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The Importance of Modern Pricing Mechanisms Chairman Ivan Wedekin: Director of Agribusiness and Energy, BM&F – Commodities and Futures Market Speakers Roberto Ardenghy : Superintendent Director of ANP – National Petroleum, Natural Gas and Biofuels Agency. Heloísa Burnquist – CEPEA Researcher- Center of Advanced Studies in Applied Economy at the University of São Paulo Paulo Costa –Executive Secretary of IETHA - International Ethanol Trade Association. Ivan Wedekin I would like to convey some points under the optic of the futures market, within an objective of the terms of a relevant market from the commercial point of view for ethanol. Initially, I would say that agriculture is an island, but surrounded by risks on all side, such as: Production, subject to the vagaries of the weather; Contracts, the existence of a legal brand and implementation of legal decisions, which is extremely complex. For this, the contracts market with arbitration clauses has increased; Credit, that is also very related to the price risk; Price. Alcohol is a commodity with a price more volatile than sugar. Its volatility reaches 50%, which represents an elevated risk for the market participants. The high volatility of the prices of alcohol and sugar occur for various reasons, like: Mismatch between supply and demand; Season nature of production; Replacement effect in the national energetic matrix; Government actions and macroeconomic policies; Capital movements (hedge fund actions). When the funds assume a more aggressive position, from the point of view of buying in the market, this doe snot generate a market tendency, but when it enters the market it reinforces that tendency. This increase can be seen, very important, in the prices of wheat. This also happens in the liquidity positions of the funds. In the case of sugar in the New York market, the funds are in a sold liquid position, after causing a high in prices. The funds reached to have a sold position above seventy million tons of sugar, half the world production. Therefore, the movement of the funds reinforces the natural tendencies of the market participants’ actions. In the case of sugar and alcohol, the Brazilian experience shows this at various times. The fact that we have an extremely volatile market generates periods of large creation and destruction of value and riches. We conclude that we are subject to an important price risk in this market. With strong oscillations, with a fall in price, it has a destructive effect on the gross profit of companies; it is fundamental to have mechanisms for protection against these oscillations. BM&F has just launched a future contract for ethanol, with some relevant characteristics. We discussed it exhaustively with participants from the ethanol sector. There were thirteen versions until we arrived at the final version. This contract has the following differentials: Aimed at exportation: quoted in dollars, formation of prices at the Port of Santos and the commodity put as free on truck – FOT; Flexibility: allows delivery to the internal market. The object of the negotiation of this contract is carburant anhydrous alcohol, in accord with the specifications of ANP and other international standards organs. It is quoted in dollars per cubic meter, free of taxes and tariffs to have visibility of the exportation price. Each contract refers to thirty thousand liters and may be negotiated all year round. In the liquidation of the contract with physical delivery, the option to choose the destination is that of the buyer’s. Delivery to the external market: the seller is responsible to place the product in the authorized terminals in the Port of Santos; Delivery to the internal market: the buyer removes the ethanol from the producing units producers authorized by the Market. The Commodities Futures Market published a freight differential table every month. For example, in the case of between Santos and Paulínia, this adjustment of freight and the additions of taxes, in accordance with the legislation in force for the physical sale of alcohol. What is going to happen with the future of this global ethanol market? First, who is going to teach us the thorny path is the international market, which will create the liquidity on a global scale. For this, it is necessary to have a price reference which helps the hedge and facilitates the pricing of the contracts. The fixation of prices, through the Esalq and Platts indices, gasoline NY, petroleum, results in an imperfect hedge and does not eliminate the price risks. The commitment of the Commodities Futures Market with the agribusiness is relevant. We offer a negotiation environment and all the support in the physical and financial liquidation of the ethanol contract. We divulge the ethanol contract and implemented a “market share” program for expansion of businesses and open positions. And, to finish, we are at the side of the participants in the market, the governments and the entities for the construction of a competitive and global market. Thank you Roberto Ardenghy In 2006, the turnover of fuels was RS$ 152 billion, with an income of R$ 50 billion in taxes (R$ 30 billion with ICMS and R$ 20 billion with CIDE/PIS/COFINS). With approximately 76% of the loads transported by trucks, the profile of fuel consumption is concentrated in diesel, but gasoline and alcohol have fundamental importance. The sale of fuel in Brazil is relatively stable between the products. But between 2005 and 2006, alcohol gained important space from gasoline. Diesel practically accompanied the growth of the economy in this period. A series of measures adopted by ANP, by the Secretaries of the Inland Revenue and by