Ethanol's future in Brazil, U.S.
June 26, 2012
by Susan Reidy
Looking beyond 2012, the world’s two leading ethanol producers will face their own unique challenges that could impact future production levels.
In Brazil, the biggest hurdle is bringing field production back to normal levels, according to a report from Rabobank’s Global Food & Agribusiness Research and Advisory Department. The report, released on March 1, examines the current ethanol industry in Brazil and the U.S., as well as the outlook for 2012 and beyond.
For the U.S., production above the 15 billion level mandated by the Renewable Fuels Standard 2 (RFS2) will face volatile economics related to the spread between oil and corn prices, Rabobank said. If corn prices increase significantly, lawmakers may scale back the mandate during periods of low corn stocks-to-use.
“The outlook for exports is heavily dependent upon what happens with the sugar crop in Brazil, the U.S.’s biggest export competitor,” said David C. Nelson, global strategist for grains and oilseeds with Rabobank. “Rabobank’s outlook for higher U.S. ethanol production is also predicated on regulatory approval for E15. If E15 is adopted by just 10 Midwestern states, it will alleviate current blend wall restrictions.”
This year, the most significant development for both nations was the end of the long-standing U.S. tax incentive. While it opens up opportunities for Brazil, it’s unlikely the industry will be able to take advantage of it as it struggles to meet domestic demand.
“Rabobank believes that the abolition of the U.S. import tariff on ethanol represents a significant opportunity for the Brazilian cane sector in the medium to long term,” said Andy Duff, global strategist for sugar and head of Rabobank’s Food and Agribusiness Research and Advisory Group in Brazil. “However, in the next few years the focus of the Brazilian industry is likely to be keeping up with the growth of potential consumption in the domestic market, which will continue to rise as a result of expansion of the flex-fuel fleet.”
The U.S. industry has grown to its current levels due to vigorous political support, including blend mandates, the Volumetric Ethanol Excise Tax Credit (VEETC) of 45¢ per gallon and the corresponding 54¢ per gallon tariff on imported ethanol. Rabobank said it sees no indication that removal of the tariff will have any significant impact on ethanol production. Brazil domestic ethanol prices were high compared to the U.S., and the U.S. was already importing ethanol through the Caribbean Basin Initiative (CBI) prior to the tariff’s expiration.
“Imports under the CBI did not have a noticeable impact on U.S. corn ethanol production in years past when Brazilian ethanol was more plentiful,” the report said.
Ethanol production in 2012 is expected to reach 13.9 billion gallons, compared to 13.74 billion gallons in 2011, the report said, with corn use of 5.04 billion bushels. Blending will be incentivized by refining margins that are positive on a current and forward basis, the report said, and margins are positive.
But, the report said, spot ethanol margins have been negative and ethanol stocks have been building. The industry will need to reduce production in the next few weeks and wait for better information on increasing blend levels.
Certification of ethanol blended to 15% (E15) could boost demand and production and drive use past the blend wall. Following approval by the U.S. Environmental Protection Agency (EPA), individual states will have to approve the higher blending rate.
Rabobank said such approval is likely at least in the Midwest, which represents about 30% of U.S. gasoline demand. That could increase the national ethanol blend wall to 15.5 billion gallons.
“Ultimately it will probably be the power of the marketplace that will drive the adoption of E15, and the economics suggest it will be used, perhaps especially in 92 octane fuel, as ethanol is an octane enhancer,” the report said.
Along with an increase in blends rates, exports will have to be profitable in order for the industry to produce beyond the mandated level, Rabobank said. The U.S.’s two largest trade partners are Brazil and Canada.
Brazil could continue to be an importer of U.S. ethanol, if the 2012 cane crop struggles. Canada implemented in December 2010 a nationwide renewable fuels blending mandate of 5%. Mandates are higher in Manitoba at 8.5% and in Saskatchewan at 7.5%. It is cheaper right now for Canada to import ethanol from the U.S. than to build the capacity to produce it domestically, so imports are likely to continue in the near to medium term, the report said.
Other consistent importers of U.S. ethanol include the Netherlands, the U.K., Finland and Mexico.
BRAZIL'S TOUGH HARVEST
Sugarcane-based ethanol has been blended with gasoline in Brazil for several decades. Producers can make both sugar and ethanol, and vary the output depending on which is more profitable. Development of flexible fuel cars, which can run on gasoline, ethanol-blended gasoline, or pure ethanol, dramatically changed ethanol usage in the country, Rabobank said.
