Brazil case study

11 March 2019

As the leading global producer and exporter of sugar and ethanol, Brazil is the marginal supplier and principal price setter for the world market. This pre-eminent position has been created by substantial industry expansion driven partly by the country’s abundant natural resources, but also through long-standing government support and market intervention.

The sugar and ethanol industries are particularly closely integrated and commercially interdependent. This means that any support offered to one activity can benefit the other. Both products are manufactured from sugar cane, whose lengthy crop production cycle spanning several years limits the sector’s ability to respond to market signals to inform growing decisions in terms of production scale.

Brazil has supported its ethanol industry over many years in a variety of ways, including incentivising sales to the domestic car fleet, substantial mandatory ethanol blending in gasoline, fuel price setting, supporting the development of flex-fuel vehicles and banning the purchase of diesel-powered cars.

The government also supports the sugar industry, though on a smaller scale. Subsidies are regularly provided to the less competitive Northeast producers at times of market stress or in response to crop failures, and general financial and Research and Development (R&D) support is also provided for the industry as a whole.

The Brazilian sugar-ethanol industry has expanded dramatically since 1975, the sugar cane ‘crush’ has increased 8-fold, its sugar production nearly 6-fold and its ethanol production 48-fold¹.

The Ethanol Programme

Sugar cane can be processed to make both sugar and ethanol. Mills which do this use common plant and equipment for the front half of the manufacturing operation, with considerable savings in fixed costs. In Brazil, sugar and ethanol are particularly integrated - sugar production is between 41% and 48% of total cane cultivation, and all but sixteen (94%) of Brazil’s sugar producing mills produce both products². This means the two activities are closely linked and commercially interdependent. Co-production of sugar and ethanol reduces costs and improves overall profitability by increasing scale production, improving process optimisation and extending the operating season. Any support offered to one activity can therefore cross-subsidise the other. There is a commercial arbitrage between products allowing processors to take advantage of relative changes in market conditions.

The Brazilian government supports its ethanol programme in a variety of ways:

The Proálcool programme

In response to the oil price shocks, Brazil decided in 1975 to introduce a national policy to increase ethanol production to reduce its reliance on imported oil. Components of this policy included: subsidising the auto industry to produce ethanol engines, tax advantages for vehicles which used ethanol, setting the ethanol price at a level which made it competitive with gasoline, taxing imported oil and subsidising distribution of the new fuel³. As a result of these incentives, ethanol production increased 20-fold over the two phases of the Proálcool programme between 1975 and 1997⁴. Much of this manufacturing plant and infrastructure remains in place today and is being used for current sugar and ethanol production.

Mandatory ethanol blending

The Brazilian government sets mandatory minimum blending rates for ‘gasohol’ (a mixture of ethanol and gasoline). For the past 25 years these have typically varied between 20% and 25%⁵, so providing a secure market for the equivalent of over 10 million tonnes of sugar each year.

Source: MAPA and updated figures from Czarnikokw

Gasoline price setting

National fuel prices are set by the state-controlled company Petrobras so providing a minimum price for the blended fuel ethanol⁶.

Tax incentives

The tax on industrialised products (IPI) is lower for flex-fuel vehicles than for gasoline powered vehicles. Since 2004 this IPI differential has been set at 18% and 25% respectively⁷. Individual states are also empowered to tax gasoline sales through the tax for circulation of goods and services (ICMS). In recent years ICMS has averaged 18% for ethanol and 26% for gasoline⁸.

Flex-fuel vehicles

About 20 years ago the Brazilian government decided to encourage the development of ‘flex-fuel’ cars with engine systems able to adapt to different blends of ethanol. In 2002, it introduced differential taxation to stimulate sales in which the sales tax on flex-fuel cars was cut below the normal rate. By 2006 over 80% of new cars were flex-fuel, and by the end of 2012 over 18 million flex-fuel vehicles were registered.

Diesel cars

Since the 1970s the Brazilian government has prohibited the private purchase of diesel-powered cars⁹ to help promote ethanol fuel sales.

Ethanol storage

The National Bank for Social and Economic Development (BNDES) has set up a sugar-ethanol support programme to help finance ethanol storage, with an annual budget of R$2bn (£480m) in 2014 and 2015¹⁰.

