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Sugar mills in the Centre/South of Brazil have made the most of the high sugar prices in recent years. In 2016/17 they processed 46.3% of the cane crop into the sweetener against only 40.7% in 2015/16.
Helped by sophisticated hedging strategies it looked like the focus on sugar would continue in 2017/18 despite the steep fall in prices for the sweetener.
By the middle of September mills had processed 48.4% of the cane into sugar.
However, the data also reveal that operators had started to switch to ethanol in August. Pundits are taking this as a sign that the remainder of the campaign will be heavily tilted towards ethanol.
Brazil’s Canaplan consultancy upped its ethanol production forecast in the current cane crop to 24.8 bln liters from 23.8 bln. At the same time it said that Center/South mills might cut sugar output by 500,000 tonnes to 1 mln tonnes this crop.
What has happened to prompt such considerable change in the production outlook so late in the season?
Outlook for ethanol has improved
The main reason for this assumption is the improved outlook for ethanol resting on four pillars:
• A preferential tax policy.
• Higher gasoline prices.
• The recovery of the Brazilian economy.
• A tariff rate quota for ethanol imports.
In July, the federal government reduced the so-called PIS/Cofins tax on fuel ethanol, while it maintained the in-creased taxation on gasoline and diesel.
The move will lift ethanol prices by only BRL0.1218 per litre instead of BRL0.1964 (to a total BRL0.2418). That of gasoline will remain at BRL0.4109 to a total BRL0.7925. The measure has improved a price advantage for hydrous ethanol at the pump compared to gasoline and this is starting to show in consumption numbers.
While local sales of hydrous ethanol in the Centre/South in August 2017 were still down 5% on the year at 1.367 bln litres, they were 23% higher than in July and reached the highest level so far in the campaign. The situation improved further in the first half of September when sales recovered to 670 mln litres, which was only 3% down on the year.
At the same time, the new pricing policy by Petrobras is starting to work in favour of ethanol. In late 2016 the state-owned oil giant decided to float gasoline and diesel prices. The new policy takes into account international pricing pari-ty plus a margin to make up for taxes and risks including foreign exchange volatility. A committee comprised of Chief Executive Officer Pedro Parente, plus the chief of the company’s refining division and the chief financial officer will decide on fuel prices. At first, the prices were reviewed at least once a month, but earlier this year this was changed to daily.
Petrobras has been selling gasoline and diesel at a premium to international prices for almost two years, helping re-cover an estimated $35 bln it lost subsidizing imports from 2011 through late 2014.
Given the fact that oil prices rose to a two-year high in September the gap between gasoline prices and ethanol prices in Brazil has widened considerably. While hydrous prices at the start of the year were around 77% of the gasoline price, this ratio has dropped to less than 68% now. As a rule of thumb one can say that filling the car with hydrous ethanol becomes attractive once this ratio is 70% and lower.
After contracting each year between 2012 and 2016, the Brazilian economy officially emerged from recession in the second quarter of this year. Unemployment fell to 13% in the second quarter of this year, though most of the jobs pro-duced were in the informal sector. And it looks like the recovery is going to continue. Economic activity rose 0.41% in July after seasonal adjustments. The median forecast in a Reuters poll indicated a 0.10% monthly advance in July. The central bank also revised the previous month’s reading to show a 0.55% increase, bigger than the originally re-ported 0.50% rise.
Latin America’s largest economy has been crawling out of the deepest recession in a century, which drove inflation to 18-year lows and allowed the central bank to cut interest rates to the lowest levels since 2013.
Slow price increases and low borrowing costs have stimulated consumer spending, which lifted second-quarter gross domestic product (GDP) growth above analyst expectations.
Economists expect that to underpin a steady economic rebound going forward, but investments should recover slowly as companies prioritize cutting debt.
The car market also seems to be on the way to recovery. Sales of flex-fuel vehicles climbed to over 186,000 units in August, the highest level since December 2015. At these levels FFVs continue to claim close to 90% of the passenger vehicle market. This is an important indicator for the return of consumer confidence and also provides a positive back-drop for future ethanol demand.
