The recent plunge in international oil prices to multi-year lows has heightened the risk for Brazil's sugar and ethanol (S&E) industry, according to Fitch Ratings. The price drop has eased the pressure on Petroleo Brasileiro S.A - Petrobras (IDR BBB / Nat. Scale AAA(bra)) to increase domestic gasoline prices, which reduces demand for alternative fuels.
Brazilian S&E producers need hikes in ethanol prices to make up for low sugar prices in international markets, but material increases in the price of the biofuel are only possible if accompanied by higher gasoline prices at the pump. While Fitch does not expect significantly lower gasoline prices at the pump, price increases remain very unlikely in the short-term.
The recent plunge of international oil prices has brought international gasoline prices to levels below Brazil's refinery prices. Petrobras' domestic gasoline prices are now above international benchmarks. This eliminates the company's downstream losses caused by selling gasoline and diesel at below-market prices and eases pressure to increase gasoline prices in 2015.
Petrobras has been unwilling to align domestic gasoline prices with international quotations in light of a challenging capex program which is expected to hinder future cash flows, as well as limited access to funding following the delayed publication of its FY14 financials. Petrobras announced a 3% increase in gasoline prices and a 5% increase in diesel prices on Nov. 6, 2014.
Lower gasoline prices at the pump would drive hydrous ethanol prices down and damage the results of S&E companies. Petrobras could reduce gasoline prices at the refinery in response to increased competition from fuel distributors who can take advantage of lower international prices for imported gasoline to gain market share. However, logistics bottlenecks and the continuing weakening of the Brazilian real prevent this scenario from materializing in the short-term. The reintroduction of CIDE, a tax on gasoline, could offset the impact of lower gasoline prices at the refinery and increase the competitiveness of ethanol at the pump. Pressure to reintroduce CIDE is mounting as the government has been struggling with its finances.
Fitch does not expect higher ethanol prices in 2015 due to the cap of gasoline prices on prices of hydrous ethanol. This will pressure the cash flows of S&E companies, which must contend with depressed sugar prices and cost increases expected this year. Sugar prices are not expected to recover quickly in 2015 and costs are expected to increase driven by higher salaries and logistics and transportation costs.
Government incentives are required to help the S&E sector. Fitch expects some relief will be provided to S&E producers following the increase of the mandatory blend of anhydrous ethanol into gasoline to 27.5% from 25% (to become effective over the next few months), the recent drop of the ICMS tax on hydrous ethanol to 14% from 19%, and the gasoline tax increase to 29% from 27% by the State of Minas Gerais announced in December 2014.
These measures are expected to increase the floor for ethanol prices and temper price volatility in the industry. Minas Gerais is Brazil's second largest consumer of fuel. The impact of lower international oil prices on fertilizers prices should also benefit S&E companies as fertilizers are an important component of S&E companies' agricultural costs.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
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