This is an extract from a recent report “Green Industrial Policy: Concept, Policies, Country Experiences” by UN Environment. This extract specifically focuses on Brazil’s Ethanol Policy.
Introduction
Brazil pioneered policies to stimulate the consumption of renewable energy sources, providing incentives for the production of hydroelectricity and ethanol. Policies that foster the industrial transformation of sugar cane into ethanol gained attention during a period of strong economic growth in Brazil under the 1964 to 1985 authoritarian political regime. The adoption of these policies was not due to environmental concerns, which were not widespread at the time. Instead, the motivations for these policies in Brazil were directly related to limiting the rise of the oil imports after the oil price shocks of the 1970s and to mitigating the macro-economic impacts of any further shocks. Brazil now runs one of the world’s most successful programmes for using renewable energies in its transport sector. These policies have produced a high proportion of renewables in Brazil’s energy matrix, more than 40 per cent in 2015, giving the country significant status in environmental and climate change negotiations.
Can these policies be considered ‘green’? On one hand, they actually stimulated the supply and demand for renewable energy. On the other hand, analysis of these policies’ implementation reveals a limited perception on the part of the government in any green dimension. This is particularly notable in the case of ethanol policy, which evolved in accordance with criteria and priorities only marginally related to green concerns. Brazil now has more than 40 years of experience with sectoral policies in this area, which involve policies aimed at the different stages of the ethanol’s production chain.
The first phase of the Ethanol policy was from 1975 to 1990: The first governmental measures aimed at encouraging the production and consumption of ethanol added to gasoline dated from the 1930s, establishing a proportion reaching 5 per cent of ethanol to be mixed with gasoline. Until the end of the 1960s, the principal economic function of ethanol production, for the government and for producers, was to avoid oversupplying sugar and depressing its prices. From 1985 until 2003, annual ethanol production stayed within the 10 to 15 billion litres range.
The second phase of the Ethanol policy was from 2002 to 2015: The political game changer between the first and second policy cycles was the growing international perception of climate risks and the enormous responsibility of fossil fuel burning for the greenhouse gas emissions that cause global warming. Ethanol, especially from sugarcane, was identified as one of the most promising options to replace fossil fuels. After 2003, propelled by strong growth in demand, ethanol production went through a period of consolidation, marked by a concentration in large companies, and by the entrance into the sector of business groups from the food and energy sectors.
Policy Lessons
Due to the long history of ethanol policies, Brazil now has one of the most successful programmes in the world for the use of renewable energy in the transport sector. No other country in the world has a fleet of almost 20 million light vehicles that can use any combination of gasoline and sugarcane ethanol the consumer wants to use. Despite recent difficulties, Brazil has maintained its position as the second largest producer of ethanol in the world, accounting for 25 per cent of global production and 20 per cent of global exports. In 2014, sugarcane was the second principal source in the Brazilian energy matrix, with 15.7 per cent of the total, compared to 39.4 per cent for oil and gas. A wide set of policy instruments, including investments, price subsidies, and demand incentives, were deployed in the 1980s to promote suppliers in the agricultural and industrial sector, especially in sectors producing capital goods such as agricultural machinery and equipment for sugarcane processing, ethanol production and stocking.
While, in the last decades, the producers of agricultural machinery have benefited from the strong performance of the Brazilian agricultural sector as a whole–and particularly from the commodities boom of the past decade–companies engaged in the production of industrial capital goods for ethanol mills suffered from the ups and downs of ethanol production and of the associated policies. As a consequence, industrial spillovers arising from ethanol policies to supply sectors, although relevant, were limited by the volatility of the demand that the ethanol-producing firms had for dedicated capital goods. In principle, the pattern of government intervention applied to the ethanol sector and the instruments mobilised to foster its emergence do not differ from the ones that guided the import-substitution industrialisation that Brazil went through in the previous decades: High tax and credit subsidies combined with instruments and incentives adapted to the specific features of the sector. The direct and indirect subsidies mobilised by the ethanol policies have been substantial compared to the size of the Brazilian economy, but were significantly reduced at the end of the 1980s, forcing the industry to consolidate.
There is no doubt that the ability to foster the emergence of new producers in the Southeast, the most developed region of Brazil, and to attract investors and large companies from other activities to the ethanol industry has been one of the main successes of the ethanol policies. This was essential for the technological and organisational modernisation of the firms acting in the sector and ultimately for their survival despite the ups and downs in its performance and the swings in the public policies. It created the conditions for reducing the production cost of ethanol, which decreased by 65 per cent from 1976 to 2005 for a number of reasons, including innovation in research and development, economies of scale and the effects of learning by doing. The crisis that the ethanol sectors underwent from 2008 was largely due to a combination of policies geared at controlling the consumer prices for gasoline in the domestic market, in a period of high international oil prices, with the reduction of the value of CIDE-Fuels incurred on gasoline sales, reaching zero in July 2012.
The assessment of ethanol industrial policies in Brazil should consider the nature and specific characteristics of this industry, at the supply as well as at the demand level. From the point of view of its final use, ethanol competes with fossil fuel and the demand for it depends basically on the relative prices of the two products, besides the regulation related to the gasoline mix with ethanol. Industrial policies aimed at fostering the demand for ethanol in Brazil combined incentives for the development of ethanol-powered cars and later for flex-fuel cars. Associated price controls or use of a specific tax, CIDE-Fuels, kept relative prices of ethanol attractive to consumers. The launching of flex-fuel cars, stimulated by tax and credit subsidies, created a potentially large and growing market for ethanol and helped to increase the price elasticity of the demand for ethanol in Brazil. Consumption of ethanol depended strongly on the price of gasoline.
