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Analysis: Is European T2 ethanol bearishness on sugar impact overdone?

Highlights

The advent of the new sugar crop and overhaul of the European sugar regime in October are causing a stir in the European ethanol industry, as market participants expect to see some sugar-beet-based ethanol capacity return to the market.

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This bearish view is manifesting itself in the form of a steep backwardation in the ethanol forward curve of Eur59/cu m between the prompt and the fourth quarter.

Although there are some other bearish indicators for Q4, including the likely ramping up of the former Abengoa Salamanca ethanol facility, the lifting of EU sugar export quotas is one of the biggest changes in the European sugar industry in recent years and has brought the sugar-ethanol parity debate into sharp focus. The Salamanca plant's owners were unavailable for comment.

As sugar export caps are removed, European producers aim to ramp up their production, which is expected to be significantly higher with increased acreage planted to start with and with favorable weather conditions pointing to a bumper crop.



Kingsman, the agricultural analysis unit of S&P Global Platts, expects the EU to produce 19.798 million mt of white sugar in the 2017-18 season (October-September), 2.887 million mt more on the year.

The processing of the new sugar-beet crop should see some of the beets directed into ethanol production and as most of the sugar-ethanol facilities have been running at low rates for some time, with feedstocks depleted, the new crop will inject at least some fresh volumes into the market.

The expectation of increased ethanol supply in October is also reflected in the steep backwardation between September and October paper of Eur27/cu m.

However, some sources say there is a lot of hype on the subject and that the sugar effect on the European ethanol market will only be marginal because beet-based producers will still aim to maximize sugar production.

Apart from the one-off effect at the start of the new crop, producers' decisions further down the line will depend on whether sugar or ethanol is more profitable, and developments in Brazil are largely seen as preceding any switches from sugar to ethanol that could happen in Europe.

"Europe will not switch before Brazil switches," a source said, adding: "in Brazil ethanol has been at break-even to sugar for quite a while and still we have only seen a very small shift -- we are not there yet in Europe."

There have been only only minor adjustments in the Brazilian sugar mix, despite the recent rise in ethanol prices and the ethanol floor, which has narrowed the spread between hydrous ethanol and New York sugar futures over the course of July.

In the second half of July, producers in Brazil directed 49.67% of the cane toward ethanol production, up from 49.62% in H1 July. Over July 1-20, sugar paid on average 125 points over hydrous on a New York No. 11 basis, but over July 21-31, sugar paid just 48 points over, data from Kingsman, showed.

By comparison, in July last year, sugar paid on average 543 points more than hydrous.

However, over the last couple of weeks, a rise in ex-mill prices meant ethanol started paying more than sugar in Brazil, with the recent increase prompting producers to start talking about an expected shift in the mix toward ethanol.

Hydrous ethanol has been paying more than sugar since August 4, with the premium increasing to 113 points Tuesday.

Parity questions aside, market participants point to the fact that switching is not that easy from a commercial perspective, with contracts in place, while a lot of volumes are hedged in advance, making producers less flexible.

Overall, it is difficult to predict the precise change in European ethanol supply over the next few months, but fundamentals aside, market sentiment tends to amplify the effect, as is already partly captured by current forward pricing.

(This version of the story corrects the Kingsman EU white sugar production estimate in the fifth paragraph.)

--Chrysa Glystra, chrysa.glystra@spglobal.com

--Beatriz Pupo, beatriz.pupo@spglobal.com

--Edited by Jonathan Dart, jonathan.dart@spglobal.com