Unica's "Ethanol Summit 2009" Chooses Brazil's Crime-Ridden Sao Paulo as Venue, Bypasses Ribeirao Preto

I'm on vacation until Monday, April 27th. But I found time to comment on the poor choice of location for the 2009 edition of the Unica-sponsored "Ethanol Summit". Instead of holding the conference in the middle of sugarcane-land, in a nice city like Aracatuba (where Plinio Nastari from Datagro and UDOP held their II International Symposium in March 2009), they picked Brazil's most unmanageable, gang-infested metropolis.

When I attended the 2007 edition of the Ethanol Summit, I didn't feel safe in Sao Paulo, as most Brazilians don't. To make matters worse, the air pollution felt second only to Beijing's. Gridlock in traffic made led me to arrive late on both days.

Here's hoping that the next edition of Unica's Ethanol Summit will be held in a place more friendly to business people - and the environment.

HISTORY OF ETHANOL IN BRAZIL: 1979 ISSUE OF VEJA MAGAZINE PROVIDES GLIMPSE INTO FUTURE FOR GLOBAL BIOFUELS – PART II

(For the first installment in the series, click here)

We continue our journey into the early days of Proalcool, Brazil's National Ethanol Program, with the second part of my translation of the article "The Petroleum from Sugarcane". The piece came out in the June 13, 1979, issue of Veja Magazine. The title of this second installment, "The Gordian Knot", conveys the many doubts, suspicions, and interests that surrounded the fuel's introduction.

Highlights:

* Proalcool, sponsored by the Brazilian president himself, faced considerable resistance from the middle levels of government. Four years after its legal institution through a presidential decree, the Program, half-starved of funding, still had little to show but promises.

* Joao Sabino Ometto, a representative of the traditional sugar and ethanol companies at the time and a member of the family that went on to establish Cosan, was understandably eager to see the program implemented.

* Brazilian consumers in the 1970s regarded the new fuel with suspicion, but the government ploughed ahead with Proalcool just the same.

* Brazilians blamed oil prices for the rampant inflation of those years - a fact that suggested to market researchers that there was indeed a market for ethanol.

* But, battered by a chronic national sense of inferiority, consumers doubted that any solution made in Brazil would work.

THE GORDIAN KNOT

So is Proalcool hopelessly lost in the scramble for energy? Makers of equipment for distillation plants swear that that is not the case. They guarantee that the current production figures for ethanol could have been beaten two years ago, if the government had released, in a more forthright manner, the promised funds. Such criticism is correct to a certain extent - so far, in the four years since its inception, Proalcool has used up only 24 billion cruzeiros (the Brazilian currency at the time), which is less than USD 1 billion. And, of the 228 projects that have been approved, only 104 have been actually built – 89 of them are distilleries constructed next to older, existing sugar plants. In other words, a large part of the production of ethanol is still coming from traditional sugar companies. There are only a handful of entrepreneurs participating in Proalcool, as most are discouraged by the slow pace of the disbursing of funds.

To Joao Guilherme Sabino Ometto, director of Companhia Industrial Paulista de Alcool and of Grupo Pedro Ometto – the largest individual producer of sugar and ethanol in Brazil - such slowness has a purely political explanation. “Private companies associated with Proalcool are 100% Brazilian, and, therefore, unable to exert enough pressure to force the Brazilian government to accelerate so fundamental a program”, he laments. There is no doubt that the gamut of interests surrounding Proalcool – in favor and against – has blocked its development .

And such interests may, in fact, constitute the Gordian knot that must be untied to make this new source of energy feasible. Another good reason to support Proalcool is that, from the point-of-view of the those with the most to gain - in other words, the consumers-, the ethanol alternative, although still seen with suspicion by many, would end up being easily accepted, according to specialists.

NO PREJUDICE – Regardless of the historical prejudice felt by Brazilians with regard to their own country's solutions, they would accept ethanol in the end for a simple reason: no one wants to do without automobiles.

“All the research we have conducted indicates that consumers associate runaway inflation and the rising cost of living with the petroleum problem. So we believe that there is a willingness to accept ethanol,” states Clarice Herzog, a specialist with twelve years’ experience in market research, and currently head of research at Standard, Ogilvy & Mather Advertising.

CHINA SHOPS FOR COMMODITIES IN BRAZIL, HOOKS PETROBRAS WITH FINANCING

On April 15, The New York Times reported that “deals help China expand sway in Latin America”.

As Washington tries to rebuild its strained relationships in Latin America, China is stepping in vigorously, offering countries across the region large amounts of money while they struggle with sharply slowing economies, a plunge in commodity prices and restricted access to credit.

The Times believes that the Chinese strategy is to “rapidly increase its lending in Latin America, as it pursues not only long-term access to commodities like soybeans and iron ore, but also an alternative to investing in United States Treasury notes.”

Petrobras and Chinese Get Cozy

The Chinese will lend Petrobras, Brazil’s national oil company, USD 10 billion. That is “almost as much as the USD 11.2 billion in all approved financing by the Inter-American Bank in 2008”.

Interestingly, the IADB, long considered an extension of the US Treasury Department by the Brazilian government, “is trying to triple its capital and increase lending to USD 18 billion this year”. But the bank, under the leadership of Colombia’s Luis Alberto Moreno, who also doubles as co-chair of the International Biofuels Commission, lost USD 1 billion in 2008, a fact that complicates multilateral negotiations to recapitalize the bank. Yet the Chinese, who became a member of the bank this year, have proposed to help with the recapitalization process, a move calculated to increase their political leverage in the region, also according to The Times.

