Ethanol And Brazil: The New Global Energy Brand?

When it comes to energy, Brazil is on its way to becoming a "global brand." Although the United States recently outpaced Brazil in ethanol production, Brazil is by far the leader in sugar-based ethanol. Its exports are growing, and it could become a major energy supplier to the world. But what Brazil is particularly known for is its grand conversion-moving almost 40 percent of its automotive fuel from gasoline to ethanol.

Ethanol in Brazil is used in two ways: either blended, in a mix of 75 percent gasoline and 25 percent ethanol, or as pure ethanol pumped directly into a car's fuel tank. On any given day, motorists across Brazil can stand in front of a pump and decide, based on price, whether they want to put ethanol or gasoline into their "flex fuel" car engine or whether they want to blend them.

Brazil has now achieved energy self-sufficiency. Ethanol is a part of the explanation, but it would be an error to think that it is the only one. There has been great success from drilling in Brazil's offshore waters, and domestic oil output has increased by 40 percent since 2000-from 1.2 million barrels per day (mbd) to 1.7 mbd in 2006. This 500,000 barrel per day increase compares to 240,000 barrels per day of ethanol consumption.

How did ethanol achieve its prominent role in Brazil? It has been made possible by a series of factors: strong government support, especially after the 1973 oil shock; continual adoption of new technologies over more than a quarter century; and the cheapest production costs in the world.

The Brazilian government made a strong commitment to ethanol in the mid-1970s, in response to the first oil crisis. At that time, Brazil was importing more than 80 percent of its oil. The first oil shock had a highly detrimental effect on Brazil's economy, influencing a significant drop in the country's GDP growth, from almost 14 percent in 1973 to five percent in 1975. A program to stimulate domestic production of ethanol as a transport fuel was embraced as the way to reduce the country's exposure to the world oil market.

This Brazilian effort began in 1975. It was championed as the Pro-Alcohol Program, since ethanol is known as alcohol in Brazil. The program consisted of both public and heavily subsidized private investment in ethanol production, together with governmental mandates to blend the fuel with gasoline and incentives to stimulate the sales of cars that ran on pure ethanol.

With government incentives, pure ethanol vehicles comprised 95 percent per cent of domestic auto production in 1984. By 1988, Brazil was consuming 1.7 gallons of ethanol for each gallon of gasoline.
In the mid-1980s, however, ethanol got caught in a vise. Oil prices fell sharply and, at the same time, international sugar prices rose. Ethanol was no longer as attractive as it had been for Brazilian producers and motorists.

By the end of the 1980s, a sharp fall in ethanol production, together with a prevalence of pure ethanol vehicles, led to a shortage, enraging motorists and damaging the credibility of Brazil's ethanol industry. As consequence, ethanol cars fell from 92 percent of total vehicle sales in 1985 to less than 20 percent in 1990. At the end of the 1990s, ethanol production was back to same level that it had been in the mid-1980s. Today, almost no pure alcohol vehicles are being produced, in large part because of an innovation that has recently helped ethanol enjoy a new boom in Brazil. This is the "flex-fuel vehicle."

The flexible fuel vehicle is a simple technological innovation that has dramatically enhanced the attractiveness of ethanol in Brazil by giving consumers choice of the fuel they can use in their cars.

After 2000, stimulated by rising oil prices and a new initiative by the government to encourage consumption of renewable fuels, the Brazilian automotive industry began to produce vehicles that could run on either ethanol or gasoline in any proportion. The previous experience with the Pro-Alcohol Program had left behind a strongly developed ethanol infrastructure, with more than 90 percent of the country's filling stations capable of offering the fuel in its pure form.

Thanks to competitive pricing for the vehicles and for ethanol, flex-fuel vehicles have been widely adopted in Brazil. They represented 80 percent of all light cars sales in 2006, a number even more impressive considering that they only started to be marketed by the end of 2003.

Today, many Brazilian motorists make their fuel choice based on the relative price of gasoline and ethanol. And ethanol is able to compete without any subsidies against gasoline. This partly is because the government taxes gasoline at a higher rate-the gasoline tax burden is 45 percent of the final price, while the tax on ethanol is only 28 percent. But the main reason behind ethanol's competitiveness is that Brazil's sugar-based ethanol has the lowest production costs in the world-estimated at $1.10 per gallon.

Good weather and high land quality are certainly important factors in keeping down the costs of ethanol in Brazil, but they are not the only ones. Sugarcane has been grown in the country since the Portuguese colonization in the early 16th century, and industrial production of ethanol as a fuel goes back to the 1930s.

The 70-year old ethanol industry has invested heavily in new technologies and processes, and biotechnology is now employed to improve the quality and productivity of the sugarcane species. Integration of ethanol production with sugarcane processing has led to significant gains in efficiency and scale. For example, the cane fiber (called bagasse) is burned to generate electricity, which powers the sugar and ethanol production plant, with surplus power sold to the central grid.

The oil input in Brazilian's ethanol production is minimal, restricted to the transporting of the sugarcane to the processing plant and moving ethanol from there to filling stations. The combination of these advantages provides Brazilian ethanol with a comfortable competitive position against oil.

The success of Brazil's domestic industry poses an important question: Can Brazil go global with its ethanol? Brazil is already the largest ethanol exporter in the world, shipping 20 percent of it annual production abroad.

International demand for ethanol is expected to keep growing in the years to come. The main ethanol consumers outside Brazil are the United States and Europe, which are seeking to increase their domestic sources of ethanol supply. But, at least with current technology, their prospects are constrained.

High volume ethanol exports from Brazil to both the U.S. and Europe are also currently impeded by import duties, though some believe that growing demand for bio-fuels could lead to loosening of these barriers. But what happens to those barriers will be highly political, both in terms of domestic politics and trade negotiations.

If trade barriers fall, Brazil's industry has much room to grow. Even excluding the rain forest and other protected areas, Brazil still has large areas that could be used to grow cane. Only two percent of the country's total endowment of arable land-and ten percent of currently cultivated land-are now under sugarcane cultivation with half of that dedicated to ethanol production.

Advances in bio-technology have substantially enhanced plant types, improving their ability to thrive in a wider range of soils and climates. All this means that there is potential to expand Brazil's ethanol production substantially and make it a major global energy supplier.

Furthermore, expansion of ethanol production in Brazil is unlikely to create the kind of food versus fuel conflicts that can be expected in other developing countries with agricultural potential.

How large a role Brazil will play in global markets will depend on many factors-the ability of the Brazilian industry to expand; the nature of fuel mandates and domestic industries of the large industrial countries; and international trade rules. Brazil's ethanol industry will continue to play a large role in meeting Brazil's domestic energy needs. It also has the potential to grow beyond the domestic market and to create large scale exports-and definitely make Brazil an energy brand around the world.