Foreign Ethanol Operations in Brazil Learn to Deal with Local Politics

Directors from Bunge are preparing to open a greenfield project in the municipality of Ponta Pora, in Mato Grosso do Sul state. The plant, called Usina Monteverde, is scheduled to commence operations in June 2009 and will produce sugar, ethanol, and electricity from sugarcane, with an initial yearly milling capacity of 1.4 million tonnes of sugarcane, expected to be ramped up to 4.5 million tonnes by 2012. Total project set-up costs are estimated at BRL 300 million, or USD 130 million.

Usina Monteverde will be Bunge’s second ethanol operation in Brazil – on September 17^th, 2007, Bunge purchased the Santa Juliana plant, located in the municipality of the same name in Minas Gerais state, from Grupo Tenorio, a Brazilian agriculture conglomerate.

In preparation for the beginning of operations, a group of officials from Bunge’s Brazilian subsidiary paid a visit, on March 27, to the mayor of the municipality. Such courtesies are more than just etiquette in the Brazilian hinterlands, where quasi-feudal relations often determine business outcomes.

Foreign investors who are unaware of the Brazilian social and business culture are the ones most likely to find their operations affected by political considerations. These include questionings about a project’s licenses, tax compliance status, environmental permits, and countless other procedures and norms whose impact can be managed by working the Brazilian government machinery, at the municipal, state, and federal levels.

Political Movements Target Ethanol Operations

One of the organizations most active against Big Agribusiness in Brazil is closely associated with Lula’s Workers’ Party, known as the PT. While the PT has adopted a more liberal, corporate-friendly stance, the Landless Peasants’ Movement, or Movimento dos Sem-Terra, known as the MST, remains far on the left of the political spectrum.

With a number of grievances stemming from the country’s centuries-old agrarian structure, the MST seeks to draw attention to its cause by disrupting the operations of foreign companies, usually through the mass mobilization of large numbers of peasants and farm workers with little or no education. They enjoy broad support among many local agents, most notably certain sections of the Catholic Church and its Land Pastorals, which in Brazil carry considerable political weight.

Interventions by the MST and like-minded movements sometimes escalate into outright invasions. In March 2007, Via Campesina (“Peasants’ Way”), the international peasants’ movement of which the MST is a member, invaded Cevasa, a mill in which Cargill had just acquired a 63% stake, to protest the presence of large foreign ag concerns in the Brazilian sugar and ethanol industry. A visit to Brazil that same month by former President Bush was the political trigger.

A state coordinator for the MST had this to say about the Cevasa invasion.

“Ethanol is of no use for the Brazilian people because it transforms Brazil into the backyard of American elites. Bush’s intention in negotiating ethanol with Lula has strengthened our resolution against him. We are here (at Cevasa) to tell him that he has no friends here.”

Considerable planning went into the Cevasa plant invasion. “Women for Life and against Agribusiness”, a sub-movement inside Via Campesina, bused in 800 women from 40 nearby municipalities. A “peaceful” occupation ensued, monitored closely by Cargill officials, who, that very same month, had to deal with the attempted occupation by Greenpeace of a grain shipping terminal on the banks of a tributary of the Amazon River in the northern state of Para.

Such episodes illustrate the dangers of doing business in Brazil. Factors like very favorable farming conditions may be outweighed, if unchecked, by political considerations. These must be addressed and negotiated, often with a multitude of “stakeholders” who are quick to smell money, compounding what is popularly known in the country as the “Brazil cost”.

Incidentally, it is worth noting that President Lula, a former union worker, still sympathizes with the MST, having famously donned a cap with the movement’s logo in 2005, at a time when a number of farms around Brazil were under illegal occupation. Today, his administration is being questioned about BRL 152 million, or USD 66 million, that have been funneled by the government to NGOs connected to the MST. These NGOs support or facilitate the MST’s political activities.

