In January the average advantage of hydrated ethanol in the Brazilian physical market over New York sugar, in cents per pound, inside of mills (price measure of the New York spot contract), was 11.86 %, down 6.0% from the previous month, when the biofuel paid 17.86% more than New York sugar.
This 6% decrease in one month was directly related to the gains observed with the driver contract in New York at the same time that the real was weaker against the dollar. Interestingly, the advances observed with hydrated ethanol in the physical market were not enough to neutralize the downward pressure on arbitrage premiums exerted by the appreciation of raw sugar and devaluation of the real.
SAFRAS & Mercado draws special attention to two important aspects of the issue of premium arbitrage. The first one is the clear trend of a switch from premiums to differentials to be observed in February, probably in the transition from the first to the second half of the month. Continued appreciation of sugar in New York due to devaluation movements of the real against the dollar are the key vectors of this movement, which is significant even in the face of occasional upward adjustments that hydrated ethanol may have in the physical market, which has not been the case in the short term, given its bearish trend even with the final stretch of the off-season and the earlier than normal start next season’s crush.
The second aspect stems from the historical comparison of the current level of premiums. Current levels of advantage of slightly more than 11% in hydrated ethanol negotiations over sugar are considered low even for the standards of season height when the average arbitrage for the biofuel fluctuates between 18% and 20% at times of weaker gains. Sometimes levels of 23% are also easy to observe.
However, against the off-season patterns, the comparison is even more strained since the average pattern of premiums of this period oscillates around 33% to 38% of advantage for hydrated ethanol, which is very different from the current level of 11%. Looking at the perspectives from SAFRAS & Mercado, we observe that the tension on premiums is once again reinforced given the still positive arbitrage level of just over 3% expected in February, and the change in the pattern for differentials to be observed in the daily evolution over this same period.
It is important to remember that this 11.86% arbitrage value seen in January is the average of the premiums during the month, because, looking at each day individually, we can find moments of minimum premiums at 6.22% (on January 22) and maximum values of 24.65%, registered on January 2. The average monthly value of hydrated ethanol in BRL 2.49, discounting 12% of ICMS in São Paulo and BRL 1.309 of PIS/Cofins and converted into cents per pound, with an average dollar at BRL 4.1525 in the period, was equivalent to USD/cents 14.06, still 1.78% above the average of USD/cents 13.82 observed in the previous month, already with freight discounts, lifting and FOB conversion. Last January average for hydrated ethanol in cents per pound posted gains of 15.67% against USD/cents 12.16 seen in January last year. On the 2019 average, the equivalent price of hydrated ethanol inside of mill fluctuates by USD/cents 14.06, which is also a value 15.67% below the average of USD/cents 12.16 accumulated in year-ago comparative period.
In short, we can interpret that, in the margin, the appreciation of hydrated ethanol in reals (+2.47%), reduced to gains of +1.78% due to the devaluation of the real against the dollar in the period (0.85%), even so had positive arbitrage premiums, albeit decreasing, even in the face of the sugar high in New York in the same period (+6.47%), which inside of mills was increased to +7.42% due to the downward movement of the real against the dollar, which resulted in an arbitrage of +11.86% for hydrated ethanol inside of mills.
SAFRAS & Mercado’s expectation for January was that the advantage of hydrated ethanol over New York sugar would hover around 17.44%, up 5.58% from the official data for the period. For February, SAFRAS & Mercado expects that the average price in reals for hydrated ethanol will fluctuate by BRL 2.53 per liter, outside of mills. Inside of mills, the average must oscillate around BRL 2.09 a liter in Ribeirão Preto. With an expected average dollar of BRL 4.29 against an average price of USD/cents 14.95 for the March/20 contract in New York, which, inside of mills, must be equivalent to USD/cents 13.40, we can have a reduction of the advantage between hydrated ethanol and raw sugar in New York to a still positive level of 3.12%.