fiscal and economic incentives for sustainable biofuels development: experiences in brazil, the u...

Inter-American Development Bank Infrastructure and Environment Department Energy Division

Fiscal and Economic Incentives for Sustainable Biofuels Development

TECHNICAL NOTE No. IDB-TN-555

Experiences in Brazil, the United States and the European Union RG-K1128 Sylvia Larrea

August 2013

Fiscal and Economic Incentives for Sustainable Biofuels Development Experiences in Brazil, the United States and the European Union RG-K1128

Sylvia Larrea

Inter-American Development Bank 2013

Cataloging-in-Publication data provided by the Inter-American Development Bank Felipe Herrera Library

Larrea, Sylvia.

Fiscal and economic incentives for sustainable biofuels development: Experiences in Brazil, the United States and the European Union / Sylvia Larrea. p. cm. — (IDB Technical Note ; 555) Includes bibliographic references.

1. Biomass energy industries—Economic aspects—Brazil. 2. Biomass energy industries—Economic aspects—United States. 3. Biomass energy industries—Economic aspects—European Union. 4. Ethanol fuel industry—Economic aspects—Case studies. 5. Energy industries—Economic aspects—Case studies.

I. Inter-American Development Bank. Energy Division. II. Title. III. Series.

IDB-TN-555

Contributor: Sergio Trindade Editor: Sarah Schineller, A&S Information Specialists

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Sylvia Larrea (sylvial@iadb.org) Contributor: Sergio Trindade (sergio.c.trindade@gmail.com), Editor: Sarah Schineller (sarahs@iadb.org)

Abstract This technical note will examine the development of the fuel ethanol industry in the United States, biodiesel in the European Union, and fuel ethanol and biodiesel in Brazil, in an effort to understand how the biofuel industry has developed in these regions. It will also evaluate the enabling environment that exists in each to support the growth of a nascent biofuels industry, via fiscal and economic incentives.

The Latin America and the Caribbean (LAC) countries have a great potential to develop a sustainable biofuels economy. However, in spite of the favorable conditions for biofuels production in the LAC region and the benefits they might bring, the development of a biofuel industry has been uneven in the region. To date, the development of biofuels has taken place in Argentina, Brazil, Colombia, Costa Rica, El Salvador, Mexico, Paraguay, and Peru.

JEL Codes: N7, O13, Q16, Q43 Keywords: Ethanol, Biodiesel, Bioenergy, Biofuels, Biofuels Development, Brazil, United States, European Union, Latin America and the Caribbean, Fiscal Incentives, Economic Incentives, Energy, Development, Agriculture.

Table of Contents Acronyms ....................................................................................................................................... 2 Executive Summary ...................................................................................................................... 5 1

Introduction ......................................................................................................................... 15

2

Background .......................................................................................................................... 17

3

Experiences .......................................................................................................................... 21 3.1

United States ................................................................................................................. 21

3.1.1 Background ............................................................................................................... 21 3.1.2 Economic and Financial Instruments ........................................................................ 23 3.1.3 Results and Lessons Learned .................................................................................... 27 3.2

European Union ........................................................................................................... 29

3.2.1 Background ............................................................................................................... 29 3.2.2 Economic and Financial Instruments ........................................................................ 31 3.2.3 Results and Lessons Learned .................................................................................... 36 3.3

Brazil: Ethanol ............................................................................................................. 36

3.3.1 Background ............................................................................................................... 36 3.3.2 Economic and Financial Instruments ........................................................................ 44 3.3.3 Results and Lessons Learned .................................................................................... 48 3.4

Brazil: Biodiesel ........................................................................................................... 50

3.4.1 Background ............................................................................................................... 50 3.4.2 Economic and Financial Instruments ........................................................................ 53 3.4.3 Results and Lessons Learned .................................................................................... 54 4

Points of Reference from Lessons Learned ....................................................................... 56

5

Conclusions .......................................................................................................................... 58

6

References ............................................................................................................................ 59

Annex I ......................................................................................................................................... 63 Annex II ....................................................................................................................................... 65

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Acronyms AGQM

Arbeitsgemeinschaft Qualitätsmanagement Biodiesel e.V.

