Wednesday, September 1, 2010

Brazil's Inventory Bubble

As we noted in last week’s newsletter, the increase of ethanol inventory in Brazil this harvest season is surpassing last season’s inventory build substantially.  The following chart clearly illustrates the dramatic change in the inventory profile between the two harvest seasons:

How much inventory does the Brazilian ethanol market need to cover the inter-harvest period when sugarcane processing and ethanol production are at minimums?  To determine the answer, we have forecasted monthly consumption for the inter-harvest period as follows:

                   Monthly Consumption
Fuel Use                 1,875
Non-Fuel Use             210
Exports                  __150

Total                      2,235 million liters

Fuel use is based on average consumption this year, according to data published by the National Petroleum Agency (ANP).  Fuel demand is lower than last year’s consumption by 160 million liters per month.  Non-fuel use is predicted to be approximately 50 million liters per month higher than last year due to the startup of new chemical (non-fuel) demand for ethanol.  This new demand is anticipated to come on line in the 4th quarter.  Exports are forecast to follow last season’s pattern. 

With the drier harvest season this year, December ethanol production will fall off to inter-harvest levels due to the poor quality of the late harvest sugarcane, which was impacted by dry weather.  This results in an estimated ethanol production of 400 million liters per month for the period of December of 2010 through March of 2011. 

These numbers indicate a market that is short by 1,835 million liters per month for the December 2009 - March 2010 time period, yielding a total shortfall of 7,340 million liters leading up to the start of the 2011 harvest.  As of August 15, Brazil’s physical inventory was 5,673 million liters and building monthly by 1,500 million liters.  Assuming this inventory build rate continues through October, and the carryout inventory at the end of the harvest season is 1,000 million liters, the Brazilian ethanol industry will meet this inventory level by mid-October.  If nothing changes in the supply/demand balance, inventory levels by the end of November could reach 10,000 million liters, assuming the industry has the storage capacity to hold this quantity.

Brazil’s ethanol prices have been remarkably stable this harvest season, due in large part to the industry’s ability to finance the increased inventory.  The ethanol market in Brazil is moving into some uncharted waters as this inventory level continues to reach new heights.  Going into October, it would not be surprising to see weaker prices in Brazil that would stimulate demand to slow down the inventory growth.  A countervailing force for lower prices is the anticipated increase in European ethanol prices.  The European ethanol market is suffering significantly from higher feedstock costs due to the poor wheat harvest, which could result in sizeable export demand for Brazilian ethanol.