KEY ISSUES FACING BRAZIL S SUGAR AND ETHANOL INDUSTRY

Transcription

1 KEY ISSUES FACING BRAZIL S SUGAR AND ETHANOL INDUSTRY May 24, 2018

2 CONTENTS INTRODUCTION... 3 THE BRAZILIAN SUGAR MARKET... 4 International Sugar Prices Outlook... 4 New Technologies and Practices Decrease Brazilian Production Costs... 5 THE BRAZILIAN ETHANOL MARKET... 6 New Fuel Pricing Strategy... 6 RenovaBio, will strongly impact long term demand for Ethanol... 9 THE ROLE OF BIOELECTRICITY AT THE SUGARCANE INDUSTRY SUSTAINABILITY IN THE SUGARCANE INDUSTRY CONCLUSION SOURCES Page 2

3 INTRODUCTION Sugarcane in Brazil is a highly versatile crop and an important part of Brazil s economy. Sugar is Brazil s fourth largest export with $8.1 billion of proceeds (4.4% of total exports), and sugarcane is the number one source of renewable energy in Brazil, supplying almost 17 percent of the country s total energy consumption. This paper will discuss sugarcane s key components: sugar, ethanol, and energy production, and the market forces and government policies that shape their present as well as their future. Sugar has been a leading activity for Brazil and an important export of Brazil since the country s founding. The Portuguese first planted sugarcane in Brazil during the 1530s. Since then, sugar has been an integral part of Brazil s social, political and economic history. Brazil is now the world s leading sugar producer and exporter, accounting for approximately 20 percent of global production and more than 40 percent of world exports. Approximately two-thirds of the sugar produced in Brazil is exported with the rest consumed domestically. Ethanol now accounts for almost 40% of light vehicle fuel needs in Brazil. All gasoline sold in Brazil includes a blend of 18 to 27.5 percent ethanol. 90 percent of new cars sold today in Brazil are flex fuel due to consumer demand, and these vehicles now make up about 70% of the country s entire light vehicle fleet. As a result, Brazilian consumers have a choice, between sugarcane ethanol and gasoline every time they fill up. This choice can play an important role in determining the supply of sugar (and its price in world markets). Surplus electricity is generated by ethanol mills, which is sold to distribution companies. For centuries, sugarcane fields around the world have been burned to eliminate the straw, making it easier for workers to cut the cane by hand. Doing so wasted one-third of the plant s energy. Mechanized harvesting eliminates the need for burning, so sugarcane straw can be preserved and its energy harnessed. In 2015, sugarcane mills supplied more than 20,000 GWh, or 4 percent of Brazil s electricity requirements. Experts estimate that sugarcane bioelectricity could reach 177,018 GWh by 2023, enough to cover 23 percent of Brazil s electricity needs, or enough to power an entire country the size of Sweden or Mexico. Page 3

4 THE BRAZILIAN SUGAR MARKET International Sugar Prices Outlook Sugar prices have declined precipitously and unexpectedly this past year due to a surprising global surplus (See Figure 1). A good portion of that surplus is largely explained by the sudden increase of productivity in India and Thailand, where millers can count on government subsidies. The sharp decline in the price of sugar has caused a shift in sugar cane processing, towards a higher mix of ethanol in Brazil. Figure 1: End of day Commodity Futures Price Quotes for Sugar #11 (One Year) The question today is whether sugar production is viable at today s international market price. In most parts of the world, producing sugar at today s prices is uneconomical unless subsidized. It is precisely these subsidies in other parts of the world, primarily India and Pakistan, that are causing the surpluses that has cause the sugar price to collapse. If some of the world s biggest producers continue with their policies, global output may take longer than expected to be adjusted producing a long-term effect on international prices. Page 4

