Brazil Turns to U.S. to Meet Ethanol Demands

Includes: CZZ, PBR.A, VLO
by: Investment U

By Tony D’Altorio

Due to escalating Latin American demand, refineries often can’t keep up with fuel consumption, so global refiners have been quietly boosting refined fuel output. According to one of the largest U.S. refiners, Valero Energy (NYSE: VLO), that’s especially true of the developing economies of both Mexico and Brazil.

Brazil’s demand for refined fuels, such as ethanol, makes sense – what with a rapidly rising middle class that is making more car purchases, many of which run on gasoline, as well as a large number of flex-fuel vehicles (FFVs) that run on either gasoline or an 85 percent blend of ethanol.

And as the world leader in ethanol production and exports, it comes as a bit of a surprise that Brazil needs help meeting its own demand…

Brazil’s Ethanol Production Falls Short…

Brazil’s ethanol production fell short last season, only rising three percent to 25.3 billion liters, according to Czarnikow, the London-based sugar broker. As a result, imports rose steeply.

Brazil bought up 70 million liters of ethanol last year from the United States, up from just one million in 2009. And so far in 2011, imports have been even stronger.

The Brazilian real’s rise against the dollar and a lack of local investment into sugarcane fields hasn’t helped, either. That combination has resulted in higher sugar prices which undermines the competitiveness of the country’s domestically produced ethanol.

Unlike the United States, which uses corn to create the fuel, Brazil relies on sugar. And because it had plenty of that to go around, the sweet stuff worked out well for a while.

But the last two years’ poor weather led to much higher sugar prices around the world. Producers reacted by diverting the commodity away from ethanol and to the food market.

Naturally, that caused something of a shortage, hence the reason why Brazil has turned to the United States.

Brazil’s Ethanol Industry Ramps Up As Sugar Prices Drop

The global sugar supply has improved in the last few months, driving sugar prices back down. That should boost competitiveness in Brazil’s domestic ethanol industry, despite the real remaining weighty.

In addition, the country is urging its fuel giants, such as Cosan (NYSE: CZZ) and Petrobras (NYSE: PBR), to increase ethanol production.

Under orders, Petrobras is tripling its share of ethanol production from 5% to 15% of the total national market to help alleviate the shortage. Brazil also hopes to keep the United States from becoming the world’s biggest ethanol exporter that way.

To further that attempt, Geraldine Kutas of UNICA, Brazil’s sugar cane industry association, spoke up recently. She essentially demanded that the United States eliminate its ethanol tariff, which runs at $0.15 a gallon until at least 2016.

The truth is, her country is already miffed since the United States continues to block Brazilian ethanol access to its ethanol market. And now that the United States wants to be both the main producer and exporter, UNICA has put its foot down.

Brazil may even take the heavily subsidized United States ethanol industry to the World Trade Organization in a dispute.

In the meantime, Brazil’s ethanol industry should rebound on its own, thanks to lower sugar prices and an expected weakening in the real. If these short-term trends continue, both Cosan and Petrobras are worth looking into.

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