VZCZCXRO9155
PP RUEHRG
DE RUEHSO #0352/01 0901758
ZNR UUUUU ZZH
P 311758Z MAR 06
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC PRIORITY 4790
INFO RUEHBR/AMEMBASSY BRASILIA 5938
RUEHRG/AMCONSUL RECIFE 2809
RUEHRI/AMCONSUL RIO DE JANEIRO 6956
RUEHBU/AMEMBASSY BUENOS AIRES 2128
RUEHCV/AMEMBASSY CARACAS 0226
RUEHBO/AMEMBASSY BOGOTA 1338
RUEHPE/AMEMBASSY LIMA 0928
RUEHAC/AMEMBASSY ASUNCION 2475
RUEHMN/AMEMBASSY MONTEVIDEO 1889
RUEHSG/AMEMBASSY SANTIAGO 1636
RUEHLP/AMEMBASSY LA PAZ 2680
RUCPDOC/USDOC WASHDC 2344
RUCLRFA/USDA WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NSC WASHDC
RHMFISS/CDR USSOUTHCOM MIAMI FL

UNCLAS SECTION 01 OF 04 SAO PAULO 000352 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EB/ESC/IEC/ENR AND EB/TPP/ABT/ATP 
STATE ALSO FOR WHA/BSC, WHA/EPSC, AND WHA/PDA 
STATE PASS USTR FOR AUSTR EISSENSTAT AND SULLIVAN/LEZNY 
H PASS SENATORS GRASSLEY, CRAPO, ALLARD 
H ALSO PASS REPS KING, ENGLISH, CARNAHAN, PETERSON, ISSA 
NSC FOR CRONIN 
TREASURY FOR OASIA, DAS LEE AND FPARODI 
USDOC FOR 4332/ITA/MAC/WH/OLAC/SHUPKA 
USDOC ALSO FOR 3134/USFCS/OIO/EOLSON/DDEVITO/DANDERSON 
 
TAGS: OREP PGOV PREL EAGR ECON ENRG BR
SUBJECT: VISIT OF CODEL GRASSLEY TO SAO PAULO: ETHANOL AND 
FLEXFUEL-ENGINE AUTOMOBILES 
 
REF: (A) RECIFE 40; (B) BRASILIA 498 
 
------- 
SUMMARY 
------- 
 
¶1. Senator Charles Grassley (IA) - Chairman of the Senate Finance 
Committee - and his delegation visited Maringa, Parana state and Sao 
Paulo, March 22-23.  Other members of the delegation included 
Senators Crapo (ID) and Allard (CO); Representatives Peterson (MN), 
English (PA), King (IA), Issa (CA), and Carnahan (MO); and Assistant 
U.S. Trade Representative for the Americas Everett Eissenstat.  In 
Maringa the delegation toured a sugar mill and ethanol plant.  In 
Sao Paulo they met with the leadership of the Federation of 
Industries of Sao Paulo State (FIESP) and the American Chamber of 
Commerce (AMCHAM), and visited a General Motors facility where they 
learned about the manufacture and operation of FlexFuel-engine 
automobiles.  This cable addresses the delegation's visit to the 
sugar mill, ethanol plant and the automobile factory, and 
discussions concerning ethanol and FlexFuel-engine automobiles.  The 
trade aspects of the visit, and Rep. Issa's separate meeting with 
the Brazilian-Lebanese community, will be reported septels.  End 
Summary. 
 
--------------------------------------- 
VISIT TO A SUGAR MILL AND ETHANOL PLANT 
--------------------------------------- 
 
¶2.  On March 22, CODEL Grassley traveled to Maringa, Parana state to 
visit the Vale do Ivai sugar mill and ethanol plant.  The group 
learned about the mill's operations as well as its business 
activities, including partnerships in port facilities and a trading 
company focused on ethanol and sugar exports.  Mark Lyons, managing 
director of Vale do Ivai's American joint venture partner Alltech, 
described Alltech's activities in Sao Pedro do Ivai. 
 
¶3.  The CODEL took a walking tour of the crushing facilities, 
distilleries and Alltech's new yeast fermentation facility. 
Delegation members asked a broad range of questions on such topics 
as production costs and productivity for sugar and ethanol, use of 
ethanol in the Brazilian fuels matrix, agricultural production 
techniques in southern Brazil, and environmental controls in plant 
operations.  After the tour, the delegation, along with the Mayor of 
Sao Pedro do Ivai, the President and Superintendent of the Parana 
Sugar and Alcohol Producers' Association, and the Director of 
Cocamar, a major agricultural cooperative in the region, attended a 
lunch hosted by the mill. 
 