Another factor that is supposed to improve the outlook for the local ethanol industry is the introduction of a tariff rate quota for the product from September 2017. According to the regulation, a total volume of 1.2 bln litres of ethanol can be imported into the country duty-free during the two year period from September 1, 2017 to August 31, 2019. This total volume will be subdivided into quarterly instalments of 150 mln litres. All ethanol of the subheadings 22.07.10.10 and 22.07.20.11 (ethanol with a water content of a maximum of 1%) imported above this volume will be subject to an ad valorem import tariff of 20%. The immediate effect of the decision was that sugar prices went up as it was expected that the move could make eth-anol production more attractive.
One of the reasons why the effect on the Brazilian ethanol market was rather muted may have been the option of the so-called duty draw-back under Brazilian law. This allows an exporter of ethanol to import a similar volume of ethanol duty-free provided certain conditions are met.
Given the fact that Brazil exports over one billion litres a year, the extensive utilization of this option would complete-ly neutralize the effect of the import tax. There is talk in the market that the government would likely be reluctant to grant large duty draw-backs as it could undermine support from the northeastern parts of the country for its political reform programs. It was the ethanol industry in this region that had lobbied for the ethanol import tariff as it faced increased competition from imported US ethanol.
From all the factors mentioned the TRQ is likely to have the least influence on local alcohol production as its conse-quences are far from clear.
Sugar market likely to remain depressed
The sugar market will be in surplus this year. The surplus or deficit in a given sugar year is understood to be the gap between production and global demand including unrecorded consumption, with the latter being the gap between ex-ports and imports. In other words, the term surplus or deficit simply means the increase or decrease in stocks.
According to our latest estimate the deficit in 2016/17 (Oct/Sep) has shrunk to 3.7 mln tonnes, while the expected surge in global production is estimated to lead to a surplus of 5.3 mln tonnes in 2017/18. This will be the first surplus after two years of deep deficits which added up to a combined 12.6 mln tonnes.
The prospect of such a sizeable surplus in the new season has led to significant pressure on global values in recent months. In fact, the surplus could even get bigger if consumption in India and China does not recover as strongly as we currently assume.
It is especially the white sugar market that has been seeing price quotes erode in recent weeks and months. In fact, the white sugar premium has collapsed from levels of as much as $115 a tonne in April to as little as $45 in mid-September, the lowest level since February 2011. This is not least due to the fact that EU sugar production prospects are getting better by the day. Also, whites producers such as Thailand, India and Pakistan seem headed for a significant rise in output in 2017/18 with the latter still sitting on a huge stockpile of unsold whites from the 2016/17 harvest. These could add even more supply to the world market in case the government approves an export subsidy.
The outlook for raw sugar supplies is not so bright given expectations that production in Brazil may be lower than ex-pected. Despite this, plentiful supplies from almost anywhere else suggest that the repercussions on the world market may not be as strong this time as would normally be the case.
A trend reversal?
Unica’s latest campaign reports suggest that sugar millers in the Centre/South are shifting their focus from sugar to ethanol. This point should not be exaggerated as this is quite normal for this time of the year. The main reason for this season-al switch is that cane quality starts to deteriorate and with that the amount of sugar that can be crystalized. At the same time mills start to manage their ethanol stocks to make sure that they have sufficient supplies for the inter-crop period.
So while the fact that mills are switching to ethanol is not really remarkable, the extent of the shift certainly is. Be-tween August 1 and September 15, 2017 mills turned around their operations from a 50% sugar mix to 48%. One year earlier it was from a little bit above 48% to 48%. This underlines that the mills’ ethanol bet is a bit more than just seasonal in nature. What needs to be determined is how this switch will affect the final production result.
We currently assume that the Centre/South will crush approximately 585 mln tonnes of cane. The sugar mix is likely to end at 47.3% against somewhat more than 46% last year. This means that sugar production could reach 35.5 mln tonnes compared with 35.6 mln tonnes last year. Ethanol output could reach 24.5 bln litres which would still be down from 25.7 bln in 2016/17.
Our model suggests that the stronger focus on ethanol during the late phase of the campaign is likely to result in only small changes in the final production numbers. At the start of the season we had suggested that sugar output could reach 35.6 mln tonnes while ethanol was pegged at 24 bln litres. This means that the production outlook will probably change only marginally with the improved outlook for ethanol.
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