ANP

Agência Nacional do Petróleo, Gás Natural e Biocombustíveis (Brazilian Agency for Petroleum, Natural Gas and Biofuels)

API

American Petroleum Institute

B-5

Diesel fuel blend containing 5 percent of biodiesel

BCAP

U.S. Biomass Crop Assistance Program

BNDES

Banco Nacional de Desenvolvimento Econômico e Social

BP

British Petroleum

BRDI

U.S. Biomass Research and Development Initiative

CAP

Common Agriculture Policy, European Union

CBI

Caribbean Basin Initiative

CENICAÑA

Centro de Investigación de la Caña de Azúcar de Colombia (Sugarcane Research Center of Colombia)

CET

Common external tariff, European Union

CIDE

Contribuição de Intervenção no Domínio Econômico (Contribution to Intervention in the Economic Domain)

CLCFS

California Low Carbon Fuel Standards

CO

Carbon monoxide

COFINS

Contribuição para o Financiamento da Seguridade Social (Brazilian Social Security Finance Contribution)

CTC

Centro de Tecnologia Canavieira (Sugarcane Technology Center)

DDGS

Dried Distilled Grains and Solubles

E10

Gasoline blend containing 10 percent ethanol

EC

European Commission

EISA

Energy Independence and Security Act of 2007

EMBRAPA

Empresa Brasileira de Pesquisa Agropecuária (Brazilian Enterprise for Agricultural Research)

EPA

Environmental Protection Agency

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ESALQ

Escola Superior de Agricultura “Luiz de Queiroz” Universidade de São Paulo (University of São Paulo’s College of Agriculture, “Luiz de Queiroz”)

ETBE

Ethyl tertiary butyl ether

EU

European Union EU

FFV

Flex fuel vehicle

GHG

Greenhouse gas

GSI

Global Subsidies Initiative, International Institute for Sustainable Development

IAA

Instituto do Açúcar e do Alcool (Sugar and Alcohol Institute)

ITA

Instituto Tecnológico de Aeronáutica (Technological Institute of Aeronautics)

IAC

Instituto Agronômico de Campinas (Institute of Agronomy of Campinas)

ICMS

Imposto sobre Operações relativas à Circulação de Mercadorias e Prestação de Serviços de Transporte Interestadual e Intermunicipal e de Comunicação (Operations Tax on Circulation of Goods and Services of Interstate and Intermunicipal Transportation and Communication)

IDB

Inter-American Development Bank

LAC

Latin America and the Caribbean

LCA

Lifecycle assessment

Mercosul

Mercado Comum do Sul (Southern Common Market)

Mercosur

Mercado Común del Sur

mt

Metric ton

MTBE

Methyl tertiary butyl ether

NREL

National Renewable Energy Laboratory, United States

ODC

Other Duty and Charges

OEM

Original equipment manufacturers (e.g. the auto industry)

PIS

Programa de Integração Social (Social Integration Program)

PLANALSUCAR

National Sugar Cane Improvement Program

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PNPB

Programa Nacional de Produção e Uso de Biodiesel (National Program for the Production and Use of Biodiesel)

Proálcool

Brazilian National Alcohol Program

PRONAF

Programa Nacional de Fortalecimento da Agricultura Familiar (National Program for Strengthening Family Farming)

R&D

Research and Development

RED

Renewable Energy Directive, EU

REN21

Renewable Energy Policy Network for the 21st Century

RIN

Renewable Identification Number, United States

RFA

Renewable Fuels Association, United States

RFS

Renewable Fuels Standard, United States.

RME

Rapeseed oil methyl ester

RSB

Roundtable on Sustainable Biofuels

RSPO

Roundtable on Sustainable Palm Oil

SECCI

Sustainable Energy and Climate Change Initiative

t/ha

Tons per hectare

U.S.

