These mandates not only establish aggressive top-line volume targets: They also set progressively more stringent provisions on what types of fuels comply with these mandates. Under RFS, 92 percent of the 2010 biofuels mandate could be met with conventional corn ethanol. By 2022, this percentage will drop to 42 percent, with the remainder to be met by three categories of advanced fuels, whose lifecycle CO2 must be at least 50 percent less than fossil fuels: cellulosic biofuel, biomass-based diesel, and other advanced biofuels. The RED requires that any biofuel used to meet the mandate meet a lifecycle CO2 reduction of 35 percent starting in 2011 for plants in operation as of January 2008, and April 2013 for plants built after 2008. This threshold rises to 50 percent in 2017.
Cellulosic ethanol producers have yet to succeed in moving past the demonstration-plant stage. The only ethanol currently produced at a mass scale that can meet the US advanced biofuel and EU thresholds is sugarcane ethanol, whose CO2 reduction is estimated at 61 percent by the US EPA and 71 percent by the EU. In the United States, regulators privately admit that they anticipate most of the RFS2’s advanced biofuels requirement to be met by imports. This would entail up to 3.5 billion gallons per year of advanced biofuels imports by 2022. Many of the National Action Plans (NAPs) outlining EU member countries’ strategies to comply with the RED also rely on biofuel imports. Hart Energy estimates that the RED will generate 800 billion gallons net imports of ethanol in 2020.
These mandates create a compelling business opportunity for sugarcane ethanol producers. First and foremost among them is Brazil, which until recently had been the dominant player in the global ethanol trade. Brazil produced 7.4 billion gallons of sugarcane ethanol in 2010. But Brazilian producers have yet to fully recover from the supply shock that resulted from the 2008 global financial crisis. Complicating the picture is the country’s rapidly expanding flex-fuel vehicle fleet that has created robust ethanol demand.
Brazil’s Flex-fuel Revolution
Ethanol has not always been considered one of Brazil’s success stories. The sugar and ethanol sector had been beset by overcapacity and by the boom/bust cycles of global sugar markets. However, the 1970s oil crises presented an opportunity for the government to cut into the country’s growing oil import bill while taking up excess sugarcane crushing capacity. The advent of ethanol-powered cars in late 1979 created a captive market for the fuel, and its production increased rapidly as a result.
Still, the country’s worsening fiscal position from 1986 forced it to cut into the amount of credit it had extended to the sugar and ethanol mills. Ethanol production stagnated as a result. The process of political liberalization in Brazil begun in 1990 created further instability in the sector. Also, a spike in world sugar prices during that time further reduced ethanol availability: Ethanol prices rose past those of gasoline, and vehicle buyers migrated en masse to gasoline-powered cars. The sugar and ethanol sector remained in the doldrums into the following decade.
However, the advent of flex-fuel vehicles in 2003 gave the sugar and ethanol industry a much-needed lifeline. The prospect of tapping into the traditionally cheaper ethanol—and yet having the freedom to switch over to gasoline in periods of tight supply—won over most vehicle buyers. Soon, flex-fuel vehicles commanded the lion’s share of sales in Brazil.
With local ethanol producers ramping up production to respond to growing domestic demand, foreign investors entered the industry. The mandated phase-out of MTBE use as an oxygenate for gasoline in the US amid environmental concerns, and its replacement with ethanol, provided an early opening into the US market – one that was eventually seized by the US corn ethanol industry. The RFS2 and RED now provide another opportunity for sugarcane ethanol producer. But are they ready to capitalize on it?
2008 Credit Crisis: Fallout on the Sugar and Ethanol Industry
The collapse of Lehman Brothers in September 2008 hit the Brazilian ethanol sector at the worst time: The sector had invested heavily over the previous years, and net debt among mills had increased nearly sevenfold between the 2005/06 and 2008/09 harvests. With credit markets seizing up, producers had to drastically cut investment and focus on generating enough cash to stay afloat. Many mills did not survive. Even many of the largest local conglomerates had to sell out: French commodities giant Louis Dreyfus acquired a controlling stake in SantaElisa Vale, while Groupo Moema was taken over by US-based Bunge. Deep-pocketed newcomers also struggled, too: BRENCO, boasting investors such as James Wolfensohn and Vinod Khosla, also failed to navigate the crisis and sold out to local player ETH.
