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### Viewing cable 06SAOPAULO352, VISIT OF CODEL GRASSLEY TO SAO PAULO: ETHANOL AND

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
06SAOPAULO352 | 2006-03-31 17:58 | 2011-07-11 00:00 | UNCLASSIFIED | Consulate Sao Paulo

`

    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

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