VZCZCXRO6406
RR RUEHRG
DE RUEHSO #0423/01 2170833
ZNR UUUUU ZZH
R 040833Z AUG 08
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 8439
INFO RUEHBR/AMEMBASSY BRASILIA 9579
RUEHRG/AMCONSUL RECIFE 4165
RUEHRI/AMCONSUL RIO DE JANEIRO 8804
RUEHBU/AMEMBASSY BUENOS AIRES 3225
RUEHAC/AMEMBASSY ASUNCION 3472
RUEHMN/AMEMBASSY MONTEVIDEO 2750
RUEHSG/AMEMBASSY SANTIAGO 2472
RUEHLP/AMEMBASSY LA PAZ 3884
RUCPDOC/USDOC WASHDC 3139
RUEATRS/DEPT OF TREASURY WASHDC
RHMFIUU/DEPT OF ENERGY WASHDC
RUEHRC/USDA FAS WASHDC 0738
RHEHNSC/NATIONAL SECURITY COUNCIL WASHDC

UNCLAS SECTION 01 OF 03 SAO PAULO 000423 
 
SIPDIS 
SENSITIVE 
 
STATE FOR WHA/BSC, WHA/EPSC FOR FCORNEILLE, E FOR GMANUEL, 
EEB/ESC/IEC FOR BHAENDLER 
STATE PASS USTR FOR KDUCKWORTH 
STATE PASS DOE/NREL FOR HCHUM 
DEPT OF TREASURY FOR JHOEK, BONEILL 
DEPT OF ENERGY FOR AMIRANDA, GWARD, CGILLESPIE 
 
E.O. 12958: N/A 
TAGS: ETRD ENRG EAGR ECON EINV TRGY BR
SUBJECT: DOHA, ETHANOL, AND THE WTO: WILL BRAZIL FIGHT? 
 
SAO PAULO 00000423  001.5 OF 003 
 
 
SENSITIVE BUT UNCLASSIFIED--PLEASE PROTECT ACCORDINGLY 
 
Summary 
------- 
 
¶1.  (SBU) The collapse of the DOHA round WTO negotiations brings 
with it a call to continue fighting US agriculture subsidies 
directly through the WTO.  In particular, the Brazilian Foreign 
Ministry (Itamaraty) may choose this fall to initiate a WTO case 
against the US tariff on ethanol imports from Brazil.  MRE U/S 
Roberto Azevedo has said publicly that a case this September is a 
strong possibility.  Such a move may be attractive politically, and 
certainly ethanol producers represented by UNICA stand to reap a 
significant profit were the tariff removed.  However, the rapid 
growth of ethanol demand in the United States and the significant 
disparity between Brazilian and U.S. prices could lead to an 
increase in ethanol exports and potentially increase local prices 
thus feeding into Brazilian inflation concerns.  Removing the tariff 
could result in an immediate squeeze in domestic supply.  Increased 
exports would have to be sourced from ethanol that would otherwise 
be sold as E-100.  So while Foreign Minister Celso Amorim publicly 
calls for removal of these tariffs, many in the private sector are 
not as enthusiastic for an immediate tariff removal and key 
legislators are hesitant as well.  End Summary. 
 
Ethanol Supply, Demand, Consumption 
----------------------------------- 
 
¶2.  (SBU) The Agricultural Trade Office (ATO) in Sao Paulo expects 
continued strong growth in Brazil's ethanol production for the 
coming two to three years, as well as continued strong demand growth 
for ethanol by Brazilian consumers.  Ethanol supply and demand 
expectations for Market Year (MY) 2008/9 are that total supply will 
increase to 26,357 billion liters and domestic demand increasing to 
22,452 billion liters.  (Note:  MY 07/8 figures are 22,255.5 and 
18,970 respectively.  End Note.)  Exports are forecast to reach 
4,800 billion liters, the majority of which will find its way to the 
United States, and an increase over the 3,630 billion liters for 
export from MY 07/8.  (Note:  It should be noted that the export 
forecast was recently increased from 3.9 billion liters after a 
run-up in corn futures prices made Brazilian ethanol exports 
profitable even with the US$0.54/gallon import duty paid.  End 
Note.) 
 
¶3.  (SBU) Higher domestic demand for ethanol during MY 08/9 is in 
large part due to the vigorous sales of flex-fuel vehicles.  The 
Brazilian Association of Vehicle Manufacturers (ANFAVEA) reports 
that flex fuel vehicles represent some 23 percent of the total 
vehicle fleet of Brazil (5.43 million units out of 23.685 units in 
2007), but more importantly represent over 90% of new car sales. 
The result of this has been a fundamental change in the energy 
matrix of Brazil.  Since February of this year ethanol has accounted 
for a higher share of vehicle fuels use than gasoline.  Two years 
ago, gasoline sales were roughly twice the volume of ethanol use. 
 
¶4.  (SBU) Ethanol is sold as a gasoline additive (at a required rate 
of 25%), sold pure as E-100, and exported.  Approximately 18% of 
total production will be exported in 2008/09, leaving 82% for 
blending and direct sales as E-100.  ATO estimates that 
approximately 33-37% of total production will be blended with 
gasoline (representing 25% of the volume of "gasoline" in Brazil) 
and 45-49% of production will be sold as E-100.  As efficiencies for 
ethanol generally run at 70% that of gasoline, the price point at 
which consumers choose one over the other is fairly well 
established.  The state of Sao Paulo is the largest ethanol 
consuming state and home to the largest producers of ethanol.  In 
addition, in Sao Paulo the industry enjoys low transportation costs 
and significant tax incentives from the state government. 
Nonetheless, the industry must discount ethanol in order to 
stimulate demand in outlying states where tax treatment is not as 
generous, and the retail price for ethanol in Sao Paulo is currently 
some 40-45% the cost of gasoline.  Rational consumers should 
 
SAO PAULO 00000423  002.3 OF 003 
 
 
continue to buy ethanol over gasoline even if the price were to 
increase close to 70% the value of gasoline. 
 
