Ethanol, Sugar And One Incompetent Government

The NY sugar market closed the week lower, reaching new lows for May/13 (17.56 cents per pound) closing the week at 17.66 cents per pound. The drop in the shortened week, due to the Easter holiday, was 54 points (11.90 dollars per ton) for May/13 with variations between 12 and 51 points along the price curve.

Quarterly Accounting
The bears were happy with the new lows fomented mostly by the melting of the grains that ended up spilling over all the commodities, including sugar. Wheat, soybeans and oat dropped more than 4% on Friday. We should not discard the fact that it was the last session of the quarter and some funds had to even their books adjusting them for the next quarter, realizing profits and/or taking losses. It is reasonable to think the market will open higher Monday.

The Brazilian central bank signaled that the government will increase gasoline prices by another 5%. If this happens, the parity with ethanol goes up more, which leaves sugar at 17.50 cents per pound, an excellent buying opportunity or at least a level that may be too risky for fresh selling to occur at the exchange.

Lousy Returns
One year ago the contract with May/13 expiration traded at 24.35 cents per pound, near the high of the contract that reached 24.75 cents. From that point on, this month has seen a drop of 27.5 %. Even if we utilize financial instruments such as the NDF of sugar -- in reals, a model offered by some banks that enables the mills to fix their sugar in the NY market converted in reals per bag -- we see that the next three expiration months of May, Jul and Oct 2013 bring a net return that is lousy.

The cash and carry for sugar from Jul/13 to Oct 13 and from Oct/13 to Mar/14 reflect an annualized rate of 10.5% and 12.4% respectively, based on the closing prices for these months. Irrespective of the fundamentals for these months, be it for the greater supply of producing countries that compete with Brazil, the fact is that a rate of this magnitude attracts the receiving of sugar for July, making us believe that these spreads are really interesting to be purchased.

To receive the sugar on Jul/13 at 17.70 cents per pound and resell it on Mar/14 for 19.05 translates to a 135 points difference (11.66% annualized). While in 2005 Brazil was producing 16 billion liters of ethanol, the USA had a production of 14 billion liters.

The then president George W. Bush determined that the volume of ethanol production be increased so that the country could depend less on fossil fuels. In the following year, headed by the MIT, a commission was formed to delineate a program to be put into practice with goals up to the year 2060 (!!).

This year, Brazil will produce 27.436 liters of ethanol while the USA will produce 56.354 liters of corn ethanol, according to the Renewable Fuels Association. In eight years, we have grown 7% per year while our brothers from the North have grown 19%.

One can raise a banner here and say that all of that growth was due to enormous subsidies given to corn producers.

I remember an edition of The Economist that had a cover page saying that we had “The end of cheap food”, an allusion to the negative effects that high oil prices were giving to corn production destined to ethanol amidst the unhappiness of cattle and poultry producers that use corn as animal feed and the food industry.

The U.S. Knows How To Execute
The fact is that the USA planned and executed. All remember the furor at the first Ethanol Summit in Brazil when Mr. Lula said that Brazil was the Saudi Arabia of ethanol. In Brazil, the political class is full of empty words.

Planning is something boring and does not gather votes. The execution depends on competent people. Several entrepreneurs dove headfirst motivated by that delirious statement of the then president in a moment that – as we have said here before – more importance was given to exaggerated and inconsistent projects on colorful Power Point presentations rather than rational Excel spreadsheets.

How many people invested what they had and did not have to expand their mills or even build new ones? The end of the story is sad since today, out of the 400 mills in Brazil, more than 70 are in a precarious financial situation due to the empty talk of irresponsible people like the above mentioned president.

Lula abandoned the sector as soon as the Pre-Sal was discovered, maybe by then seeing himself with the same totalitarian power of his guru, the late Chavez, burying Petrobras into dry oil drillings and dilapidating the value of that company that in the last 12 months alone has lost 25% of its value.

Innovation Has Helped
When we finally were able to demolish the tax barriers in the USA against the imports of Brazilian ethanol, thanks to the excellent work by the UNICA, under Marcos Jank management, we see ourselves in a position of importers of corn ethanol from that country due to the drop in production of sugar cane for two years in a row.

In other words, the sector makes an effort to innovate, working hard to overcome the adversities but has to count on the incompetence and damaging interference by the government and has the arduous task to have to deal with unqualified people representing the government, who do not know the basics of the commodities markets.

How can any company risk to put more money in a sector whose fate can be sealed by a stroke of a pen by a cyclothymic president or a minister of economy incompetent who forecasts a growth of 4.5 % for the GDP and delivers 0.9 % or still of an energy minister that cannot even pronounce correctly the word for light bulb in his own language? God, give us patience!