5 It is questionable even if Brazilian sugar producers, as the worlds low-cost producer, can be profitable at today s prices. But Brazil has an advantage that no other country has: Brazil alone, among the major sugar exporters has the flexibility to shift some sugar production to biofuels (See discussion of ethanol below). That occurs because Brazilian biofuels are made out of sugarcane, while other countries use different commodities, like corn. Therefore, most of the Brazilian mills already have mills that allow them to make adjustments to their production mix according to international sugar prices, domestic ethanol prices and freight costs. New Technologies and Practices Decrease Brazilian Production Costs Over the period from 1975 until 2014 sugarcane yields in Brazil rose 52% to more than 70 tons/hectare. By 2014 the country was not only the largest sugarcane producer, but also the largest raw and refined sugar producer. The large amount of sugar produced opened exporting opportunities, including to other big sugar producers like China that has been facing raising production costs due to higher wages and lower levels of mechanization. Besides the investments in new technologies to help reduce costs, Brazil has a stable, warm and humid climate, which along with its good soil conditions make it the perfect environment for outstanding sugarcane productivity. For example, sugarcane in Brazil can be harvested every year until five to seven years while in other major sugar producers, such as India, plantations last for only two to three harvests. From 2008 to 2015 the Brazilian sugar and ethanol industry experienced adverse economic conditions, largely because gasoline pricing policy made ethanol uncompetitive. Substantial investments made in anticipation of a growing market, proved uneconomic, resulting in high levels of debt that were not serviceable. The result was a deteriorating asset base, the closure of many ethanol mills, and flat to declining ethanol production, despite government incentives to invest in new equipment. Nevertheless, the country was able to remain as a relatively low-cost sugar producer due to its natural advantages and investments in equipment and technology on new planting techniques that have reduced costs. One example of these unique advantages is São Martinho, which is one of Brazil s most important sugar and ethanol producers. The company is in the forefront of implementing a new sugarcane planting technology that is able to reduce its costs by 20%. The technique is called MPB (in Portuguese), which reduces the required amount of sugarcane to renew the field to 2 tons of sugarcane per hectare, while traditional techniques require 20 tons/hectare. This Page 5

6 difference is possible because MPB uses selected plague-resistant pre-sprouted seedlings that are orderly planted, instead of sugarcane cuts thrown in furrows like traditional techniques. THE BRAZILIAN ETHANOL MARKET New Fuel Pricing Strategy Ethanol has been increasing significantly its importance in the Brazilian domestic market. Several factors have been contributing to that new protagonist role, such as the rapid growth of flex fuel cars, which are expected to represent 86% of Brazil s total light vehicle fleet by 2020 (See Figure 2). Also, the country is experiencing an economic recovery process, which can be an important factor to drive energy demand up. Figure 2: Flex fuel cars in a market like Brazil represent a huge advantage to consumers, since they can chose directly at the pump which fuel is more efficient based on the prices at that given moment. For ethanol to compete with gasoline in terms of price, the price at the pump must be at least 30% below that of gasoline (due to the relative level of efficiency between the two fuels). At this moment, ethanol is priced approximately at 68% of gasoline s price, making it slightly more competitive. Page 6

7 A strong sign of the ethanol competitiveness in comparison to gasoline was observed in 2017, when the ethanol demand curve moved and the gasoline demand curve moved downward, because of the substitution of gasoline for ethanol at a 39% level. Such phenomenon impacts not only the energy sector, but also the sugar industry due to its close ties with the ethanol production. This boost in ethanol s demand is expected to cause a retreat in sugar production in Brazilian mills from 47,2% to 45%. Furthermore, in July 2017, the Brazilian government approved the increase of social security taxes on fuels, making gasoline R$0,41/liter more expensive, while ethanol prices were increased only R$0,12/liter, making the later more attractive in comparison to the first. Another relevant component in defining ethanol prices in the domestic market is Petrobras new pricing policy. As a state-owned company, Petrobras used to sell gasoline below international prices in an attempt by the government to control inflation. Such a measure, however, made ethanol production uneconomical, discouraging the production, forcing the shutdown of some mills and causing massive indebtedness that created a number of bankruptcies. For that reason, in 2016, domestic ethanol prices began to follow international Brent s quotations, pushing up its price (See Figure 3). This new pricing policy combined with the low sugar prices at the international markets should be some of the forces driving a production shift from sugar to ethanol in the near future (See Figure 4). Figure 3: Brent Crude Oil International Price Page 7

8 Figure 4: Brazil s Center-South ethanol production (billion liters): 11/12 18/19E The former pricing policy of Petrobras created a below market gasoline price in the domestic market, making ethanol uncompetitive and stagnating the industry. As ethanol has now become Page 8

