Why there are no investment opportunities left in the Latin American biofuels sector

Summary: The biofuels industry was at the forefront of renewable energy investment in Latin America. Since then the industry has matured and in some instances stagnated, although two countries have become world class producers.

About the AuthorCarlos St. James is an advisor to energy investors and developers in emerging markets. He co-founded the Argentine Renewable Energies Chamber in 2005; has been a board member of the Latin American & Caribbean Council on Renewable Energy since 2010; founded the Middle East-Americas Energy Council in 2014; and publishes the Latin American Energy Review in his free time. He was recently named Summit Chairman of the upcoming LAC-CORE Finance Summit held at the Ritz Carlton in Miami, Florida this October 3-5.
LAC-CORE Finance Summit
He will also be speaking at the Argentina International Clean Energy Congress in September as well as at the the Chile International Clean Energy Congress Week in mid-October.

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Latin America has a debt of gratitude to the sector that gave birth to the entire renewable energy industry in the region: biofuels, in the form of ethanol and biodiesel. Biofuels were the recipients of the first wave of investment and are the pioneers in the region. This was followed by a second wave focused on wind; the third wave has just begun and is solar-centric. The fourth wave will be smart grids.

Biofuels as a starting point makes sense in Latin America: first generation biofuels use agricultural products as feedstock: distilling sugarcane into ethanol on the one hand, and causing a transesterification of fatty oils such as soy or palm into biodiesel on the other. These were seen as logical new value-added products in the sophisticated and capital rich agro-industrial complex of the region.

But what became of the biofuels industry as a whole? Why does it get so little attention and capital nowadays, when it was all the rage just a decade ago? This is no exaggeration: in 2006 biofuels attracted $28 billion in new investment worldwide, more than a quarter of the $112 billion invested overall in renewables that year. It attracted more than solar (which was still in its expensive European-technology-not-yet-borrowed-by-the-Chinese stage). But last year biofuels attracted a mere $3 billion worldwide, about 1% of global renewables investment. That’s quite a fall.

The answer can give us clues to what might become of other technologies as they mature.

Sugarcane-based ethanol took off like wildfire in Brazil, funded by abundant debt from the country’s development bank (BNDES), supported by the wildly popular President Lula, strong domestic blending mandates, and the country’s decision to attract more foreign investment by pretending it wasn’t really part of Latin America anymore but rather of the way cooler BRIC (Brazil-Russia-India-China) group. Production really took off and exports were high, especially to the United States – until the American corn lobby used its significant power to put a stop to that. Just the same, today Brazil remains the world’s second largest ethanol producer after the U.S.

Just south of this, Argentina was a hot mess. So much so that it couldn’t attract investment of any kind – except for the production of soy oil-based biodiesel. This also made sense: Argentina is a leading producer of soy, has a major export-focused agro-industrial complex and is the world’s largest exporter of soy oil. Why not add more to the value chain and produce biodiesel, too?

Leading Biodiesel Production CountriesArgentina and Brazil quickly became among the world’s largest producers of biodiesel but via different strategies. Brazil focused on supplying its internal market blend requirements while Argentina became the world’s largest exporter, primarily to Europe. The graph above (click on images to enlarge) shows how leading producers have fared. The two largest European producers, Germany and France (who use canola/rapeseed oil as feedstock) quickly maxed out on feedstock: there is only so much you can grow over there. The U.S. has maintained a leading role thanks to strong governmental subsidies.

Argentina was the world’s second largest producer in 2012 but now battles for fourth place with France – a battle it seems destined to win once the South American country ends its multiple legal battles on the biodiesel front. It is likely to end up a consistent third place winner, beating out Germany who cannot grow further.

But are there investment opportunities in biofuels in Latin America?

