Agricultural acclimatisation

A planned $US12 billion joint venture between Royal Dutch Shell and Brazil's Cosan SA could have global implications for the availability and take-up of bio-fuels. It isn't exactly bad news for agricultural commodity producers either.

The joint venture between one of the world's biggest oil companies and the Brazilian sugar and ethanol producer, announced on Monday, would see Cosan contribute most of its sugar cane processing facilities and ethanol production capacity of about two billion litres a year while Shell would pay $US1.625 billion in cash and vend in its Brazilian retail network.

The companies said the joint venture would enable Shell and Cosan to establish a scalable and profitable position in sustainable bio-fuels and a market-leading position in the most efficient ethanol-producing country in the world.

While initially most of the joint venture's output of ethanol would be devoted to the Brazilian market because Cosan's capacity falls about a billion litres short of the needs of the combined retail networks, the two groups made it clear they have ambitions and global plans to expand both production and distribution. Their target, they say, is to produce between four and five billion litres of ethanol a year and to grow the role of low-carbon bio-fuels in the global transportation fuels mix.

Until now, Shell, which had been scaling back its interests in other alternative energy technologies, had been focusing on so-called 'second generation' bio-fuel technologies that use non-food plant material but at this point in their developments lack commercial viability.

It is vending its interest in two firms developing second generation technologies into the joint venture and is hopeful that the technologies can be applied to Cosan's facilities using waste material from sugar production as the feedstock.

With almost all new cars in the fast-growing Brazil capable of using ethanol or a mixture of ethanol and petrol the transaction isn't high risk for Shell. However, Cosan's willingness to inject most of its assets into the joint venture is a demonstration of its conviction that its ethanol ambitions can be realised by exploiting Shell's global presence.

Shell isn't the only 'Big Oil' company keen on ethanol as a hedge against the impact of global warming on its traditional products. BP and Exxon also have beachheads in the sector, although Shell's is the biggest investment in the 'first generation' technologies, where the technology and economics are well established.

The scale of the prospective partners' ambitions is probably good news, not just for the prospect of displacement of carbon-intensive fuels, but for soft commodities and, perhaps, CSR's proposed sugar and ethanol spin-off in particular.

While it was disrupted by the fallout from the global financial crisis, there was a structural increase in demand for agricultural commodities occurring, under-pinned by the increasing wealth and demand for foods with higher calorific values in China and India.

The impact of that increasing demand was amplified by the surge in demand – much of it mandated by governments – for bio-fuels. In the US planting of corn for ethanol production, rather than food production, has been rising at double digit rates.

A bigger commitment from Brazil's sugar sector – the largest and most efficient of the global sugar producers – to ethanol production ought to help maintain the currently tight relationship between demand and supply that has seen the sugar price soar and which prompted CSR to attempt a demerger of its own sugar and ethanol businesses (and which attracted the unsuccessful overtures from China's Bright Food Group).

While there are barriers to free trade of ethanol, a significant eventual shift in the global fuel mix towards bio-fuels would therefore be good for agricultural commodity producers. The size of Shell's commitment to the sector and the proposed partners' stated ambitions would suggest Shell believes a freeing up of the barriers to trade that would enable it to exploit its global distribution networks is on the horizon.

The increased use of food crops to produce bio-fuels is one strand in the motivation for a myriad of strategic transactions that have been occurring in the agricultural sector globally as the bigger players seek to consolidate the sector and gain a bigger and more diversified exposure to the expected long-term growth in demand.

In this market the Viterra acquisition of ABB Grain, Graincorp's purchase of United Malt Holdings, the various unsuccessful attempts by Chinese companies to acquire Nufarm and the agreed alliance Nufarm eventually struck with Japan's Sumitomo Chemical are representative of that scramble for scale and geographical reach.