American Ag Consultant in Brazil Shows the Way to Foreign Investors

My friend Kory Melby lives in Brazil's Center-West, the country's agricultural heartland.

He has been showing foreigners around the region for a number of years, looking for good deals in farmland. He offers "private consulting services for hedge funds and private investors, keeping them abreast of the latest Brazilian updates on soybeans, cotton, cattle and land prices".

Kory has "over seven years' experience in the agriculture sector in Brazil. (He has) traveled extensively in the agriculture regions of the country and (has) built up and established a network of knowledgeable contacts".

Here’s one of his most recent posts:

March 14, 2009

Back in Goiania (capital of Goias state).

I covered 2000+ km of Mato Grosso (state) last week.

2nd crop corn and cotton look good.

Rainfall totals for central Mato Grosso are at 1400 mm as of March 14th. Normal is 2000 mm for this date.

The rainy season will end by the end of April. Normal rainfall amounts are 2200-2400 mm for the season.

As long as rains come for another 6 weeks, the 2nd corn crop should be fine. If rains end early, then yield problems will show up.

Soybean yields were as expected for most producers: 50 sacs or 44.5 bushel per acre.

Cash price for soybeans are about US$ 7.00 per bushel basis central Mato Grosso.

Everyone is in survival mode. They know they are not going to make much money this year. They know it will be tough sledding into 2010. Credit is expensive. All banks want 2% per month or more. One producer said he made his payments to the bank, and now the bank does not want to lend the money back out again.

Local coops are offering 2010 soybean packages for 22 sacs of soybeans per hectare for trading. This includes fertilizer, seed, and chemicals. This is not too bad.

Read the rest of his analysis here.

He also provides a translation of an article that just came out in Gazeta Mercantil, titled, “Land Prices Surprise with Full Recovery in Crisis” (Gazeta Mercantil is the Brazilian equivalent of The Wall Street Journal – minus the Murdoch stigma).

Cheap Ethanol, Expensive Sugar Change Game for Brazilian Producers

Brazilian consumers are up in arms against what they perceive as price gouging by fuel ethanol distributors and retailers: since the end of January 09, prices paid to producers in Brazil's Center-South region have fallen by 13%, from USD .3831 to USD .3329 per liter (USD 1.448 to USD 1.258 per gallon) (source: Cepea). But these savings have yet to be passed on to consumers.

The drop is happening right in the middle of the sugarcane off-season, when prices have historically been at their peak. With little storage capacity to secure a more even flow of ethanol throughout the year, supply is strongly conditioned by the availability of sugarcane for processing. This fact usually causes prices to bottom out at the height of the harvest season, which lasts roughly from April to October in Sao Paulo state, the country's main sugar- and ethanol-producing region.

This year's season has yet to begin, but prices paid to producers are at levels last seen in June 08, when the sugarcane harvest was in full swing. Folha de S. Paulo, Brazil's leading daily, reports that,

"At some fueling stations in Sao Paulo state, the difference between ethanol prices at the pump and prices paid to producers at factory gates reached 105% the week of March 16. On average, the difference was 79%."

This apparent mismatch may be laid down to a high degree of operating leverage in the fuel distribution chain, much of which results from the gross inefficiencies that mark the industry. Further, many companies are buying out of the hype that promised to make Brazil an energy powerhouse one day and focusing instead on the shorter term. The net result is that producers are expected to favor sugar over ethanol; in fact, many are now dumping ethanol inventories to raise cash in preparation for increased sugar output.

Ethanol prices may be collapsing, but the outlook for sugar looks increasingly bullish. India, the world's second-largest producer, is expected to see a shortfall in production of some 4 million tonnes. The European Union, induced by government policy reforms, is also expected to produce less. These and other changes are projected to lead to a global deficit of between 5 million and 10 million tonnes of sugar this year.

Brazil, which in the 2007-2008 season harvested a record 493 million tonnes of sugarcane, up 16% from the previous season, produced 30.7 million tonnes of sugar and 22.5 billion liters of ethanol over the same period (source: Unica. Note: figures for the 2008-2009 season have yet to be tallied). The country's capacity to sway markets for both commodities is illustrated by the recent performance of Cosan, Brazil's largest sugar and ethanol concern. In the in 2008-2009 season, it processed 44.2 million tonnes of sugarcane, more than the entire output of Australia during the same period: a comparatively piddling 36 million tonnes.

