measuring the effects of ethanol and flex-fuel vehicles ON BRAZILIAN Gasoline supply and demand: A simultaneous equations approach

Justin Martinez, EAI, Inc. / Colorado State University, 720-838-5614,

Overview

The focus of this paper is to investigate consumer response to supply and demand shifters in a transportation fuel market with a viable short-term substitute for traditional petroleum products. Many studies, using a variety of estimation techniques and studying dozens of countries, have confirmed inelastic price and income elasticities for gasoline. Transportation fuel substitution has been difficult due to the high costs and time needed to change fuel types. Flex-fuel technology reduces the barriers of substitution by providing a quick and cheap option for switching between gasoline dominant blends of fuel to ethanol dominant blends. In 2012, over 87 percent of all new vehicles sold in Brazil used flex-fuel technology, allowing Brazilian consumers to arbitrage between gasoline and ethanol. Brazil’s mature ethanol market lowers the substitutability barrier even further. Brazil has had a gasoline substitute, sugarcane based ethanol, since the 1980s. This paper extends the gasoline demand research by estimating gasoline supply and demand simultaneously in a market where the barriers to fuel substitution are considerably lower. Estimating the supply and demand curves simultaneously provides a unique insight into the effects of a well-developed ethanol market and flex-fuel technology on consumer behaviour. The results have potential implications on consumer behaviour in the United States, where the ethanol and flex-fuel vehicle markets are growing.

Methods

This study estimates Brazilian gasoline demand and supply using a simultaneous equations approach. Gasoline supply and demand elasticities are estimated using a three stage least squares estimator (3SLS). Gasoline prices in Brazil are no longer regulated by the government, requiring considerations for endogeneity. A unique data set is compiled from various official government publications including: National Petroleum Agency (ANP) and Brazilian Statistical and Geographic Institute (IBGE).

Results

Preliminary results indicate that gasoline demand is considerably more elastic in the current Brazilian transportation fuels market, and that ethanol is an imperfect substitute for gasoline. The short-term price elasticity of demand for gasoline was estimated to be approximately -1.0. Previous research has produced short-term price elasticities ranging from -0.2 to -0.3. The availability of ethanol as a substitute fuel over the short-term has dramatically changed consumer behaviour in Brazil. The short-term income elasticity was estimated at 0.48 (prior research has produced comparable income elasticities within the range of 0.3 to 0.5). The cross-price elasticity between gasoline and ethanol was estimated at 0.52. Alves and Silveira Bueno (2003) estimated the cross-price elasticity between gasoline and ethanol at 0.48. The price elasticity of supply was estimated at 0.23. Coyle et al., using a similar simultaneous equations estimation technique, estimated the price elasticity of supply in the United States at 0.28.

Conclusions

Brazil’s mature ethanol market and the adoption of flex-fuel technology have changed consumer behaviour dramatically. With a competitive substitute in the short-run, consumers are able to arbitrage between gasoline and ethanol. These results have interesting implications on fuel-tax policy and emission regulations in Brazil. Consumers will be more likely to switch fuels and reduce gasoline consumption in response to an increase in gasoline taxes, while an increase in taxes will shift the tax-burden to the refiners. For the United States, the world’s largest consumer of ethanol, national and regional policies aimed at expanding the biofuels market are likely to affect consumer behaviour in a similar way as Brazilian policies (assuming the market is able to grow enough to provide a consistent substitute for gasoline).

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