Entering Tariff-Free

With ethanol production on the rise worldwide, and increasing international pressure to eliminate trade barriers, how much imported ethanol will enter the United States in the years ahead?
By Tom Bryan | January 01, 2004
As U.S. ethanol production capacity tops 3 billion gallons per year, the industry is faced with what could be described as a paradox of rising proportions.

That is, America's door to tariff-free ethanol imports is opening a little wider with each new gallon of ethanol produced, sold and consumed domestically. In fact, every 40-mmgy ethanol plant that breaks ground in the Midwest opens a window for 2.8 million gallons of imported ethanol to enter U.S. borders through the Caribbean Basin Initiative (CBI).

It's ironic, but true. And the CBI isn't the only trade policy U.S. ethanol producers—and more importantly future ethanol producers—are keeping an eye on.

CBI imports alone could someday meet half of California's annual market demand, while the Central American Free Trade Agreement (CAFTA) brings international validity to U.S. pacts with Honduras, Nicaragua, El Salvador and Guatemala—all potential ethanol producers. The North American Free Trade Agreement (NAFTA) welcomes tariff-free ethanol imports from Canada and Mexico and the embattled Free Trade Agreement of the Americas (FTAA) proposal even threatens to remove trade barriers with Brazil someday.

There's no need to sound the alarms just yet, though.

CBI imports accounted for nearly every drop of ethanol imported into the United States last year but struggled to deliver just 65 million gallons, 70 percent of which went to California. At current volumes, CBI imports are not raising a stir with U.S. producers.

"To my knowledge, the volume brought into the United States right now is not large enough to ruffle anyone's feathers," one trade analyst told EPM, putting the situation into perspective. "Ten years from now, when the CBI's cap is 350 million gallons [per year], we might be discussing a completely different story."

Furthermore, the same trade analyst said, the proportionality of CBI imports in comparison to U.S. consumption will stay relatively fixed over time. The CBI currently allows member nations to match 7 percent of U.S. consumption (based on figures from the previous year).

"As long as the percentage is fixed at 7 percent, there's not much to worry about," he said. "In addition, there have been proponents at the state level, California specifically, who have argued that replacing MTBE with ethanol might lead to fuel shortages and price spikes. If anything, more CBI imports would help alleviate that situation and make it harder for opponents to raise complaints about supply uncertainties."

In all, 27 nations, including Jamaica, Costa Rica, El Salvador, Ecuador and Bolivia, make up the CBI region. The agreement allows ethanol into the United States free of the established 54-cent-per-gallon U.S. tariff normally levied on the alternative fuel.

The CBI, and its later incarnation as the Caribbean Basin Economic Recovery Act (CBERA), is a Regan-era program that promotes the economic development of the region by providing tariff exemptions on custom duties for hundreds of products, including ethanol. The agreement, which originally went into effect in 1984, had a planned duration of 12 years. It was later modified through the CBI II in 1990, solidifying the original agreement for another decade. The United States renewed its commitment to the policy in 2000.

CBI ethanol production primarily relies on hydrous ethanol from Brazil and surplus wine alcohol from France, Italy, Spain and other Mediterranean countries.

"It's an unpredictable business of extremely tight margins," said one company president with ties to Caribbean ethanol plants.

Both Brazilian ethanol and European wine alcohol are susceptible to a variety of factors, including falloff in availability, price fluctuations, trade regulations, currency movements and freight rates. These factors make CBI ethanol production viable only when U.S. prices rise above $1.25 per gallon.

Making matters more difficult for CBI producers, the availability of European surplus wine alcohol has diminished since the World Trade Organization (WTO) placed limitations on export subsidies that it considers "trade distorting," a U.S. trade official told EPM. Furthermore, Europe's wine alcohol surpluses are—and this is apparently is debatable—"shrinking" and have found new markets in Spain and Sweden (where it is reportedly used to fuel a small fleet of busses).

During the 1980s excessive production left European countries with what international observers called "wine lakes." Eventually, millions of gallons of wine alcohol found its way across the Atlantic to ethanol conversion plants in the Caribbean. The rest, as they say, is history.

Hydrous ethanol generally accepted as feedstock
EPM was unable to trace the origin of the U.S. government's acceptance of hydrous ethanol, which contains 5 percent water, as a CBI-qualifying feedstock for ethanol production. The rules of origin state that CBI products must originate in the Caribbean or undergo "substantial transformation" from one major tariff line to another, an EPM source said.

The inclusion of hydrous ethanol has long been a subject of debate.

"The debate over what is and what is not 'substantial transformation' goes back 20 years," said the company president EPM spoke to. "U.S. producers argued that removing water from hydrous ethanol did not meet CBI criteria. Caribbean producers argued that it did. Eventually, a settlement was reached, which left us with the policies in place today."

