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### Viewing cable 08SAOPAULO423, DOHA, ETHANOL, AND THE WTO: WILL BRAZIL FIGHT?

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
08SAOPAULO423 | 2008-08-04 08:08 | 2011-01-12 00:12 | UNCLASSIFIED//FOR OFFICIAL USE ONLY | Consulate Sao Paulo

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    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

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    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.

    Story

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