Biofuels have always been meant to be a cleaner but temporary bridge from fossil fuels to electric vehicles, so the sector’s shelf life was always viewed with trepidation. Because of its enormous agricultural capabilities, Latin America was expected to lead the way with first generation biofuels (where the feedstock caused heated debate regarding land use changes and the food versus fuel debate), then production was expected to transition towards Europe and the U.S. because of the use of more technologically-driven second and third generation solutions (“second generation” is defined as biofuels made with non-food feedstock such as algae; “third generation” would use entirely new processes to make biofuels). Neither second or third generation solutions have achieved commercial scale success anywhere, so Latin America’s prowess with first generation continues.

Latin American Biodiesel ProductionBrazil’s biodiesel industry continues to grow but is unlikely to ever export; it is all for internal consumption. Argentina’s exports have cooled and production is now evenly split between exports and the domestic market (see last graph). Colombia is the third largest market participant, all of it for domestic use but with a drawback: it uses palm oil as biodiesel feedstock, in abundant supply given the local climate, but which has proven to have technical problems and gets producers in hot water over food vs. fuel and rainforest deforestation issues.

Also, the biofuels industry suffers from overcapacity on a global scale. It operates at about 50% capacity (both ethanol and biodiesel), suggesting that more new capacity would not necessarily be a secure investment. But that doesn’t mean that there isn’t opportunity in consolidation.

Mergers & acquisitions have already taken place in Brazil with ethanol, where the industry has been around long enough and is predictable enough that assets have changed hands a few times. Not so with Brazilian biodiesel production, which, while very high, is comprised of many small producers. According to an analysis with 2010 figures (see graph below, in Spanish) the average size production capacity of Brazilian plants was only 70,450 tons/year, which makes them less efficient and hence less appealing as investment vehicles. In short, there are a lot of mom & pop biodiesel plants in Brazil.

Comparative of biodiesel plant sizesArgentina, the other biodiesel power, has a different set of problems. As the graph below shows, the industry was launched as a very successful exporter. Not only are Argentine plants large and efficient (built as add-ons to the agro-industrial complexes sitting on ports), they benefited from a very creative Differential Export Tax scheme that strongly benefitted domestic producers. This caused plenty of conflict with Europe who claimed dumping, and eventually managed to ban Argentine biodiesel (see the drop in exports after 2011, rebounding temporarily after the country found a new market in the U.S.). Significantly, in 2015 the domestic biodiesel mandates surpassed export in production for the first time ever (see blue line). Going forward you can expect both to remain comparable.

Argentine Biodiesel ProductionSo Argentine biodiesel sector has two tiers: the extremely large, hyper efficient plants owned by the agro-industrial companies (i.e., Cargill, Dreyfus, etc.) which export, and the smaller mom & pop plants that focus on the domestic market. M&A activity is unlikely with the large players unless you buy the entire production chain and effectively get into the food production business. The smaller plants also operate at some 50% capacity and are often caught up in working capital problems; there may be opportunities in this segment if you are interested in a local currency business.

The Argentine ethanol industry has had success but is controlled by a few families in the sugarcane business and definitely do not like outsiders.

Overall, biofuels have had their time in the sun and are winding down as investment opportunities — at least on a large scale. For those interested in smaller investments, in addition to the three countries mentioned above, Central America and Peru have also had some success with biofuels (typically biodiesel, which can be smaller in scale and are simpler investments).

But either way, we owe a big tip of the hat to those early biofuels investors and those government mandates for opening doors.

 

© Latin American Energy Review 2016

About the Author: Carlos St. James is the Managing Director of Santiago & Sinclair, LLC, a financial advisory firm focused on renewables in emerging markets. Carlos co-founded the Argentine Renewable Energies Chamber (CADER, by its initials in Spanish) and was its first President until 2011; is a board member and was elected the first President of the Latin American & Caribbean Council on Renewable Energy (LAC-CORE); is the founder and chairman of the Middle East-Americas Energy Council (MEAMEC); and founder and publisher of The Latin American Energy Review. His private sector background is focused primarily on finance and bringing together stakeholders so that deals get done. He advises governments on renewable energy policy, counsels private equity firms seeking to enter the region; and brings together stakeholders, including investors, for new energy projects.

He obtained his undergraduate degree in international economics from DePaul University and his masters in international relations from the Fletcher School at Tufts University.

 

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