Industry Trend Analysis - New Biofuel Policy Adds Risks to Positive Sugar Production Outlook - AUG 2017

BMI View: Brazilian sugar production will continue on its moderate upward trend, driven by farmers ' preference for sugar over ethanol. Brazilian sugar producers will maintain their dominance on international markets through industry consolidation and technological improvements. Ethanol prices are unlikely to recover in the short term, due to strong competition from fossil fuel substitutes, but could surge if planned support policies are implemented by the current administration.

Brazil's sugar output is expected to increase slightly this season as the crushing season progresses. We have revised down our production forecast for 2017/18, to 38.9mn tonnes from 39.4mn tonnes and now expect output to rise by 1.0% y-o-y, compared with 2.2% previously. A significant decrease in cane planted area (-2.3%), led by the largest producing State Sao Paulo, will be offset by an increase in the share of Total Recoverable Sugars (TRS) diverted to sugar - from 45.9% in 2016/2017 to 47.1% according to CONAB forecasts - as well as some modest increases in sugarcane yields and sugar content. The increased share of cane diverted to sugar is due to a significant decline in ethanol prices since mid-2016, as flex-car owners switch to gasoline to take advantage of prices at multi-year lows.

Preference For Sugar To Continue
Brazil - Sugar Production ('000 tonnes)
f = BMI forecast. Source: BMI, CONAB, USDA

Looking at the upcoming 2018/19 season, our forecast is for sugar production to rise for a third consecutive year. We believe international oil prices will only rise modestly in 2018, which will be reflected at the pump in Brazil given the government's plan to grant more flexibility to Petrobras in its price-setting policy. Moreover, industry lobbyists are unlikely to meet with success in their request for a 17% tariff on imported ethanol. As a result, the outlook for ethanol in Brazil remains poor on a one-year horizon, which will support the output of sugar.

Effect of Weak Currency Will Wear Off
Sugar and Ethanol Prices, BRL
Source: Bloomberg, BMI

Declining sugar prices, combined with a large debt overhang from the pre-2008 investment spree, are putting pressure on sugar mills' company finances. The industry has therefore entered a phase of consolidation, characterized by:

  • Bankruptcy proceedings: a total of 73 (mostly medium-sized) mills filed for bankruptcy protection between Jan 2009 -Jan 2017 according to MBF Agribusiness data.

  • Investment: an increase in overall sector investment aimed at boosting yields and improving logistics infrastructure.

Creative Destruction: Inefficient Mills Sinking In Debt
No. Companies Filing for Bankruptcy Protection
Source: MBF Agribusiness

In line with these developments in the competitive landscape, the Brazilian bio-security authorities (CTNBio) approved, in June, the commercial use of the world's first strain of pest-resistant GM sugarcane. Increases in average company size, investment-driven efficiency gains and technological advances will lead to a steady expansion of Brazilian production over the next three years, driven by the companies that survive the current squeeze.

Prospect of Policy Support Overshadowed By Political Instability

One major downside risk to Brazil's sugar production and therefore upside risk to our sugar price projections to 2021 is RenovaBio, a policy support programme for ethanol. It was recently approved for debate in the National Council of Energy Policy. The proposed legislation would act in the following manner:

  • Fossil fuel distributors to be required to offset the carbon content of their sales by purchasing pre-established quantities of bio-fuel and carbon credits from certified producers.

  • Biofuels produced by each company to be assigned carbon credits in proportion to the expected emissions reductions associated with their use, as compared with gasoline.

  • The requirement to purchase carbon credits to increase gradually up to 2030, until the share of biofuels in the Brazilian energy mix reaches 18%.

RenovaBio would drive demand for ethanol in the medium- and long-term, encouraging sugarcane producers to divert more of their output to ethanol. Sugar prices would respond on the upside.

Biofuel Policy To Increase Ethanol Market Share
Brazil - Ethanol Consumption Under Different Policies (% of volume of fuel sold)
Source: NovaCana. (Note: BAU = Business As Usual)

However, we have classified this as a medium- to long-term risk because RenovaBio is still in the early stages of the legislative process. We have yet to see how the legislation will be pursued, with all of the following options still on the table:

*Presidential decree ( Medida provisoria), consistent with 2019 implementation

*Urgent Bill ( Projeto de Lei, regime de urgencia), consistent with 2022 implementation

*Regular Bill ( Projeto de Lei), consistent with 2025 implementation.

The Bill faces an uphill struggle, given some early signs of opposition from fossil fuel distributors (including Petrobras) and the significant political uncertainty surrounding President Temer's administration, which has deprived the government of political capital. Given the circumstances, the government may choose to prioritize flagship labour and pension reforms in the short-term.

BMI Sugar Forecasts: Brazil
Geography Indicator 2015 2016e 2017f 2018f 2019f 2020f 2021f
National Sources/BMI
Brazil Sugar production, '000 tonnes 35,560.0 33,500.0 38,525.0 38,910.3 39,688.5 40,085.3 39,283.6
Brazil Sugar production, % y-o-y -6.1 -5.8 15.0 1.0 2.0 1.0 -2.0
Brazil Sugar consumption, '000 tonnes 11,300.0 11,462.2 11,531.0 11,692.4 11,856.1 12,022.1 12,190.4
Brazil Sugar consumption, % y-o-y 0.4 1.4 0.6 1.4 1.4 1.4 1.4