Petrobras is expected to use the loan from the Chinese to develop recently-found fields in ultra-deep waters. These are massive reservoirs: the Carioca field, announced in April 2008, could contain 33 billion barrels of oil equivalent, five times the giant Tupi discovery, announced in November 2007. According to Rigzone, the Tupi find alone is "one of the biggest oil discoveries in years outside of countries belonging to the Organization of Petroleum Exporting Countries, comparable in size to the Kashagan oil field in Kazakhstan".

Initially scheduled to come on-stream some time between 2009 and 2013, the new fields, according to Petrobras CEO Jose Sergio Gabrielli, will most likely see commercial exploration near 2020. Those familar with the conduction of business in Brazil won't be surprised if that date keeps being pushed back.

Petrobras might soon be using its deepwater E&P technology in Chinese waters. In October 2008, the president of the China National Offshore Oil Corporation, known as CNOOC, visited Rio de Janeiro and stated that the company was interested in establishing a joint venture with Petrobras for oil E&P, as well as for ethanol production in Brazil. The company is “determined to make a large investment in Brazil and want(s) to talk about this in details with the Brazilian government”.

CNOOC believes that the Chinese have the technology and the capacity to “supply what Brazil needs”. The company’s president, Fu Chengyu, also said that the agreement would pave the way for Petrobras to explore the Chinese coast. The Chinese also seek Brazilian expertise in ethanol production – CNOOC already produces 2.4 million tonnes of ethanol per year, but aims to double that amount in two years.

New Great Game Continues

Back in April 2007, I remarked how the present situation looks a lot like the “’Great Game’, which unfolded between Great Britain and Russia in the XIX century in the deserts, mountains, and steppes of Central Asia”. I said at the time that the Great Game had “made a comeback – with old and new players dueling for supremacy in a field that now includes not only the oil and gas fields of that region, but also resource-rich South America”.

“With Chinese (previous post), Japanese (previous post), Indian (previous post), American (previous post), and European (previous post) missions crisscrossing Brazil to size up the country’s potential as a supplier of strategic materials, not least of which is ethanol, it is hard not to draw an analogy with the fight for hegemony that took place in Asia between Czarist Russia and the British Empire, from the end of the Napoleonic Wars in 1815 to the beginning of World War I almost a century later.”

“The armies, spies, mercenaries, and agents provocateurs that played the game in Asia have now been replaced by investment bankers, consultants, and lawyers, at the service of governments and corporations, private and state-owned, vying for control over the most lucrative sectors not only of the Brazilian sugar and ethanol industry, but of other commodities as well. Iron ore, bauxite, orange juice, soy, corn, chicken, and beef, all of which have in Brazil a major producer, are at the top of the list.”

Game Over for US?

The US, which, since the declaration of the Monroe Doctrine in 1823, has viewed Latin America as its backyard, is awakening under the Obama administration to find that its neglect of the region over the past years has allowed its main geostrategic rival to step into the void. In light of the current collapse of the US economy, and with long-term contracts signed by the Chinese with a number of commodity suppliers in Latin America, getting China out of the region, or even counterbalancing its influence with money, looks like an increasingly difficult proposition.

Finally, another complicating factor for the US is the new currency system proposed by China.

From The Times:

“One of China’s new deals in Latin America, (a) $10 billion arrangement with Argentina, would allow Argentina reliable access to Chinese currency to help pay for imports from China. It may also help lead the way for China’s currency to eventually be used as an alternate reserve currency. The deal follows similar ones China has struck with countries like South Korea, Indonesia and Belarus.”

“'This is China playing the long game,' said Gregory Chin, a political scientist at York University in Toronto. ‘If this ultimately translates into political influence, then that is how the game is played.’”

AS US, EU FARMERS CLING TO SUBSIDIES, BRAZIL SEEKS TO RESTRICT FARMLAND OWNERSHIP BY FOREIGNERS

Earlier this month, the Associated Press went to the state of Mato Grosso do Sul, in Center-West Brazil, to take a look at how this year’s soy harvest crop is coming along. They mentioned a series of negative factors, including drought, tight credit, and slumping foreign demand.

Towards the middle of the article, they hit the nail on the head by comparing conditions in Brazil with the situation in the U.S. and Europe:

“Farmers in the U.S., Canada and Europe are hurting as well from sharply lower prices for soy, corn and beef. But experts say they generally don't hold as much debt as their Brazilian counterparts, giving them greater leeway to ride out the crisis. And many benefit from government subsidies the Brazilians don't get.”

“And many benefit from government subsidies that Brazilians don’t get” gets to the crux of the matter. Brazilian farmers are at a competitive disadvantage: the US and Europe are nanny states with centrally-planned economies, where the government micromanages the banking system and protects politically-important sectors, like autos and agriculture. But Brazilian businesses, including farmers, have no such luck.

A Game Two Can Play

Protectionism in the state-run economies of North America and Europe is triggering a backlash in Brazil. Foreign direct investment in farm properties is a case in point: there is considerable talk of restricting the acquisition of land in Brazil by foreigners. Specifically, Bill 2289/07 (Projeto de Lei 2289/07) was introduced in February 2008 by Congressman Beto Faro, who belongs to the Workers’ Party, or PT – the same party headed by the Brazilian president.

Mr. Faro seeks “new rules for the purchase of farmland in Brazil, by foreign persons or corporations”. His bill aims to “avoid the growing denationalization of rural properties, caused mainly by the production of biofuels”, which uses soybeans, among other crops, as feedstock.

