In September the average advantage of hydrated ethanol in the Brazilian physical market over New York sugar, in cents per pound, inside of mills (price evaluation of the driver contract on NYSE) was 16.52%, down 6.49% from the immediately previous month, when, in August, the biofuel was 23.01% more profitable than sugar in New York. This decrease of practically 6.5% in just a month did not stem from the decline in hydrated ethanol prices in the physical market. Quite the contrary, trading levels remained practically stable throughout the month at BRL 2.13 a liter, with some occasional deals even at BRL 2.15.
The drop in arbitrage levels between August and September clearly stemmed from the change in the New York driver contract from October 2019 to March 2020, well before the expiration of this asset. Historically there has been a trend of “alignment” between prices of the first and second screens on the New York exchange when the driver contract migrates between these two positions. However, in this specific case between October/2019 and March/2020, an unusual “gap” movement occurred between the oscillation bands of the two assets. This is because at the moment of change in the driver position, while October/2019 oscillated around 11.00 cents, March/2020 oscillated around 12.00 cents. This sharp increase in the driver’s price ended up lowering the arbitrage level of hydrated ethanol here in Brazil, to the already mentioned average level of 6.5% over the month average. On the day the reduction was even sharper, with the arbitrage going from 29.81% to 15.11% between September 11 and 12, with a negative daily adjustment of 14.70%.
Since then there has been some stability or a new range of arbitrage premiums, from 15% to 7% depending on the day, with the calculation already taking into account the new driver contract in New York, March/2020. In the meantime, we must not forget the exchange rate, which, with a weak real against the dollar in Brazil, was also a major vector of negative pressure on the arbitrage between ethanol in the physical market negotiations and New York sugar. Prices between BRL 4.15 and 4.18 neutralized a major advance in ethanol’s advantage over sugar, almost as much as the change in the New York driver contract and almost as much as the raise n the price level from 11.00 to 12.00 cents. On the other hand, as we mentioned before, the “damage” was not only greater in the face of stability and even slight support for hydrated ethanol negotiations by the end of the month, because in the general average of the period there was even decline. Otherwise, we could have even negative arbitrage levels for ethanol. But this scenario is little feasible given the continued high demand for the biofuel, relatively low stocks, and the recent 2.5% hike in gasoline, with a weak real against the dollar also indirectly helping keep hydrated ethanol prices on the rise, although that undermines the gains in the arbitrage calculation.
Briefly reviewing 2019, we see average gains of hydrated ethanol between the low of 9.92% in June and high of 23.01% in August. With a fall of 16.52% in September, we have similar patterns to those observed in May and February this year, moments of arrival of the sugarcane crop. The 2.76% decline of the real against the dollar during September (from BRL 4.0146 in August to BRL 4.1254 now in the September closed average) ended up neutralizing an important part of the increase in the advantage level of hydrated ethanol traded in the Brazilian physical market when converted into cents per pound. Besides, there is the growth of prices of the New York sugar driver contract in the margin, which increased from 11.59 to 11.78 cents a liter, 1.61% higher. Then we had a drop in the monthly average of hydrated ethanol from BRL 2.13 to 2.11 a liter, 0.84% lower.
It is important to remember that this arbitrage value of 16.53% is the average of premiums during the month of September, because looking at each day individually we can find moments of minimum premiums of 7.15% (on September 25) and maximum of 29.81%, on September 11, ironically one day before the change of the driver position from October 2019 to March 2020. Between the beginning and end of the month, hydrated ethanol in the physical market ended up rising from the level of BRL 2.06 to 2.14 per liter, with taxes. The monthly average value of hydrated ethanol of BRL 2.11, less 12% of ICMS in São Paulo and BRL 1.309 of PIS/Cofins and converted into cents per pound, with an average dollar of BRL 4.1254 in the period, equaled 11.83 cents, still 1.45% above the average of 11.66 cents of this asset in the same period last year, with freight discounts, elevation and FOB conversion. On the 2019 average, the equivalent price of hydrated ethanol inside of mills fluctuates by 12.51 cents, but is 5.62% below the average of 13.25 cents accumulated during the same time last year.
In short, we can interpret that, in the margin, the devaluation of hydrated ethanol in reals (-0.84%), reduced to a decrease of -3.61% due to the devaluation of the real against the dollar in the period (-2.76%), still had positive arbitrage premiums, even in the face of the high in New York sugar in the same period (+1.61%), which inside of mills was expanded to +2.16% with the same downward movement of the real against the dollar, which resulted in a positive arbitrage for hydrated ethanol inside of mills by 16.52%, down 6.49% from the immediately previous month arbitrage of 23.01%, but below the year’s average of 17.62% and exponentially above the five-year average for the same period, which currently fluctuates by 2.46%.
SAFRAS & Mercado’s expectation for September 2019 was that the advantage of hydrated ethanol over sugar in New York would oscillate by 17.44%, being 0.92% above the official data for the period. For October 2019, SAFRAS & Mercado expects that the average price in reals for hydrated ethanol will fluctuate by BRL 2.18 per liter, outside of mills. Inside of mills it must oscillate around BRL 1.76 per liter in Ribeirão Preto. With an expected average dollar at BRL 4.16 against an average price of 12.60 cents for October/2019 in New York, which inside of mills must be equivalent to 11.02 cents, there may be a reduction in the advantage between hydrated ethanol and raw sugar in New York to a still positive level of 8.68%.