Commodities 2021: Currency volatility continues to shroud direction for Brazilian ethanol prices

Volatility in the exchange rate between the Brazilian real and the US dollar exchange rate will continue to drive Brazilian ethanol mills' decision making in 2021 to prioritize sugar or ethanol production.

"An appreciation of the Brazilian real closer to 4.00/$1 will swing the premium to favor ethanol production by approximately 50 – 100 points over sugar production assuming current sugar and ethanol prices remain stable," said a Sao Paulo-based trader. "On the other hand, a depreciation from the current exchange rate level will ensure sugar production is favored."

If ethanol production starts paying a healthy premium over sugar production, the majority of flex mills will switch to maximum ethanol production over sugar production, thus taking thousands of metric tons of potential sugar supply out of the market and increasing the future ethanol supply by millions of liters.

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The Brazilian real against the US dollar exchange rate will also decide the volumes of ethanol imported into Brazil from abroad and ethanol volumes exported from Brazil due to arbitrages opening and closing in international ethanol markets.

The Brazilian real in 2020 experienced tremendous volatility testing record low exchange rate levels, which solidified the sugar production premium over ethanol production and closed the import arbitrage for ethanol by a wide margin.

The Real/$1 exchange rate started 2020 at 4.0196/$1 on Jan. 1, depreciated 47.52% to Real 5.9297/$1 on May 13, and since appreciated 11.6% to 5.2401/$1 on Dec. 28.

The most recent price data of the Brazilian Real/US dollar exchange rate has a current 100-day historic volatility of 18.05% compared to the US Dollar Index having a 100-day historic volatility of 5.29%.

An 18.05% 100-day historical standard deviation points to the probability that the Brazilian real within the next 100 days could potentially experience a 18.05% price move, either an appreciation or depreciation against the US dollar. This would mean a real-to-dollar exchange rate potential trading band of Real 6.19/$1 to Real 4.29/$1 in the next 100 days.

Sugar production premium over ethanol production

Brazilian mills (flex mills) have the unique ability to make minute adjustments in the ratio of their ethanol and sugar production based on which product is paying the highest market premium. These quick adjustments implemented by hundreds of flex mills situated in the Center-South can increase or decrease the potential supply of ethanol in the millions of liters and affect the future sugar supply in the thousands of metric tons.

"Mills in the Center-South will continue to maximize their sugar mix in the near term because sugar production is paying much better than ethanol production and the demand for ethanol remains below 2019 levels because of the spread of the coronavirus in Brazil," said a second Sao Paulo-based trader.

Although sugar production will be maximized in the near term, appreciation of the Brazilian real against the US dollar exchange rate could change this scenario.

Petrobras ex-refinery gasoline price movements

Market participants use Petrobras ex-refinery gasoline price increases as a discounting mechanism for ethanol prices because the gasoline price increase ultimately felt by consumers at the pump will put pressure on hydrous ethanol prices in the near term.

Consumers with flex-fuel vehicles can fill their tanks with either gasoline, which has a blend of 27.5% anhydrous ethanol, or E100. Consumers generally fill their tanks with E100 only when its price is 70% or less than the gasoline price, because of hydrous' lower energy content. Any changes in the ex-refinery price of gasoline can alter this delicate price balance.

Petrobras made 45 ex-refinery gasoline price changes during 2020 with the vast majority having a major effect on ethanol prices and this trend is expected to continue into 2021.

Petrobras utilizes a fuel pricing policy, which include international energy and foreign exchange components, to ensure Brazilian domestic prices are in line with international markets.

The import parity price for imported gasoline is a moving target and any large price movements in the international energy markets or the real/dollar exchange rate will be followed in the near term by an equivalent Petrobras price change for ex-refinery gasoline.

"If international energy markets including ICE Brent Crude and NYMEX RBOB futures priced in USD continue to increase, the Petrobras average gasoline price at refineries will likely continue to increase, thus increasing competitiveness for ethanol at the pumps," said a third Sao Paulo-based trader. "On the contrary, if international energy markets decrease in price, Petrobras average gasoline price at refineries will likely decrease thus decreasing the competitiveness for ethanol."