Brazil is the second largest producer and consumer of ethanol, accounting for one-third of the global ethanol production and ethanol consumption. In Brazil, ethanol utilises sugarcane as feedstock.
The emergence of the ethanol industry in Brazil dates back to 1930s when the ethanol was blended with gasoline in order to accommodate fluctuations in sugar demand coupled with a need to reduce dependence on energy imports. The Brazilian government launched an aggressive plan to promote ethanol consumption over gasoline under the National Ethanol Program (PROALCOOL) in 1975 as a response to the oil crisis.
There was a severe global oil crisis in the 1970s as the OPEC countries slashed production and curtailed oil exports to the countries supporting Israel during the Arab-Israel war in 1973. This led to an international crude oil shortage and a sharp increase in oil prices. The crude oil prices increased by around 250% to 11.46$/barrel in 1974 from 3.3$ in 1973 as shown in the below graph. In 1974, nearly 80% of Brazil’s oil consumption was through imports and this increase in crude oil prices placed a substantial burden on its economy. Consequently, Brazil started focusing on developing a substitute to crude oil in order to reduce dependence on oil imports, this led to the launch of PROALCOOL. Its aim was to increase the domestic production of sugarcane ethanol from 0.5 billion litres in 1975 to 3 billion litres by 1979. The ethanol blend in gasoline was to be increased by 20%. The government provided low-interest loans and credit guarantees for the construction of ethanol distilleries. Subsequently, by 1980, Brazilian ethanol production surpassed 3 billion litres and ethanol blend to gasoline was approximately 17%.
The second phase of PROALCOOL was launched in the 1980s, which focused on the expansion of sugarcane cultivation and capacity to produce hydrated ethanol (ethanol as a substitute and not as an additive to gasoline). The government provided subsidies and tax incentives for sugarcane plantation and construction of distillation capacities. The taxes were reduced for ethanol-powered vehicles and tax exemption was provided for ethanol fuel sales. The ethanol prices were also fixed at around 65% of the gasoline prices. Petrobras established a nationwide ethanol fuel distribution network in all the fuel stations. Furthermore, the government guaranteed the supply of sugarcane for ethanol production via a strict control on sugarcane acreage for sugar and ethanol production.
It was estimated that from 1975-1989, the investment required to build 1m3 of ethanol distillation capacity was US$ 213.88 and the total financing for ethanol distilleries was subsidised from 71% to 96 %. Therefore, the government expenses to support investments in distilleries were more than US$ 1.5 billion (US$ at 1987 basis). The tax reductions and exemptions were roughly around US$ 7 billion (Source: US FDA).
The high prices of crude oil along with subsidies on ethanol run cars and ethanol fuel led to a sharp increase in sales of ethanol powered cars. The share of ethanol vehicles registered in Brazil rose from a marginal 0.3% (1979) to 95.7% (1985). The ethanol consumption as a percentage of total fuel also increased from 5.6% (1980) to around 16.7% (1985).
However, as the prices of crude oil started declining from 1985 and the sugar prices appreciated in the international market, ethanol production became economically unviable. The government also pulled back on ethanol incentive policies and encouraged exports of sugar to benefit from high international prices. Thus, by the end of the decade, there was a supply crunch of ethanol fuel, this led to a decline in sales of ethanol-fuelled vehicles. Therefore, the share of ethanol vehicles declined from 93.6% (1987) to 60.5% (1989). In absolute terms, the registration of new ethanol run vehicles declined by 43% from 1986 to 1989.
In addition, by 1989 all incentives to the ethanol industry were eliminated. The ethanol prices, sugarcane acreage for ethanol production were de-regulated and export quotas abolished. However, the ethanol blend to gasoline was maintained at 22%. Hence, 1990’s marked an end of ethanol run vehicles in Brazil and the ethanol consumption was limited to blending ethanol.
The crude oil prices rose again from 2003 onwards on the back of the increase in demand. The government of Brazil, in order to control the inflationary impact of fuel prices on the economy, kept the retail fuel prices at similar levels. This was done by increasing anhydrous ethanol blending mandate and reducing taxes and this increased the financial burden on the government. The global crude oil prices increased at a CAGR of 12% (in BRL; 26% in USD) against which Brazil’s gasoline retail prices remained at similar levels between 2004-08.