As long as farmers in the US, Canada, and Europe continue to receive “government subsidies that Brazilians don’t get”, protectionism in Brazil will harden, feelings will boil over, and foreign land acquisitions in Brazil – whether for soybeans, biofuels, or minerals – will come under increasingly intense scrutiny.

History of Ethanol in Brazil: 1979 Issue of Veja Magazine Provides Glimpse into Future for Global Biofuels

("Will It Work"? This 1979 edition of Brazil's Veja Magazine reveals the hopes and doubts surrounding the introduction of ethanol in the country)


Veja Magazine has been the main Brazilian news weekly since 1968, a kind of Time Magazine and Newsweek rolled into one. It is printed on glossy paper with easy-to-digest information, presented in articles that span from one to four pages.

Veja appeals to the less-enlightened stratum of Brazil's college-educated elites. Back issues litter the waiting rooms of doctors’, lawyers’, and dentists’ offices around the country, as such professionals often rely on Veja’s drivel to tell them what to think. After leafing through it, they put it up for display to their waiting patients and clients, believing it makes them look smart.

In any event, Veja does a good job of capturing the Brazilian zeitgeist. So I decided to go back and check issues from the 1970s, when the Brazilian National Ethanol program, Proalcool, was being instituted.

What did Brazilians think of the program back then? What was the government’s strategy to introduce a novel fuel to the world’s tenth-largest economy, a country with a population of 120 million at the time? What were the roadblocks and pitfalls?

Below is the first installment of a series of translations of Veja articles from that time. It makes for a fascinating read, as we encounter the exact same doubts, gripes, and motivations, both declared and undeclared, that we are witnessing today on a global level.

The Petroleum from Sugarcane

Go to original

After years of hesitation, the Brazilian government has decided to make up for lost time and institute ethanol as the best alternative for the future.

June 13, 1979

It would be, in the opinion of its enthusiastic defenders, a sure passport to a problem-free energy future. And with formidable powers to single-handedly solve a good chunk of the country's problems, doing away, in one fell swoop, with the dark clouds that hover over the automobile industry, the balance of trade, the unemployment rate and inflation. But, in spite of all these qualities, the National Ethanol Program (Proalcool) will remain a vague promise, far from an effective path to rid Brazil of the petroleum nightmare.

Born in 1975, Proalcool ended up having to wait for an unfettered, disorderly break-out of petroleum prices that threatens to shake the Brazilian trade balance, this year with a likely shortfall of approximately USD 7 billion – about 50% of imports – to receive hope from the government. Such was the winning intention at last Wednesday’s meeting of the Council for Economic Development (CDE) in Brasilia, when new, ambitious goals and resources were added to the plan.

GLOBAL CONCERN – “This time, we won: the CDE has cinched the deal and there is no turning back now from Proalcool”, the Minister for Industry and Commerce, Joao Camilo Pena, said to a friend, as he left the meeting in a state of euphoria. In fact, the CDE decided to invest USD 5 billion in Proalcool, until the end of the Figueiredo administration (1979-1985), in order to reach an equally-ambitious number: 10 billion liters (2.64 billion gallons) of ethanol per year. With such a volume, the government expects to meet, over the following six years, additional demand for gasoline, while fully supplying 475,000 vehicles with adapted engines and 1.225 million others with a factory-made ethanol-powered engine.

Cautious, many technical personnel believe that it would be more realistic to cut the approved goals by half. Likewise, among economists, businessmen, and consumers, there is no lack of people who are relatively cool to the measure. And such an attitude is hardly surprising. After all, this is not the first time that, after a CDE meeting, ministers of state proclaim the beginning of a new energy phase in Brazil. In January 1977, for example, then-president Ernesto Geisel, at a meeting of the same Council, supposedly assigned absolute priority to Proalcool – “with unlimited funds”. However, three years after its creation, weak statistics flow from Brazil’s distilleries. Doses that are, without a doubt, below the national thirst for fuel in a country that consumes 1 million barrels of oil per day, 85% of which is imported. For this year’s harvest, for example, billions of liters of ethanol for blending are expected to be produced. They will be added, at a 20% grade, to the 15 billion liters of gasoline consumed by the 7 million vehicles in the Brazilian fleet. And, even if the goals set by the CDE materialize in 1985, the situation would not change things substantially, pessimists contend.

(to be continued)

Ol’ Boys Club Still Calls the Shots in Brazilian Commodities Markets

"It is difficult to understate the grip held by Fiesp on the Brazilian economy – and, by extension, on the global commodity markets."


BNDES, the Brazilian national development bank, is broadening the range of businesses eligible for a piece of the estimated BRL 110 billion (USD 50 billion) it will disburse this year – much of it to projects in infrastructure and industrial development, which, in turn, support the expansion of the country’s huge commodity-based sectors.

But even a cursory glance at a list of companies that received loans from the bank, which carry heavily-subsidized rates (here and here), suggests that the business attribute that really counts is the political connections of owners and managers.

Brenco

The Brazilian Renewable Energy Company, known as Brenco, belongs to a gaggle of California-based investors that includes Vinod Khosla, co-founder of foundering Sun Microsystems, and Steve Case, who suckered Time Warner into merging with AOL in 2000. The man in charge of this largish sugar and ethanol undertaking is Henri Philippe Reichstul, a consummate insider who served as CEO of Brazilian oil giant Petrobras from March 1999 to December 2001. Reuters Brasil reported in August 2008 that Brenco "obtained financing from BNDES totaling BRL 1.2 billion to build four sugarcane processing plants".

