Brazilian President Jair Bolsonaro's move to sharply cut taxes on fuels, particularly gasoline, to boost his reelection chances has squeezed ethanol's profit margins and is expected to lead mills to shun the biofuel and focus strongly on sugar.
Sugar and ethanol experts said that profits on sugarcane-based ethanol sales have fallen so low compared to those of sugar that Brazil mills, which have flexibility to make more of one or another, will shift as much as possible to sugar production as the harvest enters the second half.
"Mills are already making a loss by selling ethanol, why would they continue to produce it?" said Brazil-based analyst Julio Maria Borges at JOB Economia.
The risk for sugar producers worldwide is that prices for the sweetener could ease if Brazilian mills sharply cut ethanol production, boosting global sugar supplies.
Brazil's government has temporarily cancelled federal taxes on fuels. Since gasoline used to be taxed heavier than ethanol, erasing the taxes decreased ethanol's price advantage at pumps.
Brazilian sugar and ethanol makers constantly check the so-called ethanol parity, or the biofuel's financial return equivalent to ICE exchange raw sugar prices, to decide production strategy.
"Ethanol parity is already at 13.70 (cents per pound), what more damage can be done?", said Michael McDougall, managing director at New York-based broker Paragon Global Markets, LLC.
As a comparison, sugar futures on ICE closed at 18.35 cents per pound on Monday, nearly 35% higher than ethanol's value in Brazil.
There are, however, limitations at the moment in shifting too much production to sugar due to the peak harvesting time, says Claudiu Covrig, from CovrigAnalytics.
To cope with high cane crushing volumes currently, mills still need to use part of their ethanol facilities.
Covrig thinks that the move to sugar will happen gradually as crushing volumes become smaller on the way to the final months of the season.
According to data from industry group UNICA, the highest cane allocation for sugar was 49.7% in 2006, and the lowest 34.3% in 2019. At mid-August, the sugar mix was at 44.7%.
A poll published on Friday showed Bolsonaro would likely lose a runoff election against left-wing opponent Luiz Inacio Lula da Silva in the October election.
(Reporting by Roberto Samora and Marcelo Teixeira; Editing by Stephen Coates)
