The World According to Ethanol

Prospects for ethanol trade over the coming three to five years are probably good. As to the specifics—it's anybody's guess.
By Marc Hequet | May 09, 2008
It's an exotic mix: mounting demand in spite of sky-high feedstock costs, oil prices off the charts, a weak dollar, fierce political pressures for and against trade barriers, equally fierce agitation for sustainability—all in the vortex of economic downturn.

Forecasting the prospects for international ethanol trade isn't simple at the moment. Let's just say more production, more demand and more trade overtopping trade barriers—all are likely.

Whatever happens, expect interesting times. Darin Newsom, senior analyst with DTN, the Omaha, Neb., commodities-information service, is among those waiting for good old supply-and-demand economics to settle in. But first, he thinks, ethanol is going to have to get through its wild youth. "The corn markets are rallying on projected ethanol demand," Newsom notes, "but at the same time ethanol demand could start to shut down because that demand is helping to push the market too high. We're still feeling our way around with prices—what's too high, what's too low, how high is too high."

So let's not get ahead of ourselves—as Brazil may have. "Brazilian producers are very clear that they are expanding, that there is a lot of additional production on the way," says Arnaldo Vieira de Carvalho, based in Washington, D.C., as a sustainable-energy specialist with the Inter-Americas Development Bank. "In fact they were a little bit ahead of the market and too much ethanol has been produced lately, so the prices came down. I think in that sense they were too fast."

And yet world ethanol supply is limited. "Remember, there are only two suppliers in the world for large quantities," says Nelson Rodrigues de Matos, an investment analyst with DIMEC/Divisăo de Pesquisa in Rio de Janeiro: Brazil and the United States.

Brazil Can Grow
Brazil is better positioned to grow exports, despite the counterweight of rising internal demand. Brazil produced about 22 billion liters (5.8 billion gallons) of ethanol last year, and exported only 15.9 percent of it. "That tells you right there that what Brazil produces is going essentially to service the local market, not for export," says Adhemar Altieri, a spokesman for the Brazilian Sugarcane Industry Association, Unica.

Yet Brazil is laying the groundwork for more export. Japan appears to be a key emerging trading partner. Accentuating the relationship, Japan's Crown Prince Naruhito was scheduled to visit Brazil in June to boost trade ties. Brazil has the largest overseas Japanese community, an estimated 1.5 million.

Growing global demand for alternative fuels will mean more Brazilian exports, predicts the research firm Fitch Ratings in New York City. Climate, geography and geology, cheap land, low labor costs and government incentives all give Brazilian ethanol an edge. More than half of Brazil's sugarcane crop now goes to ethanol, and the balance may well continue to tip in that direction.

Daniel A. Sumner, director of the Agricultural Issues Center at the University of California-Davis, thinks that Brazil has limited capacity to expand sugar production—but with prices high enough "there is certainly room to push out ethanol supply there," says Sumner.

As for importers, the United States is a prospect for growth, its protective tariff notwithstanding. California's Low Carbon Fuel Standard takes effect in January 2010, just 18 months from now. Demand for low-carbon fuels will rise dramatically in that state. "California will likely be the first battleground between domestic and foreign ethanol producers," says Rahul Iyer, executive vice president at Primafuel Inc. of Long Beach, Calif.

Not So Far Apart
Wherever the epicenter turns out to be, producing nations are laying the groundwork for more trade. Key players took an important step in February when the United States, European Union and Brazil released an analysis of quality and emissions standards—and found that they're not so far apart.
Eventual agreement on ethanol-quality standards is likely to mean lower costs for producers and shippers, who would no longer be required to meet a patchwork of specifications nation by nation and region by region.

The joint analysis by the U.S. Commerce Department's National Institute of Standards and Technology and corresponding agencies in Brazil and the EU showed nine of 16 ethanol specifications the governments reviewed are "in alignment" and all but one of the remaining specifications could be aligned short-term. The hard-to-align standard is water content.

Counterproductive?
Back in the United States, some argue for a lower tariff on ethanol imports—noting, for example, that it may be more economical for Florida to import from Brazil than from the U.S. Midwest. Others also think the tariff's days are numbered as Washington's attention shifts to reducing greenhouse gases. "As soon as we start basing policy on carbon reduction and sustainability, then this tariff we have on Brazilian ethanol is going to start to look more and more counterproductive," says Primafuel's Iyer.

Imports from Brazil would help the U.S. meet its energy objectives without drawing political heat about food-vs.-fuel issues, thinks Sumner because Brazilian ethanol is from land already devoted to sugar.

