Tuesday, May 22, 2007

USING LESSONS FROM PAST, BRAZIL FOCUSES ON EXPANDING ETHANOL CAPACITY

I have been in Brazil for nearly a month now, conducting a market survey for MacDonald Associates, and the steady drumbeat of complaints over the 54-cent-per-gallon tariff, imposed by the American government on Brazilian ethanol, seems to have abated. Brazilians have come to realize that they have very little excess capacity for export – and that the main barriers to growth in the sector are domestic, not foreign-made.

That drumbeat seems to me now to have been largely the product of the Brazilian press, locked, as usual, in a love-hate relationship with everything American. A small number of pundits, mainly journalists, intellectuals, and politicos of various stripes, are the ones most eagerly trying to assert Brazil's new geopolitical position in the face of dwindling global oil supplies.

Of course, the leftwing Workers’ Party, to which President Lula belongs, also knows the stakes at play, but appears to accept the realpolitik of ethanol in the U.S., where abolishing the tariff would wreak havoc on the American corn ethanol industry.

But do not expect any ideological or strategic vision from the business community directly responsible for the production of ethanol in Brazil. It knows about all the latest plays in the Brazilian market – what company bought which refineries, etc. – but, in the conversations I have had, seemed to me to be, in general, rather clueless about the larger picture.

I have spoken with sophisticated businessmen who see no relationship between the price of oil and interest in Brazilian ethanol, even though ethanol is the only remotely viable substitute for gasoline for the foreseeable future. And any talk of more elaborate ethanol production techniques, such as biomass-to-liquids, is usually met with blank stares, with the exception, of course, of some in academia and in a few select research centers associated with large Brazilian corporations.

The dynamics of the ethanol market seem to be dictated either by the necessities of local politics, by the overarching strategy of the Brazilian federal government to milk the ethanol cow until she buckles at the knees, or by varied commercial interests looking to make a fast buck off the unsuspecting foreigner.

Brazil was founded by unsuspecting foreigners – the Portuguese navigator credited with discovering Brazil, Pedro Alvares Cabral, was, or so we are taught in elementary school, on his way from Portugal to India when a storm knocked him off course and led him to terra firma on the coast of the state of Bahia, in northeastern Brazil. Various counter-theories argue that Cabral was, in fact, scouting Spanish possessions in the New World and decided, in 1500, to claim for Portugal the easternmost chunks of the discoveries made by Columbus just eight years earlier.

While we may never know the truth about Brazil’s discovery, the make-a-quick-buck nature of the Brazilian DNA is evinced by the name “Brazil” itself, derived from the Brazil tree (Caesalpinia echinata), a hardwood containing a red dye for textiles avidly chopped down and hauled off to Europe by the first white men to arrive in the country in the early XVI century. Though not many Brazilians realize it, both the tree that gave the country its name and words such as “blaze” and “brazier” all have the same origin and are related to the color red.

Around 1600, less than one-hundred years later, the Brazil tree was nearly extinct. The Portuguese then turned their attention to the pursuit of gold, green with envy that Spain had found silver (and, to a lesser extent, gold) in its own New World possessions. But the gold jackpot was not to pay off until the late XVII century, when huge deposits were found in the state of Minas Gerais (literally, “General Mines”), where I live when not at the University of Michigan.

Between epochs of gold mining and eras of sugar, cotton, rubber, and coffee production, the Brazilian population grew to its present size of almost 200 million. Gilberto Freyre, perhaps the most renowned of Brazilian sociologists, points out in “Casa Grande e Senzala” (“The Masters and the Slaves”) that only the extremes in this perennially makeshift society got fat – the landowners, a minuscule fraction of the population, could afford to import luxury goods and food from Portugal, freshness be damned; and the slaves were fed like so much cattle by their self-interested owners. The middle castes, comprising well over half the population, were left to fend for themselves amidst the monocultures that commandeered every beast of burden available, leaving very little protein for human consumption and making the culture of vegetables, and even chickens, a nearly impossible task in an export-driven society.

And so Brazil has been an exporter of commodities for over five centuries. It was recently suggested that Brazil, along with Russia, be dropped from the “BRIC” (“Brazil, Russia, India, and China”) acronym coined by Goldman Sachs, as Brazil has very few, if any, global brands, universities, or R&D facilities. I would argue that Brazil, with its vast territorial expanses, can at least feed its population. By investing in the Pro-Alcool (Pro-Ethanol Program) of the 1970s, the country, using less than 1% of its territory, can also grow the fuel to sustain the equity of its real estate market, even in a scenario of diminishing oil supplies. In such a changed world, Brazil should try to get better deals than those it got in the past.

Follow what's happening in the Brazilian ethanol market on Ethablog, the only blog in English dedicated to Brazilian ethanol.

Monday, May 21, 2007

BRAZIL ETHANOL PROPERTIES IN DEMAND, HARD TO FIND

One of the first things that struck me about the new situation in Brazil (new as in "relative to when I left eight months ago") is the appetite with which properties are being tossed around. I have been shown the description of refineries valued at US$ 200 million or more, capable of processing 1.5 to 2.5 million tons of cane/year (roughly equivalent to an output of about 1.3 million barrels of oil equivalent every year). But seeing a description and actually finding a good property for sale are very different things.