United States

USP

Universidade de São Paulo

VEETC

Volumetric Ethanol Excise Tax Credit

WB

World Bank, International Bank for Reconstruction and Development

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Executive Summary This technical note will examine the development of the fuel ethanol industry in the United States, biodiesel in the EU, and fuel ethanol and biodiesel in Brazil, in an effort to understand how the biofuel industry has developed in these regions. It will also evaluate the enabling environment that exists in each region and the government policies that support the growth of a nascent biofuels industry, via fiscal and economic incentives.

The Latin America and the Caribbean (LAC) countries have a great potential to develop a sustainable biofuels economy. Yet, in spite of the favorable conditions for biofuels production and the benefits they might bring, the development of a biofuel industry has been uneven in the region. To date, the development of biofuels has taken place in Argentina, Brazil, Colombia, Costa Rica, El Salvador, Mexico, Paraguay, and Peru.

United States Although the development of fuel ethanol in the United States dates back more than 30 years, it was only in the last decade that this sector substantially expanded, helped by the restriction of methyl tertiary butyl ether (MTBE), first in California and, later, in the whole United States. During this period, the U.S. production of ethanol catapulted from 6.17 billion liters in 2000 to 50.3 billion liters in 2012, surpassing Brazil in 2006, with the United States becoming the world’s leading ethanol producer and consumer. In 2004, 11 percent of U.S. corn production was channeled to make ethanol and, from September 2010 to August 2011, alone, 44.2 percent of its corn crop was used to make this biofuel.

Since 1978, the fuel ethanol industry in the United States has been subsidydependent. Subsidies have remained substantially constant, regardless of the price of oil.

The combination of subsidies with high oil prices and local environmental concerns led to the boom in U.S. ethanol production. As a result, however, the cost to the taxpayer has been steep. Foregone tax revenues from tax exemptions to the sector, as well as direct subsidies from 1979 to 2008, are estimated to be between US$37 billion and US$40 billion. For 2010 alone, it was approximately US$21.5 billion. However data should include jobs created or maintained, payroll and local taxes paid, as well as foreign

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exchange saved or generated through the export of ethanol and its by-products (e.g., Dried Distillers Grains and Solubles [DDGS]).

The Renewable Fuel Standard (RFS), a U.S. federal program, which was established in the mid-2000s, stipulated an initial minimum of renewable fuel (RFS I) to be blended into transportation fuel. An expansion of this program (RFS II) increased the blend amount. Corn-based ethanol now dominates the U.S. market, resulting in meat and poultry producers contending that RFS regulations have hindered the supply of corn for animal feed and, thus, raised its price. The fructose sweetener industry has raised similar concerns.

The subsidy for fuel ethanol was initially financed by the Highway Trust Fund, gradually draining its budget for road and bridge construction and maintenance as the volume of ethanol increased. An alternative subsidy financing mechanism, the volumetric ethanol excise tax credit (VEETC) was subsequently implemented, this time funded directly by the U.S. Treasury. This program expired on December 31, 2011. In addition, The Caribbean Basin Initiative (CBI) has allowed duty-free entry into the United States of ethanol that has been merely dehydrated in CBI countries, thus bypassing the additional US$0.54 /gallon tariff (Other Duty or Charges, ODC), which also expired on December 31, 2011. Nonetheless, in spite of the success, there was no commitment to make biofuels—in this case ethanol—the fuel of choice for the U.S. economy. The lack of consensus among key stakeholders explains why.

U.S. government policy has been, and continues to be, open to a variety of options, such as hydrogen, electricity, and other alternatives yet to be developed.

However, the U.S. ethanol program is a result of effective pressure from the corn interest groups, representing important corn-belt voting states, such as Iowa, whose key goal is to increase demand and, thus, increase corn prices. In effect, corn prices increased from a 15-year low of US$75 a metric ton (mt) in mid-2000, peaking at US$287 per mt in June 2008, and averaging US$ 282 per mt in March 2013. As the numbers suggest, higher commodity prices have led to an increase in output and in prices.

