Ethanol has long been headlined as a major alternative energy source. In fact, it was prominently mentioned in President George W. Bush’s 2006 State of the Union address as part of the program to make the United States independent of Middle Eastern oil. Every year large amounts of ethanol are produced from sugar in Brazil and from corn in the United States, much of it destined for use in automobiles. Yet, ethanol has long been treated like a poor stepchild, largely due to abundant and cheap oil. That is changing. The major hike in international oil and gas prices over the last three years is forcing a lot of people to take another look at ethanol as a viable alternative in the face of skyrocketing oil prices.

Although the United States is a major producer of ethanol, the world leader is Brazil. Why South America’s largest country? The answer is found in Brazil’s fertile soil, a lack of large and easily accessible oil fields, and the pioneering spirit of the Brazilian government and private sector.

Dating back to the 16th century, Brazil has a long history of sugar production. It currently accounts for 20 percent of the world’s sugar production, which puts it ahead of the European Union with 13 percent (mainly from sugar beets), India (10 percent), and China (7 percent). In terms of export markets, Brazil again dominates, accounting for 40 percent of the world’s totals exports, dwarfing its closest competitor, the EU, which accounts for 15 percent of exports and has much higher costs of production. It is important to underscore the strength of Brazil’s sugar industry is based on the country vast availability of land, favorable weather conditions and cheap labor, making it the lowest cost sugar producer worldwide. On this agricultural foundation, Brazil can now make ethanol for around $1 a gallon, compared according to World Bank statistics to an international price of gasoline per gallon of about $1.50.

Brazil’s ethanol industry gained momentum in the 1970s, when the first oil shock forced the military government to look for some way to deal with a lack of local sources of energy and heavy import bills. Along these lines, sugar companies were granted cut-rate loans to build ethanol plants and guaranteed prices. The government also funded Urbano Ernesto Stumpf, an ethanol researcher at a Brazilian Air Force laboratory, who developed an ethanol-powered car.  In 1979, the government required Petrobras to make ethanol available at its filling stations.  In addition, car companies received tax breaks to get ethanol-powered vehicles to showrooms.  By 1983, the majority of new cars sold in Brazil ran on ethanol alone.

Unfortunately Brazil’s ethanol program faded in mid-1980s, when oil became more plentiful and cheaper.  At the same time, the state-owned oil company Petrobras stepped up its onshore and offshore exploration of oil.  

Ethanol survived the 1990s in Brazil as the government maintained the incentives for the private sector to stay engaged in some capacity -- be it through the automobile sector or sugar production. This also meant a gradual improvement in ethanol technology, making the industry more cost-efficient.  Many Brazilian government policymakers clearly remembered the oil shocks on the 1970s.  By 2005, Brazil was squeezing about 520 gallons of ethanol from a hectare (nearly 2.5 acres), a considerable improvement from 2,000 liters in 1975. At the same time, the Brazilian government helped nudge along the development of what is called “flexible fuel cars”, which can use either gasoline or ethanol.  

The early 2000s have been a boost for Brazil’s ethanol industry, largely due to increased demand for oil from China and India.  Add to this the increasing use for political purposes of hydrocarbon power by Iran, Russia, Bolivia and Venezuela and ethanol looks even more attractive.  

What is encouraging is that ethanol is now making a shift from being the domain of the public -- heavy with subsidies -- to the private sector.  The flex fuel cars are now made by the five major carmakers in Brazil. And Brazil is increasingly less dependent on foreign sources of oil, especially from the volatile Middle East – a lesson in which Washington is certainly interested.

Although the Brazilian government continues to play a major role in the country’s sugar and ethanol industries, there is a gradual shift to financing to the private sector.  Along these lines, Cosan recently went to the capital markets for funding.  The company accounts for 8.2 percent of Brazil’s total crushing capacity, 9 percent of the country’s sugar industry, and 7 percent of its ethanol industry. Brazil’s sugar and ethanol markets are very fragmented and Cosan is in the process of growing its business, partially through acquisitions, hence the turn to the markets.  Along these lines, Cosan raised money via an equity IPO and then turned to the U.S. corporate bond market.

Cosan’s bond deal is instructive of the considerable interest in alternative energy and Emerging Market plays.  The initial offer was for $250 million.  It was later upped to $300 million on a book of investor demand of $2 billion. A lot of investors did not receive any of these bonds, leaving the door open to further deals from other ethanol companies.   

While the Brazilian model of state-private sector development is not perfect, Latin America’s largest economy has made considerable progress in buffering its economy from oil price volatility in international markets. This progress has come as a result of the government having a sustained and active engagement in the development of the ethanol business, making use of a combination of subsidies, grants and other policy measures. It also sought private sector involvement, sometimes forcing involvement through policy changes.  In a world where the demand for oil is increasing, the level of supplies are in question, and political hostilities threaten to increase the worry premium on oil, ethanol certainly looks more attractive.  This would explain the growing interest from other countries, like the United States, Japan and Jamaica, in Brazil’s ethanol program.