Brazil: Who Can Hold Back This Market?

The measures adopted by the Brazilian government, such as the change in the anhydrous blend in gas from 25% to 27%, along with the growth potential of ethanol consumption in the state of Minas Gerais, due to the ICMS decrease on that product and the consumption growth of fuel countrywide regardless the economic crisis, could significantly increase the amount of sugarcane which will be designed to meet these additional needs.

The change in the blend percentage drives up the monthly consumption of anhydrous by about 75 million liters. Minas Gerais, which is the state with the second largest fleet – 10.6%, should gain hydrous consumers because of the parity acquired with the decrease in the state tax. The gain in consumption isn’t automatic just because of the favorable parity. Consumers, who take time to realize the financial advantages to ethanol, must have their habits changed. But, anyway, being conservative, Minas Gerais can help with a 1.4 billion-liter increase yearly. In addition, the Brazilian fleet will have an increase (new vehicles minus scrapped vehicles) this year by at least 2 million vehicles which together should consume another two billion liters of anhydrous and hydrous ethanol during the year. Thus, we potentially have a 4.3 billion liter increase which will consume 50 million tons of sugarcane.

It is hard to predict what the sugarcane harvest in the Center-South will be this year. The numbers range from 540 and 590 million tons, as has been the case recently. The most pessimistic ones have pointed to the drought as the villain and believe that the real damage has yet to have its magnitude correctly evaluated. Anyway, the fact is that there will be less sugar availability. Some trading companies have pushed the sugar harvest up to 34 million tons, but I cannot see this number going beyond 32.4 million (which will probably be the prediction number by Archer – not closed yet).

If these points analyzed above aren’t bullish, they at least should provide a reasonable support to the sugar market. If it weren’t for the internal political turmoil in Brazil which has driven the rate of the dollar up to the highest one in 10 years and the oil melting price on the foreign market, today we would be talking about 20 cents per pound. But, this is a different story we are dealing with.

Some other factors, however, keep bulls away from this bear-flooded market. The Brazilian real, for example, will continue to be hit by the national political crisis, which is only beginning. The growth of the world economy has put consumption on hold. China has decelerated. The declining oil barrel price, despite allowing families to have spare money, has pulled down other commodities. Over six months, we have seen oil plummeting 46.7%, natural gas 34.2%, soy 12%, sugar and coffee 11% and so forth. No agricultural commodity has gone unharmed.

On the list of difficulties and showing that there are still vulnerable points so that a market recovery can come about is the number calculated by the model developed by Archer Consulting which points to a fixation volume of the mills for the 2015/2016 harvest. This number is thought of as being low, so it makes the extremely late mills vulnerable there should be some worsening of the situation. According to the model, up until January 31st, the percentage of the fixation was at 27.27% at an average price of 17.34 cents per pound. Coincidentally, this is the same value the mills had a year ago for their average fixations for the 2014/2015 harvest, only at that point the percentage was a lot higher: 40.88%. What has happened?

A lack of credit on the part of the brokerages, which are getting more and more selective when choosing their clients, inhibiting the anticipation of hedges which demand guarantees to be deposited, could be a reason. The trading companies, which did not have a very good year due to the deterioration of the premiums on the physical market, rightly decreased the appetite for long-term contracts, unless the discounts were generous and comfortable. So, a lot of mills end up fixing gradually as they negotiate the physical. These ingredients reflect on the 13-point fall of the volume which should already have been fixed. It always explains the relatively high average for a year like this, with declining prices, for only the well capitalized and structured companies have been able to fix prices when there was a good opportunity.

And where would the bottom of this well be? Without any talent for fortune-telling or Nostradamus, I’d rather stick to the traded values in reais per ton which is the point many companies in the sector limit themselves to. The average fix for 2015/2016 is R$971 per ton. The lowest seen was R$880 per ton. Let’s imagine the worst scenario where the dollar is at 3.000 due to an eventual worsening of the political setting. This puts NY equivalent at 12.78 cents per pound for the year’s low. On average, we would be at 14 cents per pound. With the dollar at 2.7000 we are talking about 14 cents per pound as low and 15.70 as average. Where could this market go after the perfect storm is over? Or, would the funds have the same appetite to have a huge short position at present levels?

Suppose you have US$1 million which has to be bet on a digital option, that is, you have to bet the market will reach either 12 cents per pound or 18 cents per pound. Where would you place your bet? Send in your opinion.

Petrobras estimates that the subtracted value from its assets can reach R$88 billion – money used to pay kickbacks, to fill the pockets of political parties, politicians, entrepreneurs, cronies and other criminals. How must an honest entrepreneur feel when witnessing such debacle? The amount ripped off by the gangs that infest the Brazilian political life is 20% larger than all the estimated revenue of the sugar-alcohol sector in 2015.