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.

Brazil’s Import Barriers

Brazil made a big show of reducing their ethanol import tariff to zero earlier this year in order to spark the debate about the US ethanol import tariff that is up for renewal at the end of this year. Brazilian representatives cast themselves as supporters of free trade.

In today’s global ethanol market, Brazilian ethanol prices are very high relative to the US and Europe. Brazilian producers are holding onto inventory where in past harvest seasons they would be selling ethanol aggressively as the harvest gets into full swing. Recent consolidations in the ethanol industry, government inventory loan programs for producers and strong sugar prices all have lead to a more disciplined ethanol market in Brazil leading to the high prices.

Now that a price arbitrage is open to Brazil, US exporters are attempting to ship material to Brazil to capture these prices.

Brazil has imposed non- tariff barriers in two ways. One, the ethanol specification used for import requires that non-sugarcane produced ethanol must be 99.6% ethanol by volume while standard fuel anhydrous ethanol produced from sugarcane be 98% ethanol by volume (actual measurement is alcoholic degree of 99.3 that translates into 98% volume percent). There is no valid scientific reason to make this distinction for ethanol that is to be blended into gasoline.

Obviously, high purity(99.6%) ethanol produced in the US is a small fraction of the total ethanol produced and what is produced commands a 10-15 cpg premium over standard denatured ASTM specification ethanol.

The second non-tariff barrier has been extended bureaucratic delays in issuing import licenses. Traders trying to import ethanol into Brazil report frustrating delays in getting import licenses to take advantage of the wide open arbitrage. It is hard to determine the exact delays but with a strong price arbitrage to export to Brazil and reports of limited smaller cargos being shipped to Brazil, the bureaucratic delays are real.

Global Ethanol Trade Flows

Global Ethanol Trade Flows

Ethanol trade has started to slow down for many producing and consuming countries.  The table on the right titled “Global Ethanol Trade Flows” examines trade flows between various regions around the world comparing year to date April of 2010 versus year to date April of 2009.  The six key trade flows that have shown significant year over year changes are evaluated as follows:

· USA => CANADA

Looking at the table on the right, according to the US Census Bureau, exports of ethanol from the US to Canada have almost doubled this year compared to the same time frame last year.  This is due to provincial ethanol blending mandates in Canada taking effect within the last year, as well as preparation for the national E5 mandate that is set to be implemented at the end of the year.  There is one new plant expansion scheduled in Canada by Suncor of 200 mln liters in Q1 2011.  With no other new capacity on the drawing board beyond the Suncor plant, this level of Canadian imports will continue into next year.

· Brazil => CBI  => USA

Brazil’s exports to the CBI nations are down 76% of what they were a year ago.  CBI nations enjoy duty-free access to the US market.  The CBI countries have essentially no indengious ethanol production and rely solely on the dehydration of Brazilian ethanol.  The dehydration arbitrage of Brazilian hydrous ethanol is closed and we expect the arbitrage to remain closed for the foreseeable future reducing this trade flow to zero.

· Brazil => USA

Due to feedstock prices in their respective countries, imports of ethanol into the US from Brazil have diminished during the last two years.  Brazil’s poor harvest last year and substantial growth in Brazil’s domestic ethanol demand by the burgeoning FFV fleet has maintained strong domestic prices reducing the incentive to export. The US import tariff of $0.54-per-gallon tariff is also a strong barrier to open trade.  Although corn prices are rising in the US at the moment and pushing ethanol with them, it is remains uneconomical to bring material in from Brazil, especially with the added tariff.

· Brazil => Asia/Pacific

Brazilian ethanol exports to Asia are somewhat lower this year compared to the same time last year.  This market represents a potential growth opportunity for Brazil.  Other than China, there are no substantial producers of ethanol in Asia, especially for export, and countries such as Japan and India have invested in sugar mills and ethanol technologies in Brazil, leading to a natural trade flow between Brazil and these countries.  South Korea is a major recipient of ethanol from Brazil, but much of this volume is for beverage-grade consumption since  South Korea does not have a fuel ethanol blending mandate.

· Brazil => EU

Exports of ethanol from Brazil to the EU have fallen by almost half of what they were last year during the same time period.  This has been due to abundant T2 ethanol supply in Europe, as well as a function of price; when adding the EU import ethanol tariff, it simply has been largely uneconomical to send undenatured EN spec ethanol from Brazil to the EU.    We expect ethanol demand to grow in Europe with increased blending penetration percentages kicking in the second half of the year.  With this increased demand, regional price spreads will widened at some point to draw in the necessary volume to cover demand.

· USA => EU

Exports of ethanol to the EU from the US have increased substantially.  This change in trade flow has been a function of price.  Ethanol prices in the US have been low relative to EU and Brazilian prices prompting the surge in exports.  Export volumes have receded recently with the narrowing of regional prices.  This week’s strengthening in corn prices due to changes supply fundamentals will keep US ethanol prices too high for further sustained exports to the EU.