Buying (Going Long) Ethanol Futures to Profit from a Rise in Ethanol Prices

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Finance English practice: Unit 34 — Futures

  • Complete the sentences below. Use the key words if necessary.
    • Commodity futures

    are agreements to sell an asset at a fixed price on a fixed date in the future. are traded on a wide range of agricultural products (including wheat, maize, soybeans, pork, beef, sugar, tea, coffee, cocoa and orange juice), industrial metals (aluminium, copper, lead, nickel and zinc), precious metals (gold, silver, platinum and palladium) and oil. These products are known as .

    Futures were invented to enable regular buyers and sellers of commodities to protect themselves against losses or to against future changes in the price. If they both agree to hedge, the seller (e.g. an orange grower) is protected from a fall in price and the buyer (e.g. an orange juiced manufacturer) is protected from a rise in price.

    Futures are contracts — contracts which are for fixed quantities (such as one ton of copper or 100 ounces of gold) and fixed time periods (normally three, six or nine months) — that are traded on a special exchange.

    Forwards are individual, contracts between two parties, traded — directly, between, two companies of financial institutions, rather than through an exchange. The futures price for a commodity is normally higher than its — the price that would be paid for immediate delivery. Sometimes, however, short-term demand pushes the spot price above the future price. This is called .

    Futures and forwards are also used by speculators — people who hope to profit from price changes.

    More recently, have been developed. These are standardized contracts, traded on exchanges, to buy and sell financial assets. Financial assets such as currencies, interest rates, stocks and stock market indexes — continuously vary — so financial futures are used to fix a value for a specified future date (e.g. sell euros for dollars at a rate of €1 for $1.20 on June 30).

    and are contracts that specify the price at which a certain currency will be bought or sold on a specified date.

    are agreements between banks and investors and companies to issue fixed income securities (bonds, certificates of deposit, money market deposits, etc.) at a future date.

    fix a price for a stock and fix a value for an index (e.g. the Dow Jones or the FTSE) on a certain date. They are alternatives to buying the stocks or shares themselves.

    Like futures for physical commodities, financial futures can be used both to hedge and to speculate. Obviously the buyer and seller of a financial future have different opinions about what will happen to exchange rates, interest rates and stock prices. They are both taking an unlimited risk, because there could be huge changes in rates and prices during the period of the contract. Futures trading is a , because the amount of money gained by one party will be the same as the sum lost by the other.

  • British English or American English?
    • aliminium
      • British English
      • American English

    • aluminum
      • American English
      • British English

  • Match the definitions with the words below.
    • 1. the price for the immediate purchase and delivery of a commodity — . . .

      Rising Ethanol Prices and the Lessons to be Learned

      I thought it was a bit humorous recently — when corn ethanol prices dipped and were cheaper than both sugarcane ethanol and gasoline (even when adjusted for lower energy content) — that some corn ethanol proponents pointed to this as a watershed event. Their underlying message, which was repeated almost daily in the comments on my blog, was that corn ethanol had now reached the point of permanent price competitiveness with gasoline. But I have repeatedly warned about price volatility in the energy business; that nothing is permanent. Today natural gas is $4 per million BTUs, but a few years ago it was $15. Oil has traded between $10 and $150 over the past decade. And corn — upon which corn ethanol is dependent — is not only strongly influenced by energy prices, it is a commodity in its own right and has volatility that can be influenced by crop failures around the globe.

      Those who highlighted corn ethanol’s competitiveness in the summer have been pretty silent on the topic lately. The reason is that ethanol prices are sharply on the rise:

      Since the end of June, spot ethanol CBOT futures for October delivery have surged 43% on the back of a strong export market along with substantial spikes in corn and sugar feedstocks. Strength in this market is motivated by new estimates from the USDA. In short, the crop yield forecast has been lowered and the volume dedicated to ethanol output has been raised.

      So back in June, ethanol was briefly cheaper than gasoline. Today, ethanol on the spot market trades for $26.84 per million BTUs ($2.04 per gallon) and gasoline trades for $16.87 per million BTUs ($1.94 per gallon). (Sources, CBOT, EIA). But the point here is not to simply highlight that ethanol is now 60% more expensive than gasoline. After all, in the long run we may pay $50 per million BTUs of liquid fuel and be happy that the supplies are available. The lesson here is that energy prices, whether current as in this case with corn ethanol — or future speculations based on cellulosic ethanol or algae — are going to be subject to great volatility. In this context, a future projection of $2/gallon for cellulosic ethanol is meaningless.

