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Group Title: Policy Brief Series - International Agricultural Trade and Policy Center. University of Florida ; no. 03-7
Title: Ethanol from sugar : the case of hidden sugar subsidies in Brazil
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Title: Ethanol from sugar : the case of hidden sugar subsidies in Brazil
Series Title: Policy Brief Series - International Agricultural Trade and Policy Center. University of Florida ; no. 03-7
Physical Description: Book
Language: English
Creator: Schmitz, Andrew
Schmitz, Troy G.
Seale, James L., Jr.
Publisher: International Agricultural Trade and Policy Center, Institute of Food and Agricultural Sciences, University of Florida
Institute of Food and Agricultural Sciences, University of Florida
Place of Publication: Gainesville, Fla.
Publication Date: 2003
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Bibliographic ID: UF00089762
Volume ID: VID00001
Source Institution: University of Florida
Holding Location: University of Florida
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PBTC 03-7


i -ional Agricultural Trade and Policy Center



ETHANOL FROM SUGAR: THE CASE OF HIDDEN SUGAR
SUBSIDIES IN BRAZIL
By

Andrew Schmitz, Troy G. Schmitz, and James L. Seale, Jr.
PBTC 03-7 July 2003


POLICY BRIEF SERIES


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UNIVERSITY OF
FLORIDA


Institute of Food and Agricultural Sciences


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INTERNATIONAL AGRICULTURAL TRADE AND POLICY CENTER


MISSION AND SCOPE: The International Agricultural Trade and Policy Center
(IATPC) was established in 1990 in the Food and Resource Economics Department
(FRED) of the Institute of Food and Agricultural Sciences (IFAS) at the University of
Florida. Its mission is to provide information, education, and research directed to
immediate and long-term enhancement and sustainability of international trade and
natural resource use. Its scope includes not only trade and related policy issues, but also
agricultural, rural, resource, environmental, food, state, national and international
policies, regulations, and issues that influence trade and development.

OBJECTIVES:

The Center's objectives are to:

Serve as a university-wide focal point and resource base for research on
international agricultural trade and trade policy issues
Facilitate dissemination of agricultural trade related research results and
publications
Encourage interaction between researchers, business and industry groups,
state and federal agencies, and policymakers in the examination and
discussion of agricultural trade policy questions
Provide support to initiatives that enable a better understanding of trade and
policy issues that impact the competitiveness of Florida and southeastern
agriculture specialty crops and livestock in the U.S. and international markets










EHTANOL FROM SUGAR: THE CASE OF HIDDEN SUGAR
SUBSIDIES IN BRAZIL

Andrew Schmitz, Troy G. Schmitz, and James L. Seale, Jr.
University of Florida, Gainesville, Florida
Arizona State University, Mesa, Arizona
University of Florida, Gainesville, Florida


INTRODUCTION

Brazil is the world's largest producer of sugarcane, the world's largest exporter of sugar,
and the world's third largest consumer of sugar. Brazil produces sugarcane-refined sugar for
human use as well as anhydrous and hydrous alcohol, which are used mainly as a blend when
converting alcohol to domestically consumed gasoline. Over 50 percent of Brazil's sugarcane
production is converted into fuel for automobile use.

The Brazilian government affects Brazil's sugarcane market through its alcohol fuel
program. The government sets the blend ratio for blending alcohol with gasoline. At the FAO
Conference in Africa in October 2002, one of the authors was repeatedly asked whether Brazil's
fuel policy provided a hidden subsidy to Brazilian sugarcane farmers (Schmitz, Seale, and
Schmitz 2002). The answer is yes. Changes in the ethanol program and increasing blend ratios
transfer more than 100 million dollars annually in the form of hidden subsidies. However, the
effects of these subsidies on world market prices are much different than in the case of price
supports-deficiency payment type schemes. In the case of Brazil, the fuel policy can result in an
increase in world sugar prices, whereas prices would fall under alternative-type direct subsidies.
Cases may exist where world prices decrease as a result of Brazil's fuel policy even though
sugarcane production increases and producer welfare increases.

