First Thoughts on the 2018/19 Cane Harvest in Centre/South Brazil

The expectation that world oil (Brent) prices will remain in the USD 60-USD 70/bbl range, providing support for Brazilian gasoline prices, is one of the drivers of the projected strong swing to ethanol.

The exact relationship between hydrous ethanol prices and the gasoline price in Brazil is not simple. During the inter-crop period (typically December to March), when stocks of ethanol are tight, there is a clear rationale for ethanol pump prices to shadow gasoline pump price movements, typically moving to a level of 70% or so of the gasoline price. Significant further upward movement beyond this 70% price ratio is capped by flex-fuel car owners switching from ethanol use to gasoline use.

However, during the milling season, the discount of ethanol to the gasoline price always deepens. Our view is that during this period ethanol prices are less influenced by the gasoline price, and much more a function of the short term supply/demand balance for ethanol within the Brazilian market.

With the swing in the mix towards ethanol in 2018/19, we expect total cane-based ethanol supply to be higher than in the previous season (projected at 26.9bn litres versus an estimated 25.8bn litres for 2017/18). We also expect Brazilian corn ethanol supply to rise by some 0.3bn litres. And, we expect the inflow of imports from the US to continue into 2018/19.

What might this mean for ethanol prices and the ethanol/sugar trade-off? In 2017/18 (a year when sugar output was maximised), the discount of ethanol to gasoline fell to a low point of 67% (basis São Paulo prices). By contrast, in 2015/16 (the most recent season when ethanol output was maximised), the low point was 61%. Our calculations indicate that if oil prices continue in the USD 60-USD 70/bbl range, then even if the discount of ethanol to gasoline were to reach a low point of 60% at the peak of the 2018/19 milling season, the net ex-mill revenue from ethanol would still be superior to what the futures curve currently offers for sugar (see Figure 1).

Our calculations also suggest that if the current ethanol import tariff arrangements were to be suspended for any reason, imports of US ethanol at the current Chicago spot price of USD 1.40/gallon would be just about breakeven with the hydrous ethanol price at a 60% discount to gasoline (assuming USD 3.30/BRL and oil prices in a USD 60-USD 70/bbl range).

With an election coming up in October, and no shortage of drama on the domestic political scene, it would be no surprise if the BRL/USD exchange rate were to exhibit some volatility in the coming months. However, the influence of exchange rate fluctuations on the sugar/ethanol trade-off has diminished ever since Petrobras introduced its current domestic fuel pricing policy, based on import parity prices. Under these circumstances, a weakening in the Brazilian real implies higher domestic gasoline prices as well as higher local currency revenues from sugar sales. A change in this policy, following on from a change of government (given that the government is the controlling shareholder of Petrobras), remains in the ‘black swan’ category of events for now, i.e. very low probability but very high impact for the cane sector.

The outlook for the sugar/ethanol trade-off strongly suggests to us that in 2018/19 the Centre/South will be at, or close to, ‘max ethanol’. This said, no-one knows for sure what exactly this means in terms of percentage allocation between cane and ethanol; not only does it depend on installed capacity, it also depends on the size of the cane crop. We have assumed 41.5% of cane allocated to sugar in 2018/19, but, like everyone else in the world of sugar, we will be watching closely as the harvest evolves.