An additional factor that played a relevant, although secondary, role in stimulating ethanol production is the external demand. Although industrial policies can do little to increase foreign demand, trade policies can help. Brazil engaged in trade negotiations with developed countries in the mid-1990s at the Doha Round and other venues, with the liberalisation of trade barriers to ethanol as one of its top priorities in terms of market access demands. Furthermore, the country signed a memorandum with the US to define an agenda for disseminating the use of ethanol around the world, through the establishment of technical standards. None of these initiatives resulted in relevant achievements and ethanol exports still face relevant barriers to enter foreign markets.
On the supply side, ethanol competes with sugar for sugarcane as a raw material. Furthermore, being an agricultural commodity, sugarcane production and productivity depend on climate instabilities, soil conditions and other variables. While processing facilities exist that produce ethanol exclusively, the large majority of producers process the sugarcane to produce sugar and ethanol, in a mix that depends on relative prices of both products. Therefore, while on the demand side the incentives to produce ethanol depend strongly on the domestic policies related to fossil fuels, on the supply side these incentives are strictly conditioned by the relative prices of ethanol and sugar, and so by the fluctuations and trends in the international prices of sugar. These specific features of ethanol production tend to create a structural volatility in its supply, leaving it vulnerable to the vagaries of policies and markets for sugar and for fossil fuels. With new research on energy cane varieties geared specifically for ethanol production, this linkage between ethanol and sugar may be broken in the future, thereby stabilising the ethanol market.
Ethanol industrial policies have to deal with these sector-specific characteristics if they aim to foster the development of the sector, with or without environmental motivations. During the period of strong government intervention, a wide set of policy instruments were used. As already stressed, the main instruments were subsidised credit lines for investment and production, price administration and arbitration between sugar and ethanol, and purchase guarantees. Except for BNDES’ credit lines for investments, which can include a subsidies component, and the recent support for innovation in second-generation ethanol, most of these instruments have been phased out. Actually, the subsidy component of the ethanol industrial policy has lost relevance. As more interventionist policies tend to be unfeasible for fiscal reasons, government policies are likely to concentrate on two instruments: the mandatory blending of gasoline and ethanol and using CIDEFuel to influence the price ratio in favour of ethanol consumption.
Especially in a period of low international oil prices, these instruments seem to be best fitted to drive the performance of this industry in the next years, while at the same time avoiding the introduction of artificial distortions in the management of gasoline’s domestic prices. In recent years under the PAISS programme, Brazil has moved in a different direction, away from consumption mandates and demand-driving pricing schemes, toward supply-side interventions designed to boost the productivity of the agricultural resource. While there are encouraging signs, it is too early to tell whether this new approach ultimately will be successful. This is partly because we have too few years of data, and partly because the commercialisation of second-generation ethanol is still in its early stages. Success in such a dynamic field, so crowded with international competitors, is inherently uncertain.
Conclusion
Reference was made, in the introduction, to the ambivalence of the ethanol policies in Brazil, when assessed according to green criteria. On one hand, these policies can be considered green, to the extent that, irrespective of their rationale and motivations, they actually promoted changes in the structure of the energy matrix, in a direction compatible with the objectives of sustainable development. Nowadays, more than 15 per cent of Brazil’s energy matrix has sugarcane as its source and the balance of greenhouse gas emissions from the production and consumption of ethanol is clearly favourable compared to that of gasoline and other biofuels. Therefore, from the point of view of their aggregate result, industrial policies targeting ethanol production, besides being successful as import substitution policies, can also be considered green. When the entire life cycle of ethanol production is considered, the picture is more nuanced.
Other authors disagree with this view, pointing to the indirect impacts on the Amazon region of the expansion of sugarcane production. These discussions will continue, as sustainability becomes a mainstream concern. On the other hand–and this is the ambivalence– the implementation of ethanol policies reveals a narrow perception on the part of the government of their green dimension. This appears clearly in the first phases of Proálcool, during the military regime, when the expansion of sugarcane production did not consider the environmental effects and the social consequences. During the initial years of the Programme, the expansion of sugarcane production principally occurred through the extension of the planted areas, including in regions previously occupied by other economic activities, such as coffee or livestock raising. In this period, the working conditions in the production and harvesting of sugarcane, activities that involved a large number of temporary workers due to the low level of mechanisation, were far from adequate even when assessed according to the Brazilian legislation.
It is striking that the recent crisis in the ethanol sector, mostly driven by domestic policy choices related to the price of fossil fuels, followed a period when ethanol was praised in Brazil and in other countries for its green attributes. At this time, Brazil supported the use of ethanol as a biofuel, while pushing for the inclusion of ethanol in the list of environmental goods during the Doha Round negotiations at the WTO. It was impossible to imagine that a few years after this period of ethanol-euphoria the sector would go through a deep crisis that is still ongoing. Government policies, however, generated a high level of uncertainty and unpredictability that has damaged the sector and its performance. The past changes of ethanol policies in Brazil indicate how vulnerable these can be with regard to economic cycles and government priorities that are not directly linked to environmental and climate goals. As a matter of fact, until the advent of the relatively recent PAISS programme, the green dimension has never played a major role in the design of ethanol development policies in Brazil.
Conceived to promote ethanol as a substitute for fossil fuels during the oil crisis of the 1970s, these policies ended up linking the ventures of this sector to the volatility of the domestic policies for the fossil fuels sector. Thus, PAISS in this sense represents a distinct departure from previous policies. Finally, the ethanol policies have been oriented only partly towards industrial upgrading and technological learning. The main policy focus was on increased agricultural productivity. Some technological spillovers, however, are worth mentioning. These include the development of innovative flex-fuel engines; processing of ethanol-based chemicals; and sophisticated sugar and ethanol processing plants, which are likely to receive a technological boost with the shift to processing cellulose-based ethanol.
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