Brazil's sugarcane-ethanol industry has graduated from its fledgling beginnings in the 1970s to one of the biggest economic success stories in the country. The past eight years have been particularly bountiful, thanks not just to burgeoning local demand for so-called "flex-fuel" cars that run on both ethanol and gasoline, which comprise nearly 90% of all new car sales in Brazil, according to local auto manufacturers' association Anfavea. Political willpower has also been important in ensuring growing ethanol demand. So, too, has been the boost from state-owned Petrobrás and other big oil players that have taken a shine to alternative energy. But with recent big oil discoveries and a growing number of doubts about ethanol's advantages over other kinds of fuel, can ethanol keep its appeal?

The new government elected in October under President Dilma Rousseff hopes so. She's likely to continue the favorable policies of her predecessor, Luiz Inácio Lula da Silva, that have helped the sugarcane ethanol industry grow in Brazil — 27.5 billion liters of ethanol were produced in 2009, up from 22.5 billion liters in 2008 and 17.7 billion liters in 2007, while as of mid-November 2010, 22.9 billion liters had been produced, according to according to Unica, the Brazilian sugarcane industry association.

It's now been more than three years since Brazil's ethanol sector really took off internationally. As part of a broader environmental policy overhaul in 2007, U.S. President George W. Bush's Environmental Protection Agency removed methyl tertiary-butyl ether (MTBE) from gasoline and replaced it with ethanol. The policy shift opened up a host of possibilities for Brazilian ethanol simply because of the enormous number of automobiles in the U.S. A lot of American gas stations suddenly needed a lot of ethanol and Brazil seemed like the only place to invest in production outside the U.S.

However, recent events in a booming rival sector — oil — have overshadowed ethanol's growth prospect, potentially making it increasingly difficult for the fuel to vie for politicians' — and investors' — attention. Brazil is now sitting on the world's biggest oil discoveries in decades, including the latest light oil discovery announced in mid-November off the coast of Rio de Janeiro in one of the deep-water Santos Basin wells in which state-owned oil giant Petrobrás has 100% rights.

A lot of that deep-water oil will, of course, be refined into gasoline. So will Brazil's upstream oil discoveries pressure Brazil ethanol downstream? The quick answer is no, experts say. A number of factors — both political and economic — explain why, and suggest that ethanol consumption will continue to grow substantially no matter how much oil lies off the coast of Brazil.

Of Politics and Pump-priming

It's a different story for ethanol in the U.S. The 10% blend in U.S. gasoline, or E10, hasn't changed since it was introduced in 2007. Although the country's Environmental Protection Agency said in August that the blend should be increased to 15%, the oil industry has been against it, citing resulting engine performance on vehicles built before 2001.

Brazil's older vehicles have no choice but to gas up with an ethanol blend of 25% because there is no pure gasoline in the vast majority of Brazilian states. Engines on older cars made by American companies like Ford and General Motors have all been recalibrated to run on blended gasoline. But unlike in Brazil, recalibrating engines on older cars in the U.S. would take a long time simply because of the sheer number of cars — Brazil has around 30 million cars on its roads, of which 60% are 10 years old or older; the U.S. has 250 million cars on the road, with around 40% being 10 years or older.

Brazilian automakers are also embracing ethanol. In 2010, nearly two million flex-fuel vehicles and around half a million conventional engine vehicles were manufactured in Brazil, according to Anfavea. Subsidized lending from government development bank BNDES and tax breaks provide much of the incentives. Flex-fuel automakers pay a 5% industrial production tax, compared with 7% on conventional one-liter engines. Larger engines garner an 11% tax for flex and a 13% tax for conventional engines, according to the government. Then there is taxation at the pump. In most states, gasoline is taxed at a value-added tax rate of around 18%, while ethanol is taxed at 12%.

Brazil's government mandated in 1993 that oil companies that sell gasoline must blend it with 20% to 25% ethanol, depending on the market price of ethanol. The law is not expected to change because of Brazil's sudden oil bonanza. "No politician wants to reverse that," says Ricardo Dornelles, director of renewable fuels at the Ministry of Energy and Mines in Brasilia.

