Hedging Strategies for Brazilian Ethanol: an analysis of domestic and foreign futures contracts operations

Several changes in biofuels international market has influenced local market dynamics and price risks. This study proposes to assess the hedging effectiveness and basis risk of the Brazilian ethanol using domestic and U.S. futures contract from 2010 through 2019. We use the simultaneous hedging for prices and exchange rate. Our overall results indicate that hedging strategies with U.S. futures contracts were less efficient and caused higher basis risk than strategies that use domestic contracts. The results were primarily influenced by exchange rate volatility, supply shocks, and biofuels policies implemented in Brazil and U.S. While the use of foreign contracts presents participants with additional basis risk, we found that during periods of less domestic regulation and lower exchange rate variation, hedging strategies that use foreign contracts are nearly as effective as those using domestic futures contracts. Thus, market participants in Brazil should consider using foreign contracts in their hedging strategies, particularly during periods of lower expected exchange risk.