Public Organs from other origins helped regularize this market: alcohol without a known destination entered into the market with the payment of taxes and regular business relations. In the distribution segment, the market share numbers in terms of fuels, from 2001 until 2006, the so called Sindicom group, with the largest distributor companies (Petrobras, Agip, Ipiranga, Shell, Esso, Chevron, Epsol), participated with 70% of the market. There are 263 fuel distributors. The alcohol market situation is different. The Sindicom market represents 45%, of the market. The degree of competition is very high. In the case of the retail market, there are 34,406 gasoline stations. The Sao Paulo market has a large number of fuel resellers. It seems an excessive number. The press has given news of the actions done by ANP and by the state organs in combating adulteration, with several resellers being closed. Brazil has different characteristics to other countries. There are 13,392 resellers in the so called white flag market, those gasoline stations that acquire products from any origin, from any distributor. The recent Resolution no 7 by ANP authorizes a gasoline station to acquire a product from only one specific flag. It is a guarantee to the consumer that the product acquired is from \ loyal distributor, through a business contract with the station. The situation in Brazil is of dependency in respect of diesel and LPG, known as cooking gas, but with an excess in gasoline and alcohol. We have two producing agents of biofuels regulated by ANP. In the case of hydrated alcohol, the alcohol distillery has a direct tie to the distributor, which resells to the station, to arrive at the end market. For anhydrous alcohol, the agent buys gasoline A from the refinery, mixes it with the anhydrous alcohol and sells gasoline C, that is Brazilian gasoline for the end consumer. There is a series of rules set by the ANP, always in change and according to the characteristics and requirements of the market. For example: a distillery may not sell directly to as reselling station. A retail reseller transporter (TRR), may only sell diesel oil. The ANP was created by Law no 9.478/97. It has the attributes to regulate, contract and inspect activities within the petroleum, natural gas and biofuels industries, through agreements with organs of the States and the Federal District, as well as apply administrative and pecuniary sanctions set out in the law, regulation or contract. Law 11.097/05 extended the scope of ANP, conferring it with attributes related to biofuels. Law no 9.478/1997, in its article 8, defines as attributes of the ANP: Implement the national petroleum and natural gas policy, with emphasis on the guarantee of supply of petroleum and biofuels derivatives; Protection of the consumers interests as to price, quality and offer of the products. The Brazilian experience with alcohol and its mixtures are consolidated. There are no more technical discussions. The automobile industry adapted to this market reality, the so called flex fuel car, an innovative product, with a participation of 80% of cars sold and 12% of a growing fleet. The sector has met this demand. Businessmen shown great efforts and efficiency in production. We have challenges. Alcohol does not reach several States due tom the cost. With the expansion of the sugar-alcohol industry, we need to think in supplying all the States. Nine of them are self-sufficient and eighteen, importers. A journey using alcohol through the national territory requires preparation. It is being talked of the installation of two alcohol ducts, from the producers connected to the State of Paraná and another from the Petrobras – Transpetro system, to reduce transport costs. The prices of alcohol are inviting and remunerative since 2002. The question of supply and demand is a headache. The consumer will have to adapt to the reality of biofuels: of the harvest and between harvests. We are accustomed with the thirteen Petrobras refineries, with the production of petroleum in the field all year round. At the peak of the harvest, there is a large offer of the product, whilst between harvests there is an enormous deficiency of the product. Who Hill pay for this passing stock? Who will bear the costs of equalization and reduction of this volatility? The initiative of the Commodities Futures Market, to minimize the price volatility, a cause of stress to the consumer and difficulties for the government, counts upon help by ANP. There are distortions in the alcohol market, like: Excess of anhydrous alcohol in gasoline; Alcohol hydration, the so called wet alcohol, without collection of ICMS and PIS/Cofins; Evasion of ICMS and PIS/Cofins by the distributors; Direct sale of the hydrated product to the reselling station, with full evasion of ICMS and PIS/ Cofins by the distributor. These problems need to be attacked with regulation by the ANP in the sector by means of: Fixing the quality and specification of the product; Registration of the producing units in Brazil; Business rules; Obligation to send information; Consumer information: price and quality. The ANP actions have been done so that the current fuels market in Brazil and the alcohol market are more regulated. We arrived at having, in 2001, an alcohol non compliance index of 12%. We are at the end of 2006 with non compliance indices in the range of 3%, therefore, a more mature market as to quality. As a conclusion, we have an abundant supply, with a significant improvement in the quality and reduction of irregularities. The idea of a futures market, to increase the level of market contractions, is welcome and will be supported by the ANP. There is a need for updating in respect of the regulations, the