Prepared by Prudential Securities, Inc.

World sugar price action has been choppy over the last three months, but the overall trend has been upward, with March #11 futures advancing to new contract highs of 12.55 cents per pound on December 1. The strength was due to large-scale physical buying (especially by Russia) and expectations of a sizable global stocks drawdown in 1997/98. The spreads also firmed, with March/October widening to a premium of about 65 points from a discount in late September. However, the whites/raws differential has come under sharp downside pressure, reflecting the different supply/use profiles of these two markets.

Three major statistical sources have recently released global 1997/98 forecasts. Although their research methodologies differ, these sources agree that world sugar stocks will decline in 1997/98 relative to the previous season. The International Sugar Organization (ISO) expects stocks to decline 2.8 million tonnes while Czarnikow looks for a loss of 1.9 million tonnes and F.O. Licht foresees a 2.5-million-tonne drop.

We view these forecasts as being moderately price-constructive over the long term. However, the potential price impact of the projected global stocks decline may not be as strong as suggested by these predictions due to developments in India. The country accounts for much of the anticipated global stocks decline, but its sufficiently large domestic stock level may preclude the massive imports apparently expected by some market observers.

Thailand's 1997/98 cane harvest has been a major casualty of El Nino-induced weather anomalies, with sizable crop losses translating into an important price-supportive factor for #11 futures. The possibility of further El Nino-related cane damage in various origins will remain a potentially bullish market factor for several months. The major producer nations most vulnerable to cane damage include Brazil, Cuba, Philippines and South Africa.

China's 1997/98 supply/use profile represents one of the season's major disappointments for market bulls. China's well-supplied situation indicates the country will have relatively little need for imports beyond its long-term contractual arrangements with Cuba. The weak whites/raws differential also indicates that China may have little interest in buying raw sugar for tolling purposes.

The currency crash seen in several Asian countries this year can be regarded as a potentially negative market factor because currency depreciation places an additional financial burden on importers of international commodities.

Total open interest currently exceeds 200,000 lots, with the March contract accounting for more than 110,000. These large numbers constitute a warning flag for market bulls because they indicate futures may be vulnerable to substantial long liquidation pressure.

According to the USDA, global sugar ending stocks for the 1997/98 season are projected to decline steeply versus the previous year, to 21.3 million tonnes from 24.8 million. Since peaking this decade at 25.4 million tonnes in 1995/96, the trend in ending stocks has been down. We view the upcoming season's anticipated decline as a price- supportive factor for #11 sugar futures.

The USDA's forecast was released in June, before there was much information available about likely El Nino-induced crop damage. Still, several other sources have issued statistical forecasts for 1997/98 since then, and have essentially confirmed the USDA's earlier conclusion.

International Sugar Organization (ISO)

The ISO's first statistical forecast of 1997/98 (October/September) global sugar data was issued in early October. Production was forecast at 122.9 million tonnes (down 0.5% from year-ago output) while consumption was estimated at 124.6 million tonnes (up 2.1% versus 1996/97); end-1997/98 stocks were expected to decline by 2.8 million tonnes. The bullish implication of this stocks drawdown, however, is diluted because India accounts for virtually the entire decline. With India's 1997/98 import requirements estimated near 800,000 tonnes, and with global net export availability projected to increase by more than 1 million tonnes, it is possible that India's new statistical situation will exert relatively little price-making influence on the world sugar market.

Global 1997/98 output was expected to rise a modest 0.64 million tonnes versus a year ago. The largest production increases were foreseen for the European Union (950,000 tonnes), Pakistan (600,000 tonnes), the United States (375,000 tonnes), Mexico (350,000 tonnes) and Turkey (245,000 tonnes). Major production declines were projected for India (almost 3 million tonnes) and Thailand (1.2 million tonnes).