Multinationals investing in sugarcane operations, like Bunge, seek to smooth out relations with local authorities to avoid such traps. Mayors and other officials at the municipal level are the ones most likely to become allies when problems arise.

Brenco Counts on Help from Ex-Petrobras CEO

Investors often bring out the big guns when the undertaking is countrywide in scope. The Brazilian Renewable Energy company, known as Brenco, hired Henri-Philippe Reichstul, former president of the Brazilian state-owned oil giant, Petrobras, to head its Brazilian operations.

Founded by a group of US-based investors, Brenco has sizable operations planned for several localities around Brazil, including three plants in Mato Grosso do Sul state, the state where Bunge is opening its new facility. One of Mr. Reichstul’s main tasks is to use his insider connections and knowledge of the Brazilian energy market to help minimize the countless liabilities associated with such a large undertaking – not least of which are the political pitfalls of a country that has 26 states and 5,562 municipalities, each with an executive and legislative agenda of its own.

Jim Rogers Venturing into Land in Brazil, Canada, Suggests Name Change for CNBC

(click here for video)

In an interview recorded by CNBC on March 2nd, 2009, Jim Rogers says that he wants to be in "companies that actually make something".

Why? Because "the supplies of everything are going to continue to be under pressure".

"The inventories of food are the lowest they’ve been in fifty years. We have serious supply problems for many mining goods, oil, and agriculture. Even if demand goes down, or flat, as it did in the 1930s, we’re still going to have a nice market".

"I'm at the direction of a couple of funds, and what we're doing is we're buying land in Brazil, and the other one is buying land in Canada. What we're starting to do is farm it – in Brazil, greenfield projects. In Canada, existing farms. If I'm right, agriculture is going to be one of the great industries of the next twenty, thirty years or so. Maybe CNBC will have to change to 'CNBC Agriculture' (laughter) "Maybe down the road we'll be reporting from the farming pits".

But where’s the demand going to come from?

Mr. Rogers replies that, whatever happens, "we are still going to have to eat and wear clothes".

American Ag Consultant in Brazil Shows the Way to Foreign Investors

My friend Kory Melby lives in Brazil's Center-West, the country's agricultural heartland.

He has been showing foreigners around the region for a number of years, looking for good deals in farmland. He offers "private consulting services for hedge funds and private investors, keeping them abreast of the latest Brazilian updates on soybeans, cotton, cattle and land prices".

Kory has "over seven years' experience in the agriculture sector in Brazil. (He has) traveled extensively in the agriculture regions of the country and (has) built up and established a network of knowledgeable contacts".

Here’s one of his most recent posts:

March 14, 2009

Back in Goiania (capital of Goias state).

I covered 2000+ km of Mato Grosso (state) last week.

2nd crop corn and cotton look good.

Rainfall totals for central Mato Grosso are at 1400 mm as of March 14th. Normal is 2000 mm for this date.

The rainy season will end by the end of April. Normal rainfall amounts are 2200-2400 mm for the season.

As long as rains come for another 6 weeks, the 2nd corn crop should be fine. If rains end early, then yield problems will show up.

Soybean yields were as expected for most producers: 50 sacs or 44.5 bushel per acre.

Cash price for soybeans are about US$ 7.00 per bushel basis central Mato Grosso.

Everyone is in survival mode. They know they are not going to make much money this year. They know it will be tough sledding into 2010. Credit is expensive. All banks want 2% per month or more. One producer said he made his payments to the bank, and now the bank does not want to lend the money back out again.

Local coops are offering 2010 soybean packages for 22 sacs of soybeans per hectare for trading. This includes fertilizer, seed, and chemicals. This is not too bad.

Read the rest of his analysis here.

He also provides a translation of an article that just came out in Gazeta Mercantil, titled, “Land Prices Surprise with Full Recovery in Crisis” (Gazeta Mercantil is the Brazilian equivalent of The Wall Street Journal – minus the Murdoch stigma).

