 million in 1996/1997. Despite the increase projected for 1997/1998, the season's output would be one of the lowest Russia has seen in this decade.

World sugar prices were relatively firm in April, partly due to Russian buying that was purported to have reached 230,000 tonnes. One reason for the possible upswing in Russian buying activity was that importers were working to beat the May 15 deadline for introduction of a 25% tax on white sugar imports. Another reason was the apparent suspension of the oil-for-sugar swap with Cuba, forcing Russia to secure more sugar from other sources. Finally, firming of domestic sugar prices was making imports relatively more attractive. Over the last three years, Russian imports have averaged 3.1 million tonnes annually, and have been a major supportive factor for world sugar values. The U.S. agricultural attache is forecasting 1997/1998 imports at 3.2 million tonnes, about 5% below the year-ago level.

Virtually all of the problems and shortcomings afflicting Russia's sugar sector are found in Ukraine, for which the USDA is forecasting 1997/1998 output at 2.89 million tonnes, the country's lowest production level in this decade.

An April U.S. agricultural attache report saw no end to Ukraine's long-range beet acreage decline, which was attributed to "a lack of good quality inputs, shortage of capital and credit and unfavorable weather conditions." According to the report, Ukrainian farmers needed an average sugar beet yield of 30 tonnes per hectare to be profitable. Yields slumped to the 18-tonne level in 1996/1997, and the attache noted that even with good growing weather, yield could not be expected to rise significantly given the "lack of resources faced by the farmers."

During the Soviet era, Ukraine was the principal sugar refiner within the USSR. In order to protect its domestic sugar industry, however, Ukraine's government introduced a 50% tax on sugar imports in December 1996, thus effectively transferring much of the refining activity to Russia. Although the import tax has now been repealed, it remains to be seen whether Ukraine will be able to recapture its lead as a refiner. Ukraine's government has announced steps to protect its sugar industry via a bureaucratic scheme under which producers would have to buy quotas for sugar intended for the international and domestic markets (the overall domestic quota has been tentatively set at about 1.5 million tonnes). The government contends this will raise farmer efficiency, a view not shared by independent observers.

Cuba

Perhaps the quickest way to illustrate the severity of Cuba's sugar problems is to note that output, which was about 8.2 million tonnes in 1989/1990, slumped to 4.3 million tonnes in just three years and reached a 50-year low of 3.3 million in 1994/1995. With the aid of foreign credits there has been a slight production upswing, and the USDA's first forecast of 1997/1998 output is 4.5 million tonnes versus 4.4 million in 1996/1997. The USDA's 1996/1997 figure may be on the high side, as even President Fidel Castro has publicly stated that he did not expect the current crop to exceed the 1995/1996 level.

The recent production recovery, modest though it is, has fallen short of governmental targets, with officials blaming Hurricane Lily (which caused considerable crop damage last October) and the U.S. economic embargo. (Cuba's government contends the Helms-Burton Law has discouraged foreign financing and has hindered or delayed the import of machinery, chemical fertilizers, etc.). While acknowledging that weather and U.S. policy have hurt the island's sugar sector, foreign observers have emphasized other problems, such as managerial inefficiency, poor worker morale, and the use of outdated machinery. (Of Cuba's 156 cane mills, only eight have been constructed since the 1959 Communist revolution.) With tourism now outstripping sugar as the country's leading source of hard currency, the government may be more willing to streamline the sugar sector--for the first time since the Communist revolution, the government has threatened to permanently close the most inefficient cane mills.

As of May 15, this year's cane plantings were reported to have reached only 43% of the target figure, which officials blame on extensive drought conditions. According to official statements, plantings in the central and eastern parts of the island (accounting for roughly 65% of national sugar output) were "paralyzed" by adverse weather; plantings in the two leading sugar-producing provinces of Camaguey and Holguin were running about 63% and 61% behind schedule, respectively. Obviously, these early figures are a somewhat inauspicious beginning for the 1997/1998 season.

Brazil

Brazil is one of the world sugar market's crucial "swing" countries due to its huge production capacity and its ability to switch cane use between the sugar and industrial fuel sectors. Production has advanced sharply, and without interruption this decade, and is expected to reach a record 14.7 million tonnes in 1996/1997, up from 13.7 million in 1995/1996; the USDA has forecast yet another record of 14.8 million tonnes for 1997/1998. Consumption in the new season also is expected to set a new record at 8.8 million tonnes, up 300,000 tonnes from 1996/97.

The recent increase in production has not been matched by enlarged exports, and this has provided support for #11 futures prices. Part of the production increase has been absorbed by the domestic market, while some of the excess sugar was used to build stocks. It is also possible that some of these sugar stocks were included in the large tonnage tendered against the expired May contract, although an official of Copersucar, the country's foremost sugar group, said the entire delivery consisted of new-crop sugar.

The U.S. agricultural attache has forecast Brazil's 1997/1998 exports at 5.8 million tonnes, unchanged versus the previous season. (In April, Brazil's Ministry of Industry and Commerce set exports under the 1997/1998 national sugar plan at 5.4 million tonnes; the figure can be adjusted at the government's discretion.) In this context it is instructive to note that in recent remarks made at a sugar seminar in Mexico, a Copersucar representative emphasized that his country's annual exports were projected to average 7 million tonnes over the next decade. Most of the excess cane production, he said, would be channeled to the domestic sugar and industrial alcohol sectors. Thus, sugar exporters would, in effect, adopt an informal export limit in order not to put world sugar prices under undue pressure.

