China & Commodities Send Brazil into Downward Spiral

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According to a recent Gallup survey, the most positive people in the world are in Latin America. But given recent events in global financial markets, I suspect this upbeat attitude is being severely tested. While Venezuela teeters on the precipice of social unrest amid a persistent shortage of basic goods, the Brazilian economy is giving it a good run for its money in a race to the bottom.

The fortunes of both economies are closely linked to commodities. While Venezuela’s economy is inextricably tied to oil, with 95% of its exports and 50% of its economy reliant upon it, Brazil’s economy is dependent upon a number of different commodities, from iron ore to soybeans.

Even though this seeming diversification across commodities should hold the country in good stead, the opposite has happened, given China is Brazil’s largest export market; China accounts for half of all commodities that the South American nation sends around the world.

So while Brazil has been best positioned to benefit from rising demand from China in the last decade, it is now feeling the most pain as that demand wanes. To put this rampant rise in context, Brazil’s annual trade with China was only $2 billion in 2000….but $83 billion in 2013.

A perfect storm has hit Brazil as China’s economy has weakened; falling commodity prices have given way to its currency weakening to a 12-year low, all the while the Bovespa stock index has tumbled and its government debt has risen:


Brazil economy


The latest GDP data has highlighted that the Brazilian economy is heading further into recessionary terrain, with its economy shrinking in Q2 by 1.9% on the prior quarter. Unemployment is charging higher as inflation nears double-digits. In an attempt to quell inflation it has hiked interest rates to 13%, but in turn this makes its debt harder to service:


Brazil interest inflation

Brazil is the world’s eighth largest energy consumer with the fifth largest population. In the wake of lower oil prices and amid corruption at Petrobras, Brazil has lowered its production outlook for the end of the decade by 1.4 million barrels per day. It had previously announced just last September that it would produce 4 mn bpd of oil by 2022, exporting  1.5 – 2 mn bpd by 2022.

Both this production and export estimate seemed rather optimistic. After all, oil and biofuel production is around 2.5 mn bpd, while consumption has increasingly outpaced this in recent years. Brazil’s demand for liquid fuels is above 3 mn bpd, while current production of both natural gas and crude oil have only just clambered back above this level (on a barrel of oil equivalent basis).

Even though Brazil is both a global leader in terms of consuming energy and producing commodities, it is not a large player when it comes to oil exports, with the majority of its production used for domestic demand. It currently imports over 500,000 bpd of products to meet domestic demand amid under-investment in its refining industry.

Brazil has averaged 400,000 bpd of oil exports year-to-date through August, with China accounting for 30% of these volumes. The US saw nearly 20% of these exports, while India in third place saw just over 10%.

Brazil oil exports ClipperData

While August saw a lull in cargoes, the US has been a leading destination for Brazil’s heavy crude amid a bout of bargain-hunting. Looking ahead, we should see oil exports increasing from Brazil as it seeks greater revenues to offset the weakness in its economy. This export strength will persist despite a loss-leading effort by Brazil: 90% of its oil production is offshore, with break-evens higher than current market prices. All the while, lower economic activity will translate into lower domestic demand – further freeing up greater volumes for exportation.

The saying used to be ‘when the US sneezes, the world catches a cold‘, but this saying is now more applicable for China. And given Brazil’s ties to the world’s leading emerging market, its health is set to further deteriorate in the face of weak commodity prices.