South America Farmland in Demand, Seen as Hedge against Quantitative Easing

Jim Rogers has long been an advocate of investing in farmland and commodities. His partner in the Quantum Fund, George Soros, has a significant stake in Adeco Agropecuaria, which owns several farm-related projects throughout South America, including a cluster with three large ethanol plants in the remote hinterlands of central Brazil.

Brett Owens at CommodityBullMarket.com analyzes an in-depth interview with Rogers recorded in February 2009.

Three comments, relevant to a better understanding of the fundamentals driving the Brazilian sugar and ethanol industry, stand out:

* Rogers doesn't "see what can fill the economic holes of the depletion of oil in the North Sea and London's imploding finance industry”;

* “Farming will be one of the best industries in the world for the next decade or two”;

* Printing money has never, ever worked.

Mr. Rogers also attempts to explain the current crisis by pointing out that “capitalism and free markets did not fail - they weren't allowed to work by central banks, which wouldn't let people fail (starting with the bailout of Long Term Capital Management)”.

But I would argue that US capitalism did not fail for another reason: it never started in the first place. The American taxpayer financed the development of (in no particular order) computer chips, transistors, jet engines, locomotives, automobiles, airplanes, satellites, fiber optics, and other little gifts from the taxpayer to corporations in the US hi-tech industry, usually under the guise of defense spending.

So it is clear that US government interference in the economy did not begin with its rescue of LTCM in 1998, but stretches back a little further, to 1776.

But I digress. Mr. Rogers has a point about farmland, also one of the favorite asset subclasses of Marc Faber.

Mr. Faber, the Swiss-born banker who exchanged New York and Zurich for the relative safety of metropolises in southeast Asia, is also big on rural properties. He adds that there is extra value in investing in farmland in areas of the world less prone to having a nuclear arsenal, and therefore less likely to get bombed in case of a thermonuclear kerfuffle between the United States, France, the UK, and Israel.

Former president Bush should know. His family is said to have bought vast swathes of farmland in Paraguay, near the border with Brazil, Bolivia, and Argentina – according to some reports, as much as 100,000 acres, or 40,500 hectares (here, here, and here). Always mindful of his own safety, Mr. Bush, along with his family, is said to have chosen the location because of its proximity to the US Mariscal Estigarribia Military Base in Paraguay.

Some reports, written back in 2006, were pretty prescient, stating, with Roubini-esque clairvoyance, that,

“It seems a bolt-hole of protection is being established in Paraguay for US leaders who may not be safe in the US after a political revolution. It's noteworthy that the Bush gang may themselves feel the imminent instability of the US, and that perhaps not only the fall of the US Empire, but also an internal revolution in America, is not too many years away. Even today, President Bush is greatly backed and protected by the US multi-national corporations, and the US legal system that serves those corporations. So this creation of a Paraguay refuge for US leaders suggests that America's ruling powers are not confident about maintaining their hold.”

Quite the understatement, in light of the ongoing global collapse. One wonders if there would be enough room on Mr. Bush’s plot for a couple of AIG execs in need of a change of settings.

Brazilian Roads Endanger Production Plans for Adeco, Brenco, ADM, Other Brazilian Ethanol and Biodiesel Producers

Brazil’s decaying infrastructure continues to take its toll on the competitiveness of the country’s agricultural products, placing the country’s balance of trade at risk just as it struggles to disentangle itself from the international economic imbroglio.

The huge Center-West region (map), considered Brazil’s most productive agricultural frontier, is the place where infrastructure problems are most apparent. Located at the geographic center of South America, equidistant from the Atlantic, the Pacific, and the navigable Amazon River, the region’s roads are riddled with potholes and other obstacles that take a heavy toll on the trucks used to transport production – mostly soybeans – to ports on the Atlantic (the Pacific route is blocked by the Andes, while using ports on the Amazon carries a heavy political price – just ask Cargill).

