Brazil: A Government That Punishes Those Who Hedge

The futures sugar market in NY closed the week completely unchanged in relation to last week’s Friday. May/2015, which expires next Thursday, closed at 13.23 cents per pound. However, it is always worth remembering that this week’s variation was negative by 31 reals per ton, because the real closed at 2.9550 against last week’s 3.0544. A yellow light comes on here: this would be the worst of the scenarios for sugar – a stronger real with falling sugar. The lower import cost of gas in reals creates an expectation of lower prices for hydrous.

May/July spread trading at 4-point premium could, according to a broker, encourage delivery of over a million tons against May/2015 next week. The market will come up against difficulty sustaining itself at current levels if this huge expected delivery really happens besides the fact that the funds have reduced two positions by 12,000 contracts (buying NY) and the market has had little response in terms of price. It hasn’t been easy for anyone.

If the dollar and the oil appreciate, ethanol will turn more competitive and less Brazilian sugar will be made available for the export market, driving up prices in NY. If the oil goes up and the real appreciates against the dollar, oil imports in reals will stay unchanged and the sugar market will be more sensitive to the arbitrage with price tendency in NY between neutral and bearish. If the oil falls, but the dollar appreciates against the real, it will be neutral for ethanol (which does not change its parity in reals with gas) and bearish for sugar up to the profitability limit of hydrous. Finally, if both oil and dollar devalue, it will be bad not only for ethanol but also for sugar. Even being totally conservative in pondering this matrix, one can only notice that if this were a fight between bulls and bears, at current levels, it would be a technical tie with the bulls winning by one point (more due to exogenous factors - dollar and oil - than sugar).

What can change this? Is it sugarcane harvest size below 570 million tons, surprises coming out of China and Thailand, delays in crushing and carrying? This is not what one can call a hassle-free world.

By means of a presidential decree to be applied as of July 1, the government will charge a 4.65% tax on gains from financial operations, even those made for hedging purpose. That is, imagine a mill protects itself for the 2016/2017 harvest, selling May/2016 at 14.81 cents per pound and at the same time hedging that currency which for that maturity would be at 3.2650. These operations are absolutely normal and common, and we have discussed the importance of mitigating risks and so forth over and over again here. Well, converting the hedge above, we reach R$1,109 FOB equivalent per ton.

Let us assume that at this operation’s maturity next year, the market is trading exactly the same value in reals per ton changing NY and keeping the final value. If NY gets to 16, for example, the dollar trading at 3.0222, the mill will pay tax on the difference between 3.2650 and 3.0222. Thus, the hedged value of R$1,109 the mill thought to be net and right, falls to about R$1,105 – the sector is getting ripped off again. The mill will have to hedge and hope that the exchange market goes against it, since that’s the only way there won’t be any tax. This is a stupid measure - just how PT (Workers’ Party) likes to run things, throwing the logic out of the window and deteriorating the idea of risk mitigation. In the example above, should the same pattern be the same for other operations, assuming a 24-million-ton export, the sector would pay out another R$92 million on tax. Just think of the size of the hole if we consider all the other exported commodities by Brazil. Someone must help cover the fiscal deficit created by the government.

The balance sheet released by Petrobras, showing a record loss, is a slap in the face of all Brazilians. When in world history has a listed company, which had already been international reference of competence, ever included in its balance sheet losses of R$6.1 billion related to corruption? Brazil has hit bottom when it comes to morality. For twelve years, we have been watching a totally mediocre government, which excels in corruption, shamelessness, big lies, lack of morality, lack of shame, ruling a party which is a truly criminal group, who just won’t let go of the power so soon, and will keep on turning the country into a Venezuela. And realizing that the investigations carried out so far haven’t yet dug up the intellectual mentor, the big boss. It takes a lot of patience to deal with these scumbags!