FEATURE: Brazilian biodiesel production at risk amid potential bearish policies

Brazil biodiesel market participants are still struggling to understand pricing and production dynamics amid changes in the tax environment and uncertainties about imports and mandates three months into a shift away from auctions.

In a tentative bid to reduce fuel price for consumers, the federal government on March 11 announced waivers of the Pis and Cofins taxes on Brazilian biodiesel until Dec. 31.

The Pis and Cofins taxes were Real 148/cu m, independent of the feedstock used and the production locations. However, some additional discounts were granted for biodiesel produced from feedstock bought from local farmers, the ones with a "social" tag, lowering the total tax to Real 58.24/cu m, while feedstock sourced from Brazil's North and Northeast regions that tax could be eliminated altogether.

The Brazilian biodiesel program has the development of the small scale farmers as one of its main pillars, leading almost all biodiesel producers to source a large share of their needed feedstock such farmers.

From the total 369,986 cu m of biodiesel delivered to distributors in January, 99.74% had the social tag linked to it, according to national petroleum and biofuels agency ANP data. Considering that proportion of biodiesel sold with the social tag, most producers were paying less than the Real 148/cu m of Pis and Cofins taxes.

Commercial agreements

While almost no producers were paying the full Pis and Cofins taxes, a reduced mandatory blend to 10% from the initially-expected 14% and rumors of imports being allowed in April -- nine months earlier than expected -- added pressure.

On March 18 the S&P Global Commodity Insights' Platts Brazilian Biodiesel DAP Paulinia was assessed at Real 7,335/cu m on, down Real 140/cu m on the day and at the lowest level since March 9 when it was assessed at Real 7,295/cu m.

The price drop reflected the lacking luster demand in the spot market and plunging FOB Paranagua soybean oil price.

S&P Global assessed Brazilian FOB Paranagua soybean oil for May loading at $1,615.77/mt on March 18, a $73.63 drop on the day and at the lowest level since Feb. 25.

In that selling pressure scenario, distributors with term contracts for March-April delivery started to negotiate a discount equivalent to Real 148/cu m in the final biodiesel price with producers.

Multiple stakeholders from the buy and sell sides have already confirmed a wide acceptance to discount the full Pis and Cofins, even in a scenario of some producers decreasing their profit margins to reach that full discount.

"Some producers initially proposed a weighted average discount of the Pis and Cofins taxes equivalent to the share of feedstock sourced from small scale farmers, but all ended up agreeing to apply the full Real 148/cu m discount," said a large fuel distributor.

Most producers are agreeing to apply the full Pis and Cofins tax waivers to their term contracts to maintain good commercial relationships, even in when the majority were not charged the full amount by the federal government prior to March 11.

Biodiesel delivery pace

Even with the volume settled under term contracts for the two first cycles, January-February and March-April, suggesting that distributors are buying more than 100% of their compulsory targets, the actual volume loaded has been much lower.

"We have been performing the right to load 10% less than the total volume contracted," said a large distributor, adding that in mid-March buyers were still nominating cargoes bought for February delivery.

According to distributors, the high diesel price for consumers combined with a closed import arbitrage limited total diesel sales, reducing the pace of biodiesel needed.

The impact for producers has been extremely negative as they do not have any expectations of when the biodiesel will be indeed delivered and therefore paid. In addition to the cash flow impact, the lack of storage capacity and the slow pace of demand has jeopardized the trading strategy, as some sellers need to enter the market to avoid interrupting production.

Market participants consider biodiesel storage capacity equivalent to one to five days of production, where five would be possible for two large producing groups.

Amid uncertainty regarding the Brazilian biodiesel program standards, 11 producers who had contract targets imposed by ANP for the March and April delivery period decided to not reach it, up from seven producers in the January and February period.

Companies who have the possibility to convert soybean oil production toward exports are suggesting that they will not produce biodiesel while the feedstock export possibility pays a premium over the domestic biodiesel market.