Ethanol: Behind the Buzz

Regulatory Arbitrage

Cracks in the U.S.' 54-cent-per-gallon tariff on imported ethanol create arbitrage opportunities. Specifically, under CAFTA, Caribbean nations can export domestically grown and processed ethanol tariff-free. In addition, under the Caribbean Basin Initiative, Caribbean nations can perform last-step production of partially-processed ethanol from countries like Brazil and export it to the U.S. tariff-free so long as the total of such exports does not exceed 7% of U.S. production.

Last year, the U.S. imported approximately 200 million gallons of Brazilian-grown ethanol in this manner. With the U.S.-Brazil Ethanol Agreement's goal of increasing regional ethanol technology export and the U.S.' plans to increase significantly domestic ethanol production (effectively raising the 7% volume limit on Caribbean last-stage processing), interesting opportunities emerge.

The simplest play -- pure price arbitrage -- seems unsustainable.

Once ethanol becomes a market-traded commodity, opportunities for price arbitrage should disappear as the windfall of tariff-free ethanol resale is priced into the spot market. Therefore, the most attractive investments would seem to lie in ethanol plants of tariff-free nations, because they will capture value from both increased domestic production and the increased volume of last-step processing of Brazilian ethanol.

International investors are already seizing on the opportunity. Maple, a U.S. energy investment group, plans to invest $120 million in a Peruvian ethanol plant subject to a tariff-waiver under the Andean Trade Promotion and Drug Eradication Act. International agricultural giants Cargill and Brazil's Coimex Trading have also entered into joint ventures with Caribbean companies to exploit the tariff exemptions.