In 2007 Brazil was awarded the opportunity to host the 2014 FIFA World Cup -- a perfect fit for a football-obsessed nation -- which was followed by the 2009 nod to host the 2016 Summer Olympics. While they may seem like "just games" at first glance, the emerging economic superpower has much more to gain from the tournaments. The country has poured over 2% of its GDP into preparation projects that will accommodate the massive influx of world tourists expected to descend on the country's cities and launch its infrastructure into the 21st century. The investment could return up to $90 billion to the nation's economy by 2019 and create 3.63 million jobs per year. If, that is, you can look beyond cries of government corruption.
The projects range from airports to wastewater improvements and, of course, 12 new and renovated stadiums for games -- all of which were expected to be completed for the FIFA World Cup in June. In fact, all were expected to be completed this month. Amazing ambitions come with high risks, however; a fact that resurfaced on November 27 when a crane collapsed on a stadium in Sao Paulo and claimed the lives of two workers. The stadium, which is scheduled to host the opening games, won't be completed until mid-April.
Further delays at this point would pose some obvious logistical problems for the tournament, especially considering that the nation's construction industry is currently overextended. Oh, and over 1 million tickets have already been sold. There are also some not-so-obvious ramifications stemming from the overall boom in infrastructure projects. For instance, increased construction costs have hit next-generation biofuels and biobased chemical projects in Brazil from companies such as Cosan (NYSE:CZZ), Solazyme (NASDAQ:TVIA), and Amyris (NASDAQ:AMRS). Will construction delays in the city of Sao Paulo affect advanced biofuels? Let's review the odd but true relationship.
Football, inflation, sugar, and microbes
This single event seems unlikely to have a direct or long-term effect on most industrial biotech companies. It should, however, bring attention to the fact that Brazil's ambitious infrastructure projects have led to skyrocketing construction costs throughout the nation in recent years. Consider that construction costs rose 7.18% in the first nine months of 2013 according to the National Index for Construction Costs. That is over 1% higher than estimates for the country's 2013 inflation rate, although the trailing 12-month index has been as high as 7.99% in the past year. Many costs in Brazil are rising with inflation, but the construction boom is a different animal according to James Lomas from investment company Indigo Invest. As told to The Rio Times:
Construction costs are rising like everything else in Brazil due to inflation. If your project is delayed -- I have one that has just been held up for eighteen months -- you have to have everything requoted due to rising cost of materials, wages, etc. It's something that you have to factor into your appraisal more than in, say, the UK because construction here can be held up by any amount of red tape [or] problems.
Worse yet, if materials or equipment cannot be found in Brazil and have to be imported they'll be subject to import taxes -- further inflating your project's costs. While rising construction costs and inflation affect every new project, they're a much larger drag on advanced biofuel and biobased chemical projects. Why? The industry is just beginning to develop technologies for cost-competitive cellulosic ethanol facilities. Even then the economics are extremely fragile. Additionally, companies aren't exactly sure of the best way to attack commercial scale production for biobased chemicals yet.
Consider that a 10 million gallon per year cellulosic ethanol facility currently being constructed by Raizen, a joint-venture between Cosan and Shell, will cost nearly $100 million -- and it's implementing one of the best enzyme platforms in the industry with Iogen. That's a capex of $10 per gallon of capacity! The eventual goal is to lower the capex of future projects to just $5 per gallon and expand to eight total cellulosic biorefineries, but rising construction costs could threaten those goals.
Amyris has already completed construction at its first commercial scale facility for renewable farnesene, a valuable chemical building block molecule, but it, too, faces an impossible task in planning costs for future construction. The company's second commercial scale facility will likely be built by SMA, which is a joint venture with sugarcane producer Usina Sao Martinho. Construction is partially complete, but operations aren't expected to commence until 2016 at the latest. That means construction won't resume until 2015, presumably with much higher construction costs than today. Will that factor into the decision to finish the biorefinery?
Don't think the threat of rising construction costs is real? Consider another example from Solazyme. Shortly before the company's IPO in the summer of 2011 the first commercial scale facility in Moema, Brazil was estimated to cost in the range of $90-$110 million. The price tag rose to $146 million one year later, although the final price tag is likely higher now. Luckily, Solazyme and its partner Bunge obtained a loan from the Brazilian Development Bank to reduce their immediate financial obligations related to construction. While the high rate of inflation continues to whittle away at the loan amount -- $109 million using exchange rates at the end of the third quarter, down from $120 million at the time of the announcement -- it also provides a negative real interest rate on the loan. Nonetheless, future biorefineries planned for the joint venture between the two companies will be affected by rising construction costs.
A silver lining?
If you view Brazil's construction sector as a boom being fed by national infrastructure projects, then it is quite possible that the nation experiences a bust in costs in the next few years -- or sooner. Recent monthly surveys of construction companies have detected a waning in confidence for an increase in demand now that most of the projects for the World Cup and Olympics have been initiated.
Oddly enough, that could benefit next-generation biofuels and biobased chemical companies looking to add manufacturing capabilities in the country. If construction costs rise slower than inflation -- or much lower depending on the depth of the potential bust -- then companies chasing Brazil's cheap sugar feedstocks may look to expedite projects. The situation could turn into a major competitive advantage for the industry if coupled with potentially negative interest rates on future loans.
For now, the lure of the cheapest and most abundant sugar in the world is overriding fears of the nation's construction sector. The trajectory of construction costs in Brazil is still something to keep an eye on for investors in advanced biofuels and biobased chemicals. Remember: Such costs are largely non-negotiable for companies, but they still impact your investment.
Fool contributor Maxx Chatsko has no position in any stocks mentioned. Check out his personal portfolio, his CAPS page, or follow him on Twitter @BlacknGoldFool to keep up with his writing on biopharmaceuticals, industrial biotech, and the bioeconomy.
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