9 competitive with gasoline, demand has increased, but domestic ethanol mills cannot meet the entire demand. Thus despite being the second largest ethanol producer, Brazil requires imports of ethanol from the U.S. to balance demand. The Brazilian Government approved last year a new 20% tariff on ethanol imports for volumes exceeding 600 million liters/year, in an effort to stimulate national production to satisfy local demand CHART ON PRODUCTION OF US RenovaBio, will strongly impact long term demand for Ethanol The RenovaBio Program, approved by the Congress in late 2017, is an important part of Brazil s new energy policy. The program s main goals are to stimulate the production and consumption of ethanol in the domestic market, and reduce the country s dependence on fossil-fuels to aid the country in meeting its pledge to reduce greenhouse gases under the COP21 Accords. The new initiative is not meant to be a subsidy or a carbon tax, but a market-driven mechanism to increase the contribution of biofuels to the final energy demand in a sustainable and environmental-friendly way. One of the important propositions of the program is to increase the mix of anhydrous in gasoline from current levels of 27% to 30% by 2021 and 40% by the end of Another objective is to increase ethanol s percentage of total fuel for light vehicles to 40% by 2021 and 55% by These goals should have a large impact on ethanol consumption since Brazil is the third largest consumer of transportation fuels (See Figure 5). Figure 5: Transports fuels consumption USA China Brazil India Japan Russia Page 9

10 One important factor regarding the implementation of the project is the fact that Brazil already has a fuel distribution system for hydrous ethanol, used as sole fuel, and anhydrous ethanol, blended at 27% with gasoline. The RenovaBio program is currently in the implementation phase scheduled to last until June of 2018 and the complete adoption is expected to occur at the beginning of In stimulating the large adoption of biofuels, Brazil is recognizing and taking advantage of the fact that biofuels are essentially, solar energy captured, stored and distributed in an efficient and safe manner, with an extremely lower carbon emission coefficient in comparison to other fossil fuels (See Figure 6). This feature is expected to help the country achieves the greenhouse emissions reduction agreed during the Paris Agreement. Figure 6: GHG Emissions for Different Options (WtW) Considering that, in order to help the country reach its target environmental goals by 43% by 2030, RenovaBio proposed the creation of carbon certificates that will be given to producers accordingly to the production volumes and pollution grades of their facilities. Those certificates Page 10

11 will be exchangeable at the financial markets and fossil fuel distributors will be obligated to buy them according to their market share. In creating a program that rewards producers who reduce GHG, the expectation is that this financial incentive will induce investments in greater efficiency, ultimately lowering the cost of producing biofuels by more than the cost of the carbon certificates. THE ROLE OF BIOELECTRICITY AT THE SUGARCANE INDUSTRY In Brazil, besides the traditional sugar and ethanol roles, sugarcane is also used to produce bioelectricity. This form of electricity is reached by burning sugarcane bagasse in boilers. As a result, mills in Brazil have reached their auto-sustainability and some of the most efficient ones are being able to produce even more electricity than their own needs, selling this surplus to energy distributors. At 2015, bioelectricity provided by sugarcane was responsible for producing GWh of electricity, which corresponded to approximately 4% of Brazil s total energy matrix. The projections, however, are hoping that this type of energy could reach 23% of the country s total energy matrix (or 177,018 GWh) by 2023 (See Figure 7), if all the potentials are well explored. Figure 7: Page 11

12 Compared to other electricity sources, bioelectricity is known to be more environmental friendly due to lower pollutant emissions. Another important aspect, specifically in Brazil s case, is the fact that it is complimentary to hydroelectric in the sense that the period when the larger amount of biomass from sugarcane is available coincides with the draught season, when dams often have to decrease their outputs (See Figure 8). Figure 8: SUSTAINABILITY IN THE SUGARCANE INDUSTRY Despite the positive sides of producing ethanol and energy from sugarcane, some sustainability concerns may arise whenever the proposal involves expanding the planted area. The first point that directly addresses sustainability issues is the capacity of ethanol to reduce drastically the emission of Green House Gasses since biofuels are essentially solar energy captured, stored and distributed in an efficient and secure manner, as stated earlier in this report. Another important aspect is that Brazil still has a lot of land to grow its sugarcane production without damaging the Amazon rainforest, its huge biodiversity and other lands designated to protection programs. The expansion is planned to occupy only degraded pasture lands, therefore no deforestation will be needed. Currently, only 1% of Brazil s territory, from a total of Page 12