      A year from now, ethanol may once again be competitive with gasoline, or the situation could be even worse than it is now. I think one of the biggest risks hanging over the corn ethanol industry is that of a major crop failure in the Midwest. Imagine a terrible drought in Iowa that causes corn crops to fail. A corn ethanol industry that is heavily dependent on Iowa corn is going to need to scramble for supplies, and prices will be driven much higher. That would shed a spotlight on the industry that they would rather avoid; that is that ethanol could be subject to extreme volatility due to a crop failure OR to volatility in the energy markets. Public support for corn ethanol would probably vanish in such an event. People would be dealing with higher food prices as well if crops failed, once again focusing attention on the food versus fuel debate.

      This scenario is certainly not out of the question. Energy cycles take place over many years, and most of the corn ethanol industry is less than a decade old. Whether the industry survives in the long run will be highly dependent on the crops coming in reliably year after year to keep price volatility to a minimum. The lessons people should take from rising ethanol prices are that energy prices are volatile, and nothing is permanent.

      Feature: Brazilian ethanol import barriers increase structural deficit in NNE region

      Sao Paulo — Anhydrous ethanol stocks in Brazil’s NNE region was recorded by the Ministry of Agriculture and Livestock, or MAPA, at 147 million liters as of December 31, a drop of 8.9% year on year and the lowest for the period since S&P Global Platts started to track it in 2009 as imports declined due to change in quota rules.

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      The Brazilian North-northeast region is well known by its historical structural deficit of anhydrous ethanol, the one used in Brazil as a mandatory 27% blend in the Gasoline A. The region imports cargoes from US, the usual supplier, to cover its short production mainly in the first quarter of the year, when producers from Center-South Brazil are mostly out of the market due to the inter-crop season in the CS.

      That market dynamic started to change in September 2020, when the Brazilian Foreign Trade Chamber (Camex) published a new set of rules for ethanol import quotas. The new rules increased import quota by 150 million liters, moving from 600 million liters per year to 750 million, however, restricted the access to the import license just for ethanol producers, which are allowed to request a maximum quota of 2,500 liters per producer.

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      Instead of 750 million liters/year divided equally into 187.5 million liters/quarter, volumes are now restricted to 200 million tariff-free liters during the North-Northeast crushing season (September to February). The remaining 550 million liters can enter tariff free between March and August.

      “These new restrictions have hindered our import operations and the usual amount of ethanol we import per month. We are having to aggressively negotiate with mills with granted import quotas in the effort to combine quotas to fulfill a full cargo of ethanol,” said a Sao Paulo based trader.

      The production and price reaction

      A more restricted market encouraged regional producers to increase their anhydrous production to 775 million liters, a surge of 22% year on year in the period between August, 2020 to December, 2020, showed the latest data from MAPA. Despite that increased production it was not enough to meet the increased anhydrous demand in the region as gasoline prices remained more attractive than hydrous and imports are still needed.

      In 2020 the Brazilian ethanol imports into the NNE region totaled 1.01 billion liters, a plunge of 25% from 2020. S&P Global Platts Analytics estimates that Brazil will import a total of 1.35 billion liters in 2020 with 300 million liters being imported in Q1 2020. If these estimates prove correct, Brazilian ethanol imports will decline by 8.8% year on year with a decline of 24% to Q1 2020 from Q1 2020.

      “The new quota rules and trade restrictions for Brazil’s Northeast have not affected how much ethanol I am sending to Brazil. The only change has been that I am selling one cargo to multiple Brazilian buyers, but my volumes have not changed year over year,” stated a Houston based ethanol trader.

      That short stocks and imports of anhydrous ethanol are already reflecting in a regional price spike. Platts assessed anhydrous ethanol DAP Suape on January 17 at Real 2,515/cu m a surge of 15.4% on the year. According to Platts calculations on January 17, despite that price spike the import arbitrage for companies without access to import quotas remained closed in Real 87/cu m, while producers who are managing to import their quotas had an open arbitrage of Real 334/cu m.

      “Anhydrous ethanol price needs to increase in Real 100/cu m in Suape to trigger more imports,” said the international trader from an usual import company.

      In addition to the current closed import arbitrage, the trader said that lack of tank capacity is also limiting further imports right now.

      As the Brazilian gasoline has a mandatory blend of 27% of anhydrous ethanol any shortage of anhydrous could trigger a regional fuel supply issue, which would not be positive for the ethanol industry.

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