Full-fermentation producers can maximize CBI imports
In addition to the volume of CBI ethanol allowed to be imported into the United States via "substantial transformation" of European and Brazilian feedstock, the CBI allows for higher levels of "full fermentation" process ethanol derived from indigenous feedstock. This market would perhaps be spurred by very low molasses or sugar prices, according to an EPM source associated with a Jamaican ethanol plant.

Most analysts believe there is sufficient land available for sugar cane production in some CBI nations but insufficient economic potential to spur sugar cane planting for ethanol production. Reportedly, Guatemala, Nicaragua and the Dominican Republic have the potential to support indigenous production but have not done so.

In fact, there is considerable room for growth under the "indigenous production" definition of the CBI, which places no U.S. import cap on ethanol made from indigenous Caribbean feedstock, according to an October 2003 California Energy Commission (CEC) report entitled, "Ethanol Supply Outlook for California."

"While there appears to be only very limited plans for indigenous production. . . at present, the potential is being evaluated in a number of [CBI] countries and is. . . substantial," the report stated.

This year, with no indigenous Caribbean production facilities on line and only one expansion project complete, the CEC expects about 100 mmgy to be imported under the CBI, with just 50 mmgy destined for the vast 900-mmgy California market. However, plans for new or revived full-fermentation ethanol plants in Panama, Costa Rica and Trinidad-Tobago could double CBI imports in the years ahead, according to the CEC report.

Four CBI producers
There are, according to the CEC, four active CBI ethanol rectification/dehydration facilities, including two in Jamaica, one in Costa Rica and one in El Salvador. Interestingly, the CEC concluded, the limiting factor of CBI ethanol imports to California is low production capacity.

In Jamaica, Petrojam Ethanol Ltd., in some relationship with ED&F Man, operates a 20-mmgy dehydration plant, exporting fuel ethanol to the United States under CBI provisions. ED&F Man also operates its own 20-mmgy ethanol plant on the island, according to industry documents. In Costa Rica, a company called LAICA operates a 20-mmgy ethanol plant, and in El Salvador, another company (unable to be identified for this report) reportedly runs a 10-mmgy facility.

Ethanol was produced for export by Petrojam for the first time in 1985 but, according to Petrojam's Web site, the first CBI ethanol plant was established in the early 1980s by U.S.-based Tropicana. Representing an investment of about $23 million, the plant was easily the largest investment that had entered Jamaica or the Caribbean under the CBI until as late as 1987.

From what EPM was able to ascertain, Petrojam's operations have historically consisted of procuring low-cost wine alcohol feedstock from France, Spain, Italy, Portugal and Greece. Feedstock purchases have also been made from India and Brazil, according to online company statements.

The rectification of the alcohol—removing waste components including solids, methanol and higher alcohols—is the first production step for most CBI producers. One technology provider described wine alcohol from Europe as a "nasty feedstock—bottom of the barrel stuff—that requires sophisticated separation technologies."

Dehydration in Jamaica (formerly accomplished by azeotropic distillation, and more recently by the more advanced and environmentally-friendly molecular sieve technology), along with denaturing, completes the process and prepares the product for export to the United States.

U.S. regulations require CBI ethanol to be marketed through a U.S. agent. In the case of Petrojam, marketing was done previously through International Alcohols Limited (IAL), then through ED&F Man, and more recently through Moloco Inc., for sales to Murex Inc. in the United States, according to Petrojam's online company records.

CBI's potential for growth
Acknowledging that the state's fuel supply has included ethanol deliveries via marine tankers from the Caribbean, on an irregular basis for several decades, the CEC report stated, "Shipments of imported ethanol are contributing to the state's ethanol supply, and there are increasing prospects for foreign sources of supply to the state in the future."

Worldwide, most ethanol is consumed inside the nations that produce it. However, the situation appears destined for change as more nations support ethanol production and "the benefits of international trade become realized," the CEC report stated.

Officials have noted that CBI volume share—the 7 percent cap—has never been fully realized. For example, in 2003, CBI imports were estimated at 65 million gallons, just 3 percent of total U.S. consumption. That was up from 45 million gallons in 2002.

"There is room to considerably increase tariff-free imports," the CEC report determined, stating that the cap, currently at about 150 mmgy, could increase to 350 mmgy under the production goals of the pending U.S. renewable fuels standard (RFS).

However, several prohibitive factors to CBI ethanol production exist.

"Many of these countries have no oil, natural gas or coal," said the president of one engineering firm close to several CBI projects. "There are always companies looking at the Caribbean Basin for the opportunity it represents—some folks have done very well there—but getting into the game is difficult. Permitting is often a huge challenge. Energy is a constant problem and fresh water is typically scarce."

