Citing Shrinking Margins, ADM Ships Off for Brazil

Archer Daniels Midland will begin work on sugarcane ethanol production in Brazil, a company spokesman said this week. The world’s largest grain producer cited margin compressing corn prices and construction costs as the main driver, though the slowly shifting U.S. policy climate has given a number of the major ethanol players reason to look elsewhere. An unconfirmed report has ADM taking stakes in two joint ventures to open mills capable of crushing 3 million to 4 millions tons of sugarcane annually.

Though ADM has looked for years to enter the Brazilian market, the collapse of the company’s fundamentals in the U.S. are likely the primary driver. That and the growing demand for Brazilian ethanol in the U.S. ADM posted extremely disappointing earnings this quarter. The company’s earnings fell 61 percent year-over-year from $954.8 million in 2007 to $372 million in the fourth quarter. The profit loss on top of a 78 percent jump in revenues points to some severe margin compression. ADM probably had an easier time selling off its raw goods while watching markets for its finished goods - ethanol, for example - shrivel up and blow away like so many corn husks on a late fall evening.

The same high corn prices ADM benefited from on one side of its business caused another side of its business to take a pretty bad shellacking. ADM VP John Rice said that as corn prices went through the roof, “the cost to build plans these days - with stainless steel, labour costs and everything else - is going up. [Producers] don’t see the margins out there right now and finding capital is also very tough.” Also, aside from increasing blending requirements, when’s the last time you bought ethanol outright? Anyone?

The growing success of Cosan, Brazil’s largest ethanol company, may provide a key to understanding ADM’s move. Ethanol exports are moving upwards for Brazilian producers. Cosan, for example, believes exports will account for 25 percent of its output in 2008 and 2009, compared with around 20 percent in 2006 and 2007. For the industry generally, exports will be up in this period to 5 billion liters from 3.1 billion liters in the previous period. High sugar prices trumped up by some textbook import protection for American ‘producers’ has driven more sugarcane into ethanol production. That, combined with a record harvest this, year has sent sugarcane ethanol prices down compared with ethanol produced in the U.S. Some analysts now believe Brazilian producers will be able to sell profitably into the U.S. market this year despite the $0.54 per gallon tariff.

But what if you could produce in Brazil at those lower costs without having to worry about the tariff at all? As part of the Caribbean Basin Initiative trade agreement, producers in that region are exempt from the tariff. Cosan, a subsidiary of a Bermuda-registered company, has signed a number of partnership agreements with Caribbean companies to ship them hydrate ethanol to have processed into anhydrous ethanol for shipment into the U.S Though this sounds a little like the pump-and-dump scheme European biodiesel producers were screaming bloody murder about a few months ago, the fact that Brazilian producers are doing this to thwart a tariff and not take advantage of a subsidy is, in my book, completely redeeming. ADM, which I imagine has a far more extensive network of agriculture processing plants, may be looking to produce in Brazil so it can follow a similar scheme.