HOW BRAZIL'S SUGAR INDUSTRY BENEFITED FROM LIBERALIZATION

Kingsman s 2 nd Indian Sugar Summit HOW BRAZIL'S SUGAR INDUSTRY BENEFITED FROM LIBERALIZATION Marcos Sawaya Jank President of Brazilian Sugarcane Industry Association (UNICA) New Delhi, September 1 st 2010

OUTLINE I. Historical evolution of the Brazilian sugarcane sector I. The state-controlled period II. Deregulation: the pathway towards the free market II. The sustained growth of the Brazilian sugarcane sector a. Sugar and ethanol markets b. Overview of 2010/11 Center-South harvest season III. Final remarks Weather conditions Quality of raw material Perspectives

NATIONAL INTERVENTION PERIOD 1930 until 1990 June 1933: the state intervention in the sugarcane sector started with the establishment of the IAA (Sugar and Ethanol National Institute*) During the 70 s, the national program had a twofold objective, namely: increasing sugar exports and reducing energy dependency: Sugarcane Breeding Program to improve productivity Proálcool (Ethanol Program) began in 1975 as a response to the oil crisis established an E-5 mandate and encouraged the development and demand of pure ethanol-fueled cars (E-100) First domestic E-100 car produced in Brazil, know as the Little Cachaça (Brazilian Rum) * Instituto do Açúcar e do Álcool

GOVERNMENT INTERVENTION PERIOD Four major pillars Production: plan and regulate the annual sugar and ethanol production; the amount of sugarcane delivered to each industrial plant; the amount of ethanol and sugar to be produced in each state Seasonal plans were released every year informing farmers and millers about the sugarcane quantity to be processed and the price to be paid. Exports: manages raw and white sugar exports Prices: set prices for all the products (sugarcane, sugar and ethanol), based on their production costs The government set the parity prices between sugar and ethanol to make it financially indifferent for the mills to produce either sugar or ethanol; ethanol prices at the pump should not be higher than 65% of gasoline prices Consumption: set mandatory blends for ethanol in gasoline, plus incentives for the establishment of ethanol distilleries attached to existing sugar mills According to the IAA act, no sugarcane processor could be established without authorization

THE DEREGULATION OF THE SUGARCANE SECTOR A gradual process During the early 90 s, the Brazilian Economy as a whole dramatically moves towards liberalization, openness and privatization. Sugarcane industry ran along the same pathway: the first movement was the closure of IAA, the major government intervention agency, in 1990. This was followed by a gradual process of liberalization of the sector: Elimination of public production and exports controls (1990) The mandate for national agencies and sector ministries to took over some of the IAA tasks (1991) The establishment of CIMA The Sugar and Ethanol Inter-Ministerial Council (1997) CIMA s main roles: responsible for policies such as the definition of economic mechanisms for self-sustaining economic growth of the industry (e.g. establishment of credit lines for ethanol stocks); recommendation for the ethanol level blending in gasoline (20-25%); assessment of the participation of sugarcane in the Brazilian energy matrix

THE DEREGULATION OF THE SUGARCANE SECTOR A gradual process Effective measures regarding liberalization of ethanol and sugarcane prices started only in 1997. Given the social, economic and environmental importance of the sector, it was established a phasing-out process, concluded just in February of 1999 On of the major constraints for this process to move faster was the resistance of the sector on how to price the feedstocks 1999: creation of sugarcane payment model named CONSECANA It is a private sector arrangement which main objective it to share risks between sugar and ethanol producers and sugarcane growers Main rules: (1) the revenue of the sugarcane grower is proportional to the industrial revenue; (2) price of sugarcane supplied by each grower depends on the level of sucrose that the product contains

MAIN RULES OF CONSECANA MODEL The revenue of the sugarcane grower is proportional to the industrial revenue On average, sugarcane production accounts for 60% of total sugar and ethanol production costs. Therefore, the sugarcane grower receives on average 60% of the agroindustrial revenue. Price of sugarcane supplied by each grower depends on the level of sucrose that the product contains. Mill pays more for sugarcane which contains more sugar The quantification of the sugar contained in sugarcane is determined in terms of TRS ( Total Recoverable Sugar *). TRS represents the quantity of sucrose, glucose and fructose which will be effectively converted into sugar and ethanol Growers have the right to monitor mill laboratories 24 hours per day A dynamic model, subject to revisions of its parameters and improvement of its rules on a regular basis (general revisions conducted every 5 years) *ATR açúcar total recuperável

CONSECANA MODEL Price received by millers and sugarcane growers in São Paulo state 0,400 0,350 Sugarcane price respond for: 59.5% of sugar price received by the mill 62.1% of ethanol price received by the mill 0,300 0,250 0,200 0,150 0,100 0,050 2006/2007 2007/2008 2008/2009 2009/2010 Sugar average price - sugarcane growers Sugar average price - millers Ethanol average price - sugarcane growers Ethanol average price - millers Source: Orplana and Unica. Note: exchange rate used refers to the average annual exchange rate; price refers to the average price of the respective crop year