The ISO's forecast of 1997/98 sugar consumption is 124.6 million tonnes, or 2.1% above 1996/97 consumption. While this falls short of the annual growth rates seen in each of the two previous seasons, it appears as though a stronger growth rate (relative to the pre-1994/95 level) is underway. Interestingly, consumption is expected to pick up in 1997/98 for both importer and exporter markets as well as for all the economic categories within each of these markets. A potential cloud on the horizon is that the consumption growth rates for low- and lower-middle income importer nations, which account for about 40% of world sugar intake, are expected to fall.

Czarnikow

Czarnikow's November report projected global 1997/98 sugar output at 122.8 million tonnes, down 450,000 tonnes from the August forecast and roughly 300,000 tonnes below production in 1996/97. Consumption, which the firm forecasts on a calendar-year basis, was pegged at 124.0 million tonnes, up from 121.9 million the previous year. Allowing for a statistical "unrecorded disappearance" of 750,000 tonnes, the stock drawdown in the current season was projected at 1.9 million tonnes.

A major point of emphasis in the Czarnikow report was the divergence between the two halves of Europe. The European Union (the foremost exporter of whites) was expected to boost output in 1997/98 by an impressive 1 million tonnes. Meanwhile, while the states comprising the former Soviet Union, with their troubled sugar economies, seemed set to experience just the opposite–a production decline of about 1 million tonnes.

F.O. Licht

Licht's first forecast of the global 1997/98 (September/August) sugar balance was issued in November. Production was pegged at 122.7 million tonnes versus 123.9 million in 1996/97 with consumption at 124.2 million, up from 121.5 million the previous year. Stocks are expected to fall to 44.7 million tonnes by end-1997/98 from an all-time high of 47.2 million the previous season.

Although the world's importer nations are not expected to see production rise in 1997/98, Licht concluded that this does not automatically translate into stronger import demand (which would be potentially bullish for #11 futures) because global statistics are skewed by the special case of India. Also, the firm noted that production and stocks were rising in exporter nations, and that this trend seemed set to extend through 1997/98. A stocks buildup in exporter nations could imply sluggish import demand, which would be interpreted as potentially price-negative by international sugar traders.

Like the ISO, Licht has commented on the pick up in the world consumption growth rate since 1994/95. This emerging trend has been attributed to the following factors: (1) improved sugar availability; (2) the apparent end to Eastern Europe's consumption decline; (3) improved Brazilian consumption growth and (4) the inability of sugar substitutes to widen their market share of the U.S. sweetener market.

The most significant year-over-year change in the U.S. 1997/98 sugar profile is in the production category, which is projected to increase roughly 500,000 tonnes. The USDA's November forecast raised production by 100,000 tons versus the previous month's estimate. The lion's share of the annual growth comes from the beet sector, and is due largely to an increase in area harvested. Growth in cane sugar is due mostly to Louisiana, which has expanded cane acreage and improved sugar yields.

U.S. domestic sugar deliveries, a measure of consumption, are forecast to reach 9.9 million tons in 1997/98, or about 1.5% above the year-ago level. This is slightly above the five-year average annual growth rate of 1.4%, but well below the 10-year average annual growth rate of 1.9%.

The USDA's forecast of the 1997/98 U.S. supply/use profile yields a stocks/use ratio of 14.6%. The ratio serves as a convenient statistical index of sugar availability (a declining ratio signifies tightening supplies) and is used by the USDA to regulate the volume of sugar imports authorized to enter the United States during the fiscal year. The USDA has retained an administrative device similar to that used in 1996/97, under which the initial import projection can be enhanced by as many as three tranches of 200,000 tonnes each. Tranche releases are triggered automatically in January, March and May if the most current stocks/use ratio is 15.5% or less. Tranches are canceled if the ratio is above 15.5%.

Forty sugar exporting countries enjoy access to the U.S. market under the import tariff- rate quota system (TRQ) for 1997/98. The three largest quota holders are Brazil, Dominican Republic and Philippines, whose imports are regulated on a quarterly basis (with no more than 25% of their overall allocation permitted to enter the United States in any quarter). The next group of exporters (Argentina, Australia, Colombia, El Salvador, Guatemala, Nicaragua, Panama, Peru and South Africa) operates under a semi-annual system that limits shipments to half of a country's quota allotment during the first half of the year. The remaining exporting nations are free to set their own shipping patterns.

