Quantitative analysis of feasibility of hydrous ethanol futures contracts in Brazil

Brazil's first ethanol futures contract, which was implemented in 2000, failed to offer sufficient liquidity to attract market agents. The purpose of this study is to determine whether the new ethanol futures contracts launched by BMF-BOVESPA in 2010 meet the requirements to render them feasible. The originality of this work stems from its approach in analyzing different cross-hedging possibilities in the food and energy chains. This analysis, which covers the period of May 2010 to April 2012, evaluates the degree of competition in the sector, the price volatility of the spot market, the price correlations between its possible substitutes, as well as the possibility of cross-hedging Brazil's ethanol with contracts in international futures markets and their potential degree of substitution. The results of this study indicate that the new configuration of BMF-BOVESPA ethanol futures contracts meets the most requirements for viability. Nevertheless, the ethanol distribution sector is relatively concentrated, which may limit the liquidity of BMF-BOVESPA ethanol futures contracts.