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June 30, 2014

Corn-Based Ethanol Possible in Mato Grosso - at least on Paper

With an excess of corn being produced again this year in the state of Mato Grosso, there is once again renewed interest in utilizing more of the corn domestically instead of paying the high transportation costs to move the corn to livestock producers in southern Brazil or to exporters in southeastern Brazil. One of the most promising near-term prospects for utilizing more corn within the state is to use the corn to make ethanol.

In recent meeting sponsored by the Mato Grosso Soybean and Corn Producers Association (Aprosoja), research was presented indicating that corn-based ethanol facilities could pay for themselves in six years with an annual return of 27%. At least that is what it looked like on paper. The reality on the ground though is significantly different.

Producing ethanol from corn is not the problem, it can be done cheaply and efficiently. The problem is the government's attitude toward the price of gasoline and the inefficient distribution system for ethanol in Brazil. Since ethanol contains 70% the energy of gasoline, if the price of ethanol (E100) is more than 70% the price of gasoline (E25), it is more economical to use gasoline. Currently, the Brazilian government is very concerned about inflation and gasoline is a significant component of the inflation index.

Therefore, the federal government has been artificially holding down the price of gasoline, which in turn holds down the price of ethanol. Additionally, this is a presidential election year in Brazil and the Brazilian president has put a heavy emphasis on controlling inflation especially after the government has overspent heavily on the World Cup soccer stadiums. If the price of gasoline is not allowed to increase, then the price of ethanol cannot increase either.

The other problem with ethanol production in Brazil is the inefficient manner in which it is distributed to consumers. Ethanol producers are not allowed to sell directly to consumers. Instead they are required to sell to distributors who then in turn sell to consumers. The inefficient distribution system is one of the main drivers behind the cost of ethanol.

Take for example the way in which ethanol is distributed within the state of Mato Grosso. The cost of producing sugarcane-based ethanol in Mato Grosso is approximately R$ 0.40 per liter. After all the taxes are included, the price of ethanol sold to the distributors is in the range of R$ 1.40 to 1.60 per liter. By the time the ethanol is sold to the consumer at the local gas stations, the price has risen to R$ 2.05 to 2.45 per liter.

In other words, the cost of distributing the ethanol is more than twice as much as it costs to produce the ethanol. The biggest margins are for the distributors and transporters and not for the manufactures. The inefficiencies in distributing the ethanol is based on the requirement that ethanol can only be sold through distributors.

A typical sugar mill in the interior of the state is obliged to sell the ethanol to a distributor who then transports the ethanol to the state capital of Cuiaba. At the capital, the ethanol is then sent right back to the town where it was produced. The expense of this "round trip" from the manufacturer to the capital and back again to the interior has only one benefactor - the distributor and the transporter who book profits going both directions.

Investors are currently looking at the possibility of producing corn-based ethanol within the state due primarily to the low cost of corn in the state. The viability of such projects though is also going to be dependent on potential actions taken by the government to increase the price of ethanol and/or to reform the method of ethanol distribution within Brazil.