Flex fuel cars have gained more than an 80% share of new car sales, causing hydrous ethanol sales to increase significantly. As a result, Brazil has a two-tier system of anhydrous ethanol, which is blended with gasoline at a rate determined by the government, and hydrous ethanol, which is a pure fuel that can substitute for gasoline in flex fuel vehicles.
An increase in new cane-milling technology was stimulated by growth in the hydrous ethanol market, the report said. More than 110 new facilities were built between 2005-06 and 2010-11, increasing capacity by more than 60%.
Low prices in 2007 and 2009, along with the credit crunch, have had far-reaching consequences on the industry, Rabobank said. Many projects were shelved, few new projects have been announced, and the rate of renovation of cane fields declined as mills cut back on capital expenditure.
Several structural and cyclical factors caused a decline of 18% in ethanol production for 2011-12 and an 11% drop in cane production. With a fall in replanting rates, the average age of the cane crop has increased and the yield decreased.
Dry weather in 2010 hurt production in 2011-12 as did two frosts in July and August. Extremely high world sugar prices in 2011 meant mills opted to produce sugar at the expense of ethanol.
The report said there is a significant mismatch in ethanol supply and demand, causing Brazil to import ethanol from the U.S.
“Although Brazil’s ethanol exports in 2011 far exceeded its ethanol imports, the fact that imports were required at all was a major reversal of fortune for an industry, which, until recently, was the world’s largest exporter of ethanol,” the report said. “In 2011, the U.S. took over that role.”
Brazil’s new harvest starts in earnest in April, and most estimates put production at 500 million to 560 million tonnes, compared to 492 million tonnes in the previous season. Seasonal factors are unlikely to reoccur this year, the report said, but structural issues such as old cane fields will continue to have an impact for the next two to three years.
The split between sugar and ethanol may be different this season, Rabobank said, with sugar production expected to be greater than consumption. If sugar prices continue to decline, Brazilian millers may produce more ethanol than sugar.
If production reaches the high estimate of 560 million tonnes, combined with low world sugar prices, a strong dollar and a 20% blend mandate, Brazil could achieve a significant increase in ethanol production compared to the previous season, the report said.
The nation would be able to maintain exports of 2 billion liters, and require imports.
However, if production comes in on the lower end, and world sugar prices stay at current levels or move higher along with a weaker dollar, the domestic ethanol supply could be as tight as it was in the previous season. High ethanol prices would likely mean imports and perhaps a tax on exports, Rabobank said.
LOOKING TO THE FUTURE
The long-term future of the U.S. ethanol industry will likely be shaped by government policy, the report said. The RFS2 suggests that growth of the industry will slow over the next few years as increases in the mandated levels taper off. After reaching 15 billion gallons in 2015, no future growth is mandated, Rabobank said.
Future trade with Brazil also will likely be shaped by policy. As corn ethanol production flattens, further growth in renewable fuels will come from biodiesel, cellulosic ethanol or Brazilian sugar ethanol. If cellulosic ethanol doesn’t grow, and biodiesel continues its steady growth, the “other” category requirement in the RFS2 could increase to 4 billion gallons by 2015.
“This presents a huge opportunity for Brazilian and other sugar-based ethanol producers,” the report said.
The biggest challenge for Brazil will be replanting its cane fields. The downturn in cane production in 2011-12 meant the industry only reached 70% of its maximum capacity. Total milling capacity is estimated at 620 million tonnes, which means the nation could increase its output by 130 million tonnes of cane.
Such an increase in production would be enough to produce 5.4 to 6 billion liters of ethanol along with another 6.7 to 8.4 million tonnes of sugar, depending on how the cane was used. It likely will take a minimum of three years to reach this level of output, the report said.
Brazil could increase its production capacity by expanding existing mills rather than building new mills. The cost of expansion is two-thirds the cost of greenfield expansion.
Rabobank said that industry sources indicate such expansions could add 10% to 20% in capacity.
The government is boosting the industry with a $2.3 billion credit line specifically for the replanting of cane and the expansion of cane area. Rabobank said it wouldn’t be surprising if the government added additional initiatives to take advantage of the continuing growth of ethanol markets.