Brazil's Potential Role in Ethanol Trade

This year, Brazil’s exports have tracked at a level 50% below last year’s exports.  It is our opinion that Brazil’s participation in the international fuel ethanol market is going to be very limited over the next two years.  The following is a list of factors that will contribute to keeping Brazil off the fuel ethanol export market:

•          Dry weather conditions have reduced sugarcane yields per acre by 5% or more below forecast this harvest season.
•          The poor weather conditions during the last two years have conspired to disrupt the typical replanting share of 20% of the cultivated acreage.  This has left the industry with a substantially older crop in the field that yields less cane than younger sugarcane.  It will take at least another growing season to remedy this imbalance in the sugarcane crop.
•          Sugar prices are again at record levels, and it appears that the sugar industry will not be able to replenish stocks this year, leaving the sugar market fundamentally tight for at least another year. 
•          Higher sugar prices will continue the favoring of sugar production in Brazil, where mills can swing approximately 1 billion liters of ethanol production towards sugar.
•          High sugar prices generating copious amounts of cash, coupled with the government loan program for ethanol inventory, has allowed mills to show market discipline and not dump ethanol onto the market to generate cash.  This is evidenced by the industry holding more than 2 billion liters more of inventory than last year at this point in the harvest, allowing the mills to maintain high ethanol prices.
•          The startup of significant chemical demand to produce green plastics.  Braskem’s new polyethylene facility will consume 500 million liters per year of ethanol starting next year.
•          The continued growth of the flex-fuel vehicle (FFV) fleet by 2.7 million vehicles per year.  If these FFVs shift from E25 to 100% hydrous ethanol, they have the potential to consume an additional 3.5 billion liters per year of ethanol.  FFV fuel demand is very elastic and will respond to price quickly.   Higher prices this year have reduced ethanol demand by over 1 billion liters as the FFV fleet has responded to high ethanol prices relative to gasoline.  The overall size of the FFV fleet is estimated at 11.7 million vehicles by the end of 2010.  In our opinion, this is the single largest reason why Brazil, at least for the next several years, will not be a major exporter of ethanol due to the potential for a huge surge in demand domestically when the prices are set accordingly.

More E15 News

The EPA confirmed in a status update, hidden on their website on Friday afternoon before a three-day weekend, (brave bureaucrats) that an E15 waiver for 2007 model cars and younger would be decided on in late September. For automobiles in the 2001-2006 model years, a decision will be issued in November. Assuming that, at some point in the future, some portion of the automobile fleet in the US will be able to use E15, let’s consider the confusion at the pump for the average consumer. The consumer will approach a fuel dispenser and be faced with a big ugly label indicating that it is unsafe to use E15 in cars in the appropriate model years. The consumer will then think that if E15 is unsafe for some cars, why take the risk and will decide not to use E15, even if the car in question is actually compatible with E15. The price differential will be minimal at best, so an economic incentive will not exist to motivate the consumer to make the choice of filling up with E15. A bifurcated E10/E15 gasoline market will not work. With no economic incentive to purchase E15 while E10 sits next to E15 at the same gasoline pump, E15 is going nowhere. As we suggested in last week’s newsletter, getting full E10 penetration in the gasoline market and pushing FFV’s, along with E85, is going to be the route to expanding ethanol demand. E85 will work for the consumer when he sees the lower cpg price, even though, on a miles per gallon basis, it won’t be any better; consumer self-interest will kick in. The FFV/E85 strategy faces a density of demand issue, with FFV’s scattered across the US and not concentrated enough in one area to support numerous E85 station conversions. Look for lobbying to kick into high gear to expand FFV production, as well as government (federal and state) monetary support to install E85 dispensers.

E15 Update

The EPA announced last week that the agency was delaying the decision on whether to grant a waiver to allow E15 in gasoline, citing the agency’s desire to wait until the DOE has completed its engine testing in September. The DOE engine testing is focused on late model Tier II emission control vehicles that went into production in 2007. In announcing this delay, the EPA intimated that it may only approve a waiver for these types of vehicles, and older vehicles may not be part of the waiver. The ethanol industry was hoping for a minimum waiver that included vehicles 2001 or younger that would have made more than half the existing fleet eligible for E15. Backing up the waiver to 2007 or younger will shrink the available vehicles to approximately 20% of the fleet. This type of waiver will do little for the ethanol industry. As we have discussed previously, a bifurcated market will have gas station liability issues, product labeling issues, and distribution issues for the gasoline marketer offering clear unleaded 87, E10, E15, E85, and premium gasoline.

ADM has petitioned the EPA to consider an E12 waiver based on the “substantially similar” concept that bypasses any engine testing by deeming the product substantially similar. This approach appears to be a long shot. The year and half delay in making any type of decision by the EPA is indicative of the difficulty in moving the gasoline market past E10 with the existing fleet of vehicles. Always keep in mind that when a difficult decision is required by a government bureaucrat that involves risk, the “make no decision” reflex will win out, as evidenced by the long delay on this E15 decision.

We believe the clear path to large ethanol consumption is to focus on moving the fleet towards E85-capable vehicles. In order to achieve the desired amount of renewable ethanol in the US gasoline pool, the solution that Brazil has embraced is the Flex-Fuel Vehicle (FFV). The FFV in Brazil has been tremendously successful in developing the ethanol fuel market in that country. It is very inexpensive to produce an FFV versus a non-FFV, so that is not an impediment. The key to unlocking the E85 market is getting the fuel dispenser infrastructure in place. There is proposed legislation to mandate the auto manufacturers to produce 90% of the fleet as FFV’s by 2013, and the legislation offers substantial federal grants for blender pump installation at gas stations.

Looking forward into 2011, the RFS mandate increases by 600 million gallons, and the small refiner exemption will be removed. These two actions will be enough to complete 100% penetration of E10 into the gasoline pool and consume all the production scheduled to come online by the end of this year. E15 is not necessary to consume all the domestically produced ethanol over the next 18 months, but the delay is having a negative impact in market psychology.