The U.S. and Mexican sweetener industries have been locked in a dispute over high fructose corn syrup (HFCS) for most of this year that may have implications for international sugar trade patterns. Acting through Mexico's National Sugar Industry Chamber early this year, Mexican sugar producers charged U.S. corn wet millers with "dumping" HFCS on the Mexican market, and persuaded Mexico's Commerce Secretary to impose temporary tariffs on imports of HFCS from the United States. The Corn Refiners Association in the United States immediately pressed Washington to seek repeal of the tariff, claiming that only Mexico's HFCS producers (rather than sugar interests) should be officially recognized as a party to the dispute. The U.S. Trade Representative has now referred the matter to the World Trade Organization, which will examine Mexico's actions regarding U.S. HFCS imports.

With HFCS costs roughly 10%-20% below domestic sugar prices, Mexican sugar producers have cause to fear the potential inroads HFCS might make under an unregulated trade system. According to the USDA, about 1.5 million tonnes of Mexico's roughly 4.4-million-tonne caloric sweetener intake goes into end- uses for which HFCS could serve as a sugar substitute. However, given the high degree of integration between the country's sugar producers and industrial users of sugar, there is little motivation to let substitution develop as it has in the United States. Some components of the Mexican food-processing industry have supported increased use of sugar substitutes, and have challenged sugar interests to cut costs and raise productivity.

Since becoming a net sugar exporter in 1994/95, Mexico has boosted sales dramatically, and is forecast to send a record 720,000 tonnes out of the country in 1997/98. Expanded use of HFCS would cause a substantial sugar tonnage to be displaced from the domestic market, putting pressure on the country's sugar producers to find additional export outlets, particularly in the U.S. market. One aspect of this situation is that, over the longer term, increased access by Mexican producers to the United States market would signify reduced sugar shipments by other origins covered under the TRQ system.

Following the approach adopted in our earlier Quarterly Outlook reports, we are highlighting developments in those regional sugar markets that we believe have the most potential for a major impact on the world market over the next three to four months.

European Union (EU)

The EU is one of the dominant forces in the world sugar market, accounting for roughly 15% of total production and 35% of overall white sugar exports. The ISO's October forecast was for a record-setting 1997/98 output of 19.2 million tonnes, up from 18.3 million the previous season. Consumption was projected to rise to 15.1 million tonnes from 14.8 million in 1996/97. Net 1997/98 exports were expected to be up by about 500,000 tonnes from the 3.1-million- tonne level of the previous year. The sharp increase in the EU's export availability is a potentially negative price factor for the #11 market, and can also be expected to exert downward pressure on the whites/raws differential.

Reflecting the region's 1997/98 production surge, EU exports so far this season have been running well ahead of last year's pace. As of November 26, cumulative export authorizations for 1997/98 were reported at 1.32 million tonnes versus 1.15 million last year. Export authorizations were particularly brisk from late September to the end of October and helped interrupt the futures market's upside progress. Export authorizations have recently fallen below year-ago levels, but we anticipate they will pick up again in several weeks.

The possibility that several countries may join the 15-member European Union raises questions regarding the future course of EU sugar policy. While bureaucrats in Brussels have so far rejected any major restructuring of the EU's sugar regime, enlarged membership could make for a more aggressive marketing posture. New production quotas would also have to be established. However, according to a British trade representative, enlargement may prove relatively limited considering the GATT export ceilings already negotiated.

A major problem facing potential new EU members is the relative inefficiency of their sugar economies. For example, in 1989, the former East Germany had about 43 beet processing factories with an average daily slicing capacity of 1,500 tonnes. The massive infusion of West German capital and technical aid for the restructuring and modernization of East Germany's economy has reduced the number of beet factories to eight, with an average daily slicing capacity of 7,380 tonnes. Other countries in Central and Eastern Europe hoping to join the EU have nowhere near the developmental funds of the former East Germany and would presumably face a very long struggle to align their sugar economies with those of the existing EU members.