Coteminas

Under the Lula administration, this textile manufacturer took out BRL 421 million, or USD 191 million, in loans. BNDES supplied about half. It might have helped that the company’s owner, Jose de Alencar, is Brazil’s Vice-President.

Gerdau

Gerdau (Public, NYSE:GGB) “is the largest producer of long steel in the Americas, with steel mills in Brazil, Argentina, Canada, Chile, Colombia, the Dominican Republic, Guatemala, Mexico, Peru, the United States, Uruguay and Venezuela”. On December 31, 2008, BNDES owned a 3.5% equity stake in the steelmaker, with a book value of BRL 153 million, or USD 70 million. Jorge Gerdau Johanpeter, chairman of the company’s Board, is also a member of the Higher Strategic Council of Fiesp, the Federation of Industries of Sao Paulo State.

It is difficult to understate the grip held by Fiesp on the Brazilian economy – and, by extension, on the global commodity markets.

Embraer

BNDES also owns a 5% chunk of aircraft maker Embraer (Public, NYSE:ERJ), the world’s third-largest and the biggest Brazilian exporter from 1999 to 2001. It is still one of the country’s top three exporters. Embraer was created in 1969 by the same military government that instituted Brazil’s Proalcool (Pro-Ethanol) program in 1975. Throughout the 1970s, the company grew under the leadership of Ozires Silva, who later served as president of Petrobras for a short time, before becoming the Brazilian Minister for Infrastructure.

Vale

Vale (Public, NYSE:RIO), the second-largest mining conglomerate in the world, is headed by Roger Agnelli, also on the Higher Strategic Council of Fiesp. Reuters Brasil quoted Mr. Agnelli in July 2008 as saying that Vale “has a strong balance sheet and is always analyzing acquisition opportunities”. Thanks to a 4% equity stake owned by BNDES, the company’s balance sheet is that much stronger. BNDES also owns a 10% stake in Valepar, the holding company that controls Vale.

One could go on for quite a while crossing the list of businesses favored by BNDES with a Brazilian Who’s Who business guide.

The conclusion would be that a few dozen businessmen call the shots in the country, wielding tremendous influence in the global commodity markets in which Brazil is a dominant player.

(Check out the members of Fiesp’s Higher Strategic Council here. And here are BNDES’ Financial Statements for 2008, with a list of holdings on page 33).

Brazilian Development Bank Steps into Credit Void, Fans Overcapacity in Commodities

BNDES, the Brazilian government-owned development bank supported largely by payroll taxes, has traditionally been the main source of long-term financing for Brazilian corporations. As credit has dried up, the bank has begun offering short-term credit lines to companies with working capital requirements that cannot be met elsewhere. As a result, its cachet - and usefulness as a political weapon - has increased considerably.

Total investment volumes for 2009 are estimated at BRL 110 billion, or USD 50 billion. BNDES is already invested in several commodity players in Brazil, including the state-owned oil giant Petrobras and a number of sugar and ethanol operations throughout the country, such as US-based Brenco, to whom the bank extended a credit line of BRL 1.2 billion, or USD 700 million, in August 2008. (For a full list of BNDES' holdings, click here).

In fact, between 2003 and July 2008, the Brazilian sugar and ethanol industry received USD 4.1 billion in investments from BNDES. 37 projects were selected for financing by the bank, in a move that increased the country’s milling capacity by 74.5 million tonnes of sugarcane (more than twice the entire production of Australia in 2007-2008, 36 million tonnes) and contributed to the massive overcapacity now plaguing Brazilian ethanol producers.

BNDES’ predilection for large corporations leads it to finance and strengthen commodity companies that are often the largest in their industry worldwide: in January 2009, it agreed to finance the acquisition of Aracruz Celulose S.A., “a Brazil-based company engaged in forestry and in the production of pulp and derivatives”. The acquirer, rival Votorantim Celulose e Papel S.A., is now set to become the world’s largest producer of pulp. BNDES will pony up BRL 2.4 billion, or USD 1.1 billion, to help VCP cinch the acquisition, setting the stage for massive overcapacity in the Brazilian pulp and paper industry as well.

Other behemoths financed by BNDES include Valepar, which controls Vale (ticker: RIO), the world’s second-largest mining conglomerate; and the aforementioned Petrobras, which has made several massive oil discoveries off the Brazilian coast in ultra-deep waters, where production costs are prohibitive and technical challenges, profound.

Petrobras, incidentally, is also planning to step up investments in the production, distribution, and marketing of both ethanol and biodiesel. In a sign of the kind of market distortions that can be expected from using public monies to finance a government-owned bank that supports government-controlled companies, in February 2009 Petrobras forced several private biodiesel producers out of the market at a biodiesel procurement auction held by the Brazilian National Petroleum Agency. The company offered biodiesel from its three plants around Brazil for close to BRL 1.7 (USD .77) per liter – a level that private competitors, priced out of the auction, contend is 20% below cost.

Brazilian Ethanol Producers Forget They Wouldn’t Be Caught Dead with American Corn Growers

On April 3^rd, a mission from the US National Corn Growers Association visited the Sao Paulo offices of Unica, the Brazilian trade organization that represents much of the local sugarcane industry. According to a press release put out by Unica, the purpose of the meeting was “to discuss common ground in the production of ethanol from corn and from sugarcane. Both Brazil and the United States share a common identity as large producers and consumers of ethanol. Further, both countries are certain that ethanol won’t become a globally-traded commodity until there is production and use by a greater number of countries”

Sadly, Brazilian ethanol producers seem to have forgotten much of what was learned from mid-2007 to mid-2008, when runaway prices for food staples like corn gave a bad name to Brazil’s successful 35-year track record with sugarcane ethanol – to this day, and for the foreseeable future, the world’s only commercially-feasible experience with an alternative fuel for cars and light trucks.