THE BRAZILIAN SUGAR-ALCOHOL INDUSTRY

Brazilian sugarcane has three major uses: refined sugar, anhydrous alcohol, and hydrous
alcohol. Anhydrous alcohol is used as a blend with gasoline as mandated by the Brazilian
government, and hydrous alcohol is used as fuel for vehicles that are powered 100 percent by
alcohol.

Part of the reason for the substantial increase in anhydrous alcohol production in Brazil is
due to the phenomenal increase in the yield of ethanol from sugarcane. In 1999, roughly 5,500
liters were produced per hectare, whereas in 1975, per-hectare yield was only approximately
2,000 liters (Figure 1). This represents almost a three-fold increase in the efficiency of ethanol
production per year. Brazil placed import tariffs and export taxes on sugar to ensure that
alcohol-production targets were met (Schmitz, Seale and Buzzanell, 2002). The Brazilian
National Alcohol Program (PROALCOOL) was created in 1975 in response to the 1973 oil crisis.
Under this program, the Institute of Sugar and Alcohol (IAA) purchased anhydrous alcohol at an
equivalency rate of 44 liters of alcohol per 60-kilogram bag of sugar while Petrobas, the state
owned oil company, controlled ethanol distribution. Credit guarantees and low fixed-interest-rate
subsidies were also provided for the construction of distilleries and autonomous plants built
adjacent to sugar mills.










Ethanol production is still regulated by government decree. Each year, a Presidential
Decree sets an alcohol-to-gasoline blend-ratio range for the percentage of ethanol that must be
used in Brazilian gasoline.


5,500

5,000

4,500

it 4,000

S3,500

. 3,000

2,500

2,000


1,500


00 00 00 00
0'^ '^ '^ '^ 0'


Figure 1. Ethanol yield from sugarcane in Brazil, 1975-1999
(Schmitz, Seale, and Buzzanell, 2002).


Both the domestic sugar and ethanol markets are protected from competition from other
low-cost exporters. A common external tariff of 20 percent on sugar imports and 30 percent on
imports of ethanol was put in place in 2001.

BLEND RATIOS AND BRAZILIAN SUGARCANE MARKETS

The Brazilian government sets the portion of anhydrous alcohol that is used in gas-
powered vehicles. This "blend ratio" is adjusted from time-to-time by government decree. For
example, the blend ratio was 25 percent in 1970 and then dropped to 11 percent by 1976; it
increased to 22 percent in 1985, and then decreased to 13 percent by 1990; and it reached as high
as 25 percent in June 2002, and then decreased to 20 percent in January 2003.

Using the 1998 to 2001 three-year average as a benchmark, based on actual data
regarding the blend ratio, supply, and demand over a range of plausible assumptions regarding the
shape of the supply and demand curves, empirical results show that the three-year weighted
weekly average of blend ratios from 1998 and 2001 was approximately 22 percent.

Based on the data, two sets of simulations were performed to obtain empirical results for
the impact of a change in the blend ratio over a typical marketing year. The first set simulated an
increase in the blend ratio from 22 to 24 percent, reflecting what actually occurred at one point










during 2002. The second set simulated a decrease in the blend ratio from 22 to 20 percent,
reflecting what was announced in January 2003.


Increase in the Blend Ratio

The empirical results associated with an increase in the blend ratio from 22 to 24 percent
are summarized below (Table 1). The amount of cane used for anhydrous alcohol production
rose by between 8.9 and 18.2 million metric tons (mmt), an increase of between 12 and 24.7
percent.


