Higher-than-expected sugar output from Brazil is the second upset for the sugar industry in December. Barely a week ago, the Uttar Pradesh government announced a higher-than-expected floor price for procuring sugar cane from farmers. The sugar mills in the state, the largest producers in the country, will find it difficult to make money unless sugar prices move up.

One of the factors in determining prices is domestic demand and supply. More accurate estimates of supply will be available after some months; but initial estimates peg sugar output at 23-24 million tonnes (mt) in the current season, compared with 26 mt a year ago. But these estimates are known to change as the season advances.

Government data had shown that the area under sugar cane cultivation is 5.1 million ha, marginally up when compared with last year. There is a risk of actual production coming in higher than estimated.

But a new problem has emerged on the international horizon. Brazil’s sugar output numbers for the South Central America region were released last week, prompting a negative market reaction. That country’s sugar industry association, Unica, said that sugar production in the 2012-13 season, till 1 December 2012, was 32.9 mt—an increase of 5.9% year-on-year.

This is a smart turnaround in output, helped by the dry weather towards the end of the season.

Sugar output was down by 7.8% in the current season, till end-September, according to Unica, affected by rains. But dry weather in the subsequent months has helped output recover.

Analysts were estimating sugar output to be in the region of 30-33 mt, according to a news report in theFinancial Times (FT).

With the actual numbers set to match, or even exceed, the higher end of this estimate, sugar prices turned weak last week. Benchmark ICE raw sugar was trading at 18.42 cents per pound, according to theFT report, its lowest level since August 2010 and 4.2% less than the week’s opening level.

The declining prices of international sugar are bad news for Indian sugar mills for a few reasons. It makes exports less remunerative for the sugar mills, worsened by the fact that their costs continue to increase. Weak international price trends can also cause the domestic prices to remain depressed. Lastly, the rising costs may increase the viability of refining imported raw sugar, which is a threat for integrated sugar mills. The industry has begun demanding a hike in import duties, a sign of this threat appearing real, and the government has promised action on that front.

Even if the import duties are hiked, if the international prices continue to trend down, it is bad news for Indian sugar mills. Indian sugar stocks were down last week, reacting to the higher-than-expected state floor price for procuring sugar cane. Balrampur Chini Mills Ltd lost 14.8% over the previous week, Shree Renuka Sugars Ltd was down by 8.1%, and Bajaj Hindusthan Ltd was down by 5.4%.

A key risk factor is the possibility of domestic sugar output exceeding estimates. If that happens, sugar prices will turn bearish, and so will the mood of investors in sugar stocks.