As protests broke out around the world over rising corn prices, Brazilian sugarcane ethanol makers suddenly found associations with American producers very uncomfortable. Throughout most of 2007, and until commodity prices collapsed in Q3 2008, Brazilian sugarcane ethanol took a thrashing in the international media, right along with the United States’ government-financed version.

Consumers outside Brazil came to believe that all ethanol was made from corn – a misconception that was allowed to take root and grow by the complacent Brazilian producers, who believed that they really didn’t have to do much: it was inevitable, or so they believed, that a market for ethanol would be simply mandated into existence by the government in the US, as it had been in Brazil. With demand firmly in place, it would be a matter of time before the US tariff against foreign ethanol came down.

But as bitterness, even hostility, towards ethanol built up around the world, Brazilians became concerned over their tactical rapprochement with the Americans. According to a BBC report from May 2008, by then the Brazilian government “already noticed the need to clarify differences between Brazilian ethanol, made from sugarcane, which does not affect the price of food, and that of the United States, made from corn, a grain that forms the food base of several nations”.

Riding on Coattails of US Corn Ethanol Producers Not a Good Strategy

Eduardo Carvalho, president of Unica until July 2007, bet that ethanol mandates in the US would eventually create a vast market for Brazilian ethanol. He said as much at the first edition of the Ethanol Summit, the mega-conference held by Unica in Sao Paulo in June 2007.

“I don’t believe you can implement an ethanol program anywhere without a mandate for blending with gasoline” (quote on page 120, Ethanol Summit transcript, here). At the conference, he also turned to Ken McCauley, then president of the US National Corn Growers Association, and extended an invitation “from Unica to (…) the NCGA” to form an alliance. “We must be allies. The market for gasoline is very large.” (quote on page 121, Ethanol Summit transcript, here).

Brazilian producers and government officials would quickly come to regret such thinking. The same BBC article from May 2008 points out that, as food prices continued to rise in the months after the June 2007 Ethanol Summit, there was a growing sense of alarm as subsidy-free Brazilian ethanol got branded on the global psyche along the same lines as subsidy-rich American ethanol. This is when the Brazilian grand strategy to penetrate the US market began to founder.

For a while, Brazilian producers thought they had it all figured out. They would let American corn ethanol advocates do the heavy lifting of lobbying Washington for blending mandates, while Brazilian producers would just sit back and wait for demand to swamp the US industry’s supply capacity. With demand firmly in place, the US tariff against foreign ethanol would lead to shortages and price spikes, and the doors would eventually have to be thrown open to Brazilian ethanol.

Having allowed Brazilian and American ethanol to be bundled together, however, Brazilians were forced into a defensive position, simply reacting to events spinning out of their control in the wake of escalating grain prices. It wasn’t until September 2007 that Unica opened an office in DC and decided to go on the offense, with a public relations campaign that attempted to draw a distinction between ethanol made from corn and ethanol made from sugarcane (right).

By then it was too late – negative perceptions had already crystallized around Brazilian ethanol. As far as most people were concerned, not only was Brazilian ethanol causing the impending annihilation of the Amazon forest and the imminent return of widespread slavery, it was also jacking up food prices.

It is understandable that American ethanol producers would want to associate themselves with the world’s single successful experience with an alternative fuel for automotive transportation. But Brazilians’ explicit endorsement of corn ethanol, as evidenced by the recent meeting between Unica and the NCGA, will inevitably come back to haunt them, just as it did a few short months ago.

Louis Dreyfus Becomes Global Ethanol Player, Has Bradesco to Thank

With the acquisition of Santelisa Vale this week, France’s Louis Dreyfus has consolidated its position as one of the most important sugar and ethanol players in the world. For that, it should be very grateful to the Brazilian bank Bradesco.

Bradesco is the financial institution that, in March 2007, extended a USD 675 million credit line to the owners of Santa Elisa and helped broker its acquisition of the Vale do Rosario sugar and ethanol company. Santelisa Vale, which resulted from the merger, is now struggling with USD 3 billion in debt and has been forced into the arms of Louis Dreyfus (though there were plenty of other suitors) to stave off creditors, Bradesco among them.

One of Bradesco’s former directors, Roger Agnelli, is currently the CEO of Companhia Vale do Rio Doce, known as Vale (ticker: RIO), whose ADRs are traded in New York.

While most of Vale’s revenues are derived from mining-related activities, it is also the largest provider of services to the Brazilian sugar and ethanol industry, with a 28% share of the overall logistics market in the country. It runs an “integrated logistics structure (that) comprises nearly 10 thousand kilometers of railway network and five ports” throughout Brazil.

Vale, the second-largest mining concern in the world, calls itself a “pioneering (…) company that works diligently to transform mineral resources into the essential ingredients of people’s everyday lives”. It is the also “the largest publicly-traded company in Latin America by market capitalization”.

That’s why “(a)gricultural producers and exporters use Vale’s logistics services to transport their goods to the market. The integration of the railway and port system has increased competitiveness, as the market has seen an increase in the amount of soy, bran, sugar, corn and fertilizers. Rice, coffee, cotton, and goods such as soy oil, wheat flour, maize flour, refined sugar, and paste, are also transported on the railroads.”

