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Brazil Faces Looming Transport Fuel Shortfall

10 April 2013

BRAZIL - A new report concludes that Brazil will be unable to meet its domestic light vehicle demand for fuel as soon as 2017 if recent trends continue.

By 2021, demand could outstrip supply by as much as 9-12 billion litres per year, equivalent to 20 per cent of Brazil’s demand. The country must either make substantial new investment in sugarcane ethanol production or gasoline refining, or it must allow diesel light vehicles on the roads.

It was not long ago that Brazil met the majority of its light fuel demand with ethanol produced from sugarcane. This was in part due to a boom in capital investment for new ethanol projects, which reached $6.4 billion in 2008, but which dropped to just $256 million in 2012, according to Bloomberg New Energy Finance data. Partly as a result, ethanol use fell to 40 per cent in 2012, from a high of 54 per cent in 2009.

Meanwhile, the country maximized its domestic gasoline production in 2012, importing almost 4bn litres of gasoline as a result. Because the government sells gasoline cheaper than global market prices, the imports were sold at a $400m loss to Petrobras, the semi-public oil company. In January 2013 alone, Petrobras imported 700m litres of unblended gasoline.

Given the Brazilian government’s most recent economic growth and automobile demand projections through 2021, a total of up to 40bn litres of unblended gasoline may need to be imported by Petrobras from 2013 through 2021, even when accounting for planned refining capacity expansions.

While the Santos, Campos and Espirito Santo subsalt oil wells are estimated to hold 13.2bn barrels of heavy crude, Brazil will not have enough gasoline refining capacity to supply the domestic market in the medium term. The potential net cost of imports to the company, which is majority owned by the Brazilian government: up to $7bn.

“It was not long ago that Brazil was in a position to brag about nearing energy independence, in large part because of the strong growth of its ethanol sector,” said Salim Morsy, Bloomberg New Energy Finance lead analyst for biofuels in Latin America and the author of the white paper.

“But investment has slumped since for a variety of reasons, making the country increasingly dependent on foreign gasoline refiners. It’s a costly and potentially untenable position, and it puts Brazil far off track as far as its energy security goals are concerned.”

The use of diesel fuel could help address the looming shortfall, but Brazil currently prohibits the sale of diesel-fuelled passenger vehicles. Passenger vehicles account for more than two thirds of all vehicles on the roads. Motorists are therefore restricted to gasoline, ethanol or some combination of the two – a popular option driving the number of ‘flex-fuel’ vehicles on Brazil’s roads.

One alternative open to Brazil is to boost domestic ethanol production through further investment. Bloomberg New Energy Finance estimates that by 2020, at least 14bn litres of additional anhydrous ethanol production capacity would be needed to fill the domestic fuel supply gap. Brazil could up its ethanol cane crushing capacity by more than a third (287m tones) by 2021 to address the gap, but this would require around $28bn in new investment in in 2012 currency.

Brazil has other policy options. Brazil law currently caps local gasoline prices for consumers. This distorts the fuel market and makes it more difficult for ethanol to compete. It also means that Petrobras is forced at times to sell its output at a loss, particularly when forced to buy expensive imports.

While allowing gasoline prices to rise further would be politically challenging for Brazil policymakers, it would tend to boost ethanol demand and so prompt sugar processors to produce more fuel and less sugar. The government has already indicated it is looking to go in this direction, with gasoline prices being pushed up 6.6 per cent in 2013.

Brazil could also mandate more ethanol be blended into a standard litre of gasoline. Currently, the blend level stands at 20 per cent but previously it was 25 per cent. A return to the earlier standard would boost demand for ethanol and ease the price pressure on refined gasoline. A 25 per cent blending mandate is expected to be reinstated no later than the end of Q2 2013.

Finally, fiscal incentives for hydrated ethanol could help producers sell more of their product and reap better margins. Bloomberg New Energy Finance expects retail taxes on ethanol to be substantially reduced in 2013.

All of these steps could allow Brazil to keep gasoline imports at bay in the short term (until 2015). In the long run, however, the only way to avoid a significant domestic production shortfall would be for the private sector to finance a build-out of new ethanol production capacity.

Whether investors are willing to bankroll Brazil’s next ethanol boom very much remains to be seen. Brazil’s national development bank (BNDES) has historically played a central role as a debt provider to the Brazilian sugarcane industry and could be a central driver in spurring new investments.

However, uncertainty about international sugar prices, local economic conditions, demand from US motorists for imports, and local policies are all dampening investor enthusiasm.

While these risks cannot be mitigated in their entirety, Brazil’s policy makers could potentially alleviate some concerns by sending clear signals about their intent to support local biofuels development, even if it means lower sales of gasoline for state-owned oil company Petrobras as a result of more domestic ethanol supplies.

Further Reading

You can view the full report by clicking here.

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