An estimated USD 20 billion, from Brazilian and foreign sources, has been invested in capacity expansion over the past four years. As a result, agricultural output has ballooned, with another surge in sugarcane production expected this year.

While more producers will almost certainly prefer sugar over ethanol, the precise mix will be determined by market forces shaping up amid the global economic meltdown. On the supply side, the ability of companies to secure access to credit lines (a very iffy proposition right now) will be of fundamental importance. From a demand perspective, the speed at which developed countries with ethanol blending requirements rebound from the current crisis (if at all) will be just as decisive.

Of course, speculators also have a role to play. Reuters reports that, in May 2008, Peter Baron, executive director of the International Sugar Organization, predicted that:

"The tremendous flow of capital from financial institutions into commodity futures to seek diversification away from the sectors affected by the credit crunch has clearly pressured fundamentals. It is clear that the net inflow of funds in sugar futures is a decisive driver for today's world prices."

That theory, of course, went out the window with the collapse in commodity prices in Q3 2008. It may become valid again if financial players rush back into commodities, as Marc Faber, Jim Rogers, and many others have been prognosticating (incidentally, Jim Rogers' old partner in the Quantum Fund, George Soros, is one of the investors in Adecoagro, which has plans for a combined four plants in Brazil - one in Minas Gerais state and three in the state of Mato Grosso do Sul, in the country's Center-West).

While switching to sugar may be a way out for many producers in Brazil, a sizable share of the new projects that have come on-stream can produce only ethanol. These companies are taking a severe beating, as the players that produce both commodities continue to dump ethanol inventories to raise cash. (According to the Brazilian Ministry of Agriculture, the country has 420 plants: 248 produce both sugar and ethanol, fifteen produce only sugar, and 157 produce only ethanol).

In short, rising sugar prices, tight credit, and massive overcapacity do not bode well for ethanol prices. Many producers, including the much-feted Santelisa Vale, are now being forced to look for partners with greater financial heft - or fold.

-Henrique Oliveira

Brazilian Government to Finance Ethanol Inventory Build-Up

The Brazilian sugar and ethanol industry is getting pummeled by a series of outside shocks associated with the global economic downturn. First, the drop in oil prices over the past six months has taken much of the steam out of initiatives to further the world's single proven, economically-viable alternative to gasoline - namely, sugarcane-based ethanol. A GP at a fund with a sizable investment in a major ethanol operation in Brazil told me last June that his worst nightmare was oil falling back to USD 40. Wonder what he felt when it dipped into the low thirties.

Second, credit has tightened up in Brazil, as is the case everywhere else. Mill owners in the Ribeirao Preto region were said to be hawking their neighbors' properties to outside investors, in a desperate attempt to convert their insider connections into cash. Not a strategy likely to succeed, what with private equity running for the hills, most major corporate projects canceled or postponed, and FDI overall slowing to a trickle.

In an attempt to stave off the worst effects of the ongoing financial and economic drama, BNDES, Brazil's national development bank, is now funneling billions of dollars into the industry, much to the delight of organizations like Unica, the association of sugarcane growers of Center-South Brazil; Abimaq, the trade group that represents Brazilian manufacturers of heavy equipment, used to harvest, crush, and process sugarcane; and the Brazilian Agribusiness Association, known as Abag, which speaks for a mixed bag of farm-related industries that includes ADM, BASF, Bunge, Cargill, DuPont, John Deere, Syngenta, and Monsanto.

On March 20th, BNDES announced that it would finance the expansion of ethanol storage capacity, a crucial bottleneck blocking the development of the industry. Without large-enough facilities to store ethanol, companies are forced to sell it as soon as it is produced, depressing prices near the harvest season, which begins in Q2 in Brazil's Center-South region. Prices then normally rebound in Q3, a few weeks after the bulk of the region's sugarcane has been brought in and processed into ethanol and sugar.

This past season, however, the economic crisis has dampened demand abroad. Overcapacity built up in 2006-2008 has further pressured prices, which have remained at levels near their harvest season lows. BNDES is now stepping in to offer a credit line of BRL 2.31 billion, or about USD 1 billion, for inventory build-up, in the hope that more regular supply throughout the year will alleviate problems stemming from wildly-fluctuating prices and working capital requirements, both of which hamper companies' ability obtain financing in capital markets, in Brazil and abroad.

-Henrique Oliveira