26/12/06 RIO DE JANEIRO/SAO PAULO (Reuters) - Billed as a way to cut diesel imports, boost local employment and reduce pollution, Brazil's biodiesel program is running into serious obstacles, but the government says they can be resolved.

Lack of planning and primary material are the main problems that must be overcome if Brazil is to successfully mandate a 2 percent blend of the alternative diesel based on vegetable oil in all retail diesel by 2008.

The mines and energy ministry says the initial phase of the program will save $160 million annually in imports of diesel, but Brazil will first have to build a 800 million liter stockpile of biodiesel, which the National Petroleum Agency has been trying to guarantee through public tender.

Although the government has called the four auctions held so far a success for selling contracts to deliver 800 million liters in the next two years, some biodiesel suppliers are not honoring their contracts.

And, without any penalty for not delivering, they may simply leave part of the contracts unfulfilled or break the contracts altogether.

For the director of renewable fuels at the mines and energy ministry, Ricardo Dornelles, the failure of some companies to deliver biodiesel according to the contracts is merely part of working out the initial bugs of the program.

"We are starting a very important project that depends on equipment, plants and it's foreseeable there will be adjustments in the production chain as a whole," he told Reuters. "There are no diagnoses that have altered our plans."

The plan is to move to a 5 percent biodiesel blend in all mineral diesel by 2013.

He said the first auction in November 2005, only one of the companies did not honor its contract and in the second auction four of the eight participants have met the contracts, although one or two more may be brought in line with the contracts.

"What was not delivered should be placed in the next auctions," Dornelles said, who forecast two more auctions in 2007 to meet supply needs before 2008. He said that 700 million liters have been guaranteed, however.

One of the notable investors in the sector is state-run oil and gas company Petrobras (PETR4.SA: Quote, Profile , Research)(PBR.N: Quote, Profile , Research). It has already announced the construction of three new plants that will produce 150 million liters a year by the end of 2007.

Executive manager of energy development at Petrobras, Mozart Schmitt de Queiroz, said the recent complaints over the lack of primary materials should end with the use of other types of vegetable oils besides the dominant soy oil as basis for the biodiesel.

But large scale production of biodiesel that does not rely on the established infrastructure of the massive soy industry has already run into problems.

Oil from castor beans has been touted by the government as a way to bring small family farmers into the fold of the country's energy matrix and there was a surge in output after 2003 when news of the biodiesel program started.

But weak demand and oversupply of castor oil caused prices to fall from 1.10 reais ($0.51) a kilogram to around 30 centavos and area planted has since fallen from 210,000 hectares in 2005 to 149,000 ha this season, according to the government crop supply agency Conab.