Ethanol demand under the flex-fuel technology regime in Brazil

Abstract

This paper analyzes the characteristics of ethanol demand in the context of fuel mix diversification in Brazil. Currently, ethanol is the most important gasoline additive and alternative fuel consumed in Brazil and is responsible there for profound changes in the dynamics of fuel consumption. The diffusion of flex-fuel vehicles in Brazil symbolizes a new stage of ethanol expansion and is a central component of the increasing demand for fuel. Accordingly, we evaluate ethanol demand in Brazil following the introduction of flex-fuel vehicles using a cointegration approach and autoregressive distributed lag bounds tests over the period 2003–2010. The evidences confirm that during the last decade, ethanol has strengthened its position as both an independent fuel and a substitute for gasoline. There is also evidence that growth in the Brazilian automobile fleet based on flex-fuel technology is a major driving factor of long-run ethanol demand. Further, the dynamics of gasohol (mandatory blend of gasoline and ethanol) and ethanol prices operate in a symmetric manner over ethanol demand, thereby evidencing the increasing substitutability between these alternative fuels.

Introduction

In April 2008, ethanol became the second most consumed liquid fuel (in volume)used for transportation purposes in Brazil after diesel (ANP, 2010a). This attainment well demonstrates current trends in fuel consumption in Brazil and reflects the increasing importance of ethanol in the available fuel mix. The increment in ethanol consumption over the last decade is, to a great degree, attributable to certain market drivers, the most remarkable of which are the growing sales of flexible fuel (flex-fuel) vehicles (FFVs) (Anfavea, 2010) and the relative price advantage of ethanol over gasoline during this period (ANP, 2010a). However, notwithstanding the impactof market forces, the diffusion of ethanol in Brazil is also a positive response to a number of policy-oriented initiatives, including the expansion ofproductive capacity that has successfully converted a colonial cultivation (sugarcane) into the most outstanding example of biofuel application in the world (Goldemberg et al., 2004). It is also an outcome of the establishment of flex-fuel technology as the main platform for the national automobile industry.

Ethanol usage in Brazil has its roots in the 1930s, when the fuel (anhydrous ethanol) first served as an additive to gasoline (BNDES, 2008). The introduction of ethanol as an independent fuel in its hydrous form came in 1975 with policies promoting its use as a strategic response to the oil crises of 1973 and 1979 and to depressed international sugar prices (Rosillo-Calle and Cortez, 1998, Rosillo-Calle and Heatford, 1987, Rothman et al., 1983). Resounding progress in the demand for the new fuel followed in the second half of the 1970s and throughout the 1980s. Ethanol demand subsequently collapsed because of lower oil prices, the appreciation of sugar prices in the international market and the withdrawal of government sponsorship of the ethanol program (BNDES, 2008). However, during the period 1997–2003, a revised set of institutional arrangements and market-leading innovations provided new momentum for the ethanol program in Brazil (EPE, 2008). This included the creation of the National Energy Policy Council and the National Agency for Petroleum, Natural Gas, and Biofuels in 1997 and the establishment of the current regulatory framework for biofuels (BNDES, 2008), culminating in 2003 with the launch of the first flex-fuel car in Brazil (Anfavea, 2010).

It is in the context of the rapid transformation of the Brazilian fuel mix that we propose this study. Our main purpose is to provide updated estimates of ethanol demand in Brazil after 2003. To do this, we assess ethanol demand in Brazil as a function of the price of ethanol, the average income of consumers, fleet growth and cross effects with the price of gasohol. From this point onward, we refer to the blend of gasoline and anhydrous ethanol as gasohol. This is an exclusively gasoline-based fuel commercialized in Brazil for road transportation purposes. We formulate the empirical analysis using a cointegration approach with autoregressive distributed lag (ARDL) bounds test. The main benefit of this approach is that it allows the simultaneous and consistent estimation of short- and long-run elasticities in the context of a limited data series (Bentzen and Engsted, 2001, Ghosh, 2010). We carry out our evaluation using monthly data from January 2003 to July 2010.

This work is one of a number of other research initiatives concerned with better comprehending the current debate on ethanol development in Brazil. Interest in the recent history of ethanol development is an object of particular interest for researchers because of the perspectives and challenges faced by ethanol in the middle and long term. The evidence provided demonstrates that the fundamental determinants of ethanol demand in Brazil are growth in the automobile fleet followed by the influence of ethanol and gasohol prices. The results also show that ethanol and gasohol prices exhibit an inverted and symmetric effect on ethanol demand, thereby indicating that ethanol as a fuel has strengthened its position as a gasohol substitute.

The remainder of the paper is structured as follows. Section 2 provides an update of the Brazilian ethanol program, along with a review of the factors driving increased ethanol consumption in Brazil. Section 3 surveys the previous research on fuel demand in Brazil and discusses the data and methodological aspects of the study. Section 4 presents the main results and some selected policy implications. Section 5 concludes.