Russia And Ukraine

The U.S. agricultural attache's October report projected Russia's 1997/98 sugar output at 1.85 million tonnes which, while nominally above the 1996/97 level, is woefully behind the annual production levels of the early 1990s. One negative factor has been a 10% reduction in area planted to beets versus 1996/97. Local specialists characterized the potential as "excellent" earlier this year, but losses became inevitable when heavy rains impeded harvesting progress and 7 million tonnes of beets were trapped under heavy snow.

Russia's 1997/98 consumption is forecast at 4.8 million tonnes versus 5.1 million in the previous season. Although sugar intake (on both an absolute basis and in per capita terms) is well below the level seen at the start of the decade, it remains one of the highest in the world. This is partly due to the relatively higher price of many other food items such as vegetables and fresh fruit as well as to the popularity of various sugar- containing products, such as jams. Households are the main users of sugar, absorbing roughly 60% of national usage; the remainder goes to the food-processing industry.

Imports for 1997/98 are projected at 3.3 million tonnes (of which about 2.3 million are expected to be raws), little changed from 1996/97. Russia is one of the world's leading importers of sugar, and the scope and timing of its purchases tend to have a significant impact on world sugar prices. Indeed, the market's relative buoyancy in the fourth quarter of 1997 owed much to talk of Russian buying activity. (Some reports indicated that around 200,000 tonnes had been purchased for shipment between October and February. The sugar was said to be mostly of Brazilian origin, with Ukraine and Cuba mentioned as secondary suppliers.) According to the chairman of the Sugar Manufacturers Union of the Russian Federation, 27 commercial companies are now engaged in the sugar trade, replacing the government's monopoly in the Soviet era.

The long-term decline in Ukraine's sugar output shows no sign of ending, and production in 1997/98 is forecast at 2.8 million tonnes, the lowest figure this decade; some sources, e.g., Czarnikow, have pegged output closer to 2.3 million tonnes. The numerous problems plaguing the production sector (all of which are also found in Russia) include obsolete transportation and processing equipment, lack of investment, inefficient farming practices and poor management techniques, to name just a few. Governmental planners have recognized the need for greater efficiency, but this can only come about through a complete overhaul of the entire sugar sector. One sugar official recently stated that as part of a long-range restructuring effort, about half of the country's 200 beet factories would need to be permanently closed.

Like production, Ukraine's export availability remains on a long-term downtrend, which is of particular concern to Russia given that the country historically has been its major sugar source. Ukraine's continued importance as a leading supplier of sugar to Russia is based not only on geographical proximity, but also because Ukraine is virtually the sole origin willing to engage in barter arrangements involving a down payment of only 50%.

Recent trade talk indicated that Ukraine was committed to shipping at least 600,000 tonnes of sugar to Russia during 1998. This is well below the previous year's figure, and means that Russia will have to turn to other sources for a larger share of its import requirements. Earlier this year, Russia imposed a 25% duty on Ukrainian imports above certain quota levels; the Ukraine government has so far failed to have the duty eliminated.

Cuba

A catastrophic downward production spiral has taken Cuban sugar output from about 7.7 million tonnes in 1990/91 to 4.2 million in 1996/97. The Czarnikow forecast for 1997/98 is 3.6 million tonnes, the country's second lowest output in several decades.

Although the Communist authorities have made recovery of the sugar sector a major national priority, a host of problems–including inefficient governmental planning, low economic inputs, out-of-date processing facilities, poor management and adverse weather conditions–have united to frustrate the efforts of governmental bureaucrats. The government's desperation to correct the situation was evident in November when the chief of the general staff was appointed the country's new sugar minister.

Cuba's cane harvest generally runs from November through May. There is concern that the ongoing El Nino phenomenon will raise average temperatures and trigger heavy rainfall, which local sources have termed a "disastrous combination" in terms of potential sugar yields and harvesting progress. We believe that Cuba's poor 1997/98 crop prospects have already been factored into the world market's price structure, but additional crop problems or shipping delays would exert renewed bullish pressure on #11 futures. Another potential ramification is that Cuba's faltering export availability will force Russia to seek alternate sources of supply (e.g., Brazil), and may encourage other origins to step up their own production.

