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Outlook 2017: Brazilian Ethanol Prices Rise on Lower Output in 2016-17 Season

Brazilian sugarcane growers favored sugar production over ethanol production during the 2016-17 Center-South crop season, encouraged by higher prices for the sweetener in the international market.

From April 1 -- when the 2016-17 sugarcane crop season started in the world's largest producing region -- to December 21, the average price spread between sugar for export and ex-mill hydrous ethanol was 4.52 cents/lb ($99.65/mt), or 1,358% more than in the same period of 2015, when the average spread was 0.31 cent/lb, according to S&P Global Platts data.

From April 1 through December 1, the amount of sugarcane crushed in the Center-South region totaled 581.7 million mt, up 3.9% year on year, the latest data from industry association UNICA showed. From the cane crushed, 53.25% was allocated to ethanol so far this season, compared with 58.56% last season.

This shift caused hydrous ethanol production to fall 10.91% year on year to 14.0 billion liters, while anhydrous ethanol output rose 4.87% to 10.4 billion liters.

What Drove the Price Increase?

Higher international sugar prices, triggered by a global sugar shortage, also proved to be supportive for Brazilian ethanol prices. The average price for hydrous ethanol ex-mill Ribeirao Preto from April 1 to December 21 was Real 1,844.31/cu m, a rise of 18.81% year on year.

However, recent forecasts by analysts showing a world sugar surplus for the 2017-18 crop year, which starts in October, have been pushing down prices in the New York No. 11 futures market.

Since the start of the 2016-17 global sugar crop year, the highest No. 11 sugar futures settlement was 23.81 cents/lb on October 5, 2016, but in the last three months, No. 11 futures have plunged more than 5.61 cents/lb, or 23.56%, to settle on December 21 at 18.20 cents/lb.

While support from sugar shrinks, ethanol has gained some support from a an announcement by Brazilian state company Petrobras on December 5 that it would raise diesel prices ex-refinery by an average of 9.5% and gasoline prices by an average of 8.1%.

What 2017 Will Bring to the Ethanol Sector

The difference between exported sugar and ethanol prices has been gradually narrowing, reaching parity at one point before widening again. Ethanol still pays about 114 points below sugar, but because mills have maximized sugar production to the detriment of ethanol production as intercrop season nears and stocks are low, this could add support to ethanol prices.

The news that gasoline prices were set to increase also supported ethanol prices, particularly hydrous ethanol, which competes directly with gasoline at the pump. Hydrous ethanol needs to be about 70% of the price of gasoline to compensate for its lower energy content and be more attractive for drivers of flex-fuel vehicles, which operate on gasoline, hydrous ethanol or any mixture of the two fuels.

On December 6, the day after Petrobras announced the gasoline price increase, ethanol producers immediately raised ex-mill prices.

"Considering the tightness in the hydrous ethanol stocks we cannot gain competitiveness against gasoline at the pump, so we saw a great opportunity to increase ex-mill prices despite the lack of buying liquidity," a sugar and ethanol producer said of the move by Petrobras.

From January 1, 2016, to the week ended December 17, the average price parity in the Southeast region was at 70.7%, up from 65.7% in the same period of 2015.

Brazilian Otto-cycle demand, or demand for gasoline and ethanol from spark ignition engine vehicles, is estimated to drop 1.3% in 2016. Ethanol will account for 36.3% of total Otto-cycle demand, compared with 39% in 2015.

Ethanol prices could also follow the upward movement in gasoline prices, as production might fall further. Ethanol production for 2017 is expected to be 26.855 million cubic meters, down 5% from 2016, according to forecast from Kingsman, Platts' agricultural analysis unit.

International Trading

As a result of lower ethanol production, the Brazilian role in international trade flows has started to change.

Brazilian ethanol imports in November were the highest since January 2012 at 139.6 million liters, up 94% from October and up from just 10 million liters in November 2015, data from the Secretariat of Foreign Trade (SECEX) showed.

Although ethanol consumption has fallen in Brazil, the regional production is not enough to meet the demand, and imports are expected to increase next year.

Kingsman estimates imports of 762,000 cu m in 2016 and 1.56 million cu m in 2017, a 105% increase in imports year on year. By region, 750,000 cu m is expected to go to the Center-South and 810,000 cu m is expected to go to the North-Northeast.

Until Brazil can bring its sugarcane crushing back online, the U.S. is likely to remain the primary provider of fuel ethanol. Through November, the U.S. has exported 657.1 million liters of fuel-grade ethanol to Brazil, according to U.S. Census Bureau data. So far this year, exports are well above the 2015 total of 440.3 million liters.

Meanwhile, typical buyers of Brazilian product, such as South Korea, will need to adapt to the new price levels or look for a new supplier, as exports dropped due to the uncompetitive nature of Brazilian ethanol on the international market.

From April 1 to December 21, 2016, Platts' assessment of Grade B FOB Santos climbed 21.37% year on year to $551.08/cu m. On December 20, the Grade B assessment for 20-30 days forward loading, FOB Santos, settled at $637/cu m, up 12.15% from Platts' Grade B CFR Ulsan assessment at $568/cu m, signaling a closed export arbitrage.

Producers Could See Higher Prices in 2017

Brazilian ethanol producers have a chance to increase the profit margin on ethanol due to higher domestic prices, which for many small producers was seen as light in the end of the tunnel.

Following a financial crash five years ago, the Brazilian mills that have survived see an opportunity to revive production as the local fuel price policy becomes more transparent and the Brazilian economy shows small signs of recovering.

Not even the reinstatement of the PIS and Cofins taxes at Real 0.12/liter on hydrous ethanol, to be charged to mills as from January 1, has been seen as a bearish sign.