specification of alcohol, business and taxation rules. We need to participate in these discussions. Thank you. Heloísa Burnquist The work of UNICA in terms of opening markets began in the decade of the eighties, when the deregulation of the sector occurred at the time of an accumulation of production. We were hit at that critical moment. As from then, came management by our own account, and a path was traced out. We work to develop modern market mechanisms, like the futures market. Alcohol has stopped being an agricultural commodity and needs to be treated as an energetic commodity. This requires changes in terms of posture and market understanding. Many countries explore petroleum in a quite intensive manner, without providing results for their societies as a whole. It is fundamental that we organize not only the technical part, but also that of the market. To characterize the posture of the sector, I brought an affirmation by Eduardo Carvalho: “if there is one thing that the sugar and alcohol producing sector of Brazil can be proud, it is their transparency. This happens in various aspects, being more visible in the capture of prices”. I would also add to this phrase the divulgation of the price. The use of prices is fundamental to stimulate external negotiations, futures markets, and attract resources. It is important to employ modern mechanisms to develop the market, as a form of resulting profits, in the measure that new technologies appear and new partners enter the market. We joined efforts in terms of capital. We have the research done by the Center of Advanced Studies in Applied research, (CEPEA), on the cash market prices, with the technical collaboration of UNICA, ORPLANA and other governmental institutions. In the beginning of this process, the objective was to eliminate inefficiency and distortions, through deregulation. The function of determining the “right” price for a good is transference from a single organization to buyers from the offerers. It allows the “price discovery” in a transparent, competitive context, based on foundations and expectations. The levels of prices changed as a function of readjustments established by the government. This made planning and development of production in the sector very difficult. We had to work with readjustments as a function of inflation or monetary correction. Alter the deregulation, the market began to function. CEPEA was invited to accompany this and help in the development of the sugar futures market in the Commodities and Futures market. The principles are similar to those of other systems, like: Credibility: Completely independent and impartial exemption with relation to the price of the commodity; Highly structured methodology for the accurate and precise determination of the market values and the consistent application; Surveys involving the greatest possible number of participants; All the information is considered as confirmed. The precepts that it is fundamental to highlight are: Price is a function of time; Prices divulged need to accompany and express what the market understands and accepts as a reference. We have long term indicators. The indicators for anhydrous and hydrated alcohol were useful to: a) indicate market fundamentals; b) to show the rest of the world how the prices reflect the events within the market here. In this process, the first time was the futures market, and the second the Consecane in São Paulo. There is Consecane in other states, like Pernambuco and Alagoas. We will have Consecane where there is a supplier and plant. We need a mechanism in which there is an arbitration agent for the parties to converse, without entering into unnecessary friction and wasting energy unnecessarily. The Consecane in São Paulo involves the composition of a cane ATR price from a series of products. This cane evolved jointly with the price of the final products. During the period 1998 to 2006, the price of cane had a behavior similar to that of alcohol, and if we made a set of the products, a weighted average. For the futures market to make a hedge and options, we need a market spot reference for calculation of the base, for the evaluation of arbitration opportunities. In this sense, we believe this function will be met in a quite satisfactory manner. Its divulgation is reference on supply and demand, market foundations and stimuli for the development of economic opportunities to the Brazilian market, in terms of overseas capital. Parity of prices is also fundamental to explore and observe, in terms of assuming a market position. As our market function rationally, we see a clear relation between production and alcohol prices. There are manners of understanding the happenings in the composition of prices and production. We may use this information to calculate the relative profitability, for example, internal sugar market versus the external market. We work with this type of relationship. Other calculations of the parity of prices for alcohol and sugar, as well as the other functions to express the value effectively negotiated in the cash market, when there are impasses in terms of negotiations with society. We have difficulties in identifying the internal demand. That is another work developed by UNICA and other associations. The general structure of the work in CEPEA involves: Applied analyses; Economic modeling for economic impacts; Developments of routines for the collection and compilation of the indicators; Divulgation of information. Partnerships with Bloomberg, State Agency, Nybot etc. As proposals and work challenges, we put: For the States with projects under development, it is important that transparency is perceived and the price of a determined state does not