Ethanol has been the forget piece in the Brazilian sugar/ethanol mix puzzle. After the big shift to sugar last year as fuel consumption fell off due to the pandemic, ethanol prices have been climbing back slowly. However with a weaker Real and higher sugar prices, ethanol parity has been lagging substantially sugar for export. Ethanol has become something of an afterthought. In recent weeks, with the crop being downgraded due to dry weather, sugar production ideas have actually been climbing somewhat as some have been adjusting the ATR higher. Is ethanol doomed for another year of lost relevance?
Possibly not! Crude oil prices since the pandemic dive have recovered strongly, but the trend higher has been complicated by renewed virus waves, concern about a renewal of US shale oil production and OPEC’s ability to stick to their compulsory production cuts. The most recent turmoil was after the Saudis announced they would begin bringing back the 1.0 million barrels of production they had cut. We have also had a COVID wave in India, the worst any country has seen. The rise in virus cases in the country has had a direct impact on their crude oil imports and India is the third largest oil importer.
However, the United States has pushed forward with their vaccination program. 42% of the adult population is now fully vaccinated. New York has announced it will lift most COVID restrictions as of May 19, and New jersey will follow suit. California as well is lifting COVID restrictions as of June 15th. We are also seeing cases fall in Western and Eastern Europe with the exception of Russia and China has already been able to control virus cases even though they are behind on their vaccination. So the two largest economies are finally looking better and Europe should be able to make similar progress within several months.
The revival of the largest drivers of the world economy will lead to an increase in fuel consumption. The signs are already apparent. Today both gasoline and heating oil (diesel and jet fuel) both broke above recent highs. Crude looks to be heading in the same direction. A close of June WTI crude above $67.29 a barrel would point to a technical target of $79.50-80.00 a barrel. That is conceivably a further rally of 21-22% above today’s closing price.
Brazil’s current hydrous ethanol parity on Monday evening was 15.34. Anhydrous ethanol was 16.43. Hydrous ethanol rallied 3% today. If we see another 22% price increase in international gasoline and we assume that the government doesn’t let the gasoline import parity go wider than 15%, then we get a hydrous ethanol parity of 18.71 cents. Anhydrous would jump to 20.05 cents.
All this price change is assuming the Real stays stable, which is unlikely. But we would point out that President Bolsonaro recently made a step forward agreeing to make some progress on controlling the Amazon deforestation, and this move (if it is backed up), along with some progress on their vaccination program would most likely be positive on the Real. It won’t hurt if they continue to be aggressive on their monetary stance and raise rates aggressively as well. The Real several weeks ago broke a downtrend and the USD/BRL posted what appears to be a double top. This points to a test of 5.00. A firmer Real would push ethanol parity even if fuel prices did not rally.
So a word of warning for those that might have discarded any chance of a mix shift to ethanol from sugar. Do so at your own risk. Ethanol parity as well DOES NOT need to be above sugar to make it more attractive. The ability to turn ethanol into cash instead of waiting for export allows ethanol to be competitive even with a discount.
The focus on demand or the weather in Brazil might have left traders with tunnel vision. The puzzle is not complete without the last piece. Perhaps the most important piece!
Mr. Michael McDougall is Managing Director at Paragon Global Markets, LLC, New York, USA. He has been active in commodity futures for 35 years.