A key lesson from this experience shows that a number of components are required to enable the production of biofuel, starting with the need for land, water, human resources, finance, and steady policies. What will make the industry sustainable

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are the continuity of sound economic, social, and environmental practices. In the United States, the dominance of gasoline, the requirement of oxygenates, and the restriction of MTBE opened a market for ethanol. For a while, fiscal and economic incentives supported market-driven growth. However, stakeholder consensus, which, from time to time has been achieved, needs to be reviewed to ensure cooperation between the fuel ethanol industry and the oil, auto, dairy, meat, poultry, and sweetener industries. The recent expansion of hydrocarbon supplies from hydraulic-fracturing (“fracking�) of shale beds, however, could make an understanding between key stakeholders more difficult to achieve and maintain.

European Union Although the development of biofuels in Europe dates back to the 1980s, it was not until the 1990s that biofuels production started in earnest. By then, in addition to energy security, environmental concerns had surfaced, which promoted the will to move forward. Over the years, Europe has become a diesel economy. The mix of crude oil at its oil refineries has lagged behind the demand for diesel and, consequently at the same time, has yielded more gasoline than required, hence the export of surplus gasoline. The European Union (EU) has no issue regarding the use of MTBE as an additive, which further limits the prospect of ethanol penetrating the market. It is often brought into the market as an alternative to MTBE, in the form of ethyl tertiary butyl ether (ETBE).

Given that Europe has been exporting its gasoline surplus and importing diesel, the focus has been on biodiesel, rather than ethanol. Today, France, Germany, Italy, and Spain contribute to make the EU the world’s leading producer of biodiesel and, as such, the buy-in from member states for an alternative and/or component to diesel fuel is voluntary and has been historically disparate. It is useful to recall that, with respect to decision making and implementation, the nation states that compose the EU cannot be compared to the states of the United States. Even the unambitious consumption targets, based on calculated energy content (established by the 2003 Biofuels Directive, 2003/30 EC) of 2 percent by 2005 and 5.75 percent by 2010, have not and will not be met by most member countries. Overall, biofuel has reached only 1 percent of total fuel consumption in 2005, calculated on an energy-to-content basis. Official estimates peg the figure at

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only 4 percent of the transport sector’s fuel blend in 2010. At the core of these meager results lies the uncertainty brought about by the unclear definition behind the EU’s policy making. In an attempt to bring confidence to investors, the EU, on June 5, 2009, constituted the Renewable Energy Directive (RED) Directive 2009/28/EC. It contains binding targets for the share of renewable energy at member-state level, including the requirement of a 10 percent biofuel content in transportation fuel by 2020 in all member states. In order to guarantee its sustainable production, a 35 percent greenhouse gas (GHG) reduction from 2010, rising to 50 percent from 2017 onwards, needs to be achieved.

A key lesson from the EU experience is that to attract investors in countries under the same regulatory system, policy making should provide for clearly defined and flexible regulations. While policies must be reevaluated from time to time, regulatory stability should be maintained to respond to the evolving perspectives of the stakeholders and to create a background for sustainability. The current fiscal and financial crisis in the EU may make it difficult to sustain fiscal and economic support for the biofuels sector in the region.

Brazil Among the countries/region selected for this report, Brazil has focused, from the outset, on fuel ethanol from sugarcane. With a long tradition of blending ethanol into gasoline since the 1920s, the practice accelerated in the 1930s, and was kept on and off up until 1975, when it became institutionalized as described below.

Ethanol In order to provide a substitute for imported petroleum during the oil crisis of the early 1970s, Brazil implemented the National Alcohol Program (Proálcool), not only as a way in which to improve its balance of payments, but also as a means to maintain the operation of its automotive industry and create a secondary market for sugarcane. As mentioned, Brazil had intermittently been using ethanol as a fuel blend in gasoline since the 1920s, making it the obvious choice when the Proálcool policy was launched.

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The first phase of Proálcool, from 1975 to 1979, focused on achieving a 20 percent blend target, equivalent to 3 billion liters. This target was met and was followed by a second phase, from 1980 to 1985 during the second oil crisis, as a result of the IranIraq war. Consequently, hydrous ethanol was sold in most of the country for vehicles exclusively built to run on that fuel. From 1983 to 1988, almost 90 percent of the vehicles sold in Brazil ran on ethanol, with the balance using gasoline blended with approximately 20 percent of anhydrous ethanol.