India

Of the world's leading sugar producing and exporting countries, none has seen a more drastic revision of its statistical profile recently than India. The country's sugar output reached a record 18.3 million tonnes in 1995/1996, but is widely expected to decline in 1996/1997, with the USDA early this year looking for a still strong outturn of about 17 million tonnes. The April U.S. agricultural attache report, however, slashed this estimate to 14.7 million tonnes, attributing the cut to dry weather in some key cane-growing states (e.g., Maharashtra), low cane deliveries to mills on account of payment arrears (which had also resulted in a drop in economic inputs), replacement of cane by more profitable crops and diversion of cane to alternate sweeteners such as khandsari. These problems are expected to persist for the foreseeable future, and 1997/1998 output is forecast to fall to 13.6 million tonnes, roughly 7% below the 1996/1997 level.

Although India's government has reformed various aspects of the sugar industry (such as liberalizing its export system), the sugar market continues to operate under numerous governmental constraints at both the national and state levels. The government sets an ex-factory levy price (below the free-market price), which in conjunction with high production costs effectively creates a domestic price floor. With domestic prices well above international values, exports have lagged behind expectations, amounting to only about 550,000 tonnes in 1996/1997 versus earlier forecasts of roughly 1.5 million tonnes. The current outlook is for 1997/1998 exports to fall another 10%, to 500,000 tonnes, with some trade sources suggesting that India could become a net importer by late 1998. Such a development would be a potentially long-range supportive factor for #11 futures.

The whites/raws premium has recently widened to near $77 per tonne, up from roughly $65 in mid-April. The strength is partly due to a pickup in physical buying interest, with several countries (e.g., Russia, Pakistan and North African states) reportedly making sizable whites purchases. Some of the strength in the whites/raws premium also reflects concern that adverse growing conditions in various European beet areas will reduce the continent's whites availability. July and August generally mark the seasonal low for European whites availability, suggesting the premium could remain relatively firm during the next two to three months.

There has been a fair amount of movement in #11 sugar spreads this year. In late January, July futures were trading at a discount of roughly 5 points to October; by mid-April this had become an almost 30-point premium. The firming of the nearbys reflected a shift in global production ideas, with various statistical sources scaling back their 1996/1997 world production expectations. The premium also gained on concern about the availability of tenderable sugar against the May contract, which expired April 30. The premium structure weakened in April with a shift in availability concerns, especially when it appeared that most of the tendered sugar originated in Brazil. We anticipate that holders of long July positions will be switching into the back months, and look for October to reach a premium over March of at least 25-30 points.

Conference

An international sugar conference, organized by the German commodity publishing firm F.O. Licht, was held in Mexico on April 8-10. Of the large number of discussion papers dealing with various aspects of the world sugar market, several are particularly relevant to our report. Following is a brief summary of some of the major points made at the conference:

A.C. Hannah, Chief Economist

Of The International Sugar Organization

Hannah predicted that average world raw sugar prices would trade within a range of 9.0-14.0 cents (no time frame given). It was his contention that higher prices would damage the sugar market by spurring the use of its principal competitor, fructose corn syrup. Among the major factors affecting the world market, he noted: (1) the Cuban sugar sector; (2) Chinese sugar policy; (3) Brazil's sugar-versus-industrial alcohol program; (4) developments in the Russian and Ukrainian sugar economies; (5) European Union sugar policies and reforms; and (6) GATT trade reform.

Leonela Santana-Boado, Economic Affairs Officer,

U.N. Council On Trade And Development

Santana-Boado focused on the growth in intra-Latin American sugar trade brought about by regional economic pacts and local economic reforms. Sugar trade among the Andean Pact countries had reportedly risen on average to about 427,000 tonnes annually in 1994/1995, up from 57,300 tonnes in 1988/1991. Increased sugar trade within the Mercosur group was attributed to specific factors such as reduced Brazilian inflation and Argentina's adoption of a warehouse receipt finance system.

Gilberto Llerena, An Official In Cuba's Sugar Ministry

Llerena acknowledged that future production expansion hinged on greater efficiency and the availability of economic resources. With roughly 90% of Cuba's sugar sold on the free market, the speaker had no illusions about the need to rationalize production costs if Cuba were to compete effectively on the world market. A particular difficulty facing the Cuban sugar sector is its limited access to hard currency, with recent overseas financing for part of the 1996/1997 crop considered an important achievement by the Castro regime.

Peter Hume, Director, Comfin

Hume focused on the growing role of low-quality white sugar in international trade, with exports in this category projected at 1.43 million tonnes in 1997 (800,000 tonnes from Brazil) versus 480,000 tonnes in 1990. The trend was attributed to the enhanced role of private importers, who were more willing to purchase lower- quality sugar to maximize profits.

One aspect of this development was that more internationally traded sugar was becoming non- tenderable against futures, thus weakening the economic links between cash and futures sugar prices. (In this context, we note that the Paris-based MATIF exchange will begin trading a new white sugar contract having an icumsa value of 100 on June 20, which it hopes will attract Latin American business. The existing whites contract at MATIF, whose revised specification is a 45 icumsa rating, is geared toward the European market.)

We look for #11 prices to appreciate over the next three to four months, with nearest futures advancing to the 12.50-cent area. Initial forecasts of the global 1997/1998 statistical supply/use balance indicated stocks may fall (or at least remain little changed) versus 1996/1997, which is potentially price-supportive. Among the specific factors that are potentially price-strengthening are: (1) the apparent derailment of Cuba's production recovery effort; (2) expectations that India's output may decline for the next two seasons, with that country possibly becoming a net importer; (3) initial projections that Brazil's 1997/1998 exports will hold steady at the year-ago level; (4) the possibility that this year's El Nino may hurt output in several producer countries; and (5) initial expectations, based on a U.S. agricultural attache report, that China's 1997/1998 imports could come in at about 1.5 million tonnes, up from roughly 750,000 tonnes in 1996/1997.

June 3, 1997Arthur Stevenson

Prudential Securities

1 New York Plaza, New York, New York

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