Big Bottleneck: A Weak Transportation Network Is Hurting Brazil’s Once-hot Economy

On the highway that leads to Brazil’s Port of Santos,Latin America’s largest port, a line of trucks sits on the shoulder. The motorists set up lawn chairs at the side of the road, re-entering their trucks every few hours to inch forward in the line. They may spend a week or more waiting to unload their cargo in the port. In April 2013, Bloomberg reported that this line of trucks, most of which were carrying Brazil’s record soybean crop, quadrupled from its normal length of around five miles to more than 20 miles.

Meanwhile, just off the coast, more than 200 vessels waited to dock and load the cargoes. The ships would wait an average of 39 days to dock, at an estimated cost of US$30,000 per day. The soybean harvest begins in January and export shipments are usually completed by May, but 2013’s shipments were extended to July. With the containers now full and a lack of sufficient grain silos for the overflow, Brazilian farmers have been forced to leave soybeans to rot in the fields.

Over the past decade,Brazil has established itself as an economic powerhouse, though not without problems and limitations. The country emerged relatively unscathed from the financial crisis of 2008 and has experienced significant growth in recent years, including GDP growth of 7.2% in 2010. Some observers believed that sustained growth would naturally result from Brazil’s banking and energy sectors and from increased buying power among the country’s emerging middle class. Others believed that Internet access and the increased adoption of modern technology would create the conditions for continued economic growth.

The single most important factor behind Brazil’s growth pattern, however, has been the price of commodities. Since 2008, GDP growth has shown a high correlation with the Goldman Sachs Commodities Index. Exports of Brazil’s six most important commodities — iron, oil, soy, beef, sugar, and coffee -– have increased by 180% since 2007, from 28% to 44% of exports on a value basis. More than 47% of Brazil’s exports are raw materials, as opposed to manufactured goods. Much of this growth has been related to the increased demand for commodities in China.

As global growth slowed in 2012, so did the once-hot Brazilian economy, demonstrating the importance of commodity exports to the country’s health. The commodities boom also exposed a key bottleneck in Brazil’s economy, namely, the deficiencies of the current logistics infrastructure. Increased production has stressed the insufficient transportation network, particularly in Brazil’s critical port system, which handles 95% of foreign commerce. Southeastern ports are running at near 100% capacity, while ports in the rest of the country are expected to be saturated by 2016.

The challenge is no longer how to increase production, but how to export what is being produced.

Brazil remains in a strong position to benefit from the continued growth in worldwide demand for commodities. Rail-infrastructure projects in the rural center of the country have the potential to open millions of hectares of new farmland and significantly increase the production of soybean, corn, and sugar. The challenge is no longer how to increase production, but how to export what is being produced. To take full advantage of this enormous opportunity and to remain a world leader in commodity exports,Brazil must resolve the bottlenecks that are hampering exports, which seems to be an impossible task without expanding port capacity.

Brazil’s historically essential coffee and sugar trade, as well as investment in the port system at the turn of the twentieth century, allowed the Port of Santos to become the busiest in South America. Investment continued through the 1970s and early 1980s and modernized the port for the containerization movement. Brazil had enjoyed a public infrastructure investment rate of nearly 2% of GDP through the late 1970s. But a string of economic crises — namely, hyperinflation, the Asian financial crisis of 1997, and the Russian and Argentinian defaults in 1998 and 2000 — all negatively impacted dollar flows into Brazil and led to underinvestment in public-infrastructure projects. Through the 1990s, public-infrastructure investment rarely exceeded 0.2% of GDP. Currently,Brazil sits in the bottom third in the global rankings for competitiveness in road, rail, and port infrastructure.

Private investment has lagged as well. In 1993,Brazil ended the state-controlled Portobras system and turned port operations over to private corporations. The concessions system that was implemented instead allowed companies to bid on projects to construct and operate port terminals. Ports that operated on this system were subject to heavy regulation and labor restrictions. Private ports, owned mostly by large-commodity producers, were legally barred from handling third-party cargo, which led to years of private underinvestment. While the concessions system improved the situation after the Portobras era, distorted incentives led to underinvestment, high labor costs, political entrenchment, and corruption.

Current Port Infrastructure Problems

According to Antonio Carlos Duarte Sepulveda, CEO of the major logistics firm Santos Brasil, “lack of access is the principle bottleneck to the [Santos] port. The majority of cargo arrives via truck, which is a strategic error. Brazilian logistics are turned upside down.” A poll by the National Transport Confederation (CNT) reported that 61.3% of respondents found road access to the ports inadequate. Poor road infrastructure and single entry points force trucks to wait for days to enter the area, creating a huge bottleneck even before the cargo reaches the port. Railroad access suffers from a different issue: reach. Brazil’s rail infrastructure does not extend to much of the country’s rural interior. Where it does exist — mainly from São Paulo to Santos — freight trains compete with passenger trains, creating congestion between the two busy cities.