Table 1: Increase in blend ratio for anhydrous alcohol used in gasoline from 22% to 24%.
Low Sensitivity Medium Sensitivity High Sensitivity
Absolute Percentage Absolute Percentage Absolute Percentage
Difference* Difference Difference* Difference Difference* Difference
Cane Price Received by Farmers
($/MT) $0.31 3.2% $0.20 2.1% $0.12 1.3%
World Sugar Price ($/MT) $2.30 1.3% $1.47 0.8% $0.92 0.5%
Cane Used for Domestic Sugar
(mmt) -1.1 -1.6% -1.4 -2.1% -1.7 -2.6%
Cane Used for Anhydrous Alcohol
(mmt) 8.9 12.0% 11.9 16.1% 18.2 24.7%
Cane Used for Hydrous Alcohol
(mmt) -1.4 -1.6% -1.8 -2.1% -2.3 -2.6%
Cane Exported as Sugar to ROW
(mmt) -1.7 -2.6% -2.6 -4.1% -6.6 -10.3%
Total Cane Consumption (mmt) 6.4 2.8% 8.7 3.8% 14.2 6.2%
Total Cane Production (mmt) 4.7 1.6% 6.1 2.1% 7.6 2.6%
Sugar Consumer Surplus -$20 -3.2% -$13 -4.1% -$8 -5.1%
Anhydrous Consumer Surplus $180 25.5% $123 34.9% $98 55.5%
Hydrous Consumer Surplus -$27 -3.2% -$17 -4.1% -$11 -5.1%
Aggregate Domestic Consumer
Surplus $133 6.0% $93 8.5% $79 14.4%
Domestic Producer Surplus $91 4.2% $58 4.1% $37 5.0%
Aggregate Domestic Welfare $224 5.2% $151 6.0% $116 9.1%
ROW Sugar Processor Surplus -$20 -5.0% -$12 -8.0% -$8 -19.4%
*Measures an increase in the blend ratio from 22 to 24 percent over the benchmark period (1998-2001). [All prices
were converted to U.S. dollars for ease of comparison only; all welfare results are in millions of U.S. dollars.
Low Sensitivity results use initial values of demand elasticity = -0.5, supply elasticity = 0.5, and excess demand
elasticity = -2.0
Medium Sensitivity Results use initial values of demand elasticity = -1.0, supply elasticity = 1.0, and excess demand
elasticity = -5.0
High Sensitivity Results use initial values of demand elasticity = -2.0, supply elasticity = 2.0, and excess demand
elasticity = -20


In addition, the surplus accruing to sugarcane producers increases from between $37
million and $91 million (U.S. dollars) annually. Finally, aggregate welfare in the Brazilian sugar
sector increases between $116 million and $224 million (U.S. dollars). Of course, this latter
number does not include the losses accruing to crude-oil producers, crude-oil importers, etc. On










the other hand, it does not include the gains accruing to Brazilian society in general, due to the
fact that ethanol has been shown to be more environmentally friendly than gasoline made from
crude oil. In other words, Brazilian sugarcane producers would receive a subsidy of between $79
million and $133 million (U.S. dollars) per year if the blend ratio for anhydrous alcohol used in
gasoline were increased from 22 to 24 percent.

Decrease in the Blend Ratio

With a decrease in the ratio of anhydrous alcohol used in gasoline from 22 to 20 percent,
the surplus accruing to sugarcane producers decreases by between $36 million and $90 million
(U.S. dollars) annually (Table 2). Finally, aggregate welfare in the Brazilian sugar sector
decreases by between $93 million and $201 million (U.S. dollars) annually.