--------------------------------------------- --- 
CONVERSATIONS ON ETHANOL AT THE AMCHAM BREAKFAST 
--------------------------------------------- --- 
 
¶4.  During a discussion of trade issues (septel) at the delegation's 
breakfast meeting at AMCHA, Board Member Joseph Tutundjian 
suggested that ongress consider forming a U.S.-Brazil Ethanol 
Cucus as a symbolic gesture with the possibility of aking 
substantive progress on an issue importantto both sides.  This 
suggestion led to a broaderdiscussion of ethanol.  One immediate 
problem isthat demand is rapidly outstripping supply, drivin 
prices up.  Both countries need to prioritize exanding their 
production facilities to satisfy grwing demand.  In Brazil's case, 
according to theAMCHAM members, there is a shortage of the 
invesment capital needed to expand the capacity of refieries. 
Impediments to investment cited by AMCHAM embers include the high 
cost of capital in Brazi, caused in part by an extremely high tax 
burden particularly on industrial production; the burden placed on 
 
SAO PAULO 00000352  002 OF 004 
 
 
American companies investing and operating in Brazil by the 
Sarbanes-Oxley Act; and inefficient infrastructure, especially the 
high cost of transportation and inefficient port facilities. 
 
--------------------------------------------- 
GENERAL MOTORS - FOCUSING ON EMERGING MARKETS 
--------------------------------------------- 
 
¶5.  CODEL Grassley next visited General Motors do Brasil (GMB) in 
Sao Caetano do Sul (greater Sao Paulo).  GMB President Ray G. Young 
greeted the delegation and gave an overview of the company's 
history, followed by a presentation on GMB's experience with 
FlexFuel (engine systems that run on gasoline, ethanol, or any mix 
of the two fuels).  Young pointed to GMB's extensive experience in 
the Brazilian market - the company has been operating in Brazil 
since 1925.  Currently, 90 percent of GMB's product is produced 
locally because Brazil's high tariffs on automobiles (35 percent) 
discourage imports.  GM believes in the BRIC moniker (identifying 
the key emerging markets as Brazil, Russia, India, and China) and is 
currently focused on operations in these key markets.  Brazil has 
been a particularly successful market for GMB, precisely because it 
is so closed to imports.  Accordingly, GMB engineers its cars 
specifically for the Brazilian market, and several of the models 
produced here are exclusive to Brazil.  Because Brazil is still a 
relatively low-income economy, the key consumer factors in Brazilian 
auto sales are low price and high resale value - two factors that 
would later come into play with FlexFuel popularity. 
 
---------------------------- 
THE RISE AND FALL OF ETHANOL 
---------------------------- 
 
¶6.  GMB has over thirty years of experience with ethanol as an 
automobile fuel.  During the 1970s oil crisis, the GoB began to 
regulate gasoline usage.  In 1976, the GoB banned the use of 
gasoline in auto races.  Race-car engine manufacturers switched to 
ethanol to use in Brazil's popular Formula 1 races.  The racetrack 
proved a useful testing ground for the technology, and in 1978 when 
the GoB mandated that all government fleets be run on alternative 
fuels, GMB stepped in with its ethanol engine technology.  Mass 
ethanol engine production began in earnest in 1979, the year that 
the GoB began to offer attractive tax incentives for purchasers of 
alternative fuel cars.  Throughout the early 1980s, ethanol 
technology flourished and consumer demand rose dramatically.  By 
1986, ethanol-burning cars accounted for 90 percent of Brazilian 
automobile production.  The ethanol heyday was short-lived, however. 
 In 1988-89, sugar prices rose sharply.  From one day to the next, 
ethanol was no longer a cost-competitive fuel.  As a result, 
thousands of Brazilian consumers who had purchased ethanol cars lost 
their investments and Brazilians generally lost confidence in 
alternative fuel technologies. 
 
------------------------- 
THE EMERGENCE OF FLEXFUEL 
------------------------- 
 
¶7.  It wasn't until 1992 that GMB began to run its first FlexFuel 
studies.  Brazilian consumers felt burned by their experience with 
ethanol engines in the 1980s.  GMB, however, still believed in 
ethanol technology and sought to develop an engine that could serve 
as a hedge against fuel price fluctuations.  FlexFuel engines were 
developed with this goal in mind, with flexible fuel usage, meaning 
that the engines can run on gasoline, ethanol, or any combination of 
the two fuels.  The FlexFuel engine system has a fuel sensor that 
continually monitors the mix of ethanol and gasoline in the tank and 
instructs the engine to alter performance based on the fuel mix. 
 
