A Sweet, Sweet Gambit for Investors

A Sweet, Sweet Gambit for Investors

by Carl Delfeld, Investment U Senior Analyst
Thursday, September 1, 2011: Issue #1591

Keeping a keen eye on politics can lead to profits – both here and abroad.

That’s why I’m keeping one on Washington and the possibility of big changes to the next farm bill. Particularly in terms of how we subsidize ethanol production in this country.

Right now, there is surprising momentum to end or scale back ethanol subsidies. And this would be a big win for American consumers and taxpayers.

But while all of this is happening, I’ve got my other eye on our chief agricultural rival, Brazil. While the end of our subsidies would be a big deal, Brazil is going in the complete opposite direction in an effort to double its ethanol production from sugarcane. (When you hear ethanol, you may think it’s only produced with corn. But in Brazil, they use sugarcane.)

And investors who focus on Brazil could see a sweet return from South American ethanol producers if they know how to play the market. Let’s dig deeper…

Reversal of Fortunes

In June, Sen. Tom Coburn’s (R-OK) efforts to repeal $6 billion in ethanol subsidies and remove a $0.54-per-gallon tariff import tax on the fuel came up short. Nonetheless, political pressure and timing suggests the blank check to corn farmers may soon vanish.

The best news is that if Congress does nothing (their specialty), the subsidies will expire at the end of this year. Sure, special interests will fight hard for a delay. But budgetary pressures loom even larger.

Even Sen. Grassley (R-Iowa) and other farm state lawmakers now support legislation to reduce the tax break without eliminating it for several more years.

The timing could not be better for Brazilian ethanol manufacturers. Brazil is already the largest ethanol exporter in the world, and is second only to the United States in production.

And as the U.S. cuts back, Brazil’s government has recently launched new financing and other tax incentives for sugarcane ethanol manufacturers in hopes to double the country’s national production by 2020.

Brazil’s giant state-run development bank will soon turn on the spigots and unleash about $20 billion to fund expansion in the sugarcane sector through 2014. This is a serious wager, equivalent to about two-thirds of the industry’s annual output.

Where Ethanol Supply Increases Meet Vehicle Demand

There are plenty of vehicles ready to tap into this increased ethanol supply. About 85 percent of all vehicles in the country (it is a surprising 75 percent right now) are projected to be “flex-fuel” by the year 2020. “Flex-fuel” vehicles are able to operate on gasoline, ethanol, or any mixture of the two.

Since 1976, the government has mandated that flex cars in Brazil run on a blend of gasoline and ethanol. Since 2007, the blend has been at 25 percent ethanol and 75 percent gasoline.

As that demand rises, the market should see more and more sugar diverted toward ethanol. In 2010, 54.2 percent of all Brazilian sugarcane went into ethanol production. That figure will rise to 68.5 percent by 2020.

But more sugarcane for ethanol should mean less sugar on world food markets. This can only mean higher sugar prices down the line – and they’re already at a 30-year high.

Two Great Plays in Sugarcane Ethanol

First, take a look at Brazil’s Cosan (NYSE: CZZ). The company produces sugar and ethanol and trades for near book value.

Earlier this year, Shell and Cosan launched a $12 billion biofuels joint venture. The new firm, Raizen, will merge its ethanol, sugar and conventional fuel divisions to become the fifth largest company in Brazil based on revenue.

Another play is Bunge (NYSE: BG), a global agribusiness and food production company. Bunge just announced a $2.5 billion investment to boost its sugar and bio-energy capacity in Brazil through 2016.

The cash will go into eight of the group’s mills and will expand crushing capacity by 50 percent. It will also “be primarily focused on the bio-energy sector, mainly ethanol,” said Adalgiso Telles, Bunge’s director of corporate affairs.

This sugarcane gambit could yield some sweet profits. But be sure to use trailing stops to protect your investment and your profits.

Good investing,

Carl Delfeld