Brazil

Brazil's long-range production surge remains intact, with 1997/98 (May/April) output forecast by the U.S. agricultural attache to reach a record 15.2 million tonnes, up from 14.7 million the previous year. In contrast, the ISO has left its production forecast for 1997/98 unchanged versus the previous season, citing potential El Nino-related crop damage. Brazil's 1997/98 sugar exports are projected at 6.4 million tonnes, up 10% from the year- ago level. This represents an increase of roughly 500% since 1990/91, and makes it easy to see why Brazil has become a seemingly permanent "problem" for sugar bulls.

Roughly one-third of the cane production will be processed into sugar, with the remainder channeled into industrial alcohol production. Cane availability has been pegged at 305 million tonnes, of which 250 million will originate in the Center-South region and 55 million in the North-Northeast. One reason for the enhanced sugar output is that several cane millers have diverted more cane to sugar production from industrial fuel. Within the alcohol sector, there is a trend toward increased anhydrous alcohol production versus hydrated alcohol output. (Anhydrous alcohol is used as a gasoline additive; hydrated alcohol is used as a fuel for alcohol-powered vehicles.)

Tests designed to examine the feasibility of an alcohol-diesel mixture and its use in existing diesel-powered engines are underway; we do not know when the definitive test results might be released. The outcome of these tests is potentially significant because studies indicate that annual alcohol usage would rise by 1.5-1.8 billion liters with a 5% alcohol addition to diesel. (In 1996/97, Brazil produced 14.4 billion liters of industrial alcohol.)

Brazil's sugar sector is unique in that its cane millers have the flexibility to switch their annual sugar/alcohol mix to a degree that simply does not exist in any other sugar origin. Thus, in any one year sugar production and exports are partly a function of the annual alcohol production targets established by the industry. This relationship could work to the disadvantage of sugar output, because the anticipated phasing out of industrial alcohol subsidies in 1998 is expected to drive many cane millers out of business. According to a recent U.S. agricultural attache report, this could lead to a sugar production decline of 10%-20% within five years.

China

China's 1997/98 statistical outlook represents a major disappointment for market bulls. The U.S. agricultural attache has projected output at 7.2 million tonnes, an increase of roughly 100,000 over 1996/97 and the country's best production figure since 1992/93. Other sources anticipate an even stronger performance: Czarnikow is forecasting that 1997/98 output will be about 600,000 tonnes up from the previous year and Licht's projection shows an even larger increase of roughly 800,000 tonnes.

The potential significance of China's greatly improved production prospects is the likelihood that the country's import needs will fall substantially in 1997/98. The attache report forecasts that imports will be off by about 22% in 1997/98; other sources predict an even larger drop. The ISO has gone so far as to say that it seems "unlikely" that China will import any sugar during 1997/98, with the exception of its long-term contract with Cuba (which the market has discounted). We view this situation as a long-range negative factor for world sugar futures.

India

With 1997/98 production projected at 13.4 million tonnes, down an astonishing 4.8 million tonnes from the record high of 1995/96, India represents the most extreme case of recent production fluctuations in a major origin. Although the huge production decline was accompanied by significant consumption growth, the country did not have to resort to imports over the last two seasons due to the existence of very large domestic stocks. These stocks effectively cordoned off India from the world market, explaining why the sharp production decline (which resulted in a bullish international statistical sugar profile), did not translate into far stronger world sugar prices.

India's huge sugar stocks and faltering export profile have softened the profitability of the cane milling sector, with mill owners becoming very tardy in paying growers promptly for their cane. In turn, this has led to poor farming practices (e.g., reduced fertilizer use), with some farmers switching to other products, including non-centrifugal sweeteners (the 1997/98 cane area is estimated to be down 5% from a year ago). Although the government has attempted to halt the downward production spiral (e.g., raising the percentage of free market sales to 70% of output), mounting payment arrears to growers remain a major stumbling block. There is no reason to believe that 1998/99 will see a major production upswing.

