Mar 23, 2007(Dow Jones) - SAO PAULO and BUENOS AIRES - Brazil's major soyoil producers are preparing for a fight against Argentina over the biodiesel market, hoping Brasilia can convince Buenos Aires that Argentine tax policies are bad for Brazil's biodiesel program.

Brazil soy oil is the number one ingredient used in making biodiesel. Soy oil companies think Argentina's cheaper costs will cut them out of the market, especially the export markets.

"We're going to convince the government that they have to gun for Argentina on this issue, play tough," said Carlo Lovatelli, president of the Brazilian Vegetable Oils Industry Association, or Abiove.

"Biodiesel investments are heading to Argentina and not Brazil because it makes more sense to produce it there than here because of tax and trade incentives. We can be importing biodiesel from Argentina very soon," Lovatelli said.

Brazil wants to become the world's hub for biofuels. It's already the world's leading sugarcane ethanol producer and just entered into a partnership with the U.S. to promote world ethanol use.

Brazil President Luiz Inacio Lula da Silva has said repeatedly that Brazil's agricultural revolution depends on a future where "we plant and harvest fuel."

While Brazil's ethanol program is mature and growing, the biodiesel segment is "crawling," Lovatelli said, adding that major companies such as Bunge prefer to invest in Argentina and are leaving Brazil behind.

Miguel Biegai, a biodiesel analyst for Safras & Mercado, an agribusiness consulting firm, said Lovatelli has a point.

"Brazil can import from Argentina. I'm sure they can make biodiesel for less," Biegai said.

Brazil produces biodiesel at roughly $0.50 a liter, or 1.40 Brazilian reals on the low end, according to Safras & Mercado. Production costs can be as high as BLR1.60 a liter. Argentina can make it for $0.22 a liter, according to Argentine agribusiness consulting firm Abaceb.

In early February, Argentine President Nestor Kirchner signed an executive order to create a national biofuel law designed to make Argentina a biodiesel exporter. Kirchner put a low 5% export tax on biofuels, compared with a 24% export tax on soyoil. That makes it more beneficial for soyoil companies to sell their soyoil to fuel refineries for export than it does to export pure soybean oil for human consumption, Lovatelli said.

Domestic demand is also assured as Argentina's Biofuels Act mandates a 5% content of biodiesel or ethanol in the nation's fuel by 2010. The measure also provides tax breaks for companies investing in the sector. Santa Fe Province, which dominates soybean production and processing, has also offered a host of tax breaks to stimulate biofuel production.

But analysts here say Argentina is much more interested in exporting. Argentina wants to export biodiesel to the European and U.S. biofuels market, while its rival to the north is worried that Argentina's cheaper product will simply cut Brazil out of the export market and surely make investing difficult.

"We are only now realizing that there are a lot of opportunities to export biodiesel, but this is not ethanol. This is a very young segment and investments are being made contrary to what competing interests say," said Oswaldo Oliva Neto, chief of the Strategic Planning Department of the Presidential Palace.

Archer Daniels Midland (ADM) is building a biodiesel plant in Mato Grosso state and state oil firm Petrobras (PBR) is investing millions in a fuel called H-Bio, which is a blend of refined soyoil with diesel.

Lovatelli, who also has ties to Brazil-based oilseed and biodiesel giant, Bunge, said Abiove would be lobbying Lula's office and the Foreign Relations Ministry on making biodiesel more attractive for corporate investors. Current investments aren't enough.

Brazil's current biodiesel program was designed as a social program. It gives benefits to biodiesel makers who buy raw materials from poor family farmers from the north east. The benefits include complete tax exemption on all biodiesel made from oilseeds purchased on family farms in that region.

Other oilseeds not grown in those regions will pay at least 22 cents a liter, Biegai said.

Brazil law will require a 2% mixture of biofuels in all diesel by 2008, or 850 million liters. Most of that biodiesel will be made from soyoil, a product Brazil and Argentina have in abundance.

"As a biodiesel producer, Argentina simply has the benefits of better logistics, better policies, and increased capacity," said Biegai.

Other market players suggest that some companies contracted by Brazil's National Petroleum Agency, or ANP, to produce and sell biodiesel will be unable to supply the tax-free oils to make biodiesel. Companies that participate in the ANP biodiesel auctions are required to sell biodiesel made from oilseeds purchased from family farmers.

If companies have to declare they are making the fuel from soyoil, most of it produced on large commercial farms, they'd have to pay a tax, raising their costs. Those costs would be passed on to the consumer and could make biodiesel as expensive as diesel fuel.

Should those companies be unable to meet the ANP requirements, Argentina would likely be called in to fill in the gaps.

Nevertheless, Brazil is expected to supply the 850 million liters required by 2008. The years beyond are anybody's guess.

Neto said the government has no plans on changing the current tax structure for biodiesel production. Whether the industry can convince Brasilia to go after Argentina, however, will be known in the months ahead.

Given the Argentine strategy to become a biofuels exporter, it is unlikely Brasilia negotiators will get very far with Kirchner.