SAO PAULO 00000352  003 OF 004 
 
 
When burning ethanol, for example, pistons need a higher compression 
ratio, and the fuel sensor instructs the engine to adjust 
accordingly.  The first FlexFuel concept car was built in 1995, and 
mass production for the consumer market began in 1999. 
 
-------------- 
FLEXFUEL MANIA 
-------------- 
 
¶8.  In 2004, demand for cars with FlexFuel engines began to soar. 
Because of widespread ethanol use in the 1980s, Brazilian gas 
stations were still ethanol-capable.  Moreover, ethanol distribution 
networks were still in place.  In 2004-05, with ethanol prices half 
those of gasoline, owners found that their cars were not only 
cheaper to operate, but that their resale value was at an all-time 
high.  These two factors drove FlexFuel production to 
higher-than-anticipated levels.  Industry estimates in 2003 placed 
FlexFuel market saturation at 80 percent by 2008.   FlexFuel's 
popularity, however, shattered these estimates, and by 2005 FlexFuel 
cars accounted for 90 percent of Brazilian new car production.  In 
2005, GMB's flagship Sao Caetano do Sul plant was 100 percent 
FlexFuel production, and overall GMB production was 98 percent 
FlexFuel.  All major automotive companies operating in Brazil - 
Ford, Fiat, Renault, Volkwagen - were producing cars with FlexFuel 
engines.  By all measures, FlexFuel was a hit.  Brazil began to draw 
international attention and kudos for its widespread use of 
alternative fuel technology. 
 
------------------- 
FLEXFUEL CHALLENGES 
------------------- 
 
¶9.   FUEL QUALITY - Despite FlexFuel's success, the technology is 
not without its challenges.  One concern is low fuel quality.  GMB 
reports that Brazilian gas stations frequently dilute their fuel 
(gasoline and ethanol) with water.  This can confuse the internal 
sensor mechanism in the FlexFuel engine and compromise fuel 
efficiency.  Currently, GMB is campaigning against this practice at 
the fuel distributor level and working to re-engineer the sensor 
system to detect water in the fuel mix. 
 
¶10.  RISING ETHANOL PRICES - Another concern is the recent increase 
in the price of ethanol over the first few months of 2006.  The 
popularity of FlexFuel cars and the increasing price of sugar on the 
international market have constricted ethanol supply in Brazil's 
internal market and have consequently driven up ethanol prices. 
Brazil is at the tail end of the 2005 sugar harvest season and is 
just beginning to process last year's sugar yield.  Thus, domestic 
ethanol supply may pick back up in a few months.  In addition to 
ethanol's higher price, the fuel is also less efficient than 
gasoline.  Although it increases an engine's horsepower by 2 to 5 
horses, ethanol offers fewer miles per gallon than gasoline. 
 
¶11.  ETHANOL'S BREAK-EVEN POINT - The break-even point for choosing 
ethanol over gasoline is 70 percent.  This means that as long as the 
price of ethanol is 70 percent of the price of gasoline at the pump 
or less, it is more economical for consumers to fill-up with 
ethanol.  If the price of ethanol exceeds 70 percent of that of 
gasoline, then gasoline is the better choice.  Ethanol's 70 percent 
benchmark represents a trade-off between price and efficiency.  In 
Sao Paulo, the biggest FlexFuel and ethanol market, the price of 
ethanol is currently 71 percent of that of gasoline, so right now it 
s more cost-effective for FlexFuel car owners to buy gasoline.  If 
the price of ethanol remains over 70 percent for a long period of 
time, this may suppress demand for FlexFuel cars. 
 
 
SAO PAULO 00000352  004 OF 004 
 
 
¶12.  A SILVER LINING - Overall, GMB believes that the spike in 
ethanol prices can be positive, because it shows the consumer the 
flexibility of FlexFuel technology.  There is no loss to consumers 
if the price of ethanol spikes - they can simply switch to gasoline. 
 GMB hopes this will go a long way towards restoring consumer 
confidence in alternative fuels, a confidence that has been lagging 
since the ethanol spike of the late 1980s. 
 
------- 
COMMENT 
------- 
 
¶13. Brazil's successful ethanol fuel model has generated great 
interest in the United States and throughout the world.  FlexFuel 
technology appears to have solved the problem of gasoline price 
fluctuations.  The main constraints to even greater internal use and 
exports are problems in expanding the supply of ethanol quickly 
enough.  End Comment. 
 
¶14. This cable was coordinated/cleared with Embassy Brasilia and 
with Senator Grassley's office. 
 
MCMULLEN