Petrobras: Too Good To Be True

The minister of Economy, Mr. Mantega, has postponed until next week the meeting that was to occur this past Friday, of the Petrobras Council, over which he presides, and where it would be discussed the new methodology for fuel prices so as to make them aligned with prices practiced in the international markets. Currently the fuel prices to consumers are being used as a tool to fight inflation, in a way that is so retrograde as the thinking pattern of the minister. Mantega has been resisting at full force to change this unsustainable situation for Petrobras. It was too good to be true.

Due to this weak posture, in contrast to the arrogance exhibited by him and his cohorts, Petrobras loses, since it imports gasoline at higher prices than it sells to fuel distributors. The taxpayers also lose, since they are financing this subsidy given to gasoline, whether they own automobiles or not. The sugar and ethanol sector is losing as well, since it cannot plan the future of their industry while there is a subsidy to gasoline prices. According to some estimates, the increase of fuel prices (gasoline and diesel) would reinforce the cash flow of Petrobras by 50 billion reals, extremely needed to them who are planning investments of 240 billion dollars to 2017.

The NY sugar futures market, as it is expected, ended up reflecting not only the cold shower mentioned above, but also the apathy of the export markets. Even with the Environmental Protection Agency – EPA – in the US announcing a reduction on the utilization of biofuels for 2014, which means less space for the Brazilian ethanol exports to that country, there was not a lot of impact as first thought. The internal market in Brazil has a lot of space to absorb totally the ethanol production in Brazil for the next crop, especially if the so called methodology mentioned above is introduced.

According to the calculations by Archer Consulting, even by limiting the ethanol exports for next year to 1.25 billion liters, assuming that percentage of flex vehicles that utilize the ethanol remains unchanged, as well as the participation of Brazil in the international markets, and the internal consumption is also unchanged, we will still need to crush in 2014/15 approximately 617 million tons in the Center-South, very close to the crushing capacity that is close to 624 to 630 million tons. There are optimistic “forecasts” for the next crop that are showing up to 630 million tons.

NY closed the week quoted at 17.39 cents per pound, lower 16 points (3.53 dollars per ton) for Mar/14. The other traded months, with the exception of May/14 that closed basically unchanged, all closed slightly higher, between 6 to 18 points (1.30 to 4.00 dollars per ton).

The sugar production costs as per the Archer Model is R$ 34.4840 per bag ex-mill. The anhydrous production cost is R$ 1.1242 per liter and the hydrated is R$ 1.0792 per liter, both ex-mill. The contribution margins are good, had it not been for the high financial cost for the mills. For the well capitalized ones, the estimate for operational gains (market less production costs, without financial costs) is around US$ 6.57 per ton of crushed sugar cane. In rough terms, the operational gain of the sector is R$ 8.5 billion while the financial costs, according to a financial institution, are at R$ 8.8 billion per year.

The historical volatility annualized for the market in the last 50 days is 21.34 %. The 100 days is at 18.33 % and the 200 days is 18.75 %. There has been a slight alteration in the short term with more participants being worried about a possible price increase due to bullish factors which are still incubated, but can emerge at any time. As an illustration, the market oscillation in the last 50 sessions was 343 points. The 100 days had an oscillation of 423 points, the same as the 200 days. This is really a boring market. The oscillation record for 200 days is 5.440 points (!) between Nov 21th1974 and Sep 11th 1975 (from 11.60 to 66.00 cents per pound!!!).

The number of open contracts in the futures market for hydrated ethanol at the BM&F Bovespa is today around 3.30 lots, which is very little considering the hedging potential that this market can demand. It is likely – if Petrobras approves the new methodology to adjust fuel prices – that we will have a substantial growth in the ethanol trading at that exchange. The operators for over the counter deals, will be able to in a not too distant future, create hedging operations of derivatives that will take in consideration the WTI in NY, the ethanol at the BM&F and the dollar. I believe this market will be even more sophisticated once the professionals begin to better understand how the protection mechanisms in the market work. A free market, without the government interference, will enable the existence of products that will attend even the hedging of the production mix. We have lots of room to grow still.

Only to register it, the gasoline price in Brazil today if it were following the international parity, would be R$ 3.157 per liter at the pump, a difference of at least 10 %. This is the reason for Mr. Mantega fears.

Have a good week everyone.