Sunday, 14 December 2008

Keep an Eye on Brazilian Ethanol Producers

The credit crunch first hit Brazilian food and cellulose producers that placed wrong wagers on the direction of the currency. The losses were huge: it was about $3 billion (and the number may grow bigger.) As time goes by and the crisis hits the biggest emerging market countries, investors scour for new victims. 

The ethanol sector in Brazil is, in the view of some knowledgeable insiders, the next casualty. Many of these found in the liquidity boom that the world economy enjoyed since 2003 a easy and cheap source of funding -- hopeful that the feast would last for a few more years. But the winds changed direction, and now credit has dried up. In the past weeks, three ethanol producers filed for debt restructuring in state courts. The figure, although similar to Chapter 11 in the U.S., allows these companies to present a refinancing plan for the equivalent of 60% of their debts. For banks and other creditors, the prospect of this is not good at all, for it will be a local judge who will decide whether the companies can file for bankruptcy or not. Judges in recent years have been favourable to the bankruptcy-bound agents, in detriment of banks, bondholders and trade lenders. The derivatives scandal that I referred to in the first paragraph has created also some legal void and now banks are being punished by court rulings that want to annul those contracts -- making the financial system vulnerable to further losses. 

Part of the irrational exuberance that benefited the industry in the past three years is now backfiring. The sector's capital deadly sin was using for years short-term credit facilities (such as trade loans) to finance long-term expansion projects -- many of these companies were expecting that demand for ethanol as a substitute for gasoline would soar, and invested heavily on greenfield plans and acquisitions. The three companies above were hit by a rising cost of borrowing, while another (Santa Elisa Vale) is said to have lost a lot of money in the derivatives front. 

Bottom line is, will the credit crunch hamper the upcoming harvest? The most probable outcome is no. The current harvest will actually be quite good. An industry executive told me last week that the problem may appear next year, when the lack of credit may make it unaffordable for a number of mills to pay for maintenance costs. The cost of producing raw sugar is still above costs (and the currency depreciation is still helping a lot.) If the government decides to trim gasoline prices, ethanol will be the first victim: let's remember that it is still a domestic-oriented industry. Another thing that could actually help the sector would be that global supply dwindles along 2009.  

Agnelli's Labour Law Proposal May Sink, But The Crisis Has Made it Relevant

Cia. Vale do Rio Doce CEO Roger Agnelli told Estado de S. Paulo newspaper in an interview published today that he has discussed twice with President Lula the necessity of easing labour legislation in Brazil as a way to reduce the impact of a global recession on Brazilian exporters. He is right, in part. 

The labour legislation in Brazil dates from 1943 and it imposes an awful burden on the finances of companies, either oriented to exports or to the domestic market. An executive at a food processing company recently told me that his company's biggest liabilities come from lawsuits filed by his own employees and the detrimental role of unions on the company's day-to-day operations. Agnelli should urge Lula to change the legislation not only on a temporary basis -- as the article suggests he did, -- but on a permanent basis. Also, it should reach companies and employees for each and every sector in Brazil. 

I don't see room for a fast-track passage of such an initiative in Congress (despite 2009 not being an electoral year.) I don't see the opposition engaging in such a difficult issue, and business groups are concerned it may backfire on them. But the debate has been opened at a moment almost every economist and analyst had forgotten about its relevance. This is a subject that we will be following as the crisis and its impact on the Brazilian economy unfolds.