The faltering production picture is expected to force India to resume large-scale imports around mid-1998; current expectations are that the country will import roughly 800,000 tonnes during the 1997/98 season. Imports of this magnitude would make India a net importer for the first time since 1994/95, and would constitute an important supportive factor for world sugar prices.

Thailand

The 1997/98 year promises to be difficult for Thailand's sugar sector, which is expected to see production crash as a result of earlier El Nino- induced dry conditions. The current forecast is for 1997/98 outturn of only 4.6 million tonnes, about 26% short of last year's production and the country's lowest output since 1993/94.

Thailand is in the grips of an economic crisis, and this may delay the recovery of its sugar sector. Terms for commercial banking loans have become more restrictive, property values have fallen, interest rates have escalated and some of the country's Asian customers (currently grappling with economic and currency crises of their own) may scale back on sugar purchases. In addition, some cane millers who had diversified into other industries (e.g., tourism) have had to contend with huge losses in these businesses. Prefinancing of cane–an often decisive factor in persuading farmers to produce sugar rather than other competitive crops–could be jeopardized in the current economic climate.

The U.S. agricultural attache has forecast 1997/98 exports at 3.7 million tonnes, 1 million below the year-ago figure and in line with projections made by other statistical sources. Thailand's reduced export availability can be viewed as a major, long-range price-supportive factor for the #11 sugar market.

The whites/raws premium has fallen to historical lows, and reflects the current divergence between the white and raw world sugar markets. Among the negative pressures acting on whites is the substantial year-over-year increase in the EU's 1997/98 sugar output, the enhanced export availability of another leading exporter of whites (Brazil), and the construction of several refineries in the Middle East. The raw sugar market remains relatively tight, with prices supported due to production problems in several important origins such as Cuba, Russia and Thailand. The narrowing whites premium presents various problems for the raw sugar trade, not the least of which is that the current differentials deter the buying of raw sugar for tolling purposes. We do not expect a speedy turnaround in the whites/raws differential, but believe that India's projected 1997/98 statistical situation (high imports, low exports) could lead to a firmer premium in several months.

Sugar #11 price seasonality reflects overall global production and shipping patterns. World sugar availability generally reaches a peak between March and May. (For example, the Thai and Cuban export peaks usually occur during this period, and cane harvests in the southern hemisphere origins, such as Australia, Brazil and South Africa, begin about this time.) Improved availability acts as a price depressant, with values tending to fall to their lows by summer. End-summer/early autumn is the period when global stocks are usually at their seasonal minimum, ushering in a period of relative price strength that tends to run through the last quarter of the year. In some years, fourth-quarter price strength may be reinforced by large-scale purchases from India and China. (Harvesting in these countries tends to conclude by March, so potential imports can be delayed until later in the year.)

In our August Quarterly Outlook we forecast that March futures would advance to the 12.60- to 13.20- cent area within three months; the actual high, made on December 1, was 12.55 cents.

We are maintaining our moderately bullish long- range price perspective, and look for nearest futures to reach a high between 13.20 and 14.00 cents in the first quarter of 1998. We expect that nearest futures will hold above the 11.20-cent level on any pullback. As we go to press, the March/October premium appears overextended, and we expect to see some narrowing over the near term. Long range, however, we expect the premium structure to remain firm.

Disappointing 1997/98 production in several countries (e.g., Cuba, India, Thailand, Russia and Ukraine) has created relative tightness in the global raw sugar market. That tightness, and its price-supportive influence, would be reinforced if the ongoing El Nino were to create additional crop problems in one or more of the following origins: Brazil, Cuba, Philippines and South Africa.

We believe the major negative market forces, e.g., increased EU production and the likelihood of low-level Chinese imports, have been factored into the market. One important exception is the market's huge open interest, which leaves futures vulnerable to a "shakeout" by speculative longs.

December 9, 1997 Arthur Stevenson

Prudential Securities, Inc.

One New York Plaza, New York, New York

Consensus National Futures and Financial On Line Index

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