A Sea of Soy

Soybeans are the region’s main crop – according to McKinsey & Co., Brazil is the world’s third-largest producer of the beans, and the second-largest producer of soy oil and flour. The continuous growth of soybean fields spills over into neighboring Paraguay and Bolivia, and then on to Argentina, creating what has been dubbed the “Republic of Soy” (Argentina, also according to McKinsey, is the world’s number one producer of soy oil and flour and the fourth producer of soybeans).

The region is attractive to soy growers because of very favorable climate and soil conditions. But gains in productivity are largely offset by higher logistics costs: shipping averages around USD 360 per hectare, while the figure for the coastal state of Parana, just south of Sao Paulo state, is around USD 135.

In fact, the availability of feedstock in the Center-West has jumpstarted a now-thriving biodiesel industry in the region. ADM produces 500,000 liters (132,000 gallons) of biodiesel per day at its plant in Rondonopolis, Mato Grosso state. In August 2008, it announced that it would expand daily production to one million liters, or 264,000 gallons. The state governor, Blairo Maggi, heads Grupo Andre Maggi, yet another major player. In 2005, Mr. Maggi was awarded the “Golden Chainsaw” by Greenpeace Brazil in recognition of his efforts in favor of the Amazon forest, which straddles the border between his state and the northern state of Amazonas.

Besides making the Center-West’s soy less competitive, the region’s crumbling infrastructure also challenges Brazil’s growing ethanol industry. Since 2006, the Center-West, which comprises the states of Mato Grosso, Mato Grosso do Sul, and Goias, has seen a boom in the development of greenfield ethanol projects.

Brazilian Center-West a New Ethanol Frontier

Adeco Agropecuaria S.A., in which George Soros is a major shareholder, has a sizable sugarcane project under development in the region. Marcelo Vieira, Mr. Soros’ Brazilian partner in the undertaking, says that,

“The creation of a great ethanol company is underway in the state of Mato Grosso do Sul, which will make yearly revenues jump from the current USD 125 million to USD 600 million within eight years”.

When the project is fully operational, the ethanol production cluster will comprise three separate plants. The first plant, in the municipality of Angelica, opened in July 2008 and can crush an estimated 3.5 million tonnes of sugarcane per year. In addition to the plant in Mato Grosso do Sul state, Adeco also owns the Monte Alegre plant in the municipality of the same name in Minas Gerais state, further east.

Another four plants in the region belong to the Brazilian Renewable Energy Company, known as Brenco. The venture is backed by a gaggle of US-based investors that includes Vinod Khosla, one of the founders of Sun Microsystems; Steve Case, who co-founded AOL; Ron Burkle, California supermarket magnate and a good friend of Bill Clinton’s; Steve Bing, film producer; James Wolfensohn, ex-World Bank president; and Henri-Philippe Reichstul, the company’s CEO and former president of Petrobras, the giant Brazilian state-owned oil company.

Brenco and Adeco Ethanol Operations in the Brazilian Center-West

Plant Name	Location
Brenco
Morro Vermelho	Mineiros, Goias state
Agua Emendada	Mineiros, Goias state
Alto Taquari	Alto Taquari, Mato Grosso state
Perolandia	Perolandia, Goias state
Costa Rica	Costa Rica, Mato Grosso do Sul state
Adecoagro
Angelica	Angelica, Mato Grosso do Sul state
Second plant of the Angelica complex	Municipalities of Angelica and Ivanhema, Mato Grosso do Sul state
Third plant of the Angelica complex	Municipalities of Angelica and Ivanhema, Mato Grosso do Sul state

Transportation Overly-Reliant on Roads

In the Center-West, an area of 620,000 square miles (roughly the size of Alaska), a network of highways and smaller roads built by the federal government, beginning in the 1950s, is pummeled by a constant flow of trucks carrying up to 40 tonnes of grain each.

Transportation by rail and river is practically non-existent, due to government developmental policies favoring road transportation that date back half a century.

