AMSTERDAM – For investors that have been trying to keep up with the latest developments in the Brazilian ethanol market, news report didn’t seem to offer a very clear picture in the past few weeks. Early last month, CNN reported that “long-term investors in Brazilian ethanol (are) unfazed by (the) dollar crash”. FX Street reported the same day, “Brazil sugar and ethanol market loses competitive edge on dollar”. Dow Jones reported near the end of October that the Brazilian ethanol consumption “shows no sign of slowing”, substantiated by a Reuters article reporting that “Brazilian auto sales jump to record high in October” of which 86.5% was flex-fuelled. Reuters, however, also reported that “tight profit margins in Brazil's ethanol and sugar industry this year have led to delays in the projected start-up of new plants” and sugar consultant Kingsman said “(ethanol) export will be challenging because of logistical problems and large supplies in United States”. To summarize, Brazil has record domestic demand for ethanol and an rapidly increasing flex-fuel vehicle market share, yet also declining ethanol exports in 2008, tight profit margins resulting in delayed construction, in a time when the Dollar/Real exchange rate reduces its competitive edge, yet not on the long run.
Ethanol Statistics sat down with Marcos Lutz, Chief Commercial Officer at Brazil’s largest ethanol producer Cosan, to discuss the latest developments in the Brazilian ethanol market. Mr. Lutz was able to provide the proper context that is needed to interpreted the news reports mentioned above. He emphasized the flexibility of Brazil’s supply chain. “From the consumer to the distributor we have a matrix that is flexible as a whole,” he said, “and because of that, we are able to cope with a lot of changing variables.”
Brazil could export 10 billion litres within one year
One of the best examples of Brazil’s flexibility, according to Mr. Lutz, was the surge in international demand from the United States, following the MTBE ban in 2006. By lowering the mandatory ethanol blend from 25 to 20%, by converting more sugarcane to ethanol instead of sugar and because 12-13% of its vehicle fleet was capable of running on both gasohol and E100 ethanol, “Brazil was able to reduce its internal demand by 30% in just 5 months, to enable Brazilian producers to export to the U.S.” The range of this flexibility is enormous according to Mr. Lutz. “Why did we export 3 billion litres? Because the demand was 3 billion litres. I would say that, if we have a one year notice, Brazil could export more than 10 billion litres of ethanol. And we need that one year notice only to adjust the logistics for export, nothing else.”
Smaller international demand, changing geographic markets
Impressive as that may be, experts currently predict a sharp decline in international demand. To that, Mr. Lutz agrees. “International market will be smaller than last year and next year it will be even smaller. This is because European countries and the United States are increasingly filling their demand with domestic production.” This, however, does not imply that exports will evaporate next year. A shift in export markets does seems logical. “Europe is trying to fill its demand, but with some problems. I foresee some shortages in Europe if the prices of wheat maintain current levels, resulting in high ethanol prices.” In addition, although the short term effects is “huge”, Mr. Lutz doesn’t foresee any long term effects from the weak dollar, saying “I cannot see the depreciation of the dollar relative to the real go too much further. The Big Mac in São Paulo is probably twice as expensive as in New York, which doesn’t make sense.
Domestic demand: Pending natural gas shortage and flex-fuel vehicles
Contrary to international demand, domestic demand is skyrocketing because of the increasing market share of flex-fuel vehicles. In October, 86.5% of all new car sales was accounted for by flex-fuel vehicles and according to Mr. Lutz this causes an annual increase in domestic demand of 3 billion litres. But surprisingly, that is not the most important development at the moment. Mr. Lutz shares his concerns about the natural gas shortage in Brazil. According to him, “that immediately affects 2 to 3 billion litres of domestic demand, because natural gas vehicles can burn ethanol and gasoline as well. This is an immediate demand, causing a major problem that is about to happen in the short term.”
Delayed construction
Domestic demand seems to be able to compensate for declining international demand, yet we read that new projects are delayed because of tight margins. To what extent is this actually happening? Mr. Lutz finds it hard to say, but has noticed people moving slower. “I haven’t seen investments cancelled, but some new projects seem to be postponed. It is hard to measure, but I would say current price levels would cut at least half of the projected growth. But than again, these price levels will probably not maintain on the long run.”
Consolidation: Timing is key
Current tight margins do seem to push a considerable number of mill owners to offer their facilities for sale. Consolidation seems inevitable with over 350 companies in the market. But the timing for large scale acquisitions is currently not ideal according to Mr. Lutz. “What we have seen is a lot of people trying to sell mills in Brazil, but there is not much happening in terms of effective deals. This is because the expectation of the seller is different from the expectation of the buyer. In the end, expected cash flow has to be close to what is being asked and that is currently not the case.“ Something that will probably change in the near future, as he adds “The sellers are selling because they need to sell. So I see the prices going down first.”
Foreign capital: International competition
Considering the acquisitions of Bunge, Cargill, Infinity BioEnergy and Abengoa, foreign investors don’t seem to mind the current price level for acquisitions. But even they will adjust their growth strategy says Mr. Lutz. “The fact is that a lot of new capital came into Brazil with a focus on market entry, on placing themselves. But on the long run, I see international capital much more organized and disciplined than Brazilian capital. Currently, Cosan is still the only large consolidator in Brazil, so I look forward to other companies joining that party.
© Ethanol Statistics 2008