Professionals with distinguished careers in public service have quit their jobs to set up a fund or otherwise attract foreign investments and channel them to this or that project, hawking whatever particular investment strategy flavor is believed to be the most marketable. A hefty check from the Interamerican Development Bank (BID) and other cheap-money multilateral institutions is considered a plus.

Sergio Thompson-Flores, a former diplomat with a career in banking, has set up Infinity BioEnergy (previous post), a US$600 million dollar fund, in association with American partners, using the London stock exchange's lightly-regulated Alternative Investment Market as a platform. His fund has bought at least four properties in the past year and is, presumably, still shopping around. Henri Philippe Reichstul, the former president of Petrobras, has started Brenco (Brazilian Renewable Energy Company - previous post), with partners such as James Wolfensohn, former World Bank chief; Vinod Khosla, one of the founders of Sun Microsystem and legendary Silicon Valley VC; and Steve Case, former head of AOL. The partners have committed US$200 million (out of an announced project total of US$ 2 billion) to the initial stages.

The list goes on. And on.

The frenzy that has taken hold of Brazil is, at once, a reason for Brazilians to rejoice and a cautionary sign. The agricultural expansion currently going on in regions like the interior of Sao Paulo state and the flatlands in the westernmost portion of Minas Gerais state does not appear to have been the subject of adequate studies - a recipe for environmental and labor mishaps that can tarnish the image of Brazilian biofuels overseas, at great cost to the entire industry. Over the coming weeks, I will be surveying some of these sites in loco to better assess the transformations underway, part of the market study I am carrying out with Tom MacDonald, a research specialist with the California Energy Commission and the principal at MacDonald Associates.

Quite interestingly, Brazil has invented the IMBY, analogous to the American NIMBY (Not in My Backyard). The Brazilian IMBY cries out loud for foreign investments to plunk themselves somewhere inside its borders - states like Minas Gerais, the third-largest ethanol-producing state in Brazil, have lowered or are considering lowering their respective value-added taxes to become more attractive to foreign capital.

The Brazilian IMBY stands in stark contrast to the American BANANA ("Build Absolutely Nothing Anywhere Near Anyone"), the typically-American personage that has elevated gasoline prices to an all-time high and further spiked interest in Brazilian ethanol.

Funny how BANANA Republics rise and crumble...

Follow what's happening in the Brazilian ethanol market on Ethablog, the only blog in English dedicated to Brazilian ethanol.

BRAZIL ETHANOL SURVEY TRIP WEEK ONE

After arriving from Michigan at Guarulhos International Airport near Sao Paulo on April 27th, 2007, I ran to the gate for my connecting flight to Belo Horizonte, the city of three million where I am conducting a broad, in-depth survey of the Brazilian ethanol market. There I was greeted by the most recent of the infrastructure malaises that affect Brazil: the “airport blackout”, a quasi-strike by Brazilian air traffic controllers that kept my plane on the ground for over four hours.

These delays have become a fixture in Brazilian air travel, ever since an Airbus was downed over the Amazon in September 2006 by a freak collision with a private jet. Blame was ultimately assigned to the overworked, underpaid air traffic controllers, who felt stung and decided to follow the air traffic control rules to the letter, effectively slowing down take-offs and landings. The extended waits in airport lounges add to the price of doing business in Brazil, but also offer the opportunity to get to know your fellow sufferers a little better.

So it was that I met an executive from CVRD (Companhia Vale do Rio Doce), the largest producer of iron ore in the world – so big, in fact, that it has started its own air service to shuttle its executives from one Brazilian city to the other, in an attempt to remedy the intractable air traffic control problem.

The same CVRD executive told me that the company, who he says consumes 15% of all the electricity generated in Brazil, is also planning to build its own power generators – a fact that speaks to the capacity of private investments to bypass the ossified structural problems that have long hampered Brazil’s growth. Whether the problem is the sub-standard highway and railway system, ports with insufficient storage capacity, or inefficient distribution systems, large capital injections are often an efficient way to solve it.

A flood of foreign dollars has sent the real, the Brazilian national currency, soaring nearly 5% over the past month. The high interest rate paid out by the Brazilian federal government, undervalued assets on the Sao Paulo exchange, and a steady stream of direct investments (especially in the hard assets / commodities market) have led to an oversupply of dollars. The strong real is now playing against Brazilian exporters, who have been clamoring for the Brazilian government to set a floor of two reais to the dollar – with no success. Today, one American dollar buys 1.96 reais – just four weeks ago, it bought 2.11.

In the following weeks, please check back for updates on my four-month trip to survey the Brazilian ethanol market for MacDonald Associates and the William Davidson Institute at the University of Michigan.


Follow what's happening in the Brazilian ethanol market on Ethablog, the only blog in English dedicated to Brazilian ethanol.