Funding for infrastructure construction, repair, and upkeep, scarce even before the onset of the current economic crisis, is now dependent on the largely-dysfunctional Growth Acceleration Program, known in Portuguese as Programa de Aceleracao do Crescimento, or PAC. The Program was originally intended to promote government investment in infrastructure works, including housing, sanitation, and public transportation. Private investment was supposed to follow the government’s lead, but, so far, the initiative has very little to show, in a classic case of Brazilian over-promising and under-delivering.

Trucks carry 60% of the cargo in Brazil. The country’s reliance on road transportation dates back to the 1950s, when the Brazilian government, engrossed in the construction of a shiny new capital in the Brazilian central highlands (still considered the middle of nowhere by most Brazilians), sought to develop a new transportation infrastructure to connect the city, inaugurated in 1960, to the country’s large urban centers, nearly all of which are located at least one thousand miles away, in the areas by the coast: Rio de Janeiro, Sao Paulo, Belem, and Salvador, among others.

To support a fledgling auto industry, and to boost national sentiment, the Brazilian government decided to emulate the American interstate highway system built during the Eisenhower years. Railways would have been a much more cost-effective solution, but were seen as an alternative for poor countries and had no place in the bright future Brazilian leaders envisioned.

Today Brazil pays the price for these misguided aspirations, not only in the form of lost revenue and competitiveness, but also in vehicular deaths, which, for the period between 2003 and 2006, averaged 34,000 cases per year. That is roughly the same figure as for the United States – which has a fleet ten times the size of Brazil’s.

Brazilian Ethanol Leaders Plot End to US Ethanol Tariff, with a Little Hand from US Corporations

This week, sugar and ethanol industry honchos are gathered at the Sugar and Ethanol Brazil conference, held by F.O. Licht, AgraFNP and International Business Communications in Sao Paulo.

As expected, the US ethanol tariff, the Brazilian industry’s favorite bogeyman, is a recurrent topic, with speakers lining up to point out the unfairness of not taxing the import of gasoline and other petroleum fuels, while punishing ethanol with a 54-cent-per-gallon tariff, plus a 2.5% ad valorem tax.

The Brazilian Agribusiness Association, known as Abag and supported by Archer Daniels Midland, Cargill, and other large American ag concerns, points to the establishment of strategic partnerships with countries in the Spanish-speaking portion of Latin America as a way to build critical mass for sugarcane-based ethanol. But the association believes that gaining unfettered access to the US market is still the key to a global ethanol market, one in which the biofuel is a freely-traded, widely-consumed product.

In the words of Luiz Carlos Correa Carvalho, one of Abag’s directors,

“We defend (negotiating with the United States). We are initiating conversations with American authorities and imagine that President Obama has great chances, as does (Brazilian) President Lula, based on work done in the Americas, to get rid of the addiction to oil.”

While Mr. Carvalho doesn’t mention how, specifically, he and his organization are engaging the US government, it is fair to imagine that Icone, a think tank focusing on international trade issues that originated inside Abag, is involved in the process. Andre Nassar, Icone’s General Director, is also the director for international trade of the Agribusiness Department of Fiesp, the powerful federation of industries of Sao Paulo state, by far Brazil’s largest ethanol-producing region. Both positions held by Mr. Nassar were, until recently, occupied by Marcos Jank (here and here), currently serving as president of Unica, the trade group that represents the sugarcane industry of Brazil’s Center-South region and one of the main foes of the US ethanol tariff.

Interestingly, then, money from companies like ADM and Cargill, key players in the United States’ corn ethanol production chain, finances the fight against the US ethanol tariff. They support the Brazilian Agribusiness Association, which supports Icone, which supports Unica, which opened a DC office in September 2007 and launched an advertising campaign in 2008 stating that the tariff is the main obstacle to an ethanol-powered future in the US.

