September 20, 2012 / 6:58 PM / in 5 years

Analysis: Brazil ethanol returns to US as biofuel rules pave way

SAO PAULO (Reuters) - Brazilian ethanol is rushing back into the United States after a three-year ebb, drawn less by the severe drought that has inflated corn costs than by biofuel regulations that could more than triple next year’s shipments.

Even as corn prices shot to record highs above $8 a bushel while sugar futures languished at near two-year lows of 19 cents per lb, Brazil’s sugar-based ethanol production was still more costly than U.S. corn-based domestic supply, traders say.

Brazilian ethanol is competitive in the U.S. market, thanks only to credits from the U.S. Environmental Protection Agency, which requires that fuel companies use 500 million gallons (1.9 billion liters) of so-called advanced biofuels to blend into gasoline this year. The EPA recognized Brazilian ethanol as advanced in February 2010.

Brazil has the only ethanol industry with the scale to meet the current U.S. advanced fuel mandate. The question is whether it can ramp up capacity for next year, when the EPA is expected to triple the requirement to 1.75 billion gallons.

“Brazil will not likely be able to meet that kind of increase in one year,” Plinio Nastari, president of the Brazil-based sugar and ethanol consulting firm Datagro, said. “But this holds huge potential for mills here.”

Brazil’s main center-south cane region is half done harvesting a 510 million metric ton crop, up from 494 million last year. Nastari said Brazil would need an extra 60 million metric tons of cane to export an additional 1.25 million gallons of ethanol to the Unite States.

Martinho Seiiti Ono, director of SCA - one of Brazil’s biggest ethanol brokers, however, said Brazil has the potential to meet a more than threefold increase in U.S. demand.

“If the U.S. offers mills better returns than they get on sugar, it’s possible to ship three times as much,” Ono said.

Brazilian sugarcane industry association Unica on Thursday raised its estimate for ethanol exports this season by 38 percent to 2.55 billion liters (675 million gallons).

Ono said 500 million gallons of those exports would reach the U.S..

Even if Brazil cannot fully fill the tripling of mandate, the increased demand from North America could push sugar prices higher, given that corn stocks won’t recover soon to ease the cost of U.S. ethanol production.

While Brazilian ethanol is doing little to ease the burden on U.S. fuel companies to meet much larger EPA mandates for standard renewable fuels -- separate from the targets for “undifferentiated advanced biofuel”, which only includes fuels with a low environmental impact -- they may herald the rebirth of an industry in deep distress.

Brazilian ethanol exports -- up 41 percent so far this year -- spiked in July and were on course in September to register an all time record month, Brazilian trade ministry data showed. U.S. data show ethanol imports, almost all of which come from Brazil, have averaged 63,000 barrels per day (bpd) over the past seven weeks, the second-highest rate since 2006.

“Exports have been very strong,” said Julio Maria Borges, the head of local ethanol consultancy Job Economia. “Returns from ethanol exports to the United States are good -- they are on par with sugar.”

CORN VS SUGAR

The complex economics of global ethanol markets opened a new chapter this summer. The price of corn surged on the worst U.S. drought in half a century, which in turn pushed up ethanol by 15 percent. U.S. ethanol plants consume 40 percent of corn.

Meanwhile, sugar prices have slumped 20 percent since August due to a glut in the sweetener. But ethanol prices have still not dropped sufficiently in tandem to make the biofuel competitive on the U.S. market without the EPA credit to advanced biofuel imports.

Unlike in 2008, when Brazilian ethanol exports reached a record nearly 5 billion liters, this year’s shipments required an extra incentive to make the cane-based fuel competitive: RINs, the renewable identification numbers that the EPA gives to ethanol producers and importers to make sure mandates are met.

RINs on Brazilian ethanol are worth 37 cents a gallon, down from 80 cents in June and $1.20 a year ago, traders say, providing the financial incentive for fuel firms to import.

Without that subsidy, Brazilian ethanol now arriving in New York Harbor at $2.98 per gallon would not compete with U.S. corn-based ethanol at $2.60 per gallon, traders say.

The cost of U.S. corn-based ethanol will need to rise further to make Brazilian ethanol competitive if RINs weaken.

Many of the production cost increases in the past few years for Brazilian ethanol and sugar are structural. The industry has seen taxes and labor costs rise and getting product from the mill to the port remains the Achilles’ heel of the country.

STRUCTURAL COSTS

The EPA is due in November to decide whether to go through with raising the renewable fuels mandate for this category of advanced ethanol to 1.75 billion gallons next year.

Traders say it is still unclear whether it will go ahead with the full increase given the supply limitations in Brazil, the only supplier of consequence of advanced ethanol.

If the EPA carries through, the increase would help revive Brazil’s once booming ethanol industry, which has seen investments in new capacity fall from as much as $15 billion a year to hardly anything since the financial crisis caught the sector over leveraged in unbridled expansion.

More than 10 percent of Brazil’s roughly 400 mills have shuttered in the past few years, which has further limited the sector’s capacity to produce ethanol and sugar.

It remains to be seen whether local mills can maintain this level of ethanol exports through the rest of the year, especially with spring rains around the corner that will slow ports, cane crushing and eventually lead to the shutdown of mills for the interharvest period.

Mills are investing in expanding their cane output, but it is not clear if they can keep pace with the EPA’s schedule for boosting advanced biofuels use in the coming years.

Brazil cannot fully meet its domestic demand at present due to drought and poor investment in its cane belt. The government reduced the blend of anhydrous ethanol in gasoline almost a year ago from 25 percent to the current 20 percent. And officials are keen to raise the blend again as soon as they deem supplies sufficient to support local demand without stoking inflation.

Moreover, the country imported 1.2 billion liters (320,000 gallons) of U.S. corn-based ethanol in 2011 to supplement domestic demand for the fuel, but that trade dried up after the drought ravaged the North American corn crop.

“If Brazil could occupy more of the gaps in the U.S. ethanol market, it would, but we’ve got our own problems,” said Arnaldo Correa, the president of commodities risk analyst Archer Consulting.

Reporting by Reese Ewing; Editing by Marguerita Choy

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