In 2009, Brazilians consumed 22.8 billion liters of ethanol compared with 19.05 billion liters of gasoline, according to the country's National Petroleum Agency (ANP). Between 2000 and 2009, ethanol consumption rose 135%, from 9.7 billion liters to 22.8 billion liters, while gasoline rose 8.8%, from 17.5 billion liters to the 19.05 billion liters.

What's in the Pipeline

Among the players in Brazil's ethanol industry, it's Petrobrás that is often the center of attention. Although oil is the state giant's core business, it is spending nearly US$1 billion to build a 1,200 kilometer (745.6 mile) ethanol pipeline. , in which it will have a 20% stake. Five other companies invested an additional US$2 billion. Groundbreaking started on November 23 on a stretch of land between the towns Riberão Preto and Paulinia, notes Dornelles.

In a way, Petrobrás needs ethanol more than ethanol needs Petrobrás. Since 2009, Brazilian drivers have largely been filling up with 100% ethanol at gas stations instead of the blended gasoline — and with good reason. A liter of gasoline in São Paulo state, the most populous in Brazil, costs US$1.41 — or US$5.20 a gallon — a price that would cause panic in the U.S. Pure ethanol costs US$0.94 a liter, or US$3.4 a gallon.

Even though an ethanol powered car won't travel as far on a full tank of fuel as a gasoline-powered engine, it will get drivers around 70% of the way. A car driving 100 miles on ethanol costs around US$0.80 less per gallon than a car going the same distance on gasoline, according to current pump prices in São Paulo.

Ethanol consumption is good for Petrobrás, maintains Joel Velasco, a lobbyist for Unica in Washington, D.C. Velasco spends much of his time debating with other lobbyists at the Renewable Fuels Association, the U.S. trade association for the fuel ethanol industry, about the advantages of Brazilian sugarcane ethanol, which is said to be cheaper and cleaner than the corn ethanol manufactured in the U.S. He also tries to convince oil companies and Congress that Brazilian sugarcane ethanol would complement, rather than compete against, the corn ethanol market and be much cheaper without the current U.S. tariff– he recently told National Geographic magazine that without import tariffs, the average American could save about US$0.05 per gallon using gasoline blended with sugarcane ethanol.

Counting Blessings

Back in Brazil, there's another reason besides politics why Petrobrás is ethanol friendly. "The ethanol blend is extremely important for Petrobrás, unlike its peers in the U.S.," Velasco notes. "If you reduced the blend, it would make gasoline more expensive compared to pure ethanol and then you'd have customers filling up with 'E100'" — pure ethanol — instead of the blend. That hurts Petrobrás's sales. On the other hand, if ethanol output falls, Petrobrás doesn't have the refining capacity to meet gasoline demand and so it has to import gasoline or oil from Venezuela, costing the company a lot of money. The blend is a blessing for Petrobrás."

On November 18, Paulo Roberto Costa, Petrobrás's supply director, said it has to invest US$78.7 billion over the next four years in its refineries or risk becoming an "enormous" importer of gasoline. Ethanol reduces those import pressures and allows the company to sell gasoline overseas at higher prices, experts say. Petrobrás was forced to import gasoline earlier this year because of higher demand caused by higher ethanol prices. When ethanol prices rise, consumers turn to gasoline since they can travel farther on a full tank of gas.

"Imagine if there was no blend at all, or if it was 'E10' like it is in the U.S. Petrobrás would have a hard time competing and [would] need more gasoline," Velasco notes. As for the future, "when flex-fuel cars become the majority of the car fleet [in Brazil] within a decade and if all you sell is a gasoline blend, you are losing out on a big market of consumers who could — and often do — choose pure ethanol over gas."

In April, Petrobrás bought a 46% stake in Açúcar Guarani, a publicly listed sugar and ethanol company, for US$920 million. It's a start for the oil firm to get a firmer foothold in ethanol production, while helping secure the supply of ethanol for BR, its gas station subsidiary and the largest fuel distributor in Brazil by market share.