Mr. Jank, the president of Unica, sees demand, repressed by the tariff and other protectionist barriers, as the main constraint to the development of a full-fledged global market for ethanol. Speaking at the Sugar and Ethanol Brazil conference, he said that,

“We cannot talk of ethanol as a global commodity as long as the tariffs do not fall. That is what will create a market.”

With the help of ADM, Cargill, and others, Mr. Jank is bound to succeed.

(For a full list of members of the Brazilian Agribusiness Association, click here)

-Henrique Oliveira

BRAZILIANS FED UP WITH ETHANOL TARIFF, NOT GOING TO TAKE IT ANY LONGER

Somewhat belatedly, Brazilians have decided to flex their muscle on Capitol Hill. The problem is, there isn't much to show off yet.

A host of well-known Brazilian organizations with assorted grievances, such as the US tariff imposed on imported ethanol, have apparently realized that political cachet in Washington is something that requires proper care and dedication, to say nothing of money. Many are now earning frequent flier miles on trips to DC.

Unica, the association that represents the sugarcane industry of Brazil's Center-South region, opened its office in the American capital in September 2007, when it hired Joel Velasco to head its US lobbying efforts. Mr. Velasco is also senior adviser to Stonebridge, "the premier international advisory firm at the nexus of commerce and public policy", which, according to its web site, helps "global business navigate the most promising and challenging markets".

One of the challenges that Mr. Velasco is navigating is the suppression of the ethanol tariff. The US government currently levies a charge of 54 cents, in addition to a 2.5% ad valorem tax, on each gallon of imported ethanol.

Doing away with (or at least reducing) tariffs on ethanol, Brazil's pride and joy, is something that ranks high on the country's wish list. In fact, the topic dominated the agenda when the Brazilian president, Luis Inacio Lula da Silva, met with Barack Obama on March 14, effectively trumping issues like the global economic meltdown.

Obama admitted that the tariff was and would remain a source of tension between the two countries, but expressed confidence that "over time this source of tension can get resolved" (read partial transcript of the meeting here). Sounds like the US president is leaving the door open to reducing or eliminating the tariff if corn prices spike again to the point where the marginal benefit of supporting the chicken feed wing of US agribusiness outweighs the marginal political utility of the corn ethanol caucus.

Mr. Velasco certainly has his work cut out for him. In his endeavors, he can count on the assistance of Brazilian organizations like Fiesp, the powerful federation of industries of Sao Paulo state. Former Brazilian Minister of Agriculture Roberto Rodrigues, a colorful figure who tirelessly promotes the cause of Brazilian ethanol abroad, is president of the organization's Agribusiness Council, created just in 2006 and already one of the most influential bodies in Brazilian agriculture.

Mr. Rodrigues is also co-chair of the International Biofuels Commission, along with ex-Florida governor Jeb Bush and Inter-American Development Bank president Luis Alberto Moreno, a Colombian technocrat who rose to prominence as head of the Instituto de Fomento Industrial (IFI), which is

"the Colombian government’s industrial finance corporation, and a holding company for many of the largest state enterprises in the country. As head of IFI, Moreno led a successful privatization program and developed new financing instruments for private industry to take advantage of the (former Colombian president) Gaviria administration’s economic liberalization policy" (source here).

Others at Fiesp can work with Mr. Velasco in his fight against the tariff. Marcos Jank, the president of Unica since Eduardo Carvalho stepped down in June 2007, was also the Director of Foreign Trade of Fiesp's Agribusiness Department, known as Deagro, until 2008. He has since been replaced by Andre Nassar, who is the general director of Icone, a think tank hatched inside the Brazilian Agribusiness Association, known as Abag. Abag represents the Brazilian subsidiaries of Archer Daniels Midland, Bunge, Cargill, Monsanto, and Syngenta, among others.

