Feature: Center-South Brazil hydrous price loses implied premium on possible supply shortage

Strict quarantines in March have caused a precipitous fall in hydrous ethanol prices from a record high price earlier in the month, effectively removing the implied premium initially caused by a potential supply shortage.

"Hydrous ethanol prices have dramatically decreased in a short period of time because of the lower likelihood for a supply shortage in early April and newly instituted Petrobras gasoline price cuts," said a Sao Paulo-based trader. "Demand for hydrous ethanol had been expected to outstrip supply by an estimated 350,000–450,000 cu m during the second week of April, but the possibility of this scenario has greatly diminished."

Hydrous prices had tremendously increased from Feb. 5 to March 2 because of a possible supply shortage in early April due to a two-week delay to the start of the sugarcane harvest because of unevenly distributed rain in the Center-South from September 2020 into January.

S&P Global Platts assessed Center-South hydrous ethanol at Real 2,805/cu m on March 24, down Real 790, or 22%, from the most recent high of Real 3,595/cu m on March 5. The Center-South hydrous ethanol price is up 13.3% so far in 2021.

Sao Paulo has implemented urban driving restrictions to limit the movement of citizens and remained in the purple phase of coronavirus quarantine, as of March 25, the strictest level for the state. Under this quarantine phase only essential sectors of the economy will function, such as pharmacies, supermarkets, gas stations and public transportation.

The cities of Sao Paulo and Rio de Janeiro have planned a weeklong holiday from March 26 to April 4 to try to reduce the spread of coronavirus and associated intensive care unit utilization rates.

The anticipated decrease in light-duty vehicle use resulting from the lockdown and the associated drop in ethanol demand has contributed to a 22% decline in the price of hydrous ethanol.

"March hydrous ethanol sales in the Center-South should show a drop between 20%-30% on the month," a second Sao Paulo-based trader said. "March hydrous ethanol sales in the Center-South had been pegged around 1.6 million cu m before quarantines were implemented, but now should be around the 1.10 million-1.30 million cu m level."

Distributors have been utilizing existing ethanol inventories to supply their distribution network rather than make new ethanol purchases in the spot market until there is further clarity to how greatly near-term demand will be affected.

"The scenario of a supply shortage in hydrous ethanol is waning because of countrywide strict quarantines and the associated drop in ethanol demand should enable stock levels to remain at comfortable levels before the start of the harvest," said a third Sao Paulo-based trader.

Petrobras' second gasoline price cut in March

Petrobras instituted an average gasoline price decrease of 3.99% at refineries March 25.

Petrobras has decreased its ex-refinery gasoline price by 8.7% in the past week due to weakness in international energy markets. The first price decrease in 2021 occurred at refineries March 20.

Market participants use Petrobras' ex-refinery gasoline price increases as a discounting mechanism for ethanol prices because the gasoline price decrease ultimately felt by consumers at the pump will pressure hydrous 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 hydrous ethanol, 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 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.

Petrobras had increased ex-refinery gasoline prices around 53% in 2021, which had given massive support to hydrous ethanol prices in the first few months of 2020 because of an increase in consumer demand for cheaper hydrous ethanol.

Currently the Petrobras ex-refinery gasoline price is up 40% in 2021.

BM&F hydrous forward curve flips to contango

The Brazilian Commodities and Futures Exchange's forward curve is in a state of contango because stricter quarantines throughout Brazil have caused a massive drop in near-term demand for hydrous ethanol and alleviated fears over a supply shortage. The deeper the hydrous ethanol forward curve falls into contango, the lesser the immediate demand is for hydrous ethanol accompanying an increase in supply.

Starting in early February the front-month hydrous price had risen in a far greater magnitude than later contract months due to fears over an ethanol supply shortage in the spot market in early April, leading to a steep backwardation of the hydrous futures curve.

The supply shortage scenario which drove the price of hydrous ethanol to a final crescendo during the week ending March 25 has now been removed from the hydrous forward curve.

"The hydrous ethanol supply in the Center-South is expected to cover demand through the end of April," said a Rio de Janeiro-based trader.