As a result of the pullback in investments, sugarcane acreage expansion has slowed considerably, and many new projects have been put on hold. Perhaps most critically in the short term, a cutback in sugarcane field maintenance and replanting expenditures has led to a decline in productivity yield. Agricultural yields in Brazil’s main sugarcane producing region have declined by 20 percent in the current harvest, falling to only 74.2 tons of cane per hectare. Hart Energy expects ethanol production to fall to 5.8 billion gallons in 2011 – a 21.5 percent decrease year-on-year.
Even as mills have struggled to stay on top of their finances during the aftermath of the 2008 crisis, domestic demand for ethanol has kept growing. A value-added tax regime favoring flex-fuel vehicles over gasoline vehicles, which ran from late 2008 until March 2010, added fuel to the fire. Vehicle sales have remained on a record-breaking pace, and ethanol consumption grew by 25 percent between 2007 and 2010. Demand pressures have all but wiped out the price difference between ethanol and gasoline, which now are now at near parity on an energy-equivalent basis (the energy content of ethanol is close to 70 percent of that of the gasoline sold locally, which itself has ethanol content of 18- to 25-percent, depending on market conditions).
Surplus? What Surplus?
Given today’s reality of an industry still struggling to recover from a supply shock, even as it copes with growing domestic demand, has cut deeply into Brazil’s ethanol exports. These have shrunk to little over a third of what they were in 2008 (see Figure 1). Weak harvest results of the current harvest will cut into exports even more, and have led fuel distributors to import US-made ethanol to keep the local ethanol markets in balance.
Figure 1: Ethanol Balances in Brazil, 2000-2010 (unit: billion gallons)
Can the industry realistically provide the billions of gallons in potential demand expected to materialize by the end of the decade? Even under a best-case scenario, the process of ramping up production will take several years. A substantial amount of investment needs to be made in clearing out and replanting old cane fields to maximize the productivity of existing fields. The Brazilian government is considering additional measures to spur this kind of investment. The enactment of such measures will certainly help; but, just as important, the presence of better-capitalized, larger scale players will put more mills in position to invest in their cane fields. This process should begin to yield results by the 2013/14 harvest.
Next, more acreage must be planted to maximize existing crushing capacity. Limited availability of suitable land (which command very high prices) in São Paulo, the hub of the Brazilian sugar and ethanol industry, limits the upside of doing so in the mills in that state. Acreage expansion in other states, where land is abundant but logistics is less compelling, will have to continue.
Lastly, new, greenfield clusters of mills will need to be planned and constructed. For projects with all of the construction and environmental permits already in hand, the lag between start of construction and operation at full capacity can take four years, nearly five. As such, substantial additions via greenfield projects will not make a huge dent until after 2015. And let’s not forget: Brazil’s flex-fuel fleet will continue to grow, and so will demand pressures from the domestic market.
According to the projections calculated in the Global Biofuels Outlook, Brazil will manage to resume its central role in world ethanol markets by 2020. However, it is unlikely that there will be enough exportable surpluses to meet all of the renewable fuel mandates expected to be in place at that time. Hart Energy projects Brazil will produce 8.5 billion gallons by 2015 and 13.1 billion gallons by 2020 (see Figure 2). Nevertheless, demand is expected to reach 8.1 billion gallons in 2015 and 11.5 billion gallons in 2020. This growth assumes a relatively conservative 4.2-percent per year in vehicle sales growth and is based on a projected decline in ethanol fill-rates among flex-fuel vehicles – a projection based on a narrowing between gasoline and ethanol prices locally.
Figure 2: Ethanol Outlook in Brazil: Ethanol Required v. Ethanol Produced (unit: billion gallons)
Even so, net exports total only 1.6 billion gallons. True, the ethanol trade between Brazil and the US (i.e., corn ethanol sent to Brazil, sugarcane ethanol sent to the US) that is already taking place could expand in scale and free additional volumes of sugarcane ethanol, but it is hard to envision these trade flows becoming large enough to account for the remaining 5.6 billion gallons of advanced ethanol expected to be needed by the US and the EU in 2020.
What Gives?
Renewable fuel mandates are relatively new policy tools. Mandating compliance with future goals before they have become technically feasible in the present works sometimes – case in point: The Corporate Average Fuel Economy (CAFE) standards in the US. Adoption of renewable fuel mandates is proving to be far more challenging; it is highly likely that the existing mandates will have to be redrawn to conform to the technological and economic realities of today’s transportation fuels markets. Goals are likely to be scaled back, timelines are all but certain to be extended. Nevertheless, the overall importance of biofuels in transportation sector’s resource base will continue. It’s not a question of if (determining the extent of biofuels role as a contributor to sustainable transportation; rather it’s a question of when. Even further, it’s a question of how much.
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