By Ana Ionova and Marcelo Teixeira
LONDON/SAO PAULO (Reuters) - Brazilian sugar companies are increasing their capacity to produce ethanol in the face of depressed global sugar prices and government policies expected to boost demand for the biofuel.
A shift to ethanol in the 2018-19 season slashed Brazil's sugar output by 9 million tonnes to a 12-year low and more switching to the biofuel next season could help to wipe out a global surplus weighing on sugar prices.
Brazil could also lose its crown as the world's biggest sugar producer to India for the first time in 16 years, according to the U.S. Department of Agriculture.
For Brazilian sugar cane processors, switching to ethanol has proved an attractive trade-off as the increased focus on the biofuel partly shielded mills from a plunge in global sugar prices in September to their lowest since 2008.
Executives at major Brazilian sugar firms Biosev (SA:BSEV3) and Usina Coruripe http://www.usinacoruripe.com.br/en, as well as smaller producers such as Usina Batatais http://us.usinabatatais.com.br and Usina Cerradao http://www.usinacerradao.com.br, told Reuters they were now investing in more ethanol capacity ahead of next season.
Biosev, for example, Brazil's second largest cane processor, said it was installing distillation columns at two plants in the Mato Grosso do Sul cluster to give the mills the option of using 90 percent of their cane for ethanol, up from 50 percent now.
In another sign the industry is making a longer-term bet on ethanol in step with Brazil's biofuels policy, JW https://www.jw.ind.br/en, a leading Brazilian ethanol equipment maker, told Reuters it has hired 200 people to cope with a surge in orders.
Brazil first rolled out policies to use more biofuels in 1975 after OPEC's supply embargo drove up oil prices. So-called flex-fuel cars that run on pure ethanol or a gasoline-ethanol blend now make up 80 percent of Brazil's light vehicle fleet.
In a new push, the government this year approved a program called RenovaBio that mandates fuel distributors to gradually increase the amount of biofuels they sell from 2020.
Brazil's Ministry of Mines and Energy expects RenovaBio to push demand to 47.1 billion liters in 2028 from 26.7 billion in 2018, helping Brazil's ethanol industry recover from years of competition with subsidized gasoline prices.
"Investments are only made looking into the long term," said Plinio Nastari, chief analyst at Brazilian consultancy Datagro https://www.datagro.com/?lang=en. "Part of these investments are being made because of the establishment of these targets."
(For a graphic of Brazil's ethanol production click here https://tmsnrt.rs/2QeaG03)
ETHANOL BETS
The global market could also offer opportunities for Brazilian ethanol producers as countries look for ways to reduce their carbon footprint, including China, which is rolling out the use of ethanol in fuel nationwide by 2020.
This season, Brazilian mills earmarked 64 percent of cane to ethanol as domestic sales surged by some 40 percent due to high gasoline prices in Brazil, the world's fourth largest consumer of transportation fuel.
Many mills can already churn out sugar or ethanol, with some flexibility on the mix. The firms investing in distillation columns hope the reconfigurations will give them the scope to produce even more ethanol if prices remain attractive.
Besides Biosev, which is controlled by commodities trader Louis Dreyfus, Usina Coruripe, a top 10 Brazilian cane processor, said it plans to invest about 300 million reais ($79 million) to crush more cane and increase its ethanol capacity.
"Our mix is still very high on sugar due to the configuration of the plants, but we are seeking to change that," Chief Executive Mario Lorencatto told Reuters.
Usina Batatais, a company that can crush 7 million tonnes of cane per crop at its two mills, said changes it made last season at one of its plants in Sao Paulo state meant it could allocate as much as 80 percent to ethanol.
"We almost doubled hydrous ethanol production from last year to this," Luiz Gustavo Junqueira, innovation manager at Usina Batatais, told Reuters.
While investments vary, a mid-sized mill can spend about 20 million reais to add a distillation column that boosts ethanol output by 40 million liters, said Willian Hernandes, partner at financial advisors FG/A http://www.fga.com.br/eng, which helps mills raise capital.
Hernandes said three firms could start expanding capacity as soon as this month ahead of the next sugar cane crop in April.
Mills are also investing in storage tanks so they can hold onto ethanol and sell it when prices are higher, said Alexandre Figliolino, a former investment banker now advising sugar and ethanol companies.
SHUNNING SUGAR
Brazil's dramatic switch to ethanol this season slashed its sugar production by 20 percent and, if ethanol remains attractive next season, mills could allocate more cane to the biofuel.
"With all the plans we have heard about, mills could probably take another 2 million tonnes of sugar out of the market next season," Hernandes said.
The U.S. Department of Agriculture and the International Sugar Organization both expect India to eclipse Brazil in 2018-19 as the world's largest sugar producer.
Ethanol's appeal over sugar is influenced by several factors including gasoline prices and the Brazilian currency, so it's still uncertain how much cane will go to ethanol in 2019-20.
"With no RenovaBio in place yet, I'd say we're looking at the same old situation," said Eder Vieito, senior commodity analyst at Green Pool https://greenpoolcommodities.com. "If the world needs sugar, sugar prices will move to a price level that ethanol can't match - without losing significant demand to gasoline."
A weakening in the real and crude oil has dragged down the price at which sugar is on a par with ethanol to just above 13 cents/lb, analysts estimate. But that's still above sugar prices now of about 12.4 cents (SBc1).
"Prices are still sending to producers the signal to maintain a strong ethanol focus next year," said Datagro's Nastari said.
LOWER CARBON FOOTPRINT
However, dwindling sugar stocks in Brazil have supported domestic prices, which could spur a short-term increase in production.
It is also unclear whether Brazil's incoming president, Jair Bolsonaro, will maintain the policy of aligning domestic fuel prices with global prices. While it has improved the competitiveness of ethanol by removing price caps on gasoline, higher prices at the pump have angered many Brazilians.
Sugar also holds an appeal for mills because producers can hedge returns with futures contracts - a mechanism that doesn't yet exist for the domestic ethanol market, said John Stansfield, analyst and trader at Group Sopex.
Outside Brazil, the ethanol market looks set to expand as well thanks to policies designed to lower emissions. Ethanol and sugar consultancy F.O. Licht expects global demand to rise at least 2 percent a year over the next decade.
And while Brazilian ethanol often cannot compete with low-cost U.S. supplies, Brazil's cane-based ethanol has a lower carbon footprint that could appeal to governments striving to meet Paris climate agreement commitments.
Colombia, for example, is one of several countries changing biofuel policies to prioritize the use of varieties with a lower carbon footprint. Brazilian ethanol has begun trickling into the U.S. state of California this year because fuel distributors can earn more credits under the state's decarbonization scheme.
"In comparison to local biofuels such as corn ethanol, cane ethanol from Brazil has a much lower carbon footprint," said F.O. Licht managing director Christoph Berg. "It's therefore a relatively attractive fuel."
High tariffs still pose a barrier in many countries, including China where Brazilian ethanol is subject to a 30 percent duty, though analysts say trade tensions between Washington and Beijing could provide an opportunity.
"At the moment, it does not seem to be around the corner that China would reduce the import tariff on Brazilian ethanol," Berg said. "But they would be competitive if the tariff is removed."