Add fluctuating feedstock availability and WTO restrictions to those limitations and the Caribbean Basin starts to look like a risky place to build an ethanol plant.

Other trade agreements
Beyond CBI ethanol imports, additional opportunities exist for tariff-free ethanol imports into the United States through NAFTA and the Andean Trade Preferences Pact.

Through NAFTA, both Canada and Mexico can avoid U.S. tariffs. In fact, Canada is in the midst of a nationwide ethanol expansion program. However, aside from small shipments to the Northwest United States, Canada has sent few gallons south. Mexican ethanol production has been under evaluation for some time but there are no projects under development there currently.

Under the Andean Trade Preferences Pact, Peru, Bolivia, Colombia, Venezuela and Ecuador could also avoid the U.S. ethanol duty. The pact grants preferential tariff status in exchange for efforts to fight narcotics production. Thus far, none of these countries has become a significant producer of ethanol, but the potential exists, according to the CEC.

In fact, a proposed state-sponsored project in Peru is reportedly planning to build a giant 200-mmgy ethanol system made up of several distilleries located along an extensive $100 million ethanol pipeline. Peru's target market: California.

In mid-January, India's Praj Industries Ltd. announced that it signed a contract to set up two green field ethanol plants in Colombia. The contract is reportedly with one of Colombia's largest sugar conglomerates, Groupo Ardila Lulle, and attracted the attention of companies in Brazil and Europe. If built, the Colombian plants would be designed to operate on cane molasses and cane juice. The company said ethanol produced at the plants would be exported to the United States.

Other countries that may be eligible for tariff-free importation of ethanol into the United States include what are referred to as the "Least Developed Countries," a group of 49 African, Asian and South Pacific nations. In October, a Brazilian company announced its intentions to build a large-scale ethanol plant in Angola.

CAFTA, recently accepted by the United States, Honduras, Nicaragua, El Salvador and Guatemala, overlaps with CBI provisions in terms of opening up trade with Caribbean Basin nations. The new agreement will not further impact the ability of CBI member nations to export ethanol to the United States, according to the Renewable Fuels Association, because CAFTA does not modify existing CBI agreements. CAFTA will be pending before Congress in 2004 (probably this summer EPM learned) and must be ratified by the U.S. House and Senate.

Several major agriculture interest groups oppose the policy.

"The sugar industry is upset about CAFTA because it will likely increase sugar imports to the United States," an industry trade analyst told EPM. "That also means that quick, easy sugar imports will steer would-be ethanol producers away from building plants in those countires. They're not going to build ethanol plants and convert sugar into ethanol when they can simply ship the sugar."

A major threat to U.S. producers is, of course, Brazil, the world's top producer of ethanol. With over 4 billion gallons per year of production capacity, Brazil unquestionably has an interest in supplying the California market. However, even as very low-cost producers, Brazilians could not compete with U.S. ethanol prices after paying the 54-cent-per-gallon tariff. Thus, Brazil appears resigned to importing its product to the United States under the limited conditions of the CBI.

However, some trade analysts believe Brazil could potentially start importing ethanol into the United States duty-free under the proposed FTAA. The FTAA is a decade-old international effort to unite the economies of the Americas into a single free trade area in which barriers to trade and investment would be progressively eliminated. The controversial plan, however, has not been accepted and would face the intense scrutiny of Congress and a broad range of U.S. interest groups. An EPM source close to the trade talks said that if FTAA is accepted, there will be immediate resistance to duty free ethanol imports from Brazil.

"If the FTAA is accepted, Brazilian ethanol becomes an immediate concern," an EPM source said.

Compounding matters, the Office of the U.S. Trade Representative has a stated policy of working toward "open markets abroad" and "at home."

"That means eliminating export subsidies, reducing tariffs and monitoring domestic subsidy programs," one trade representative told EPM.

Meanwhile, nations around the world, from Thailand to China to Australia, are developing ethanol production programs. Most of these nations are building infrastructure for domestic usage, but some are also exploring export markets. There are outlet markets developing, too, as Japan is becoming an increasingly significant importer of ethanol.

How do all these international developments affect trade?

"In the longer term, it appears that ethanol will become an increasingly-traded international energy commodity, accompanied by international commodity exchange postings and transactions among more supplying and consuming countries," the CEC report concluded.

In the words of the trade official who spoke to EPM, "CAFTA and the CBI might not affect the U.S. ethanol industry that much today, but international trade will be a much bigger deal in the near future. The ethanol industry probably needs to start preparing for that." EP

The author of this article, EPM Managing Editor Tom Bryan, interviewed several expert sources for this article. However, many of contacts (all but one) requested anonymity, choosing not to be identified by name, company or agency. In the order of fairness, EPM made the eventual decision to keep the names of all sources in this article confidential.