The delays continue when the goods arrive at the ports. Between 1997 and 2007, export cargo tripled while the Brazilian government spent less than R$3 billion (US$1.29 billion) on port infrastructure investment. The World Economic Forum now ranks Brazil’s port infrastructure 135th among 144 worldwide. According to the American Association of Port Authorities, of the 40 operational ports in Brazil, the top five shipped more than 45% of all tonnage in 2012. Containerized exports are even more concentrated, according to the Brazilian Ministry of External Relations, with almost 36% of all containers leaving Brazil through a single port (Port of Santos) in 2012. The current wait time for a ship to dock and be loaded with cargo at the Port of Santos is 35 days, and wait times at the Port of Paranaguá average 55 days.

These delays have already proven costly. For example, a Chinese soy operator recently cancelled a two-million-ton order due to the shipping delays. While many delays are due to expanded production and lack of capacity, much of the bottleneck is due to the red tape created by the port bureaucracy. To move cargo, one must deal with 16 different government agencies. The result is an exorbitant cost of doing business. Brazil’s port costs for containers ran 81% and 166% above those of Northern European and Asian ports, respectively, according to Morgan Stanley.

The Future of Brazil’s Port System

Brazil has recognized the need to increase investment in the national port infrastructure. Legislation earlier in 2013 has changed the regulatory framework and has expanded the possibility of private investment in the ports. Three aspects of this new legislation, in particular, open the possibility for quickly expanding port capacity and relieving the pressure Brazil’s ports currently face — third-party cargo, the National Dredging Program (PND), and improved concessions legislation.

One of the most important aspects of the new legislation is the change in how private ports deal with third-party cargo. Previous legislation heavily restricted the amount and type of additional cargo a private port owner could handle in addition to its own. Under the new law, private ports can now ship cargo from other companies and can ship types of goods other than their own. An analysis by Credit Suisse determined that this aspect was the most significant piece of the new legislation.

In addition, private ports are no longer subject to the same onerous labor regulations as public ports. According to Sepulveda, due to the difficult regulations involved in hiring public port workers, the ports experience “an exceptional loss of productivity when the best employees are not actually able to be selected to work on a project.” The possible gains in productivity realized by expanding the private port system represent possible cost savings of up to 25%-30%, according to Credit Suisse.

The current lack of capacity in Brazil’s port system begins even before the freight enters the port.

Brazil has also made a significant investment in dredging its ports. Because of their geography, their age, and a worldwide trend toward larger ships, the ports are shallow and restrict the containerized capacity of vessels that can dock at many of them to 3,000-4,000 twenty-foot equivalent units (TEUs). Brazil has invested R$3.8 billion (US$1.63 billion) to increase the depth of the ports. Even though dredging is a major undertaking, increasing the depth to at least 14.5 meters will allow more modern ships with capacity as great as 8,000 TEUs to enter many more ports.

Finally, the new port legislation addresses the concessions system. The government plans to send to auction again many of the previously held concessions. Winners will be chosen based on a combination of the highest bid, the lowest tariff, and the greatest expected productivity. This will allow new players to enter the market and force the old guard to improve processes and become more competitive. The Port of Santos, for example, expects productivity to increase by 30% under the new system.

Brazil also has the opportunity to reduce dependence on the ports in the southeastern region of the country, especially as agricultural production continues to migrate northward. The Brazilian Soybean Producers Association estimates that transport costs would fall by at least 18% for soybeans trucked via BR-163, a new highway being constructed from Mato Grosso to Santarem, even as the project has run into significant construction delays. This route would allow transporters to leverage the Amazon River port system, as shipping distance from Mato Grosso to Santarem is similar to current routes. According to one shipping expert, changes in the Panama Canal’s pricing system for bulk cargo will allow Brazil to leverage the northeastern ports to ship through the canal and cut shipping times to China.

These recent legislative steps show that Brazilian authorities understand and are attempting to address the insufficiency of Brazil’s port infrastructure. As a result of recent public protests, however, the federal government is feeling pressure to increase spending in education, healthcare, and welfare programs. As the government attempts to allocate resources, will it invest enough in infrastructure to meet future rising demand? Credit Suisse estimates that the recent spending packages that raise infrastructure spending to 1% of GDP will address only 20% of Brazil’s infrastructure needs, the vast majority of which will be invested in road and rail expansion. This expansion will open enormous swaths of farmland in the central-west region of the country, further increasing production and putting even greater pressure on the port system.

Despite the recent downturn, the foundations of the economy leave Brazil in a position for excellent growth over the short and long term. The country’s potential to sustain significant GDP growth and remain a major supplier of commodities to the world depends on its logistics infrastructure to transport efficiently the recent increases in production. The significant investments required for these projects will require corporations, investors, and politicians to come together to find intelligent private and public investments to develop the robust and efficient logistics system necessary to carry Brazil through the next phase of growth.

This article was written by Daniel Azoulai, Henry Dunlop, and Brian Kuettel, members of the Lauder Class of 2015.

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