necessarily have a surcharge or discount. Each State should have its market mechanics understood and consolidated; Accompaniment of the relative profitability of various cultures, another subject that has been often approached today throughout the talk; Markets for new products and sub-products; Highlight international divulgation of the indicators; Develop structural models, mainly for composition of scenarios. Thank you. Paulo Costa To have an approach by the energetic commodity, ethanol needs to be handled in a different manner in relation to sugar. The period of Brazil Alcohol (BBA), is a true mark. Alter that, the exportations just advanced. Up to 2002, exportations were practically only industrial ethanol, destined to drinks, the paint industry, the famous standards Korea and Japan. The participation of fuel alcohol was small. The big turning point was 2004, when ethanol stopped being a residual product to exportation, and became a commodity wanting to be born. Until then, exportations complied with two functions: Residual, to ship the quantity that was left over in the internal market; Regulatory, at times of excess production in market, to drain off the products in the face of the lack of a storage place and prices even lower than production costs. In IETHA, we work in the assembly and structuring of a market for this commodity. We achieved exportations of 3 to 4 million cubic meters. These numbers will remain, whether we like it or not. We have restrictions concentrated in the logistics aspects and infra-structure, both in the origin and the destinations. We have expectations of the development of exportation ducts that are being designed or under construction, to supply whole ships with one hundred thousand cubic meters, well above the current 20 to 30 thousand cubic meters. It is not enough to have ducts to transport and supply the load of a cargo ship with one hundred thousand cubic meters with agility. The destination needs to be ready. We had this experience in the area of orange juice, at the beginning of the eighties, when Brazil changed the transport of drums for crops. The ducts, tanks and ships were ready, but the destination points were not prepared to receive a large volume all at once. Then, the maturation period of this international ethanol market, as a commodity, will take some years to complete the adaptation logistical. One does not discover an ethanol well in the Campos Basin, by drilling and flowing. There is a dependence on investments, construction, equipment etc. The guiding characteristic of the international market at this time is a high demand, disproportional to the supply reality. There lacks a long term guarantee of supply. In November 2001, in a Congress in Japan, The Japanese buyers approached their difficulties in importing six million cubic meters. We sill meet this reality today. The demand exists, but there lacks a supply and guarantee of supply. Another point is the lack of basic criteria for sale There is no standard contract in the market. There is an absence of protection, of the hedge. The Commodities Futures Market developed an exceptional contract, the first step to establishing a hedge mechanism in dollars. But there are no instruments of this size at the international level. In the International Ethanol Trade Association (IETHA), we thought in the sale to the whole world. The Brazilian market is a supplier of ethanol for the world. We have the tendency of the old formula of the “Flat Price”, however, we have time in out favor, to construct the necessary clauses and transform it into an international commodity, it is there that IETHA arises. The mission of IETHA is to establish clear criteria to support the international sale of ethanol, supported on standard business and transport contracts, with specifications and quality for ethanol and industrial fuel, to create a certificate with a high credibility of sustainability. We work together with Inmetro and the ABNT for the creation of certification of sustainability. The basic mission of IETHA is to develop market mechanisms to transform the ethanol fuel into a world commodity, to be sold with the possible protection instruments developed by the markets. We have the final drafts of a business contract and the specifications that were developed, supported on the existing experiences and standards, to place in a format acceptable by the market. We have specifications for anhydrous alcohol, developed through methodologies accepted internationally like the Brazilian Resins Institute (IBR), Standard Technical Merchandise (STM) and ANP. We will present the numbers in Brussels at the end of February and will present them in Washington at the NAST which is the equivalent of Inmetro in the United States. Amongst the manners of pricing is the “Flat Price”, most used, as already commented. We develop bilateral agreements between exporters and importers, to remove the problems with the lack of availability of the product, which ends up inhibiting the action of the end user by not being able to count on a determined volume. There are more frequent manners of hedging for exportations, like: Protection against the American petroleum/gasoline index; Chicago Corn Futures Market Index, Opis and Platts. For the application of a future price for the ethanol market, we need an international futures and options market. Ethanol is not sugar. We use as a referential the Chicago Ethanol Market, used for the protection of the production of ethanol from American corn. By the manner that it was structured, the Commodities Futures Market contract will also be a strong instrument for protecting the Brazilian exporter. Thank you.
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