We have been using this space for some time now to show our readers the importance of the oil and currency binomial (real against the dollar) and its implication on hydrous ethanol pricing and, by parity, sugar pricing, and availability.
In the previous governments, the gas price was administered by the federal government so as to keep the fuel at the pumps cheap in order to foster the consumption and the sale of popular cars. Taxpayers, as shown here before, were the ones who paid for this bill because Petrobras cash flow was facing a huge shortfall not just due to the corruption institutionalized by Lula and his gang, but because it was selling fuel below the foreign parity and the mills that had been massacred by the artificially cheap gas price, found themselves compelled to trade hydrous ethanol below the production cost. That’s another story, though.
The indisputable fact is that when oil was trading above 130 dollars per barrel in 2008 on the world market, the sector missed the boat because it didn’t have the chance to take advantage of the favorable events going on to fill up the company’s cash flow. The mills weren’t able to savor the bonus of the oil price hike.
Today, in a totally distinct scenario, but at least in alignment with the international parity, in the midst of a perfect storm which combines the pandemic caused by the coronavirus (which will badly damage the demand of the product) and the fight between Russia and Saudi Arabia, the mills will have the arduous task of enduring the depressed prices and bearing the burden of negative margins. That’s tough.
The main burden will come through the fall estimate in fuel consumption (Otto Cycle) for this year, which should come to about 3% with a bearish bias. Over these first days of lockdown imposed by state governments of the main Brazilian states, the decrease in fuel sales at the gas stations has been between 50 and 70%. Depending on the length of this quarantine, we might see this number get worse.
Likewise, the parity of ethanol with sugar has lost ground. According to a trader in the countryside of São Paulo, the last offer – no buyers – pointed to R$ 1.7000 per liter at the mill – tax-free. Taking into account Friday’s sugar closing in NY for May/2020 at 11.10 cents per pound and the dollar trading at R$5.1000, hydrous is being offered at an equivalent sugar with a 55-point discount against the Exchange.
Another burden to be faced by the mills this year is sugar price. When Archer Consulting releases the volume priced by the mills, the data collection is based on a sugar export estimate and, based on it, we release the corresponding percentage. Evidently, this base should increase. If more sugarcane is designed for sugar production, it’s just natural to assume that part of this extra production is still unhedged, especially for those mills with a larger credit restriction. But this is not the only problem.
World sugar consumption had been growing at 2.2% per year for a decade. Five years later, it dropped to 1.5%. Today it’s estimated that it is at about 1%, despite Asia continuing to grow above 3% per year. With the coronavirus outbreak, some analysts believe the impact on world sugar consumption will cause a two-million-ton drop due to the sharp downturn in out-of-home food consumption.
If the Center-South produces the volume we expect it will, with all the pressure that hydrous will face due to the deteriorated oil prices out there, the long-expected world sugar deficit for this year might be seriously jeopardized. Center-South produces more, Thailand produces less, but world consumption also drops.
Everybody is at their wit’s end, regardless of the market they are in. The decision-making process has gotten more complex, more ingenious, more stressful, and it is often coupled with a thick cloud of variables. Any of the twelve labors of Hercules seems way easier when we come up against the current scenario. You must take a deep breath and not make any hasty decisions. Protect yourself as much as possible.
The insurance offered by the market, be them in exchange, sugar, oil, ethanol, will be more expensive for obvious reasons. Nobody offers you an umbrella on rainy days. If they do, the price they will charge you is outrageous. We have to learn to buy umbrellas when the sky is blue, cloudless and the sun is shining brightly. But things hardly ever happen that way.
Curiously, talking to some traders from the commodities market, I see more and more interest in the so-called antifragility that Taleb has been talking about a lot for almost eight years. The term coined by the Lebanese professor based in the USA suggests that instead of just resisting shocks (supply, demand, epidemic, etc) we stay stronger when they occur. We talked about this a little over two years ago (see link https://www.archerconsulting.com.br/artigos/artigo4813/?lang=en ). We have to get something out of this crisis.
The non-indexed funds completely covered their long positions, which helped the sugar futures market in NY fall heavily. The question is whether now they will enter short and pressure the market even further. It’s estimated they are short now by 7,000 lots.
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William N. Goetzmann is a Finance Professor at Yale and has made an interesting study on Stock Exchange breakdowns using data on 101 global markets from 1692 to 2015. Extremely great, the yearly declines on the markets are usually followed by positive returns. This is not true for smaller declines. They identified 1,032 events in three centuries where the market dropped more than 50% over a 12-month period. By conditioning these events and controlling several other factors, he found out that the markets tend to recover the year after the breakdown. Goetzmann calls this breakdown and recovery pattern “negative bubble”. Curiously, the pattern is only good for great falls (over 50%) – smaller declines show persistence, not reversal.
Arnaldo Luiz Corrêa