International Relations

As Petrobrás dips into ethanol, other oil companies have moved upstream into ethanol production, while sugar companies have moved downstream into gasoline distribution to diversify their fuel markets. For example, sugar and ethanol giant Cosan bought gasoline distributor Esso from ExxonMobil in 2008 for US$826 million. Now, Cosan — the world's largest sugarcane ethanol producer and distributor — accounts for 20% of fuel distribution in Brazil.

Companies like Cosan have helped the ethanol industry attract the interest of big oil. While BP and Royal Dutch Shell might not be enamored with the corn ethanol in the U.S., they are investing in Brazil's sugarcane ethanol. BP is now in the process of buying 50% of Cerradinho, a Brazilian sugar and ethanol group, in a US$466 million deal, adding to the 50% stake in ethanol venture Tropical Bionergia that it bought in 2008. Meanwhile, Shell announced in early 2010 that it is also teaming up with Cosan in a US$12 billion joint venture. If the deal goes ahead as planned, it would make Cosan and Shell the world's biggest ethanol exporter.

Petrobrás might be involved in ethanol because of government demands, but Shell wants to rival the state-owned company's access to ethanol for its gas stations. "While there is still plenty of integration planning to do before we launch the proposed joint venture, this is an important milestone in our effort to create one of the world's most competitive, sustainable biofuels companies," Rubens Ometto Silveira Mello, Cosan's chairman, stated in a press release.

After U.S. gasoline policy changed in 2007, investment in Brazilian sugarcane grew significantly. Goldman Sachs invested US$217 million in ethanol ventures and private investors like AOL co-founder Steve Case createdBrazilian Renewable Energy Company (Brenco), with a former Petrobrás CEO. (Brenco merged this year with ETH Bioenergia, a recent spinoff of privately held Brazilian conglomerate Odebrecht.)

It was a different world in 2007, however. Oil prices were approaching US$120 a barrel with no price declines in sight, and many believed that high gasoline prices in the U.S. and climate change concerns in Japan and Europe would make ethanol a global commodity within a few years. Oil prices have since lost around 40% from their 2008 highs of $145 a barrel and ethanol has yet to become a tradable commodity with a futures market like petroleum. But domestic and foreign capital is still flowing into the sector.

However, Brazil has come under fire for its ethanol program. Two years ago, Bloomberg TV reported on the poor living conditions and underpaid staff within the industry. The companies have responded by slowly moving to eliminate the hand cutting of sugar cane crops. Deforestation is also a concern — Brazil had been heavily criticized for cutting down the Amazon and other forests to grow sugarcane to make ethanol. Less than 5% of Brazil's sugarcane is grown in the Amazon region; the majority is grown in the southeastern and central part of the country, which has been deforested for generations and now faces rigid environmental standards. Amazon deforestation continues, however, mostly due to livestock, lumber and subsistence farming in the region. And critics say there is a domino effect taking place, with burgeoning sugarcane crops forcing other agriculture — mainly livestock — into the Amazon.

And as in other countries, Brazil's ethanol industry has had to address concerns about their crops diverting land and resources from food crops, potentially leading to food shortages and price inflation. Brazil sugar production is rising, albeit not as fast as ethanol — 31 million tons of sugar were produced in 2009 and 30.5 million tons were produced as of mid-November in 2010. Sugar production is based on global supply and demand, so when the world markets demand less sugar, Brazil produces more ethanol, proponents note.

According to Brazil's Energy Ministry, ethanol consumption is expected to hit 37.6 billion liters in 2011, 42.3 billion in 2012 and 47.3 billion in 2013. Exports are forecast to be around 3.9 billion liters next year, rising to 4.9 billion liters in 2012 and 6.1 billion liters in 2013. The sector needs around US$50 billion in new investments by 2015 to meet the country's demand, according to ETH Bionergia.

The government is understandably bullish. After all, such growth is good for consumers — and for employment figures, since in aggregate, the sugar-ethanol sector has expanded job opportunities in cities, port towns and rural towns throughout the country over the last 10 years.

Petrobrás's oil discoveries "are an important resource for Brazil and also very good for the world," notes Dornelles. "But those discoveries will not in any way reduce demand for ethanol or change the new president's policies on ethanol."