RenovaBio

In November 2017 Brazil’s President announced a major new policy to reduce dependence on oil and cut emissions, by expanding biofuels to provide 18% of the country’s energy by 2030. The policy is formed of a biofuels-related emissions trading scheme in which ‘emissions credits’ will be created and assigned to producers in proportion to the amount of ethanol they produce. National emissions reduction targets will be broken down to individual distributors, which will be required to purchase the emissions credits from ethanol and other renewable producers. The Brazilian government will control the market dynamics and will set the targets and value of the emissions credits. It is expected that the new policy will incentivise the construction of at least 25 new ethanol plants, each with an average crushing capacity of 4 million tonnes of cane¹¹.

The Policy Environment 

The Brazilian model is one of higher domestic prices and a substantial surplus for ethanol production or export of sugar to the world market.

The government has consistently sought to support and expand ethanol production and reduce dependency on imported petroleum against a backdrop of strong economic growth. This has involved numerous interventions such as:

Sugar cane price

Brazilian cane supply contracts include revenue sharing conditions in which the cane price paid to the supplying farmers is derived from the market prices of both sugar and ethanol¹². This further strengthens the integration of the sugar and ethanol ‘co-production’, and ensures that government support and subsidies – for either sector – are shared with the farm suppliers.

Direct financial support for sugar cane

A variety of government controlled financial provisions are available directly for the cane sector.

Northeast cane aid

The government offers short term subsidies at times of distress for cane growers in the Northeast, where conditions are less favourable for cane production. For example, a drought relief initiative was introduced for Northeast cane farmers in 2011 worth US$250m¹³.

The sugar cane innovation programme

In February 2014, the Brazilian Sugarcane Industry Association (UNICA) announced a new initiative ‘PAISS Agricola’ funded by the national bank BNDES, to incentivise innovation in the sugar-ethanol sector. A total of R1.5bn (£350m) has been made available from 2014 to 2018 to improve cane seed varieties, machinery technology and ethanol compatibility¹⁴.

Exports

Brazil supports its exports through the use of export credits, guarantees and insurance as part of the Project for Export Financing (PROEX) programme funded by the Banco do Brasil. Payments for sugar exports (normally less than US$0.4m/year), are notified to the World Trade Organisation (WTO)¹⁵.

General agricultural support which benefits the cane sector

Various general agricultural support measures are used by the Brazilian government, which can have indirect benefits for the cane industry.

Debt restructuring

Brazil has a history of assisting its agricultural sector at times of crisis by negotiating favourable repayment conditions on debts¹⁶. This facility may be relevant in the future for restructuring debt in the cane sector, given the current high level of indebtedness of Brazilian mills (a record number filed for bankruptcy in 2015)¹⁷.

Agricultural research

The national bank BNDES supports agricultural research including sugar cane. The programme funded a total of R1.9bn (£450m) in 2014¹⁸.

Our Analysis

Brazil is the leading global producer and exporter of sugar and ethanol and its marginal supplier, and is therefore the principal price setter on the world market. The sugar and ethanol industries are closely integrated and commercially interdependent – most cane mills are able to produce both products and decisions are normally taken in concert across both industries depending on relative market conditions and attractiveness. Support offered to one industry therefore benefits the other.

The ethanol industry has received significant and long standing support from the Brazilian government, including mandatory ethanol blending, incentivising ethanol investment and sales, and discouraging the use of diesel cars. The government also controls fuel prices which provides a minimum price for the blended fuel ethanol. These policies have helped drive the substantial expansion in the ethanol industry in recent decades, which has benefitted the overall cane sector and sugar industry.

Brazil also supports its sugar industry. Direct subsidies are offered at times of economic stress to its less efficient producers and general agricultural support is also available for the sugar cane sector to improve machinery technology and agronomy.

Because it has such a large exportable surplus of both sugar and ethanol, Brazil is the single most important influence on the world sugar market. Its government policies in both sugar and ethanol therefore have a substantial effect on world market levels, and have contributed to its instability and historically low levels.

Unrestricted access for Brazil to EU or UK markets would expose buyers, farming partners and processors to this volatility. Without insulation from extreme price cycles, our inability to respond to price volatility could put investment in the industry and its viability at risk.