CONSECANA MODEL Sugarcane quality and price received by sugarcane growers in São Paulo state Kg TRS/ton sugarcane 150.86 146.57 143.25 132.75 40,00 0,20 Sugarcane price (US$/ton) 35,00 30,00 25,00 20,00 15,00 TRS price Average price of sugarcane paid to sugarcane growers 0,18 0,16 0,14 0,12 0,10 0,08 0,06 0,04 0,02 10,00 2006/2007 2007/2008 2008/2009 2009/2010 - Source: Orplana and Unica. Note: exchange rate used refers to the average annual exchange rate; all statistics (price and kg TRS/ton of sugarcane) refers to the average of the respective crop year

The Brazilian sugarcane sector after the state intervention period: sustained growth

EVOLUTION OF BRAZILIAN SUGARCANE PRODUCTION Sugarcane area and yield (1980 = 100) 600 Deregulation 500 400 300 200 100 0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Total TRS Area Source: MAPA and CONAB (2009 e 2010). Note: TRS is the amount of product obtained per ton of crushed sugarcane.

BRAZILIAN SUGAR PRODUCTION AND EXPORTS 35 30 25 Harvest Exports Production season Million Tons Million Tons Exp/Prod 2007/08 18.6 31.0 60% 2008/09 20.8 31.1 67% 2009/10 24.1 32.9 73% Production Millio on tons 20 15 10 5 - Exports 1989/90 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10p Source: MAPA, UNICA e Secex. Note: 2009/10p preliminary data as production for North-Northeast region was calculated from data obtained up to August 16, 2010. Data regarding sugar exports from 1989 until 1995 refers to civil year.

BRAZILIAN ETHANOL PRODUCTION 20 15 10 1975 PROÁLCOOL 1st phase PROÁLCOOL CRISIS at the end of the 80s FLEX FUEL vehicles begin to be sold Billion liters 5 0 1951/52 1953/54 1955/56 1957/58 1959/60 1961/62 1963/64 1965/66 1967/68 1969/70 1971/72 1973/74 1975/76 1977/78 1979/80 1981/82 1983/84 1985/86 1987/88 1989/90 1991/92 1993/94 1995/96 1997/98 1999/00 2001/02 2003/04 2005/06 2007/08 2009/10p Anhydrous ethanol Hydrous ethanol Source: MAPA and UNICA. Note: 2009/10p - preliminary data

NATIONAL AUTOMOBILE AND LIGHT VEHICLE FLEET 30 March 2010: the Brazilian flex fuel fleet reached 10 million vehicles 25 20 15 10 5 0 jan/03 mai/03 set/03 jan/04 mai/04 set/04 jan/05 mai/05 set/05 jan/06 mai/06 set/06 jan/07 mai/07 set/07 jan/08 mai/08 set/08 jan/09 mai/09 set/09 jan/10 mai/10 Flex Fuel Gasoline Ethanol only Source: UNICA. Note: Otto Cycle refers to vehicles powered by gasoline and ethanol, as well as flexible fuel vehicles.

EXPANSION OF THE FLEX-FUEL TECHNOLOGY Number of flex-fuel models 90 75 60 45 30 15 Number of new FFV models 0 dez/09 mar/10 mar/03 jun/03 set/03 dez/03 mar/04 jun/04 set/04 dez/04 mar/05 jun/05 set/05 dez/05 mar/06 jun/06 set/06 dez/06 mar/07 jun/07 set/07 dez/07 mar/08 jun/08 set/08 dez/08 mar/09 jun/09 set/09 Today, 11 auto-makers produce 83 different flex-fuel models. Source: ANFAVEA. Elaboration: UNICA. Note: Adoption rate consists of relative speed that an innovation is adopted by members of the social system - ROGERS, Everett M. Diffusion of Innovations. 4 th ed., New York: The Free Press, 1995, p.250.

2.400 GROWTH OF FLEX-FUEL VEHICLE AND MOTORCYCLE FLEET Evolution of Brazilian ethanol and gasoline consumption 2.000 Gasoline Millions of liters 1.600 1.200 Ethanol 800 400 0 Jan. 2000 Apr. 2010 Source: ANP. Elaboration: UNICA. Note: ethanol consumption includes the demand for anhydrous and hydrous ethanol; gasoline consumption includes the demand for gasoline A (without anhydrous addition).