Additionally, coinciding with the rising gasoline prices, the flex fuel vehicle cars were launched in Brazil in 2003. The flex-fuel cars run on gasoline and hydrated ethanol, soon after the launch, the sales of flex vehicles increased sharply. The share of flex fuel cars among newly registered vehicles increased from around 4% (2003) to more than 90% (2008). The quick adaptation of flex vehicles in Brazil was mainly on account of tax incentives, the price advantage of ethanol vs. gasoline, ease of switch between gasoline and ethanol along with an established nationwide hydrous ethanol distribution network. The hydrous ethanol provides lower mileage as compared to gasoline, thus, the price ratio between hydrous ethanol and gasoline should be between 65%-70% for the former to be economically viable.
The government offered tax incentives to flex vehicles in the form of lower taxes as compared to gasoline-only powered vehicles. It also provided tax incentives to fuel ethanol in various forms to promote ethanol consumption. The Brazilian fuel ethanol industry with a healthy demand from the domestic market, rising gasoline prices and supportive government policies looked very promising in 2008. The ethanol production and consumption in Brazil grew at healthy CAGR of 13% and 11% respectively between 2003 and 2008. This was due to increase fuel demand from flex fuel vehicles.
The sugar prices in the international market increased sharply by 170% from USD 11.81/lb in 2008 to USD 32.1/lb in 2010, this led to a higher diversion of sugarcane towards the production of sugar in Brazil. This also led to a stagnation of ethanol production amid 2008 to 2010, although the domestic ethanol demand increased at a CAGR of 9% during the same period. Moreover, Brazil faced a drought situation in 2011, which impacted the sugarcane production and subsequently the ethanol production. All this led to an increase in ethanol prices by CAGR ~12 % during the interim. The Brazilian government reduced blending mandate to 20% (from 25%) and abolished ethanol import duty to counter huge ethanol demand-supply gap. This impacted the country’s status as an ethanol exporter in the global market. Brazil’s share in the global ethanol export declined sharply and it became a net importer in 2011 and aided the US, which became a leading ethanol exporter in the world.
The global sugar prices moderated from 32.1 USD/lb (2010) to USD 14.5/lb (2014), which led to diversion of cane towards ethanol production. Thus, the ethanol production increased by a CAGR of 7.6%, slightly higher than the demand growth of 6% during 2011-14. This resulted in stable ethanol prices, in the range of 1.9-2.0 BRL/litre during the period. Brazil’s ethanol export experienced a downward trend from 2013 onwards on account of tight ethanol demand-supply scenario in the domestic market. A high Brazilian ethanol price made the Brazilian sugarcane-based ethanol less competitive as compared to the US corn-based ethanol in the global market.
The Brazilian economy declined by 3.85% and 3.25% (source: Brazil Central Bank estimates) in 2015 and 2016, this led to a decline in the overall fuel consumption in the country. Notwithstanding, the decline in fuel consumption, the demand for ethanol increased in 2015 (before declining in 2016) due to rise in ethanol blending mandate from 25% to 27%. This came into effect from March 2015. The ethanol production though grew at a slower pace of 6% in 2015 (against demand growth of 10.8%). This was on account of a lower availability of sugarcane due to decline in the harvested area (2% Y-o-Y decline) as farmers shifted to other profitable crops like soybean and corn. Further, there were adverse weather conditions, which resulted in lower sugarcane yield (12% Y-o-Y decline) and TRS. This led to a sharp increase in ethanol prices by 35% (Y-o-Y) in 2015. This upward trend continued in 2016 on the back of lower ethanol production. Although domestic ethanol demand also declined in the same year owing to diversion of cane towards sugar production on the back of improved global sugar prices. However, crude oil prices declined significantly following the year 2014, but ethanol prices in Brazil increased. This was guided by higher gasoline prices on account of excessive taxes imposed by the Brazilian government on gasoline.
Ethanol prices in Brazil are expected to remain firm in 2017 and will be supported by higher cane diversion towards sugar production and increase in gasoline prices as announced by Petrobras. The global sugar prices are also expected to remain strong in 2017. However, these are projected to gradually decline in 2017 and 2018, on account of improvement in global sugar supply by Brazil and India.