May 18, 2007

 

Brazil's soy industry braces for margin squeeze

 

 

With the US dollar now falling below 2 Brazilian reals, the country's soy crushing industry is near a full red alert, traders and consultants say.

 

"Companies will soon go into cost-cutting mode. No one was prepared for this kind of devaluation," said Jose Zilio, an international biofuels consultant at ALF International in Sao Paulo.

 

"It is going to be a lot harder for companies to export value added goods in general, not just soy complex. This is bad news for crushers that do not have operations in Argentina," said a head trader at a US multinational in Sao Paulo who wished to remain anonymous.

 

The dollar closed Wednesday at 1.953 reals, its lowest level against the Brazilian currency since January 2001. The government has used routine mechanisms to purchase dollars and keep the real from strengthening further, but none have worked. The dollar fell below the psychological 2.00-real barrier on Tuesday.

 

Argentina is Brazil's closest competitor when it comes to value-added soymeal or soyoil exports. The big multinationals--Archer Daniels Midland, Bunge, Cargill and Louis Dreyfus--control roughly 60 percent of Brazil's soy crushing market. Some do not have operations in Argentina, where they can benefit from the higher priced meal and oil exports. Here in Brazil, they are mainly exporters of raw material.

 

Brazil's soy industry has been up in arms for the last two years about a law that taxes soy crushers on soy purchased out of state. The roughly 12 percent tax is then payable in tax credits. But soy companies don't want the credit, they want the cash. The battle against the tax law continues with the government. Regardless of the law, however, a weaker dollar will make Brazilian soymeal and soyoil even less competitive than it already is compared to rival Argentina. The trend is for Brazil to just keep on exporting soybeans, from farms to ports.

 

A tonne of soybeans leaving Brazil in March cost importers about US$273 per tonne. By comparison, soyoil cost US$612.80 on average, according to government numbers.

 

Zilio said the weaker dollar in Brazil will lead large soy crushers to start cutting services such as cell phone contracts, internet, and reductions of executive travel expenses. That will affect the local economy first.

 

"The government will announce all sorts of temporary tax breaks to help these exporters. But overall, for soy companies, it's belt tightening time," Zilio said, adding that the major players will all see margins reduced.

 

"This has been happening for a long time. Brazil is just not exporting value-added goods and this dollar does not help. It might be too soon to tell what this all means for us," said Thiago Simon, a soy buyer at mid-sized Brazil soy company Sperafico Agroindustrial.

 

High commodity prices have helped both farmers and large traders deal with the weak dollar. Thanks to the growing fuel crop trend, major importers like China are now having to pay more cash for corn, soybeans and soyoil. If Brazil takes more soyoil out of the market to produce biodiesel locally, that could push soyoil prices even higher, Zilio said.

 

The government is considering raising its 2 percent biodiesel mix to 5 percent. The diesel fuel blend becomes a requirement in January 2008. Soyoil accounts for over 80 percent of Brazil's current biodiesel production, though the idea is to move away from the costly vegetable oil and use sunflowers and other oilseeds, any commodity price spike is welcome here given the dollar devaluation.

 

Then again, traders point out, higher soy complex prices just serve to help bring in even more dollars to the country, strengthening the Brazilian real even further. Most soy market estimates now are for the dollar to hit 1.80 reals by August.

 

This week, Deutsche Bank analysts said worldwide dollar weakness could easily last until 2011.

 

In March, direct foreign investment into Brazilian agriculture was US$12 million, less than 1 percent of the total FDI for the month, according to Central Bank figures. Fuels, including ethanol, accounted for US$49 million, or 2 percent of the month's total. Brazil's economy has the attention of investors, and agriculture and biofuel is probably just the tip of the iceberg. Money is flowing in to Brazil regardless of the commodity boom. That bodes well for a strong Brazilian real.

 

"Margins will be squeezed this year if soy companies didn't hedge against currency devaluation," said Glauco Monte, an analyst at risk management firm, FC Stone.

 

"Then again, from here on in, any hedging they do is going to be on a very weak dollar. Brazil can't compete on value added soy at these dollar levels," Monte said.