David R. Just

The Economics of Brazil's Ethanol-Sugar Markets, Mandates, and Tax Exemptions

Sugarcane in Brazil is processed into sugar and/or ethanol, often in flex plants that can switch between the two products. We develop an economic model of flex plants, export demands, and two domestic fuel demand curves for a blend of ethanol with gasoline consumed by conventional cars, and ethanol consumed only by flex cars. We analyze the market impacts of the following policies: the blend mandate; fixing gasoline prices below world prices; the high gasoline tax; and a higher tax exemption for ethanol blended with gasoline. Because Brazilian and U.S. ethanol prices have become linked, a change in Brazilian ethanol policy or a shock in world sugar markets can now impact U.S. ethanol and corn prices. We show that in theory, each policy analyzed has an ambiguous impact on ethanol and sugar prices. Empirically, however, a low gasoline tax and a high tax exemption for ethanol used in the fuel blend reduce ethanol and sugar prices; this contradicts conventional wisdom. Overall, we find that policy reforms implemented in 2010 offset the ethanol price increase by about 27% due to outward shifts in fuel transportation and sugar export demand curves, and due to a reduced sugarcane supply caused by bad weather. Our model illustrates the importance of Brazils ethanol policies on world commodity markets; it also provides insight into how the Brazilian government can adjust policies to better control domestic inflation while minimizing impacts on investment.

An Enhanced Exposition of the Corn-Ethanol-Energy Price Linkages and Implications for Time Series Analysis of Biofuel Policy Impacts

The purpose of this chapter is to critically assess a burgeoning literature that uses high-frequency time series (HFT) econometric analysis (using daily, weekly or monthly data) that frantically seeks a link between feedstock and biofuel prices (say corn and ethanol), biofuel and gasoline/diesel prices, or directly between feedstock (e.g., corn) and crude oil prices. All of these papers explicitly or implicitly state that their objective is to determine the impact of biofuel policies on food commodity prices, and that their results have policy implications. To them, the impact of biofuel policies simply depends on the size and significance of the positive relationship between these prices: feedstock, biofuel, energy, or crude oil prices. Granger causality tests are also undertaken (studies even find corn prices “cause” crude oil prices!) If no link is found or the evidence is mixed then biofuel policies’ impact on crop prices is just that: none or unclear, respectively. All papers in this HFT econometric literature come to one of these three conclusions on biofuel policies’ impact on commodity markets: yes, no, or maybe.

The Interaction Effects Among Biofuels, Policies, and Countries

The models developed in this book span different feedstocks, biofuels, and countries and, therefore, we have already come across several important interactions. For example, we closed the previous chapter on how the expiring US tax credit impacted Brazilian ethanol prices. In the chapter before that, we showed how the complex structure of the US mandate affected domestic and international ethanol and biodiesel prices and trade. Throughout the book so far, we showed how market shocks or policy changes can affect regime changes (e.g., the mandate versus tax credit binding). These interactions can occur across biofuel policies, within a country and across countries and biofuels.

The Economics of Biodiesel and the Central Role of the European Union’s Policies

Biodiesel averaged 20 percent of total world biofuel production by volume in the period 2010–2012.1 Biodiesel is expected to reach 25 percent of total biofuel volume by 2025. However, its share in vehicle miles traveled is higher because a gallon of biodiesel obtains 91.3 percent of the miles traveled compared to a gallon of diesel whereas ethanol produces an estimated 70 percent of the miles traveled as gasoline—and diesel engines, on average, get approximately 37 percent more miles per gallon than gasoline (see Box 2.2). The European Union, United States, and Brazil are, respectively, the world’s largest producers and consumers of biodiesel. The European Union consumed 42 percent of total biodiesel in 2013 (down from 75 percent in 2005), and it is expected to decline to 40 percent in 2020 (OECD/FAO 2014).