Brazilian Ethanol Emerges from the Doldrums

Things are looking better for Brazil’s sugar-ethanol industry after a rough period last year, when production and exports fell sharply and many mills struggled to operate amid a major financing squeeze.

“Last year was very tough and the sector suffered a lot,” says Eduardo Leão de Sousa, executive director of the União da Indústria de Cana-de-açúcar (UNICA), the industry’s main lobbying group. “Ethanol and sugar prices fell and the industry was very indebted so banks would not provide working capital financing.”

The funding gap meant many over-leveraged mills had to curtail production, losing money. Meanwhile, ethanol demand from key markets in the U.S. and Europe fell sharply, depressing exports. Overall, production fell to 25.6 billion liters from 27.5 billion in 2008 while exports totalled 3.1 billion liters versus 4.7 billion liters the previous year.

The situation left suppliers — many of whom are owned by family businesses — starving for cash, forcing them to sell to larger local and international producers who took advantage of the situation to snap up ethanol to meet targets at bargain prices.

M&A Spree

“Some of the [new production] projects were cancelled but what we saw mainly is a frenzy of mergers and acquisitions,” de Sousa notes. “The big, deep-pocketed energy firms went bargain shopping.”

The result has been a much more robust industry controlled by energy and commodity giants such as Bunge, Louis Dreyfus, Brazil’s Cosan and Petrobras, BP and Shell, which have all bought distressed mills and continue to scope out opportunities in the sector.

“A lot of them have re-thought their strategy and are looking to expand not only domestically but increasingly internationally,” de Sousa says.

Brazil’s ethanol is 100% made from the country’s vast sugar-cane fields. From 2002-2007, the industry saw huge growth as the local flex-fuel car market began to take off and entrepreneurs saw a goldmine in supplying the cleaner transport fuel to developed markets in the U.S. and Europe.

All in all, investors poured U.S. $20 billion into the sector and 100 mills were established. Industry observers, however, acknowledge that financiers were overly enthusiastic about the sector’s prospects, triggering a bubble that burst when the credit crunch shifted into high gear in late 2008.

But the dust has now settled and de Sousa says the sector has very good “short- to medium-term prospects.” He expects domestic demand to grow 10% this year and exports to increase in line with production, which is set to also rise sharply in 2010 as international demand strengthens on the back of a recovering global economy.

Brazil should add another 3 million new flex-fuel cars this year while exports should increase at least 5%, boosting production to 28 billion liters, analysts say. So far, there are 11 million flex-fuel vehicles in Brazil and the market has added 2-3 million units a year.

“The market is growing hugely with as many as 80 models for consumers to choose from,” de Sousa says, adding that subsidies have put prices in line with regular gasoline-powered models.

Will Investment Return?

While investments froze last year, producers and financiers are looking at new opportunities. “There is a lot of interest from many players to raise production to gain economies of scale so investments will definitely rise this year and in the medium term,” de Sousa notes.

He adds that the investment scenario is much more clear now than in the pre-crunch years. “The developed world is buying on a more technical basis and knows how much and the type of fuel it requires now.”

However, he conceded future investments will be “more cautious” than in boom years and declined to guess a figure.

Sidney Chameh, President of Brazilian Private Equity and Venture Capital Association (ABVCAP), said there a new ethanol funds being planned but nothing like “the crazy times” before the credit crunch hit in 2007. However, he acknowledged that there are still good investment opportunities in the sector.

The industry’s capital base is stronger as a result of the consolidation spree with two-thirds of it now owned by large energy groups, which Chame says have been busy boosting profits and improving corporate governance.

Antonio Duarte, which manages the Terra Viva ethanol fund for private equity manager DGF, says investors could start backing new production ventures as soon as next year where this year they are concentrating on strengthening their businesses. Local and international ethanol demand is also expected to increase more robustly in 2011 and beyond.

“There won’t be that many investments this year as many mills are still finalizing the expansion projects began two years ago,” he says. However, DGF is confident about the sector’s future and will likely launch a second ethanol fund in the next 12-18 months. The fund, which will be called Terra Viva II, will be larger than the current, $166 million fund, which is now 50% committed.

Duarte also expects the IPO market to open up for ethanol producers next year, boosting funding opportunities for new projects.

“The industry has few funding sources,” he says, adding that Brazilian development bank BNDS has backed many production ventures while many others have been financed by bank syndicated loans and export financing loans. Buyout funds have also been an important funding source.

While Brazil currently exports just 10% of its ethanol production, its mainstay biofuel, biodiesel, has been growing at a much slower pace.

But duarte says upcoming demand in the US and Europe will sharply boost that figure. The US renewable fuel standards and the EU’s renewable energy directive will see bioethanol blends increase substantially by 2020, he notes.

The US will need some 136 billion gallons of ethanol by 2022 while Europe will consume 18 billion liters in 10 years, he says. “They will not be able to meet this demand alone and will definitely have to import,” de Sousa points out.

That’s certainly enough to keep the industry going and given Brazil’s booming economy, which was hardly affected by the credit inferno and ensuing global recession, soaring domestic demand should keep those mills busy for the foreseeable future.

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Ivan Castano is a freelance journalist based in Miami. His work has appeared in Thomson Reuters’ International Finance Review (IFR), Dow Jones’ Financial News, Euromoney, Trade & Forfaiting Review and a range of trade publications covering the capital markets, private equity, loan, credit and restructuring markets. He is fully bilingual in Spanish and English having been raised in Ecuador, Colombia and Spain. Ivan has worked and lived in Los Angeles, New York, Madrid and London.

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