“There are two times in a man’s life when he should not
speculate: when he can’t afford it and when he can.”.
Mark Twain (1835-1910)
American writer
The dollar tried hard to nip at R$6.0000, a level which a couple of months ago would have been unimaginable in 10 out of 10 renowned economists’ minds in the country. Anyway, the poor trajectory of the Brazilian currency has helped the mills fix the sugar price for export, not only for the current crop but also for the two following crops. On Friday, the North American currency closed the day at R$5.8540.
NY closed with July/2020 at 10.38 cents per pound, almost unchanged against last week’s closing. However, the longer the maturity, the greater the fall was, suggesting that there actually was some pressure from the contracts with longer maturity showing a possible hedge activity by the Center-South due to the exchange rate.
Some mills, which have already increased the sugar volume fixed for the next 2021/22 crop, are starting to price sugar for export of the 2022/2023 crop as well, taking advantage of the favorable profitability provided by the exchange rate volatility. And all this despite the difficulty imposed by many banks which serve the sector, which understandably, are decreasing their exposure to the currency risk.
The mills complain about the difficulty in closing NDF (Non-Deliverable Forward) operations, a currency forward contract with cash settlement, with very long terms. Unlike what used to happen in the recent past, the dollar curve currently provided by the banks just about writes off or bites any spread gain between the domestic and foreign interest rates, under the argument of the exchange rate risk which they [the banks] are taking.
The values the mills are getting out of the export sugar pricing for the next two crops, selling futures contracts in NY and doing NDF operations to lock in the exchange, produce a good return if we compare it with the cost of production of the most efficient companies of the sector.
Our estimate is that these mills should have an average cost of sugar production equivalent to R$ 1,100 per ton FOB Santos. The fixations we are talking about have an average today of R$ 1,450 per ton for the 2021/22 crop and R$1,452 for the 2022/23 crop, both adjusted to net present values.
A strong argument is as of 2011, so with over nine years of data (except for the 2016/2017 crop), the NY quotes converted into real per ton against the dollar rate on the day informed by the Central Bank and adjusted by the IGPM (General Market Price Index) were below R$1,450 per ton in 63% of the times. If we don’t adjust the values by the IGPM (General Market Price Index), this percentage goes up to 99%.
Another important fundamental is that the values upon the implementation of the physical contracts these fixations refer to, freight to port and elevation costs, for example, can be smaller than the current ones in real per ton at the time of physical delivery, since we are considering an inflated exchange rate. Therefore, profitability can be even higher. Focus Bulletin, for instance, estimates an exchange rate at R$ 5.0000 for the end of 2020, R$ 4.8300 for the end of 2021, and R$ 4.5400 for the end of 2022.
Since late February, when the real depreciation intensified, the open position of the futures contracts for the 2021/2022 crop has grown by 56%. Over the same period, the position for the 2022/2023 crop has gone up by more than 200%. Of course, in absolute numbers, the former has grown by almost 3 million tons of equivalent sugar and the former has grown by close to 750 thousand tons. These volumes don’t necessarily mean price-fixing, but at least they show the scale of the movement there has been since then.
Clouds of uncertainty hovering over the economy. We are all conjecturing and planning all the time at best the next day. We have been living one day at a time. The greatest mystery the market tries to deal with is fuel consumption. Experts believe that the worst (40% drop) is already gone. We just don’t know how long this downsizing will go on for.
Excess availability of sugar in India, for example, is making government agencies suggest that the excess of sugarcane be used for the production of ethanol. The drop in consumption decreases the rate of sugar sales and affects the sugarcane producers who are starting to feel the payment delay for raw material by some mills. The difficulties here are just as huge as they are there.
Brazil exported 19.3 million tons of sugar over a period of twelve months from May/2019 to April/2020, a slight 4% drop against the same previous period. With ethanol, there was an inverse trajectory. We exported 1.95 billion liters, a volume 14.6% above that over the same period last year. Will we be able to increase this volume to 23 million tons this crop year? This is the famous one-million-dollar question.
Volatility is the risk perception that the market has about a certain scenario. In Brazil, President Bolsonaro, unfortunately disappointing a substantial share of his voters, is himself responsible for the deterioration of the domestic political scene. Democracy implies composition, capacity for dialogue, persuasion ability, an ability to change without giving up on ethical principles. We cannot treat opponents like enemies. The real reflects the implications of badly carried out policies by Bolsonaro. We will still suffer a lot.
I keep thinking about our world today, with the representatives we have in the main countries of the planet if they were transported on a time machine to hold the same offices during the Second World Ward. Today, we would undoubtedly be in the darkness.
Have a nice weekend everybody.
Arnaldo Luiz Corrêa
