Brazil ethanol prices seen low despite sugar spike

SAO PAULO (Reuters) - The recent surge in sugar prices to their highest level in 28 years and growing demand for ethanol in Brazil are insufficient to support prices of the biofuel, which remain below production costs.

Ethanol and sugar prices are usually linked as they have to compete for the same cane. But as many mills face cash constraints they see ethanol sales as the only way of raising cash to pay debts, pressing down prices.

"The new distilleries that came on line recently have a more fragile financial situation as they are still paying initial investments and don't have much cash flow, so all output is sold in the market. They don't build stocks," said Plinio Nastari, director at Datagro consultancy.

About 55 units came on stream in Brazil in the past two years, and nearly all of them are planned to produce only ethanol in the first four to five years of operation.

"They have been suffering a lot," Nastari said.

Usually, if sugar prices are high, mills divert more cane to the production of the sweetener, reducing ethanol availability, which leads to higher prices for the fuel.

But the difference between sugar and ethanol prices has been widening as sugar futures rally, mainly due to a shortage of the commodity in India, the world's No. 1 sugar consumer.

Mills able to produce both ethanol and sugar are in the vast majority in Brazil, accounting for 82 percent of the cane crushed, according to the Sugar Cane Industry Association, Unica. In 2009/10, they have directed half of the harvested cane to sugar production and half to ethanol.

Distilleries, which produce only ethanol, have accounted for 26 percent of the fuel produced so far, Unica said.

STRONG DEMAND

Unlike sugar sales, which are nearly all hedged in New York and London futures markets, ethanol in Brazil is sold in the spot market. So prices for the fuel can be greatly influenced by the influx of sales, analysts say.

"It's the peak of the harvest, so you should not expect prices to go up now," said Heloisa Lee Burnquist, sugar analyst at agricultural think tank Cepea/Esalq.

Hydrous ethanol was traded on average last week at 705 reais per cubic meter, down 5 centavos from a week earlier, according to Cepea. That is below production costs.

Nastari said the difference between sugar and ethanol prices has not been so big since 2007. Then, sugar was trading at around 9 cents a lb in New York and ethanol prices soared due to a boom in Brazil's domestic ethanol demand.

According to Datagro, last Wednesday, when sugar settled at nearly 23 cents per lb in New York, hydrous ethanol at FOB equivalent returns was 53 percent lower than sugar.

"Such a difference was rarely seen in the past," Nastari said, despite sugar often offering higher returns than ethanol.

The stronger returns from ethanol in 2007 and 2008 were "atypical years", Nastari added.

Brazil's domestic demand for ethanol, however, has been at a record high -- due to low prices compared with gasoline and the growing number of flex-fuel cars. Launched in 2003, these vehicles, which can run on any mixture of ethanol and gasoline, already account for 35 percent of the national fleet.

In July, ethanol demand reached 2.07 billion liters (547 million gallons), up 21 percent from the same month in 2008, Unica said.

Cosan, one of Brazil's largest ethanol groups, sees current ethanol supplies as big, despite mills' efforts to produce more sugar. High carryover stocks from last season have contributed, Cosan Financial Director Marcelo Martins said last week.

But the company sees stocks in the interharvest (January-March 2010) dropping, indicating a possible price recovery.

"They will rise, but only up to a certain point, as gasoline prices are a limit for them. I see a 10 to 15 percent rise, no more than that," Nastari said.

source: reuters