Brazil has what China wants…

A money manager in Brazil once said to me, “Brazil has what China wants and is willing to sell it.” How much does this summarize the growth of the commodity sector in Brazil?

Condemned to prosperity
Nov 12th 2009
From The Economist print edition

Brazil has learned to love its commodity sector
NOT many countries are named after commodities. There is Argentina, from the Latin word for silver; Côte d’Ivoire, a reminder that nature’s endowments do not always lead to prosperity; Panama and Uruguay, whose names may come from indigenous words for fish; and also Brazil, which became known for its Brazil wood, the source of a valuable dye. Prior to that Italian merchants apparently called it the land of parrots. Brazil has already lived through several commodities booms: precious metals in the 17th century, sugar in the 18th and coffee in the 19th. Yet none of them benefited the country as much as the current one.

The large discoveries of offshore oil made by Petrobras in 2007, which have generated so much excitement recently, have made it easy to forget that Brazil is already the world’s largest exporter of coffee, sugar, chickens, beef and orange juice. It also exports vast amounts of soya and iron ore, as well as other ores and metals. Its commercial forests are the source of much of the world’s pulp. If other countries opened their markets, Brazil would supply them with ethanol to fuel their cars too. A history of booms and busts in the markets for raw materials is written into the country’s landscape.

Yet for a long time Brazil did not capitalise properly on all this wealth. Brazilian intellectuals used to argue that the country’s role as a commodity producer permanently consigned it to the periphery of the world economy. Then two things changed. First, improvements in the country’s financial system and greater economic stability allowed businesses to invest without fear that some economic catastrophe was likely to befall the country. This is reflected in the large share of investment going into the commodity sector. Second, the worldwide boom in commodities this decade made it more profitable to plough fields and dig holes, bringing about a big change in Brazil’s terms of trade (see chart 4).

Plough, scatter, repeat
It is safe to assume that the world’s hunger for protein is not going to abate. People start eating lots of meat when they reach an income of about $10,000 per person. Some 80% of the world’s population have yet to get to that point. As they do so, finding spare land and increasing the efficiency of farming will become ever more important. Brazil has plenty of spare land, even without destroying its forests to create more, and much of its farming is done by small, family-run businesses that could increase production with more capital and better management.

Brazil has already pulled this off once. Largely thanks to the work of Embrapa, a government research agency, Brazilian farmers in the 1960s and 70s steadily increased the area in which crops could be cultivated. Acidic soil, with little phosphorous and lots of toxic aluminium, was rebalanced, and crops were specially bred for Brazil’s tropical environment. Between 1968 and 1997 a total of 116 new varieties of soyabeans were launched. In the past few years new ones have been added at the rate of almost 100 a year.

Among other things, Embrapa, working with private-sector companies, is trying to develop a variety of wheat that will grow in Brazil. At the moment, reckons Julio Pisa of BrasilAgro, which owns 166,000 hectares of farmland in Brazil, the country has 20m spare hectares of good productive land. Not all of this will be as sumptuous as in Rio Grande do Sul state, where some farmers can harvest a tobacco crop, a corn crop and a bean crop from the same land in a single year (culminating in a lively bean festival in January), but it will be pretty good. Perhaps more importantly, Mr Pisa points out, when Brazil exports food it is also exporting water, and Brazil is fortunate enough to have a surplus of fresh water per head of population.

But before Brazil’s agriculture can reach its full potential, there are a few problems to overcome. The first is a long-running argument about who has the right to what piece of land. Land tenure becomes less and less certain as you approach the equator. In the Amazon this results in deforestation as farmers cut down trees to establish de-facto ownership of land. In other parts of the country the disputes take the form of farm invasions by the Landless Movement (MST), which has many ideological sympathisers in the government, including the president himself.

The MST tends to go for farmland that is not too far from cities, but Fibria, a big producer of wood pulp, has had trouble with invasions of forests it owns in remote parts of Bahia state. These invasions can be colourful: one group, made up entirely of women, likes to arm itself with pitchforks before descending on farms.

As might be expected of a loosely organised movement in a big country, the MST appears in lots of different guises, depending on the place. One of its oldest settlements, at Pirituba in São Paulo state, now looks a bit like a kibbutz tinged with new-agey environmentalism. By contrast, in the northern state of Pernambuco MST members shot and killed four men earlier this year.

Lost highways
A second problem holding commodity producers back is Brazil’s patchy infrastructure. After much sifting through data, the World Bank’s Growth Commission concluded that, in order to keep growing fast, developing countries should invest around 25% of their GDP, of which about 7% should go on infrastructure. Brazil’s investment level has been creeping up towards 20% in recent years, but in 2007 the government invested just 0.1% of GDP on improving transport.

For some of the biggest companies this is not a problem. Vale has its own railway lines, which allow it to get its iron ore from Carajás to market without much trouble. The company is also a shareholder in MRS Logística’s railway network in the south of Brazil, along with CSN and Usiminas, another steel company. Just as in America in the late 19th century, when Standard Oil and Carnegie Steel used the railroads under their control as a weapon against their competitors, these companies are able to maintain a system that works well for them but not for others. Some 60% of freight in Brazil goes by road and only 20% by rail, compared with an even split in the United States. América Latina Logística’s rail network is open to whoever wants to use it but covers only part of the country.


Running out of road

Once goods are loaded into trucks, everything slows down. Brazil’s lorries, on average, are 14 years old. Their bumpers are usually adorned with foot-high letters declaring that the driver has put his trust in God, which is just as well given the state of the roads and some of the overtaking that lorry drivers do.