Without Vale’s assets, many sugar and ethanol producers scattered throughout Brazil’s vast hinterlands would be left literally stranded.

Mr. Agnelli’s story with Vale goes back to even before when he joined the company. In 1997, a group of companies, called the Brazil Consortium, acquired 41.73% of the common stock belonging to the Brazilian federal government for BRL 3.338 billion, which translated into USD 3.14 billion at the time. The final bid brought Vale’s total price to BRL 12.5 billion, or approximately USD 11.29 billion.

One of the participants in the banking syndicate that valued the company was Bradesco, where Mr. Agnelli served as an executive officer from 1998 to 2000, quitting the job to join Bradespar, a Bradesco spin-off.

The new position was created when Bradesco, having helped value Vale, set up an investment division in March 2000 to hold and manage Bradesco’s non-financial assets. Today, Bradespar’s holdings include a 17.4% share of Valepar, which controls Vale.

Mr. Agnelli served as CEO of Bradespar from March 2000 to July 2001, when he became Vale’s main executive. Under his tenure, the market capitalization of the company has grown to USD 76.95 billion.

From USD 11.29 billion in 1997 to USD 76.95 billion in April 2009. That’s a CAGR of 17.34%.

Not bad.

France’s Louis Dreyfus Acquires Significant Stake in Santelisa Vale, Will Mill More Sugarcane than Australia

Santelisa Vale, a company formed in 2007 after the merger of the Santa Elisa and Vale do Rosario sugar and ethanol companies, has just sold a significant stake to Louis Dreyfus Commodities Bioenergia S.A. The exact numbers have not been disclosed.

Before the deal with Louis Dreyfus was approved on Monday, April 6^th, a host of other contenders, including Sao Martinho and Bunge, had attempted to woo Santelisa Vale. At the time, offers for a 40% stake were estimated by the local business media at BRL 3 billion, or USD 1.4 billion.

Together, the two companies will have a combined yearly processing capacity of 40 million tonnes of sugarcane – more than the entire Australian output in the 2007-2008 harvest year, a paltry 36 million tonnes. In milling capacity, Santelisa Vale-Louis Dreyfus are also just a step behind Cosan, the world’s largest producer of sugar and ethanol, which milled 40.3 million tonnes in the 2007-2008 season, producing 3.24 million tonnes of sugar and 1.52 billion liters (400,000 gallons) of ethanol (see MD&A, p. 4, in Form 20-F here). One tonne of sugarcane yields, on average, 80 liters, or 21.16 gallons, of ethanol.

Santelisa Vale is choking on the debt it took on in March 2007 to finance its acquisition of Nossa Senhora do Vale do Rosario. At the time, the owners of Santa Elisa, the Biagi family, offered Santa Elisa itself as collateral and took on USD 675 million in debt from Bradesco – until recently, Brazil’s largest private bank. Now they are struggling with a debt load of BRL 3 billion, or USD 1.4 billion.

With the acquisition of a stake in Santelisa Vale, Louis Dreyfus is extending its shopping spree in Brazil. In February 2007, the company doubled its local milling capacity when it acquired four mills belonging to the Tavares de Melo Group. At Santelisa Vale, Louis Dreyfus joins a coterie of investors and partners that includes Goldman Sachs, Global Foods, Carlyle/Riverstone, and Discovery Capital.

Other European players are also significantly expanding their production and trading operations in Brazil. Sucden, Tate and Lyle, Czarnikow, and Tereos, which owns Acucar Guarani, are all busy helping their respective countries in Europe kick the sugar beet subsidy habit.

George Soros Loves Petrobras, Bullish on Brazil, Ethanol

According to Seeking Alpha, Petrobras (PBR), the Brazilian oil company, topped the list of holdings by Soros Fund Management in Q4 2008, when the petroleum giant accounted for 19.53% of Soros' portfolio. Canada’s Potash (POT), the world’s largest miner of potassium carbonate, was a distant second, with a 9.4% slice.

Soros is also invested in another, privately-held Brazilian energy company: Adecoagro, which runs assorted farming operations around South America, including the production of ethanol from sugarcane. In Brazil, Adecoagro is developing a cluster with three plants in the state of Mato Grosso do Sul, in the country’s Center-West. Located in the municipalities of Angelica and Ivanhema, the cluster, named Angelica Agroenergia, will crush an estimated 3.5 million tonnes of sugarcane per year when completed. Incidentally, Soros’ ex-partner in the Quantum Fund, Jim Rogers, is also big on Brazilian farmland.

Soros’ recent appetite for Petrobras ties in with his greenfield project, as Petrobras played a central role in the inception of Brazil’s National Ethanol Program (Proalcool) in the 1970s (picture, right: Petrobras execs with an ethanol-powered Brazilian Beetle, circa 1975).

At the time, the Brazilian government, rather than convince private companies to distribute ethanol on their own – an impossible task, given the country’s fledgling automotive services industry and continental dimensions - got Petrobras, fully-owned by the state at the time, to use its vast network of fueling stations, which spans the entire country, to distribute the fuel. Brazil thereby avoided the chicken-and-egg problem currently holding back the industry in the US.

While many people familiar with Proalcool know that the program was launched by a military dictatorship, few realize that there were limits to what the government could actually mandate, as it was far less authoritarian than, say, the Russians after the 1917 revolution, or the Germans in the 1930s.

The Brazilian president at the time, Ernesto Geisel, had been CEO of Petrobras right up to his election by the Brazilian Congress in 1974. Geisel then used his insider knowledge of both the military and Petrobras to get the ball rolling on ethanol as a large-scale alternative to gasoline, whose supply had been threatened by the Oil Embargo of 1974.

