Brazil’s ambition to become a major player in the global auto industry’s quest for alternative fuels was given a boost this year by significant agreements with the U.S. and the European Union to promote the development and use of biofuels.

The move is indicative of South America’s new status as one of the fastest-growing vehicle markets in the world. The region’s largest vehicle market, Brazil is at the global industry’s forefront in the use and production of ethanol from sugarcane, with flex-fuel vehicles now accounting for 70% of passenger cars.

Meanwhile, Brazil’s overall new-vehicle sales and production this year hit historic levels, with access to credit, unprecedented economic and political stability and lowered interest rates continuing to spur consumer confidence.

The country is expected to see sales rise 25% to 2.45 million vehicles and production climb 13% to 2.96 million units in 2007, compared with 2006. Neighboring Argentina should see deliveries grow to as much as 600,000 vehicles.

Given the region’s checkered past, the big question is whether the current record growth is sustainable. It’s an important issue for General Motors Corp. and Ford Motor Co., which are counting on South American operations for an increasing chunk of their revenues to offset losses in North America.

GM’s top executive for the region suggests Brazil’s success has legs. Unlike past recoveries, when industry executives held their breath waiting for the bottom to fall out, this time indications are the boom-and-bust era finally may be over, says Maureen Kempston Darkes, GM’s President of Latin America, Africa and Middle East (LAAM) operations.

“A lot of foreign investors are going into Brazil because they see the economy and the political situation having stabilized,” she says. “So I think there’s a very good opportunity here, and this period of growth has quite a good likelihood to continue for several years.”

GM is considering adding third shifts at its regional assembly plants to meet demand. The auto maker builds nine models in three plants in Brazil, totaling 482,121 vehicles in 2006. It also makes three models at its Rosario, Argentina, facility, for 71,000 units last year.

The two countries are part of the region’s Mercosur free-trade pact that continues to account for 46.9% of GM’s sales, albeit down from 59.4% in 2000.

GM will invest $500 million in Brazil and Argentina to build a new small car for South America, due in 2010, that will be positioned below the Celta in price at the equivalent of $10,000-$12,000.

Earlier in the year, the auto maker gave Brazil the nod as its center for the development of compact pickup trucks. The company expects to sell close to 500,000 vehicles this year, a 20% improvement over 2006, giving it a 21% market share.

Ford is forecasting South America’s auto market to keep growing next year but at a slower pace than 2007, from which it expects a record year on an industry-wide basis in Brazil, Argentina and Venezuela.

The fourth-largest auto maker in the region in terms of volume behind GM, Volkswagen do Brazil Ltda. and Fiat Automoveis SA, Ford’s South American unit last year reported a $661 million profit, a 65% gain over prior-year.

Ford, which saw 14 consecutive quarters of growth by the end of August, plans to invest $1.1 billion in its Camacari, Bahia, plant, which currently is running on three shifts six days a week. There also are plans to build a new ’10 model at its Sao Bernado do Campo plant.

Brazilian parts makers say Ford intends the upcoming B-segment car strictly for export to North America, with annual production of 50,000-100,000 units to begin in 2009 or early 2010.

Low-cost, entry-level vehicles are key to Brazil’s future, with a number of global auto makers announcing plans to enter new models in the segment, for both domestic and export markets.

Renault SA most notably launched its low-cost Logan subcompact at its plant in Rio de Janeiro in July and says future cars will be designed especially for the regional market.

PSA Peugeot Citroen is investing $500 million in the Mercosur region through 2010 to increase its 7% market share, with a goal of 12 new models. PSA last year built 160,000 units and is aiming to increase that to 400,000 annually by 2015, for a 15% share.

To do so, PSA will hire 1,000 engineers and designers to staff new development centers in Brazil and Argentina and also increase local content significantly from the current two-thirds, with an eye on entry-level cars aimed at Brazil and China.

Realizing the country’s potential for unprecedented growth, Miguel Jorge, Brazil’s minister of development and a former director of Volkswagen AG, is working with the National Association of Automotive Vehicle Manufacturers (Anfavea) to set up a program to make the automotive industry more competitive.

The goal is to increase production capacity to 5.5 million vehicles annually by 2011, compared with its 3.5 million-unit capacity at present, with a focus on strengthening automotive engineering and product development.

Jorge is encouraging auto makers in India and China to consider building vehicles in Brazil for the Mercosur region, noting it costs $80 million-$100 million to launch a vehicle in Brazil, giving multinationals a competitive edge over subsidiaries in other countries.

Global Insight Inc., an automotive forecasting firm, is predicting sales of 3.9 million vehicles in Brazil this year, while Anfavea’s prediction is more modest at 2.45 million units, with the expectation that growth will sustain 10% per annum for the next three years.

While the final 2007 tally won’t be known for several months, industry watchers have little doubt the country’s blazing economy soon could see the domestics turning to imports to meet demand.

– with Dave Zoia in Detroit and Sol Biderman in Brazil