Goodbye Tariff, Hello Shortage? 
------------------------------- 
 
¶5.  (SBU) Removing the tariff could result in an immediate squeeze 
in domestic supply.  While the GOB mandate for blending with 
gasoline (currently 25% by volume) could easily be reduced in a 
tight market environment, increases in E-100 prices would inevitably 
stimulate increased gasoline consumption and demand for ethanol for 
blending would rise in response.  ATO Sao Paulo therefore believes 
that volumes of ethanol destined for blending would be unlikely to 
change substantially.  Increased exports would have to be sourced 
from ethanol that would otherwise be sold as E-100. If those volumes 
were sufficient to allow domestic producers to concentrate on core 
markets (especially Sao Paulo), prices would rise toward the market 
clearing rate for a more concentrated market characterized by more 
favorable tax rates and low transport and handling costs.  If retail 
prices were to approach 70% of the gasoline price in the Sao Paulo 
market, this would imply an increase on the order of fifty percent 
in prevailing ethanol prices, possibly fueling inflation concerns. 
This scenario would almost certainly unfold in the event that export 
volumes were to double (to 30% of the total production). 
 
¶6.  (SBU) These potential market distortions have many in the Brazil 
ethanol industry viewing either a gradual tariff reduction or a move 
towards a quota system as preferable.  Either move would allow for 
Brazilian ethanol production to increase over time to supply the US 
demand while minimizing disruptions in the domestic market.  Former 
Director General of UNICA (association that represents the majority 
of sugar growers and ethanol distillers in Brazil), Fernando 
Ribeiro, stated that he sees the US ethanol mandate as well as 
demand by ethanol buyers, distributors, and end-users in the US as 
eventually leading to either a tariff reduction or institution of a 
quota system in the near term.  While a quota would allow better 
control over export volumes, Ribeiro believes that a gradual tariff 
reduction would be better as it would continue to help promote 
growth of ethanol production in third countries.  He also stated 
that he believes the GOB would take "aggressive" steps to control 
export volumes if there were a real threat to supply for the 
domestic market. 
 
¶7.  (SBU) Roberto Giannetti de Fonseca of FIESP (Federation of 
Industries of Sao Paulo) told Econoff that he would prefer to see a 
two-tiered system of tariffs on ethanol exports to the US with 
ethanol for blending staying in a tariff regime and E-100 for US 
flex fuel vehicles imported duty free.  He stated that a movement 
towards a completely open trading regime would cause short-term 
distortions in the domestic market; however, he emphasized that in 
the medium to long-term, Brazil would be able to take advantage of 
this opportunity to supply the US demand. 
 
¶8.  (SBU) Dra. Heloisa Lee Burnquist, Researcher at the Center for 
Advanced Studies on Applied Economics (CEPEA) of the University of 
Sao Paulo stated that Foreign Minister Amorim's statement on seeking 
redress at the WTO count to eliminate countervailing  duties in the 
U.S. on Brazil's ethanol export appeared "more political than 
anything else."  She agreed that in the absence of a tariff, 
producers would welcome the ability to sell abroad at higher prices. 
 However, she does not see the same possibility for distortions in 
domestic supply that others have indicated. 
 
¶9.  (SBU) Chairman of the Senate Biofuels Committee Chairman Joao 
Tenorio has a different concern.  Tenario told Brasilia Econoff he 
worries that if the tariff were removed, the Brazilian biofuels 
industry would ramp up production.  But without the tariff in place 
protecting the U.S. domestic industry, Tenario worries that U.S. 
reliance on ethanol as a fuel will never reach its real potential, 
resulting in backsliding of ethanol use.  Such a development in his 
view could leave an over-stimulated Brazilian industry with nowhere 
to turn for a viable market to absorb its product. 
 
SAO PAULO 00000423  003.3 OF 003 
 
 
 
¶10.  (SBU) COMMENT:  On the surface, pursuing a WTO case on the 
ethanol tariff may be a logical plan B approach to lack of 
resolution through the Doha Round.  In analyzing existing stocks of 
ethanol, future production in the short-term, the volume of US 
demand, and the key role that ethanol plays in the Brazilian fuels 
matrix, a complete removal of the tariff would likely cause 
disruption to the Brazilian economy.  In order to counteract this 
threat, the GOB may be forced to act itself in placing a quota on 
exports of ethanol to the US in order to maintain domestic supply. 
While this should give the GOB pause in pursuing a WTO case against 
the ethanol tariff, politics may win over economics.  UNICA will 
likely foot the bill for any GOB attempt to seek redress at the WTO 
as its members stand to gain immediately from any reduction in the 
ethanol tariff; however this too remains unresolved as we understand 
industry is pressing for GOB to cover part of litigation costs, 
estimated at three million dollars.  END COMMENT. 
 
¶11.  This cable was coordinated with and cleared by the Embassy in 
Brasilia and the ATO in Sao Paulo. 
 
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