THE VEGETABLE OIL REVOLUTION - FROM THE KITCHEN TO THE CAR

UNCLAS SECTION 01 OF 02 BRASILIA 001480

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SUBJECT: THE VEGETABLE OIL REVOLUTION - FROM THE KITCHEN TO THE CAR

REF: 05 BRASILIA 1992

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1. Summary: Brazilian energy parastatal Petrobras recently
publicized the development of a new diesel fuel, H-Bio, further
bolstering Brazil's already prominent position in the world of
biofuels. A hydrogenated synthesis of petroleum and vegetable oil,
Petrobras is touting the social, environmental and economic benefits
of the fuel as well as its capacity to reinforce Brazil's energy
independence. Industrial tests of H-Bio began on June 20, and the
company expects commercial/industrial production to commence by the
end of 2006. While certain obstacles still merit attention, H-Bio
fits into Petrobras' long-term emphasis on green fuel development.
End Summary


2. Petrobras officially announced H-Bio in May of 2006 and later
executed a test of industrial production on June 20, replete with
President Lula's attendance. Developed by CENEPES, Petrobras'
division for research and development, over the past 18 months, the
parastatal claims that H-Bio has proven technically and commercially
viable. Accordingly, Petrobras has recently patented the fuel's
production process.


3. H-Bio is a fusion of vegetable oil and petroleum, refined into a
single diesel fuel via hydrogenation, or the addition of hydrogen
molecules to the mixture. It should not be confused with biodiesel,
which is a pure vegetable oil that distributors blend with
previously refined diesel. Analysts predict that the principal
vegetable component for H-Bio will be soy oil, which represents
Brazil's largest commercial agricultural crop and, according to
experts, would not be subject to scarcity issues often associated
with ethanol. As Petrobras President Jose Sergio Gabrielli
affirmed, if the price of soy is too high or there is an
insufficient crop, the company can revert to producing conventional
diesel. According to initial estimates, Petrobras will utilize
roughly 256 millioQcubic meters of vegetable oil in 2007 and 425
million cubic meters in 2008. The latter accounts for roughly 16.4%
of Brazil's annual soy oil exports and would represent a stable
internal demand for soy. That said, one of the purported benefits
of H-Bio, is the capacity to manufacture the fuel from a variety of
different oils, including but not limited to soy, castor, cotton and
sunflower.


4. As a "green fuel" H-Bio, according to Petrobras, offers consumers
a myriad of advantages. These include higher ignition potential
(and therefore decreased emissions),increased fuel efficiency,
decreased sulphur emissions, and lower production costs. Petrobras'
officials also claim that H-Bio does not generate harmful byproducts
normally associated with diesel refinement. The most significant
advantage, however, for Brazil is the dollar cost savings on
imported diesel. While Brazil is self-sufficient in oil production
it still imports petroleum derivatives, including diesel, of which
it imports 10% every year. By the end of Q08, Petrobras' predicts
a 15% drop in imported diesel at a savings of approximately US$ 145
million per year. By 2011, increased production should save Brazil
nearly US$ 240 million a year on diesel imports. Long-term
estimates for H-Bio production and the substitution of conventional
diesel have not yet been defined.


5. Petrobras' implementation time-line will proceed in two phases.
In the short-term (2007 to 2008),Petrobras will develop logistics
for large-scale production in three refineries. Commercial
production should begin in December 2006 at the Regap refinery in
Minas Gerais and expand into two more refineries: Repar in Parana
and Refap in Rio Grande do Sul in 2007. An estimated US$ 38 million
in investment is required to retrofit the plants. Phase two (2009
to 2011) should witness infrastructure expansion into two additional
refineries, requiring an additional US$ 23 million in investments.
The overall cost of retrofitting refineries to produce H-Bio is
relatively low and the task is not technically difficult.
Refineries simply require a hydrogenation facility. Moreover,
handling and storage requirements remain the same for H-Bio as for
conventional diesel, meaning that it is unnecessary to invest in new
distribution and holding infrastructure. Petrobras' director of
supply Paulo Costa has also highlighted that conventional diesel
engines require no modifications to run on H-Bio. Other analysts
have claimed that engines might benefit from the fuel's property as
a lubricant.


6. Despite the optimism surrounding H-Bio, the vegetable oil supply
chain and potential environmental repeQussions need to be
addressed. One question facing Petrobras, at least in terms of

BRASILIA 00001480 002.2 OF 002


investment, is the infrastructure required to transport and store
large quantities of vegetable oil prior to refinement. Sylvestre
Calmon, a technology manager for refinement technology at
Pretrobras, admitted that the company's refineries do not currently
have adequate facilities to receive large quantities of vegetable
oil. Moreover, there is a lack of economic analysis accounting for
the cost of transporting vegetable oil to the refineries. Some
analysts are questioning the economic viability of the fuel.
Petrobras also needs to determine the excess Hydrogen requirements
necessary to propel H-Bio into large-scale commercial production.
There are also potential environmental concerns. Recent studies
have revealed links between soy cultivation and both biodiversity
loss and deforestation in the Amazon. Providing a stable, long-term
incentive to produce additional soy may put additional stress on
Brazil's conservation efforts.


7. In spite of these concerns, the creation of H-Bio appears to fit
into Petrobras' and the GoB's long-term strategy of both leading the
world in biofuel production and partnering with developing countries
to promote their distribution. At the June 20 ceremony, Lula stated
that the technology allows for partnerships with African countries
which can then export products to Europe. He added, "this is not
just a project for Brazil, but for other poor countries." H-Bio is
also consistent with the GoB's National Biodiesel Program (reftel)
as distributors will add biodiesel to both H-Bio and conventional
diesel. According to Petrobras President Gabrielli, "biodiesel and
H-Bio are complementary and represent a new type of fuel-economics
in the world scenario". Most importantly, H-Bio augments Brazil's
self-sufficiency in diesel. Dilma Rousseff, former Minister for the
Ministry of Mines and Energy and currently President Lula's Chief of
Staff, stated that Brazil was seeking self-sufficiency in oil and
effective participation of green fuels in the energy matrix. H-Bio
should achieve this.


8. Comment: H-Bio is yet more evidence that Brazil is the world's
leader in biofuels, from both technological and production
perspectives. With further investment in the technology, H-Bio has
the potential to count prominently as one of the solutions to the
world's looming carbon crisis. And, while one can predict neither
the long-term impact of H-Bio nor the influence that it will exert
on energy development, its development is laudable.

WILLIAMSON