-Henrique Oliveira

Cheap Ethanol, Expensive Sugar Change Game for Brazilian Producers

Brazilian consumers are up in arms against what they perceive as price gouging by fuel ethanol distributors and retailers: since the end of January 09, prices paid to producers in Brazil's Center-South region have fallen by 13%, from USD .3831 to USD .3329 per liter (USD 1.448 to USD 1.258 per gallon) (source: Cepea). But these savings have yet to be passed on to consumers.

The drop is happening right in the middle of the sugarcane off-season, when prices have historically been at their peak. With little storage capacity to secure a more even flow of ethanol throughout the year, supply is strongly conditioned by the availability of sugarcane for processing. This fact usually causes prices to bottom out at the height of the harvest season, which lasts roughly from April to October in Sao Paulo state, the country's main sugar- and ethanol-producing region.

This year's season has yet to begin, but prices paid to producers are at levels last seen in June 08, when the sugarcane harvest was in full swing. Folha de S. Paulo, Brazil's leading daily, reports that,

"At some fueling stations in Sao Paulo state, the difference between ethanol prices at the pump and prices paid to producers at factory gates reached 105% the week of March 16. On average, the difference was 79%."

This apparent mismatch may be laid down to a high degree of operating leverage in the fuel distribution chain, much of which results from the gross inefficiencies that mark the industry. Further, many companies are buying out of the hype that promised to make Brazil an energy powerhouse one day and focusing instead on the shorter term. The net result is that producers are expected to favor sugar over ethanol; in fact, many are now dumping ethanol inventories to raise cash in preparation for increased sugar output.

Ethanol prices may be collapsing, but the outlook for sugar looks increasingly bullish. India, the world's second-largest producer, is expected to see a shortfall in production of some 4 million tonnes. The European Union, induced by government policy reforms, is also expected to produce less. These and other changes are projected to lead to a global deficit of between 5 million and 10 million tonnes of sugar this year.

Brazil, which in the 2007-2008 season harvested a record 493 million tonnes of sugarcane, up 16% from the previous season, produced 30.7 million tonnes of sugar and 22.5 billion liters of ethanol over the same period (source: Unica. Note: figures for the 2008-2009 season have yet to be tallied). The country's capacity to sway markets for both commodities is illustrated by the recent performance of Cosan, Brazil's largest sugar and ethanol concern. In the in 2008-2009 season, it processed 44.2 million tonnes of sugarcane, more than the entire output of Australia during the same period: a comparatively piddling 36 million tonnes.

An estimated USD 20 billion, from Brazilian and foreign sources, has been invested in capacity expansion over the past four years. As a result, agricultural output has ballooned, with another surge in sugarcane production expected this year.

While more producers will almost certainly prefer sugar over ethanol, the precise mix will be determined by market forces shaping up amid the global economic meltdown. On the supply side, the ability of companies to secure access to credit lines (a very iffy proposition right now) will be of fundamental importance. From a demand perspective, the speed at which developed countries with ethanol blending requirements rebound from the current crisis (if at all) will be just as decisive.

Of course, speculators also have a role to play. Reuters reports that, in May 2008, Peter Baron, executive director of the International Sugar Organization, predicted that:

"The tremendous flow of capital from financial institutions into commodity futures to seek diversification away from the sectors affected by the credit crunch has clearly pressured fundamentals. It is clear that the net inflow of funds in sugar futures is a decisive driver for today's world prices."

That theory, of course, went out the window with the collapse in commodity prices in Q3 2008. It may become valid again if financial players rush back into commodities, as Marc Faber, Jim Rogers, and many others have been prognosticating (incidentally, Jim Rogers' old partner in the Quantum Fund, George Soros, is one of the investors in Adecoagro, which has plans for a combined four plants in Brazil - one in Minas Gerais state and three in the state of Mato Grosso do Sul, in the country's Center-West).