Brazil's sugarcane-ethanol industry has graduated from its fledgling beginnings in the 1970s to one of the biggest economic success stories in the country. The past eight years have been particularly bountiful, thanks not just to burgeoning local demand for so-called "flex-fuel" cars that run on both ethanol and gasoline, which comprise nearly 90% of all new car sales in Brazil, according to local auto manufacturers' association Anfavea. Political willpower has also been important in ensuring growing ethanol demand. So, too, has been the boost from state-owned Petrobrás and other big oil players that have taken a shine to alternative energy. But with recent big oil discoveries and a growing number of doubts about ethanol's advantages over other kinds of fuel, can ethanol keep its appeal?

The new government elected in October under President Dilma Rousseff hopes so. She's likely to continue the favorable policies of her predecessor, Luiz Inácio Lula da Silva, that have helped the sugarcane ethanol industry grow in Brazil — 27.5 billion liters of ethanol were produced in 2009, up from 22.5 billion liters in 2008 and 17.7 billion liters in 2007, while as of mid-November 2010, 22.9 billion liters had been produced, according to according to Unica, the Brazilian sugarcane industry association.

It's now been more than three years since Brazil's ethanol sector really took off internationally. As part of a broader environmental policy overhaul in 2007, U.S. President George W. Bush's Environmental Protection Agency removed methyl tertiary-butyl ether (MTBE) from gasoline and replaced it with ethanol. The policy shift opened up a host of possibilities for Brazilian ethanol simply because of the enormous number of automobiles in the U.S. A lot of American gas stations suddenly needed a lot of ethanol and Brazil seemed like the only place to invest in production outside the U.S.

However, recent events in a booming rival sector — oil — have overshadowed ethanol's growth prospect, potentially making it increasingly difficult for the fuel to vie for politicians' — and investors' — attention. Brazil is now sitting on the world's biggest oil discoveries in decades, including the latest light oil discovery announced in mid-November off the coast of Rio de Janeiro in one of the deep-water Santos Basin wells in which state-owned oil giant Petrobrás has 100% rights.

A lot of that deep-water oil will, of course, be refined into gasoline. So will Brazil's upstream oil discoveries pressure Brazil ethanol downstream? The quick answer is no, experts say. A number of factors — both political and economic — explain why, and suggest that ethanol consumption will continue to grow substantially no matter how much oil lies off the coast of Brazil.

Of Politics and Pump-priming

It's a different story for ethanol in the U.S. The 10% blend in U.S. gasoline, or E10, hasn't changed since it was introduced in 2007. Although the country's Environmental Protection Agency said in August that the blend should be increased to 15%, the oil industry has been against it, citing resulting engine performance on vehicles built before 2001.

Brazil's older vehicles have no choice but to gas up with an ethanol blend of 25% because there is no pure gasoline in the vast majority of Brazilian states. Engines on older cars made by American companies like Ford and General Motors have all been recalibrated to run on blended gasoline. But unlike in Brazil, recalibrating engines on older cars in the U.S. would take a long time simply because of the sheer number of cars — Brazil has around 30 million cars on its roads, of which 60% are 10 years old or older; the U.S. has 250 million cars on the road, with around 40% being 10 years or older.

Brazilian automakers are also embracing ethanol. In 2010, nearly two million flex-fuel vehicles and around half a million conventional engine vehicles were manufactured in Brazil, according to Anfavea. Subsidized lending from government development bank BNDES and tax breaks provide much of the incentives. Flex-fuel automakers pay a 5% industrial production tax, compared with 7% on conventional one-liter engines. Larger engines garner an 11% tax for flex and a 13% tax for conventional engines, according to the government. Then there is taxation at the pump. In most states, gasoline is taxed at a value-added tax rate of around 18%, while ethanol is taxed at 12%.

Brazil's government mandated in 1993 that oil companies that sell gasoline must blend it with 20% to 25% ethanol, depending on the market price of ethanol. The law is not expected to change because of Brazil's sudden oil bonanza. "No politician wants to reverse that," says Ricardo Dornelles, director of renewable fuels at the Ministry of Energy and Mines in Brasilia.