Brazil has the world’s third-largest road network, but only 12% of it is covered in asphalt. IPEA, a government economic-research agency, reckons that road deaths per vehicle on the road in Brazil (some 35,000 in 2006, the latest available figure) are six times as frequent as in Japan.

When the trucks eventually make it to the port, often after spending hours in traffic jams, everything slows down again. Brazil’s ports tend to be run as offshoots of the civil service rather than as private companies, with all the problems that entails. To speed up the loading and departure of ships, companies sometimes find they are required to make extra payments, which publicly listed multinationals struggle to explain in their accounts—and to justify to their shareholders.

Brazil’s ports are both more profitable and less efficient than their peers elsewhere. Competitors who want to enter the market are discouraged. When Eike Batista, the most swashbuckling of Brazil’s current crop of entrepreneurs, applied to build a new port in São Paulo state he was unable to secure an environmental permit for his project. There is also a suspicion that Brazil occasionally uses its sluggish customs service to influence trade data. Strikes have sometimes coincided with periods when the real has been particularly strong and imports have been rising fast.

Many people seem to believe that all this can be turned around. At the start of 2007 the government announced a “programme for accelerating growth”, concentrating on infrastructure, which most agree is a small step in the right direction. Several state governments have subcontracted the expansion and improvement of existing roads to private consortia which are allowed to collect tolls. Infraero, the state company that runs Brazil’s airports, is stepping up its investment. Pablo Haberer of McKinsey, a management consultancy, reckons that in four or five years’ time Brazil’s airports will be better than those of the United States.

But even when the federal and state governments are behind new infrastructure projects and money has been allocated, often nothing happens. The prospect of hosting the football World Cup in 2014 and the Olympics two years later should inspire some action. But it would be a stretch to argue that the roads, airports and stadiums that will be built or renewed for the benefit of sports enthusiasts will be exactly what Brazil’s exporters need.

Below the salt
These problems have been with Brazil for some time, and companies mostly find ways around them. But the discovery of abundant oil off the country’s coast poses a different set of challenges.

To begin with, the oil sits three to four miles below the sea, between layers of salt. This is deeper than any company has tried to drill before. Because it is so deep down, the oil will come out hot and then cool rapidly as it nears the surface, leaving deposits of paraffin that will clog up pipes. Gases under high pressure will come out at the same time as the oil. The drilling platforms will be 185 miles out to sea, out of range of helicopters. Some combination of boats, floating platforms and helicopters will have to be employed to get rig workers there and back.

To solve these problems, Petrobras has announced the world’s largest capital-expenditure programme, worth $174 billion over the next few years. This is a boon to companies such as GE, which has a $250m deal with Petrobras to supply Christmas trees (the part that anchors an oil rig to the sea bed). The government has said that it expects Petrobras to work with oil-services firms like Schlumberger and Halliburton, as well as with foreign oil companies that want to boost their reserves.

No doubt many foreign oil companies will come to Brazil and partner Petrobras in the new fields. Compared with many places where they do business, Brazil is a model of predictability, good regulation and respect for contracts. However, the calculation has just been made more complicated for them by the federal government’s announcement that it is getting rid of the regulatory framework that has served the country well for ten years and helped to bring about the new discoveries.

The existing system, in which royalties are paid to the state, could be tweaked to reflect the risk of exploration in the fields below layers of salt (though this appears to be low). But the government wants to replace it with a new set of rules that would involve it more directly in the management of exploration and production. Under the latest proposals a new state oil company, Petro-Sal, will take part in all new ventures. Petrobras will also have a guaranteed stake in each block. Other companies can come in as minority partners. Lula is also insisting that everything used to extract the oil should be made in Brazil, which will push up costs and slow things down. All this makes it less attractive for foreign investors to get involved, at a time when Brazil needs a lot of capital to make the most of its new discovery.

Although the numbers suggest that Brazil is at last making proper use of its agricultural and mineral riches, there is another side to the boom that is not reflected in the figures. High commodity prices are correlated with deforestation in the Amazon as trees are cut down to create farmland to feed Brazil’s domestic market. It is a dreadfully wasteful process because the thin soil is quickly exhausted and ranchers move farther into the jungle, leaving a devastated landscape behind them. The forests of the Cerrado, an area of savannah punctuated with trees that once covered much of central Brazil, are disappearing even faster.

As for mining, for every multinational like Vale that collects data on injuries and deaths in its mines there are plenty that do not seem to care much about what happens to their workers. Of the ten largest mining companies operating in Brazil contacted by The Economist, only a couple had numbers on deaths and injuries in their mines. In the informal part of the mining sector, from wildcat gold-miners in the middle of the Amazon to the guseiros who dig for pig iron in Minas Gerais state, things are even worse.

Where intellectuals once worried that Brazil’s natural resources would confine it to a marginal place in the world economy, now they are concerned that Brazil’s commodity wealth will condemn the country’s currency to getting ever stronger, making life impossible for manufacturers with their sights on exports. They probably have a point. But it could be dealt with much more easily if Brazilian companies did not find themselves squeezed between two walls that are constantly pushing in on them. On one side is a public sector that taxes too heavily and spends badly. On the other is a large black economy that they find it hard to compete with.

Published by Janar Wasito

Janar Wasito is the manager of Magis Capital in San Diego, CA. He is a graduate of Harvard and Stanford Law School, and a former Marine Officer.

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