By the end of the 1970s, ethanol was sold all over Brazil at stations belonging to BR Distribuidora, the Petrobras subsidiary in charge of distribution created in 1971. The move was soon copied by Shell, Exxon, Texaco, and other oil players that, if one is to believe the foreign media, supposedly won’t have anything to do with ethanol.

In March 2008, Petrobras started a subsidiary dedicated to biofuels, called Petrobras Biocombustivel. Is Petrobras once again taking the lead away from oil and into biofuels?

Not if you judge by the company’s investment plans. Petrobras’ commitment to biofuels may be gauged by its newly-released business plan for the 2009-2013 period. The company intends to invest USD 122 billion in petroleum-based fuels, including USD 104.6 billion for oil E&P, USD 11.8 billion for gas & energy, and USD 5.6 billion for petrochemicals.

The amount set aside for biofuels? A grand total of USD 2.8 billion – 2.3% of what will be invested in petroleum exploration and production alone.

Brazil Sugar, Ethanol, Equipment Makers May Turn to Alcohol

Sertaozinho, a town located near the city of Ribeirao Preto in the interior of Sao Paulo state, is ground zero in Brazil’s sugarcane land – and, these days, also a hotbed of discontentment for businesses in the sugar and ethanol industry that are having a hard time securing credit.

The place is a kind of Detroit for equipment manufacturers, the main difference being that Sertaozinho makes things that people actually want. Dedini, the largest Brazilian equipment manufacturer, has a plant in the city, as do dozens of other businesses that produce or refurbish the machinery used to process sugarcane into sugar and ethanol.

Without credit, producers are dumping ethanol on the Brazilian domestic market to raise cash, depressing prices. Brazil’s Center-South region is right in the middle of the off-season, when prices should be at their highest. But a liter of hydrous ethanol is selling for BRL .5926, or USD .2588, at factory gates. Eight weeks ago, on February 6, the price was BRL .8208, or USD .3584. That’s a 28% drop in less than two months. Once this year’s sugarcane crop starts rolling in later this month, prices are certain to be depressed further.

Producers who can make both sugar and ethanol are gearing up to boost production of the former, enticed by high prices caused by decreased output in the European Union stemming from regulatory issues and a prolonged drought in the sugarcane-producing countries around the Indian Ocean, including Australia, India, and Thailand.

But many of the operations set up over the past three years, after the current boom began, can produce only ethanol, as they lack the equipment for sugar production. According to the Brazilian Ministry of Agriculture, the country has 420 plants: 248 can produce both sugar and ethanol, fifteen produce only sugar, and 157 can produce only ethanol. The pure ethanol producers have been the hardest-hit: without adequate storage facilities, they are forced to sell into a depressed ethanol market.

Players the world over are waiting to get a better idea of Brazil's crop harvest for the 2009-2010 season. According to Plinio Nastari, founder of Datagro, one of the leading sugar and ethanol consultancies in Brazil, the harvest is expected to come in at 598 million tonnes – a 5.72% increment over the figure for the 2008-2009 sugarcane year, when 566 million tonnes were cultivated. Of these, 20 million tonnes were not processed, indicating massive overcapacity arising from substantial capex spending in agricultural production capacity over the past few years.

The 2009-2010 Brazilian monster crop should shift the supply curve of sugarcane out, while a sugarcane production deficit in India will place upward pressure on sugar prices. Indian production of sugar is likely to tumble to 14.5 million tonnes in the year ending Sept. 30^th, 2009, down from 26.3 million tonnes produced during the previous season. With an annual consumption of 22.5 million tonnes, India, the world’s largest sugar consumer, will become a net importer.

Mr. Nastari from Datagro sums up the drama unfolding in the Brazilian sugar and ethanol industry:

"Credit is scarce now and the sugar and ethanol companies, which had financing costs of 6% to 8%, are now paying from 20% to 23% per year, a high figure for an industry whose return on investment is between 11% and 13%. This change has significantly reduced working capital.”

Official government projections for the 2009-2010 harvest year will be released at the end of April by Conab, an agency inside the Brazilian Ministry of Agriculture that makes projections about the country’s production of sugarcane (click here to access the organization’s sugarcane crop database).

Starved for credit, saddled with overcapacity, and burdened by debt, the Brazilian sugar and ethanol industry may find comfort in another of its products: cachaca, the rum-like spirit that goes into caipirinhas, Brazil’s national drink. Bottoms up.

Brazilians in US Face Prospect of Flying Home for Good: Airline Industry on the Roof

When the global airline industry jumped out of the pan of runaway fuel prices and into the fire of the ongoing global collapse, the future for global voyagers started looking really bleak. By the end of March 2009, stock prices for AMR Corporation, parent of American Airlines, had fallen 65% year-on-year, while UAL Corporation, which owns United Airlines, had fallen 79%. Both are now penny stocks, with AMR trading at USD 3.19 and UAL, at USD 4.48.

The outlook for their continued existence is pretty dim: in February 2009, international air traffic plunged 19% year-on-year, according to the Air Transport Association. After taking USD 8.5 billion in losses globally in 2008, the industry expects to lose another USD 4.7 billion in 2009.

American and United are two of the most important airlines connecting Brazil to the US. American Airlines transports more passengers – 12.1 million passengers in 2004 – between the US and Latin America than any other company.