Yet U.S. ethanol interests make a strong case for maintaining the tariff. Removing it would amount to U.S. taxpayers subsidizing foreign production, tariff backers argue. The Renewable Fuels Association contends that the tariff offsets the 51-cent-per-gallon tax incentive that petroleum refiners receive for ethanol they blend, no matter whether it originates in the United States or Brazil. Without the tariff, says RFA, American taxpayers would in effect pay Brazilian ethanol producers 51 cents for each gallon of ethanol the United States imports from Brazil.

If the U.S. persists in protecting its own ethanol industry, Brazil is unlikely to resort to protectionist measures in agriculture, says economist Sumner—but another kind of retaliation may come from China, Japan and Korea. A Japanese economist told Sumner of UC-Davis about pressure to raise Japanese grain and oilseed tariffs to encourage domestic production of feed grains, wheat and oilseeds in Japan "because with the big price jumps and demand for ethanol production," says Sumner, "the U.S. is considered as perhaps not a reliable supplier."

Europe Hesitates
Europe, meanwhile, has been rethinking its own biofuels mandates, worried about feedstock sustainability. Exporters hold their breath. "If you don't have mandates, our trade would be significantly reduced," says the Inter-American Development Bank's Carvalho.

Europe's fixation on sustainability means certification must be thorough, says Carvalho. Any scandal suggesting that presumably certified feedstock is otherwise would make headlines around the world, he cautions, and careless certification "will bring harm. You have to do it right. One project wrongly done may affect the whole future of the market." Bad news, adds Carvalho, brings "a wave of worries" and unnerves politicians.

Sustainability will affect ethanol price, predicts Nathanael Greene, senior policy analyst in New York City with the Natural Resources Defense Council. Ethanol from feedstock that doesn't meet sustainability standards will become less valuable. "I think you'll see pressure on the market to move away from some feedstocks that have the worst types of land-use-related impacts, like palm oil," says Greene.

U.S. producers may even gain an edge in sustainability as the cellulosic market develops, environmentalist Greene thinks. "We may find ourselves quite possibly an exporter of low-carbon biofuels if we were really aggressive about finding these options that don't interfere with food and feed and fiber," he says.

The reason? Language in the federal Renewable Fuels Standard "is more aggressive in that it has a broader scope" than the EU's prescriptions for sustainability, notes Greene. "It seems entirely possible we would end up in a place where our standards and regulations are stricter," he muses, "and therefore be ones that the European Union would be willing to accept."

The biggest obstacle to growth in both Brazilian and U.S. ethanol production is success in getting the world to use it. Who goes first? Nations won't require an ethanol blend unless they are convinced enough production is available.

As that comes to pass, if it does, it creates an opportunity for ethanol producers wherever they are. "Brazil alone would never be able to produce sufficient ethanol to service a global demand," says Revisson Bonfim, director of the Latin America Corporates Group for Fitch Ratings. "Therefore other countries will need to produce ethanol in scale,
commoditizing it. Only then could fears of a shortage diminish."

If ethanol trade barriers fall, Sumner expects "more imports into the U.S. maybe a doubling." That would drop U.S. ethanol prices and result in more U.S. use of ethanol—meanwhile raising world prices because U.S. imports would draw down world supply.

It would also mean "some reduction" in U.S. ethanol production and in use of corn for ethanol, says Sumner. High corn prices make U.S. ethanol less competitive, and have the effect of pulling in more ethanol imports even over the high tariff wall, he adds.

‘Voodoo Economics'
And so it goes. As if the international ethanol market isn't already wacky enough, consider this: In March, Oanda plc, Nigeria's biggest energy company, was fined by the Nigerian government for importing E20 that reportedly damaged thousands of vehicles. In subsequent weeks, however, the company's share price actually rose 60 percent on the Nigerian Stock Exchange. Observers speculated darkly about "wanton manipulation." "It is only here in Nigeria you find such voodoo economics happening," an official told The Vanguard, a newspaper in Lagos, Nigeria's largest city.

Unless voodoo has bewitched the whole sector, ethanol will correct eventually. "That's the expectation," says Carvalho of the Inter-Americas Development Bank, "because we believe it is a good solution."

Meanwhile, if you can find the fundamentals, cling to them. It's going to be wild out there and things will change. Check back with us again—in about 20 minutes.

Marc Hequet is international editor with Ethanol Producer Magazine. Reach him at mhequet@bbibiofuels.com or (701) 636-0636.