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Brazilian Ethanol – Not the Solution But Part of the Energy Solution

Commodities / Ethanol Oct 03, 2007 - 01:31 PM GMT

By: David_Urban

Commodities

Best Financial Markets Analysis ArticleWorldwide, the United States is the largest producer of ethanol with Brazil running in second place. Brazil is the largest exporter with significant land available to ramp up production.

Ethanol in Brazil started in 1975 when the military government started a program which gave consumers tax breaks if they purchased ethanol-powered cars and fixed prices and purchased farmers production. The government also invested in research which has improved the yields three-fold in the past 30 years.


Fast forward to 2003 and President Lula cut taxes on ethanol and gave tax breaks to makers of flex-fuel cars. Today, more than 12 percent of the cars on the road in Brazil can be powered by biofuel and more than 80% of all new car purchases are flex-fuel vehicles.

Significant foreign investors are getting involved as well. George Soros has purchased a stake in Adeco Agropecuaria SA, a Buenos Ares-based agriculture company producing ethanol in South America . According to Soros , Brazil can ramp up production to supply ethanol to the world as the country has an area the size of the UK free to plant sugar cane without competition from other crops.

Brazilian Renewable Energy Company Ltd. closed on a $151 million dollar private placement with prominent shareholders like US supermarket magnate Ron Burkle, AOL founder Steven Case, and former World Bank President James Wolfensohn. The company is headed by Philippe Reichstul, former CEO of Petroleos Brasileiro SA.

In terms of comparing the United States and corn to Brazil and sugarcane one first starts with crop yields where corn is planted and harvested every year whereas sugarcane provides five cuttings over six years before being replanted. 5 times the amount of sugarcane to corn in terms of weight (100 lbs. to 20 lbs.) is needed to produce one gallon of ethanol but in terms of crop yield per acre, sugarcane out yields corn by a factor of 8:1. This means that in the end an acre of sugarcane produces 650 gallons of ethanol while corn produces 400 gallons.

If the United States were to increase the acreage of corn it would come at the expense of other crops while Brazil has the available land to expand sugarcane acreage. Brazil can convert 250 million acres of degraded pastureland to sugarcane production along with 225 million acres of savannah. If all 475 million acres were converted it is estimated that Brazil will be able to produce enough ethanol than when converted to gasoline (ethanol has only about 67% of the energy of gasoline) will produce the equivalent energy of 205 billion gallons of gasoline. As a point of comparison, the United States consumes approximately 120 billion gallons of gasoline per year.

Harvesting sugarcane is a very labor intensive process which means that the process is open to future efficiency gains from process industrialization. During the ethanol creation process a fibrous waste material called bagasse is created. Burning the bagasse in the facility allows for the creation of electricity which powers the plant. By burning bagasse, the process becomes self-sufficient in energy whereas the corn in the United States is harvested by gasoline burning equipment.

Brazil exports 20% of their production with the United States accounting for one-third of the exports with Japan and India consuming most of the rest. The Netherlands , Japan and Sweden are interested in increasing their imports of Brazilian ethanol to meet Kyoto treaty requirements.

Brazil 's sugar cane based ethanol sells for as little as $1.14 per gallon making Brazil a low cost producer of ethanol on the global market. Brazil has no subsidies or import tariffs on ethanol while the United States has a $0.51 per gallon subsidy and $0.54 per gallon import tariff. The import tariff was established in 1980.

Ethanol barons have enlisted Lula to help finance an expansion in ethanol producing plants. Brazil 's National Bank for Economic and Social Development is reviewing a request for $3.5 billion in new loans at a preferred interest rate as low as 8.55% in contrast to the market rate of 11.25%. During the four year period from 2003 to 2006, the bank lent $2.34 billion to the sugarcane industry.

The US has goals of switching over to ethanol but there is not enough farmland in the US to produce the amount of corn required. The current protectionist tariff is hindering the transformation from oil to ethanol as Brazilian ethanol can help hold back any significant increase in demand.

The United States has significant disadvantages when compared to Brazil . First, while the amount of available cropland is significant our growing season is not year round. Second, the amount of gasoline consumption in the United States is far greater than Brazil which makes any complete switchover challenging. However, given the state of world affairs, our dependence on light sweet crude oil from Nigeria , the inability to significantly expand productive capacity, and our inability to control demand a switchover to fuels like diesel and biofuels is inevitable. Brazilian ethanol will not completely solve the problems of the United States or make us energy independent but it is a start.

The key takeaway is that while Brazilian ethanol is not the solution for the energy needs of the United States , increased exports to foreign countries like the Netherlands , Japan , and India whose oil dependence is far less can be very profitable for investors going forward. Brazil 's sugarcane industry is still highly fragmented with the largest player holding a market share of almost 9%, more than 3 times their nearest competitor. It is likely that one or two producers will create a wave of consolidation which will create global players capable of better serving the world's ethanol needs in the future. For smaller countries with less total demand ethanol can play a major part in reducing the countries energy needs. For larger countries with significant demand, ethanol can play a key role in shaping the countries energy future.

Sugarcane based ethanol is a low cost alternative with a bright future ahead.

Sources: ‘Energy Agriculture – Brazilian ethanol', Dan Hofstrand, AgDM newletter article, June 2007.

‘Ethanol Boom draws Prominent Investors,' International Herald Tribune, March 16, 2007 .

‘ Brazil Ethanol Boom Belied by Diseased Lungs Among Cane Workers,' Michael Smith and Carlos Caminada. September 28, 2007 , www.Bloomberg.com.

1Q08 Investor and Analyst Presentation, www.cosan.com .

By David Urban

http://blog.myspace.com/global112

Communications are intended solely for informational purposes. Statements made should not be construed as an endorsement, either expressed or implied. This blog and the author is not responsible for typographic errors or other inaccuracies in the content. We believe the information contained herein to be accurate and reliable. However, errors may occasionally occur. Therefore, all information and materials are provided "AS IS" without any warranty of any kind. Past results are not indicative of future results.

PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN THE STOCK, BOND, AND DERIVATIVE MARKETS. WHEN CONSIDERING ANY TYPE OF INVESTMENT, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER.

Before making any type of investment, one should consult with an investment professional to consider whether the investment is appropriate for the individuals risk profile.

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