Looming Power Crisis Poses Most Serious Near-Term Challenge to Brazil's Sugar and Ethanol Industry

As I have previously pointed out on this blog, Brazil faces a power shortage similar to the one that crippled the Brazilian economy in 2001. Back then, the federal government announced, as soon as the end of the rainy season, which lasts from October to March, made it clear that hydroelectric reservoirs had not been replenished, that all consumers - including homes, businesses, and factories - would have to cut their consumption by 20%, or face stiff fines.

This jolt came on the heels of the mini-recession associated with the burst of the tech bubble in the U.S. a year earlier and had Brazilians scrambling to eliminate whatever could possibly be seen as "waste". Commercial users, of course, in many cases had little choice but to scale back business - a course of action that may be in store for many of the companies in Brazil's sugar and ethanol industry now in 2008.

In November 2007, the utility company that supplies electric power to distilleries in the interior of Sao Paulo state, CPFL, contacted large consumers and notified them that it "may" have to rescind contracts locked in earlier, when power was abundant and cheap.

Dams supply 70% of Brazil's electricity. Because water levels in the hydroelectric reservoirs of Brazil's Center-South, which includes the states of Sao Paulo, Minas Gerais, and Rio de Janeiro, are close to the critical 60% level, CPFL may have to switch production to its more expensive thermal units, driving up the price to final consumers.

Even that may not suffice to stave off shortages and a cut-back on consumption may be, once again, mandated. This possibility would have a negative reinforcing effect for sugar and ethanol equipment companies located near the city of Ribeirao Preto, which manufacture boilers and other pieces of machinery used to burn bagasse and generate electricity from sugarcane residue - a surplus that is sold to the public grid and that today accounts for about 10% of the income of a large distillery.

With a looming shortage, these equipment makers face the prospect of being unable to meet the orders placed for the manufacture of new pieces or the refurbishing of existing ones, threatening to decrease total output and productivity levels in the industry and inflicting pain on established players and new ones alike.

Unless a deluge descends upon the river basins of Center-South Brazil between now and March, companies would do well to price in the cost of a power-down lasting several months, as was the case in 2001. Or they can hope for the best and, if that fails, point the finger at Saint Peter, the guardian of the gates of Heaven who Brazilians believe responsible for regulating the weather.

The federal government certainly will.