R$/liter hydrous ethanol CONSUMPTION vs. PRICES Brazilian ethanol and gasoline consumption X price received by hydrous ethanol producers in São Paulo state 2.300 2.100 1.900 1.700 1.500 1.300 1.100 900 700 500 1,4 1,2 1 0,8 0,6 0,4 0,2 jan/07 mar/07 mai/07 jul/07 set/07 nov/07 jan/08 mar/08 mai/08 jul/08 set/08 nov/08 jan/09 mar/09 mai/09 jul/09 set/09 nov/09 jan/10 mar/10 mai/10 Million of liters Ethanol Gasoline Hydrous ethanol price Source: ANP and CEPEA.

STRONG CONSOLIDATION MOVEMENTS There is still many opportunities for more M&A in Brazil Despite recent mergers and acquisitions, the productive sector is still very fragmented and with little entry barriers Higher concentration in commercialization to gain more market power Main challenge for the new agents of the sugarcane sector: management and logistics of sugarcane production.

SUGARCANE INDUSTRY: NEW PRODUCTS AND NEW USES New products Sugar New uses Bus Ethanol Aircrafts Bioelectricity Motorcycles Bio-ethylene Alcohol chemistry (bio-plastics) Bio-hydrocarbons Bio-hydrocarbons (cane diesel, jet fuel) Elaboration: UNICA.

OVERVIEW OF 2010/11 CENTER-SOUTH HARVEST SEASON 400 Rainfall in the South-Central region 300 200 100 0 Aug Sep Oct Nov Dec Jan Feb Mar Apr Mai Jun Jul Historical average Aug 2008 - Jul 2009 Aug 2009 - Jul 2010 Source: CTC and INMET.

OVERVIEW OF 2010/11 CENTER-SOUTH HARVEST SEASON Monthly productivity in South-Central region 110 50% [t sugarcane / ha] 100 90 80 6.7% 2.6% 0.2% 0.5% Productivity is projected to decrease during next months 40% 30% 20% 10% 0% 70-4.6% -10% 60 Mar Apr May Jun Jul Aug Sep Oct Nov Dec Variation 2009/2010 2010/2011-20% Source: CTC.

OVERVIEW OF 2010/11 CENTER-SOUTH HARVEST SEASON 35 30 25 20 New units in South-Central Brazil 15 10 5 0 30 25 19 19 5 9 5 3 a 5 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11p 2011/12e 10 new mills in 2010/11 harvest season, 3 to 5 new mills in 2011/12 Source: UNICA. Note: estimate.

2010/2011 HARVEST UPDATE OF SOUTH-CENTRAL REGION A B C 2008/09 2009/10 2010/11 (*) C/B (%) Harvest Sugarcane crushed (million tons) 504.9 541.9 570.2 5.2% Production Sugar (million tons) 26.7 28.6 33.7 17.7% Anhydrous ethanol (billion liters) 8.2 6.2 7.3 17.8% Hydrous ethanol (billion liters) 16.8 17.5 19.1 9.1% Total ethanol (billion liters) 25.1 23.7 26.4 11.4% Quality of raw material TRS per ton of sugarcane (kg/t) 140.9 130.2 141.3 8.5% TRS total (million tons) 71.1 70.8 80.6 14.1% Share Sugar (%) 39.5% 42.6% 43.9% Ethanol (%) 60.5% 57.4% 56.1% Exports Ethanol (billion liters) 4.2 2.8 1.4-47.5% Sugar (million tons) 17.7 21.2 22.8 7.3% Source: UNICA. (*) Revision published on August 26, 2010.

FINAL REMARKS Deregulation should be a gradual and transparent process so that agents can adjust accordingly. Energy sector (such as transport fuels and electricity) will always need some level of state regulation but they have to be clear, as much marketdriven as possible, and with a long term horizon (long maturity period of investments). Public policies should optimize steps taken by the private sector. Competitiveness of the sugarcane supply chain requires coordination and cooperation among its agents (e.g.: Consecana, sustainability criteria, communication efforts).

FINAL REMARKS Cooperation among countries is fundamental: a. Agriculture: technological transfer and adaptation for sugarcane varieties and management b. Industry: industrial processing for sugar and ethanol, co-generation and new developments, such as bioplastics, alcoochemicals, biohydrocarbons c. Automobile industry: flex-fuel vehicles, engine improvement d. Exchange of knowledge on regulatory and sustainable practices e. Facilitation of direct investments f. Forums such as the Global Sugar Alliance cooperation for WTO resultas (e.g.: panel against EU sugar policies and the Doha Round)

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AGENDA Potential growth in supply and demand Demand» Growth of flex-fuel vehicle and motorcycle fleet» New products and new uses» Expansion of ethanol use in the chemical industry» Use of bioelectricity» Increase of global ethanol consumption» Increase in global sugar consumption Supply» Competitiveness of the productive system and growth potential

AGENDA Risks and challenges» Volatility of the Energy Policies in Brazil» Pricing policies of gasoline and taxations (CIDE and ICMS)» Consolidation, costs, logistics and economies of scale» Tariff and nontariff barriers to Brazilian ethanol» Risks of bioelectricity regulations» Increasing social and environment costs