Table 2: Decrease in blend ratio for anhydrous alcohol used in Gasoline from 22% to 20%.
Low Sensitivity Medium Sensitivity High Sensitivity
Absolute Percentage Absolute Percentage Absolute Percentage
Difference* Difference Difference* Difference Difference* Difference
Cane Price Received by Farmers
($/MT) -$0.31 -3.2% -$0.20 -2.1% -$0.12 -1.3%
World Sugar Price ($/MT) -$2.30 -1.3% -$1.47 -0.8% -$0.92 -0.5%
Cane Used for Domestic Sugar
(mmt) 1.1 1.6% 1.4 2.1% 1.7 2.6%
Cane Used for Anhydrous Alcohol
(mmt) -8.9 -12.0% -11.9 -16.1% -18.2 -24.7%
Cane Used for Hydrous Alcohol
(mmt) 1.4 1.6% 1.8 2.1% 2.3 2.6%
Cane Exported as Sugar to ROW
(mmt) 1.7 2.6% 2.6 4.1% 6.6 10.3%
Total Cane Consumption (mmt) -6.4 -2.8% -8.7 -3.8% -14.2 -6.2%
Total Cane Production (mmt) -4.7 -1.6% -6.1 -2.1% -7.6 -2.6%
Sugar Consumer Surplus $21 3.2% $13 4.2% $8 5.2%
Anhydrous Consumer Surplus -$160 -22.6% -$105 -29.7% -$77 -43.3%
Hydrous Consumer Surplus $28 3.2% $18 4.2% $11 5.2%
Aggregate Domestic Consumer
Surplus -$112 -5.1% -$74 -6.7% -$57 -10.4%
Domestic Producer Surplus -$90 -4.2% -$57 -4.0% -$36 -4.9%
Aggregate Domestic Welfare -$201 -4.6% -$131 -5.2% -$93 -7.3%
ROW Sugar Processor Surplus $20 5.2% $13 8.3% $8 21.5%
*Measures a decrease in the blend ratio from 22 to 20 percent over the benchmark period (1998-20001). [All prices
were converted to U.S. dollars for ease of comparison only; all welfare results are in millions of U.S. dollars.]
Low Sensitivity Results use initial values of demand elasticity = -0.5, supply elasticity = 0.5, and excess demand
elasticity = -2.0.
Medium Sensitivity Results use initial values of demand elasticity = -1.0, supply elasticity = 1.0, and excess
demand elasticity = -5.0.
High Sensitivity Results use initial values of demand elasticity = -2.0, supply elasticity = 2.0, and excess demand
elasticity = -20.










CONCLUSIONS


Brazilian sugarcane producers receive indirect subsidies through Brazil's fuel-alcohol
program. If Brazilian sugarcane producers are risk neutral, an increase in the blend ratio from 22
to 24 percent will raise the domestic price of sugarcane by between 1.3 and 3.2 percent. Brazilian
sugarcane producers would benefit from these price increases. Brazilian producers would receive
between $37 million and $91 million (U.S. dollars) annually in indirect sugarcane subsidies from
an increase in the blend ratio. Some advocates who promote the production and use of fuel
alcohol in Brazil foresee the development of a substantial fuel-alcohol-export market. In 2002,
only about 0.5 to 1.0 billion liters of ethanol were exported annually. To help promote the trade
globalization of ethanol, Brazil is providing information on the economics and technological
aspects of ethanol production and trade worldwide.

If Brazilian sugarcane producers are risk averse, there will be a supply response to
Brazilian fuel policy. In this case, the size of producer subsidies is larger than in the absence of
risk aversion effects. Specifically, if the Brazilian government dictates an increase in the
alcohol/gas blend ratio, both the demand and supply curves for Brazilian sugarcane will shift
outward to the right. World sugar prices can fall due to an increase in the blend ratio making the
Government policy trade distorting.

REFERENCES

FNP. 2002. Agrianual 2001 Anuario da Agricultura Brasileira. Sao Paulo, Brazil.

JOB Economica. 2002. Weekly Sugar and Alcohol Report 4 (April). Sao Paulo, Brazil.

Peter Buzzanell and Associates, Inc. 2000. The Brazilian Sugar and Alcohol Industry: 2000 and
Beyond. Reston, VA (June).

Just R., D. Hueth, and A. Schmitz. 1982. Applied Welfare for Economics and Public Policy.
Upper Saddle River, NJ: Prentice Hall.

Schmitz, Andrew, Troy G. Schmitz, and James L. Seale, Jr. 2002. Brazil as a dominant player in
the world sweetener market: Do prices matter? FAO Third International Sugar Conference,
Maputo, Mozambique (October).

Schmitz, Troy G., James L. Seale, Jr., and Peter J. Buzzanell. 2002. Brazils domination of the
world sugar market, in Sugar and related sweetener markets in the 21st century: International
implications, edited by Andrew Schmitz, Thomas Spreen, Charles B. Moss, and William
Messina. Wallington, England: CABI Publishers.

USDA (United States Department of Agriculture). Various years. Sugar and Sweetener Situation
Outlook Yearbook. Market and Trade Economics Division, Economic Research Service,
Washington, D.C.

S2001. Brazil sugar semi-annual report. Sao Paulo, Brazil: U.S. Agricultural Trade Office
(October).




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