13 7,5% authorized occupation, is destined to sugarcane production (See Figure 9), which gives a lot of room for the industry growth. Figure 9: In addition, new production techniques are being used in order to reduce the impact of this activity. Among the most important ones are the use of burning free crops, especially in the state of São Paulo, where 97,5% of the sugarcane production is free of burning techniques. Another important technique is the industrial reuse of water, which allowed a water consumption of 40% in the process. CONCLUSION Based on the data provided by this research, what can be observed is that sugar and ethanol markets have very distinctive outlooks for the near future. While sugar is facing an international crisis due to its lowest prices since 2015, ethanol is experiencing a fast increase in demand led by initiatives that promote the sugarcane or corn made fuel to replace fossil fuels as the primary energy source for the transportation systems. Page 13

14 Brazil has a key role in both markets. As the world s largest sugar producer the country is responsible for more than 40% of global exports. Besides, Brazil is the second largest producer of ethanol in the world, only lagging behind the US, which has corn-based production, while Brazilian ethanol is made out of sugarcane and most of the production is directed to the domestic market. The fact that Brazilian ethanol is made out of sugarcane has a positive outcome, since part of the technology used to produce sugar can be shared with ethanol production. During the past years, there were lots of ethanol mills closures and bankruptcies, due largely to Petrobras old fuel pricing policy that fixed the price of transports fuels below international prices. This policy, which helped to create unhealthy balance sheets, caused the stagnation of the ethanol industry in Brazil. However, with Petrobras revising its fuel pricing strategy and the Federal Government started creating actions to increase ethanol production and consumption, the industry is expected to rebound. Additionally, the low sugar prices and the lack of good perspectives for the near future, due to protectionist acts of other important sugar producers in the world, create an extra incentive for Brazilian mills to shift their operations, adding more ethanol to their production mixes in substitution of sugar. These changes are expected to increase the produced amount of ethanol comparatively to sugar by 2,2% during the 2018/2019 season. Also, the several incentives given by the Federal Government to stimulate the domestic ethanol production and demand help to mitigate eventual risks for investors. Some of these new policies include the new RenovaBio program, expected to increase the mixture of anhydrous in gasoline from 27% to 40% by 2030 and secure the complete usage of ethanol by 55% of the light vehicles fleet. In addition, 90% of the new cars sold in Brazil come equipped with flex fuel technology, giving to consumers the opportunity to choose between ethanol and gasoline directly on the pump rather than the showroom. The last important aspects are the electricity production that has been developing from the sugarcane industry. More than just an alternative source of revenues to the millers, the electricity produced from sugarcane accounts for 4% of the country s total energy matrix and it is expected to grow until 23% by Furthermore, sugarcane production in Brazil has lots of room to grow without compromising sustainability concerns, since new techniques are being adopted to reduce water utilization and the fact that the production currently occupies 1% of the country s territory, from a total of 7,5% authorized occupation. Page 14

15 Therefore, given all the indicators that the Brazilian ethanol industry is entering at a recovery phase, the initial cycle of this process may represent a good opportunity for investors, since there are still plenty of inexpensive distressed assets in the Brazilian sugarcane industry, and reduced risks due to favorable local bankruptcy laws and the flexibility to convert from sugar to ethanol production. Page 15

16 SOURCES Australian Department of Agriculture and Water Resources (2016). The Brazilian Sugar Industry. Retrieved from Citi Research Datagro. (2018). Producers Should Allocate More Sugarcane to Ethanol Production in 2018/19. Retrieved from Nastari, Plinio (2018). Santander ISO Datagro NY Sugar and Ethanol Conference World Sugar Supply & Demand for 17/18 and 18/19 (Oct/Sep). Shinzato, P. (2018). Sugar Global Balance Estimate. INTL FC Stone Inteligência de Mercado. Retrieved from Sugar Cane.org. Bioelectricity. Retrieved from Sugar Cane.org. Brazilian Transportation Fleet. Retrieved from UNICA (2017). Ethanol Summit. Retrieved from USDA Economic Research Service. (2014). USDA Sugar and Sweeteners Outlook. Retrieved from Page 16