The possible collapse of the entire airline industry, which Niall Ferguson, Tisch Professor of History at Harvard, believes imminent (see interview here) will pose an existential dilemma to Brazilians living abroad. Many have chosen to move to the US, either legally or illegally, in part because of the availability of cheap flights to Brazil, which offer an escape route if the going gets tough.

I have several Brazilian friends who live in the US and Europe and come down to Brazil once or twice a year to visit family and friends. Take cheap flights out of the equation and a fair number of Brazilian expats would have to seriously consider whether they would want to continue to live in countries that are falling apart at the seams and adopting an increasingly hard line on immigration. In the US, officials are cracking down on the scores of illegal Brazilians manning the counters of fast food restaurants in Boston. They are also cutting back on the number of H1-B visas used by the likes of Microsoft, McKinsey, Merrill Lynch, Lehman Brothers, and others to “retain top foreign talent”, like many of the newly-minted MBAs I graduated with.

Climbing on the Roof

The situation of airlines in Brazil isn’t much better than in the US. Using a typical Brazilian expression, I would say that it has “climbed on the roof”. This expression originates from a popular joke that places two Portuguese men, Manuel and Joaquim, at the butt end (in a rare instance of revenge by the colonized, the Portuguese are to Brazilians what the Poles are to Americans, or the Irish to the British).

The story goes like this: Manuel had to take a trip and asked Joaquim to look after his house, especially his pet cat. One month later, Manuel receives a letter from Joaquim dryly stating, “Your cat fell off the roof and died”.

Manuel is quite shaken by the news. He is also upset about the way it was broken to him. So he writes back to Joaquim.

“You almost gave me a heart attack! That’s no way to break news like that. First, you should have written, ‘Your cat climbed on the roof’. In the next letter, you could have written, ‘Your cat went for a night walk’. Then, in the third letter, you would write, ‘Your cat slipped, fell of the roof, and, unfortunately, is now dead.”

One month later, Manuel receives a letter from Joaquim.

“Your mother has climbed on the roof.”

It seems that Gol and TAM, Brazil’s two main airlines, have also gone on a little roof-climbing. On March 31^st, Gol’s ADRs traded at USD 2.83 on the NYSE, down 82% y-o-y, while TAM’s ADR closed at USD 5.50, a 72% yearly drop.

I have read various reports by American stock analysts that talk about the strong fundamentals of the Brazilian airline industry. They seem convinced that the large size of the country makes flying necessary.

Not really. Nearly 45% of Brazil’s population lives in the country’s South-East region (red area in map), which comprises the states of Sao Paulo, Minas Gerais, Rio de Janeiro, and Espirito Santo and occupies just over 10% of the country’s territory.

The nation’s three largest urban centers are located there: the Greater Sao Paulo, with a population of about 20 million; the Greater Rio de Janeiro, with 12 million; and the Greater Belo Horizonte, with 5 million. More importantly for the Brazilian airline industry, they are relatively close to one another, if compared to major American metropolises.

Sao Paulo is 429 km (268 miles) from Rio de Janeiro and 586 km (366 miles) from Belo Horizonte, while Rio is 434 km (271 miles) from Belo Horizonte. Until the 1990s, air travel was reserved for the affluent; today, relatively-cheap tickets appeal to people who had never flown before. Increased traffic at linchpin airports like Sao Paulo’s Congonhas and Rio’s Santos Dumont, both built in the 1930s, effectively overwhelm the system.

Add to this demographic density the fact that 12.26% of Brazil’s GDP is produced in or around the city of Sao Paulo, whose growth has provoked a brain drain in other large urban centers, and one begins to understand why the steady ramp-up in air traffic of the past fifteen years, which some analysts believe essential to the Brazilian economy, is not an irreversible trend.

Business travel doesn’t carry the same weight in Brazil as it does in the US or Europe. When I speak with Brazilians working in Sao Paulo for US-based consultancies like Bain, BAH, and BCG, it strikes me how little they travel, compared to their US colleagues. As these and other multinational services companies are almost all based in the city of Sao Paulo, and their clients are located either downtown or on the city’s industrial outskirts, they get to sleep in their own beds every night, something most management consultants in the US consider a luxury.

Volatility in oil prices adds to the difficulties in planning a badly-needed overhaul of the aviation infrastructure. There was talk of building a new central airport for Sao Paulo after July 2007, when Brazil had its worst accident ever. An Airbus A320 belonging to TAM overshot the runway at Sao Paulo’s Congonhas airport, located in downtown Sao Paulo, killing 199 people. Because of the airport's densely-populated environs, there is little room for error (picture).

And in September 2006, Gol lost a Boeing 737-800 over central Brazil, when it crashed into an executive jet, killing all 154 on board the 737 – a fatality stemming, in good measure, from overworked and underpaid air traffic controllers.

These occurrences lead to the inevitable conclusion that the system is pretty stretched. With an outlook dimmed by the current crisis and by uncertainty in the oil market, further investments look pretty dicey.

Homecoming?

The large numbers of educated Brazilians who have moved from their home towns to the city of Sao Paulo, usually in search of better-paying jobs in finance, advertising, consulting, and other service industries, may find themselves contemplating a dilemma similar to the one faced by Brazilians abroad: whether to stay in Sao Paulo, a city with intractable crime, congestion, and pollution problems that are not likely to get any better (especially in a world of increasing scarcity), or make their way back to Belo Horizonte, Rio de Janeiro, and other secondary cities.

To be sure, émigrés returning home would have to lower their professional expectations. But they would also have more immediate access to the Brazilian countryside, with its plentiful supplies of food, water, and ethanol. In the current macro environment, that is no small thing.