In 2009, Brazilians consumed 22.8 billion liters of ethanol compared with 19.05 billion liters of gasoline, according to the country's National Petroleum Agency (ANP). Between 2000 and 2009, ethanol consumption rose 135%, from 9.7 billion liters to 22.8 billion liters, while gasoline rose 8.8%, from 17.5 billion liters to the 19.05 billion liters.

What's in the Pipeline

Among the players in Brazil's ethanol industry, it's Petrobrás that is often the center of attention. Although oil is the state giant's core business, it is spending nearly US$1 billion to build a 1,200 kilometer (745.6 mile) ethanol pipeline. , in which it will have a 20% stake. Five other companies invested an additional US$2 billion. Groundbreaking started on November 23 on a stretch of land between the towns Riberão Preto and Paulinia, notes Dornelles.

In a way, Petrobrás needs ethanol more than ethanol needs Petrobrás. Since 2009, Brazilian drivers have largely been filling up with 100% ethanol at gas stations instead of the blended gasoline — and with good reason. A liter of gasoline in São Paulo state, the most populous in Brazil, costs US$1.41 — or US$5.20 a gallon — a price that would cause panic in the U.S. Pure ethanol costs US$0.94 a liter, or US$3.4 a gallon.

Even though an ethanol powered car won't travel as far on a full tank of fuel as a gasoline-powered engine, it will get drivers around 70% of the way. A car driving 100 miles on ethanol costs around US$0.80 less per gallon than a car going the same distance on gasoline, according to current pump prices in São Paulo.

Ethanol consumption is good for Petrobrás, maintains Joel Velasco, a lobbyist for Unica in Washington, D.C. Velasco spends much of his time debating with other lobbyists at the Renewable Fuels Association, the U.S. trade association for the fuel ethanol industry, about the advantages of Brazilian sugarcane ethanol, which is said to be cheaper and cleaner than the corn ethanol manufactured in the U.S. He also tries to convince oil companies and Congress that Brazilian sugarcane ethanol would complement, rather than compete against, the corn ethanol market and be much cheaper without the current U.S. tariff– he recently told National Geographic magazine that without import tariffs, the average American could save about US$0.05 per gallon using gasoline blended with sugarcane ethanol.

Counting Blessings

Back in Brazil, there's another reason besides politics why Petrobrás is ethanol friendly. "The ethanol blend is extremely important for Petrobrás, unlike its peers in the U.S.," Velasco notes. "If you reduced the blend, it would make gasoline more expensive compared to pure ethanol and then you'd have customers filling up with 'E100'" — pure ethanol — instead of the blend. That hurts Petrobrás's sales. On the other hand, if ethanol output falls, Petrobrás doesn't have the refining capacity to meet gasoline demand and so it has to import gasoline or oil from Venezuela, costing the company a lot of money. The blend is a blessing for Petrobrás."

On November 18, Paulo Roberto Costa, Petrobrás's supply director, said it has to invest US$78.7 billion over the next four years in its refineries or risk becoming an "enormous" importer of gasoline. Ethanol reduces those import pressures and allows the company to sell gasoline overseas at higher prices, experts say. Petrobrás was forced to import gasoline earlier this year because of higher demand caused by higher ethanol prices. When ethanol prices rise, consumers turn to gasoline since they can travel farther on a full tank of gas.

"Imagine if there was no blend at all, or if it was 'E10' like it is in the U.S. Petrobrás would have a hard time competing and [would] need more gasoline," Velasco notes. As for the future, "when flex-fuel cars become the majority of the car fleet [in Brazil] within a decade and if all you sell is a gasoline blend, you are losing out on a big market of consumers who could — and often do — choose pure ethanol over gas."

In April, Petrobrás bought a 46% stake in Açúcar Guarani, a publicly listed sugar and ethanol company, for US$920 million. It's a start for the oil firm to get a firmer foothold in ethanol production, while helping secure the supply of ethanol for BR, its gas station subsidiary and the largest fuel distributor in Brazil by market share.

