Soy Bean Price Hike Ices Prize Petrobras Biodiesel

H-Bio, an experimental variety of biodiesel presented with great pomp by Petrobras in May 2006, promised, according to the Brazilian state-owned energy company, to save the country USD240 million in 2007, with a 25% reduction in imports of regular diesel.

But the fuel, characterized by a “high conversion yield, at least 95% v/v to diesel, without residue generation, and a small propane production as a by-product”, has not been produced by the company since August 2007. Petrobras cites the incapacity to procure sufficient amounts of vegetable oil as the main obstacle to the program.

While Brazil has the largest soy oil industry in the world, the federal government has centered its policy on small, peasant-based farming and encourages Petrobras to source vegetable oil from single-family farms, thereby diverting assets toward small-scale projects and away from larger undertakings that could deliver more oil per unit of capital expenditure.

These small producers face not only production challenges, managing oil-yielding feedstocks they are unfamiliar with (these include sunflowers, cotton, jatropha, castor beans, and oil palms, as well as animal residue like tallow), but must also come together in cooperatives with other farmers to reach scope and scale for product creation and commercialization.

Little (and usually low-quality) schooling among peasants makes such an endeavor nearly impossible. Cooperatives that do show some degree of success tend to receive some form of aid from the government, usually in the form of technical assistance. Agronomists and engineers, from federally-funded universities, R&D centers, and companies like Petrobras, work with cooperatives and farmers to achieve the goal of simultaneously reducing both fossil fuel use and poverty – only to discover that the situation reverts to the baseline scenario when aid ceases (i.e., everything goes back to square one).

That is the case because Brazilian federal policy has adopted an ambitious goal for biodiesel, aiming, in one fell swoop, to alleviate rural poverty, to diminish inequalities between Brazil’s more developed Center-South and the drought-stricken North-East, and to reduce the country’s dependence on foreign oil.

This rather tall order led Sergio Gabrielli, president of Petrobras, to announce in 2007 that the company, the main agent for Brazilian federal energy policy, would hedge its bets for biodiesel development by not relying solely on small farmers to get the oil it needs. Instead, it would also develop alliances with the large, mostly foreign-owned agricultural concerns that operate in Center-West Brazil, where large swaths of the vast Brazilian wooded savannas, called the Cerrado, have been planted over with soy, creating the so-called “Republic of Soy”, which spills over into Bolivia, Paraguay, and Argentina, but has its heart in Brazil’s remote hinterlands south of the Amazon forest.

But heightened domestic and international appetite for soy beans and byproducts – in natura, as soy meal, as animal feed, or for biodiesel – predictably led to a price spike that has forced Petrobras to shelve its H-Bio plans. In May 2006, when the fuel was first announced, a 60-kg sack of soy beans sold for USD25, according to Brazil’s Cepea (Center for Advanced Studies in Applied Economics). In November 2007, the price was up 85%, at USD46.

Petrobras, which announced in October the discovery of the largest oilfield found anywhere on the planet in 2007, is widely seen as a leader and innovator in deepwater offshore drilling – but it is learning the painful lesson of the Law of Receding Horizons. Prices forecasted when a project is conceived do not stay put – they go up until supply can adjust to the new levels of demand induced by the project.

This and other setbacks led Ildo Sauer, a director removed from Petrobras in September 2007 for political reasons, to qualify the Brazilian biodiesel program as “a disaster”, prompting the Minister for Agrarian Development, Guilherme Cassel, to counter the assertion by stating that he believes it is, rather, “a success”.

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.