While switching to sugar may be a way out for many producers in Brazil, a sizable share of the new projects that have come on-stream can produce only ethanol. These companies are taking a severe beating, as the players that produce both commodities continue to dump ethanol inventories to raise cash. (According to the Brazilian Ministry of Agriculture, the country has 420 plants: 248 produce both sugar and ethanol, fifteen produce only sugar, and 157 produce only ethanol).

In short, rising sugar prices, tight credit, and massive overcapacity do not bode well for ethanol prices. Many producers, including the much-feted Santelisa Vale, are now being forced to look for partners with greater financial heft - or fold.

-Henrique Oliveira

Brazilian Government to Finance Ethanol Inventory Build-Up

The Brazilian sugar and ethanol industry is getting pummeled by a series of outside shocks associated with the global economic downturn. First, the drop in oil prices over the past six months has taken much of the steam out of initiatives to further the world's single proven, economically-viable alternative to gasoline - namely, sugarcane-based ethanol. A GP at a fund with a sizable investment in a major ethanol operation in Brazil told me last June that his worst nightmare was oil falling back to USD 40. Wonder what he felt when it dipped into the low thirties.

Second, credit has tightened up in Brazil, as is the case everywhere else. Mill owners in the Ribeirao Preto region were said to be hawking their neighbors' properties to outside investors, in a desperate attempt to convert their insider connections into cash. Not a strategy likely to succeed, what with private equity running for the hills, most major corporate projects canceled or postponed, and FDI overall slowing to a trickle.

In an attempt to stave off the worst effects of the ongoing financial and economic drama, BNDES, Brazil's national development bank, is now funneling billions of dollars into the industry, much to the delight of organizations like Unica, the association of sugarcane growers of Center-South Brazil; Abimaq, the trade group that represents Brazilian manufacturers of heavy equipment, used to harvest, crush, and process sugarcane; and the Brazilian Agribusiness Association, known as Abag, which speaks for a mixed bag of farm-related industries that includes ADM, BASF, Bunge, Cargill, DuPont, John Deere, Syngenta, and Monsanto.

On March 20th, BNDES announced that it would finance the expansion of ethanol storage capacity, a crucial bottleneck blocking the development of the industry. Without large-enough facilities to store ethanol, companies are forced to sell it as soon as it is produced, depressing prices near the harvest season, which begins in Q2 in Brazil's Center-South region. Prices then normally rebound in Q3, a few weeks after the bulk of the region's sugarcane has been brought in and processed into ethanol and sugar.

This past season, however, the economic crisis has dampened demand abroad. Overcapacity built up in 2006-2008 has further pressured prices, which have remained at levels near their harvest season lows. BNDES is now stepping in to offer a credit line of BRL 2.31 billion, or about USD 1 billion, for inventory build-up, in the hope that more regular supply throughout the year will alleviate problems stemming from wildly-fluctuating prices and working capital requirements, both of which hamper companies' ability obtain financing in capital markets, in Brazil and abroad.

The loans will be offered at effectively-subsidized rates (BNDES is, after all, a government-owned bank, just like financial institutions in the United States). 5 billion liters, or approximately 1.32 billion gallons, of ethanol are expected to be thusly financed. Collateral for companies seeking a slice of public monies through BNDES will be 150% of volumes negotiated.

With public financing, producers hope to weather the economic storm, reversing the surge in defaults among sugarcane growers, ethanol and sugar producers, and diverse suppliers. These novel credit lines by BNDES mark a departure from the bank's traditional business of offering long-term financing for equipment and machinery made in Brazil - a thinly-disguised subsidy for thinly-disguised (industrial) protectionism.

In fact, Manoel Bertone, the Agri-Energy Secretary at the Brazilian Ministry of Agriculture, says that BNDES will "institutionalize" the new credit lines, conceivably opening the door to long-lasting political exploitation of the facility. The extra, low-cost money will bring a sigh of relief not only to the large sugar and ethanol concerns, but also to the tens of thousands of small sugarcane growers who depend on them to buy their production.

-Henrique Oliveira