SAO PAULO (Dow Jones)--Is Brazil's white-hot ethanol sector set to cool?
Over the past year, the country - the world's lowest-cost ethanol producer -has attracted an electrifying amount of investor interest, due to fresh anxieties about global warming and towering world oil prices.
But as investors as far afield as the U.S., France, Norway and Japan have poured into the country's fast-expanding sector, prices to acquire or build Brazilian ethanol mills have shot up as much as 30%-100% from a year ago.
Still, another window of opportunity may be on the verge of opening up for those keen to invest and patient enough to wait, say a growing number of local millers and traders.
If they're right, Brazil's ethanol price bubble could begin to ease as soon as six months to a year from now, after a season of slumping New York sugar prices could force indebted local millers to sell off assets more cheaply.
"Out Of This World"
Currently, after the extraordinary returns of the profitable 2006-07 season and fierce global interest in biofuel output, prices for existing mills have soared "out of this world," said Paulo Diniz, the finance director of Brazil's largest miller Cosan SA, to investors at a recent conference call.
With mill prices at hefty premiums, many investors - like the George-Soros backed agribusiness firm AdecoAgro - have opted to pour funds into Greenfield milling projects instead. Still, even here, the price of everything from mills, equipment and renting land has also risen at least 10%-15% compared to a season ago, while the U.S. dollar has weakened 3%-8% against the Brazilian real, eroding export profits, local millers say.
"The worst price rise for me, is not the price of land, it's the price of equipment, which has risen 20%-30% in the last year," said Luiz Guilherme Zancaner, the president of Unialco milling group, which is building a new mill in Mato Grosso do Sul. "Today, even with the weaker dollar, it still costs more to build an ethanol distillery than it did a year ago."
Worse for the sector, however, some local millers warn that the sector may have already expanded too far, too fast.
"With all the buzz about ethanol, people have definitely put the cart before the horse," added Marcos Wanderley, a director at key northeast cane group Coruripe. "There's been all this expansion in the sector, but almost nothing concrete in terms of exports has as yet materialized."
Falling Returns
Moreover, it's a far different world today from a year ago, when the global sugar industry seemed headed for a fourth year of a sugar deficit and benchmark New York Board of Trade raw sugar prices roared to 25-year highs of over 18 cents a pound.
After a tsunami of sugarcane planting from as far afield as China to Columbia, the market is set to be swamped with a global sugar surplus of over 8.5 million tons for the market year to September 2007, according to the International Sugar Organization.The year after, the global sugar deluge could be even bigger, others predict.
Even in Brazil, the world's lowest-cost sugar producer, millers warn privately that they fear they'll have to tighten their belts over the next two seasons as New York sugar prices - currently trading at roughly 9.50 cents a pound - tumble below Brazilian costs of production.
"The age of euphoria is over," said Luiz Gustavo Junqueira Figueiredo, the commercial director of Alta Mogiana mill. "We've fallen into a new reality."
Others argue that investors shouldn't stop being bullish, but should stay hard-headed about their investments.
"The moment to invest is not now - but perhaps at the end of the year, when sadness descends on all the millers who didn't fix prices," said Unialco's Zancaner. "That's what big groups like Cosan are waiting for."
Investor Advice
How should all this market noise affect those still keen to enter Brazil's ethanol sector?
For starters, conduct thorough viability studies, say local millers. One difficulty is that there are few hard and exact rules for pricing Brazilian mill assets. Factors to consider include long-term New York sugar price projections and mill production costs, as well as available land for future expansion and transport costs to the nearest ethanol export-equipped port.
An easy sleight of hand is calculating the price to pay for a ton of cane-crushing capacity. Even there, however, prices have soared, possibly to illogical heights, say some. Clean Energy Brazil in March announced that it had paid an "attractive" multiple of $79 per ton of cane-crushing capacity for a minority equity stake in a local milling group.That's about 60% above what Cosan paid for its acquisition of a year ago at under $50 a ton, though 10%-20% lower than other market quotes.
Others add that, in the end, investors should remember that they are assuming a big risk - given unknown future demand for ethanol, huge Brazilian logistical problems, and rising costs - and price accordingly.
"I believe in a brilliant future for Brazilian ethanol, (but) I see investments stopping temporarily, as investors realize that the returns for their shareholders might take years longer to come backthan they had projected," added Tarcilo Rodrigues, the director of Bioagencia ethanol consultancy.
In the long term of course, the fundamentals continue to be good, say most energy analysts. As long as world oil prices float above $50 a barrel, then global biofuel demand is set to take off.
Meanwhile, Brazil's sugarcane-based biofuel, which competes less directly with global food supplies than the U.S. corn-based variety, still continues to be cost-competitive with gasoline these days, at just $39 a barrel to produce.
Still, "whichever way you look at it, prices these days don't make any sense - unless you're looking for returns over a very long period of time," added Antonio Augusto Duva, the manager of the Sao Paulo soft commodities desk of French bank BNP Paribas.
"There's all this hype about clean energy and Brazil," said Duva."But at the end of the day, what you have to remember is you're not selling clean energy to the future, you're selling sugar and ethanol."
Source: Grace Fan, Dow Jones Newswires; 5511 3145 1489; brazildowjones.com