International Relations

As Petrobrás dips into ethanol, other oil companies have moved upstream into ethanol production, while sugar companies have moved downstream into gasoline distribution to diversify their fuel markets. For example, sugar and ethanol giant Cosan bought gasoline distributor Esso from ExxonMobil in 2008 for US$826 million. Now, Cosan — the world's largest sugarcane ethanol producer and distributor — accounts for 20% of fuel distribution in Brazil.

Companies like Cosan have helped the ethanol industry attract the interest of big oil. While BP and Royal Dutch Shell might not be enamored with the corn ethanol in the U.S., they are investing in Brazil's sugarcane ethanol. BP is now in the process of buying 50% of Cerradinho, a Brazilian sugar and ethanol group, in a US$466 million deal, adding to the 50% stake in ethanol venture Tropical Bionergia that it bought in 2008. Meanwhile, Shell announced in early 2010 that it is also teaming up with Cosan in a US$12 billion joint venture. If the deal goes ahead as planned, it would make Cosan and Shell the world's biggest ethanol exporter.

Petrobrás might be involved in ethanol because of government demands, but Shell wants to rival the state-owned company's access to ethanol for its gas stations. "While there is still plenty of integration planning to do before we launch the proposed joint venture, this is an important milestone in our effort to create one of the world's most competitive, sustainable biofuels companies," Rubens Ometto Silveira Mello, Cosan's chairman, stated in a press release.

After U.S. gasoline policy changed in 2007, investment in Brazilian sugarcane grew significantly. Goldman Sachs invested US$217 million in ethanol ventures and private investors like AOL co-founder Steve Case createdBrazilian Renewable Energy Company (Brenco), with a former Petrobrás CEO. (Brenco merged this year with ETH Bioenergia, a recent spinoff of privately held Brazilian conglomerate Odebrecht.)

It was a different world in 2007, however. Oil prices were approaching US$120 a barrel with no price declines in sight, and many believed that high gasoline prices in the U.S. and climate change concerns in Japan and Europe would make ethanol a global commodity within a few years. Oil prices have since lost around 40% from their 2008 highs of $145 a barrel and ethanol has yet to become a tradable commodity with a futures market like petroleum. But domestic and foreign capital is still flowing into the sector.

However, Brazil has come under fire for its ethanol program. Two years ago, Bloomberg TV reported on the poor living conditions and underpaid staff within the industry. The companies have responded by slowly moving to eliminate the hand cutting of sugar cane crops. Deforestation is also a concern — Brazil had been heavily criticized for cutting down the Amazon and other forests to grow sugarcane to make ethanol. Less than 5% of Brazil's sugarcane is grown in the Amazon region; the majority is grown in the southeastern and central part of the country, which has been deforested for generations and now faces rigid environmental standards. Amazon deforestation continues, however, mostly due to livestock, lumber and subsistence farming in the region. And critics say there is a domino effect taking place, with burgeoning sugarcane crops forcing other agriculture — mainly livestock — into the Amazon.

And as in other countries, Brazil's ethanol industry has had to address concerns about their crops diverting land and resources from food crops, potentially leading to food shortages and price inflation. Brazil sugar production is rising, albeit not as fast as ethanol — 31 million tons of sugar were produced in 2009 and 30.5 million tons were produced as of mid-November in 2010. Sugar production is based on global supply and demand, so when the world markets demand less sugar, Brazil produces more ethanol, proponents note.

According to Brazil's Energy Ministry, ethanol consumption is expected to hit 37.6 billion liters in 2011, 42.3 billion in 2012 and 47.3 billion in 2013. Exports are forecast to be around 3.9 billion liters next year, rising to 4.9 billion liters in 2012 and 6.1 billion liters in 2013. The sector needs around US$50 billion in new investments by 2015 to meet the country's demand, according to ETH Bionergia.

The government is understandably bullish. After all, such growth is good for consumers — and for employment figures, since in aggregate, the sugar-ethanol sector has expanded job opportunities in cities, port towns and rural towns throughout the country over the last 10 years.

Petrobrás's oil discoveries "are an important resource for Brazil and also very good for the world," notes Dornelles. "But those discoveries will not in any way reduce demand for ethanol or change the new president's policies on ethanol."