Both phases of the program were supported by a host of policies that included not only the maintaining of a blending regulation, but also the introduction of (i) economic and financial incentives that incorporated low-interest loans to farmers and ethanol distilleries; (ii) a tax exemption for vehicles that ran on ethanol; (iii) subsidies for ethanol production (minimum-purchase-and-price guarantees); and (iv) sugar, gasoline, and ethanol price controls.

When oil prices dropped sharply in 1986, government priorities changed and Brazil permitted Petrobras, its energy corporation, to pump gasoline back into the market at the expense of fuel ethanol. This action led to Proálcool’s third phase, from 1986 to 1990. However, the lack of resources caused the phase-out of incentives in 1988–89, marking the end of Proálcool program. The declining output led to a shortage of ethanol, and the Brazilian government, in order to curb inflation, controlled prices by lowering them at the pump. This led to an increase in demand and a severe shortage of ethanol, with consumers withdrawing from the use of hydrous ethanol vehicles. The ethanol blend content in gasoline subsequently decreased to 18 percent and, later, to 13 percent.

During the two decades after 1991, all subsidies were removed, with the exception of a mandatory anhydrous ethanol blend that varies between 20 and 25 percent and some preferential tax treatment for ethanol. Despite the lack of government intervention, the Brazilian ethanol industry has, nevertheless, expanded, driven by the private sector and aided by the emergence of the flex-fuel vehicle (FFV) in 2003. FFVs can use any proportion of hydrous ethanol and “gasoline” (a blend of 20 to 25 percent anhydrous ethanol in gasoline). Ethanol accounted for a maximum of 50 percent of all fuel used in light vehicle transport in Brazil. At the same time, given the inflexibility of the domestic refined crude slate, Brazil had to export its surplus gasoline.

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During Brazil’s southeast harvest season, the sugarcane industry can provide up to 5 percent of the country’s electricity, derived from sugarcane bagasse, leaves, and straw.

Bagasse is only available for six to eight months of the year during the dry season in this region, where there are large hydropower plants and where the bulk of the product’s demand lies.

The original objectives of the Proálcool program are considered to have been achieved. Brazilian experts estimate that, between 1976 and 2004, this biofuel has saved Brazil US$60.74 billion in gasoline imports (at the 2005 exchange rate). In contrast, expenditures during the 15 years’ implementation of Proálcool (1975–90) amounted to US$1.5 billion in subsidies for construction of distilleries and foregone fiscal revenue of US$7 billion (Dias Leite, 2007).

A key lesson is that principal to Brazil’s success has been the Proálcool program’s goals being clearly defined from inception and, while the program itself evolved according to changing conditions, a commitment to its main objective remained in place. Emphasis is given to the key role of the stakeholders’ consensus at all phases of the program (of the sugarcane and automotive industry, Petrobras, and the Brazilian government) relating to the challenges: making access to liquid fuels for transport feasible, increasing demand for sugarcane, selling vehicles, and protecting the supply of oil while, at the same time, ensuring their own interests. In general, when oil prices drop, it becomes a challenge to maintain the consensus initially arrived at.

Brazil, at the same time, uses compressed natural gas in fueling light vehicles, in particular the taxi fleets in its major cities, which can represent an alternative to fuel ethanol. What looms large on the horizon, however, is what could be the sudden expansion of Brazil’s oil reserves, given the large offshore discoveries of oil in the PreSalt. This could lead to further challenges.

Biodiesel Brazil has had a long history of evaluating vegetable oils as diesel substitutes, beginning with the ProVeg Program in the early 1980s. For many reasons, this initiative did not progress (Trindade, 1996). However, the launch of the National Program for the Production and Use of Biodiesel (Programa Nacional de Produção e Uso de Biodiesel

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[PNPB]) in December 2004, replicating the success of the Proálcool program, showed that for Brazil to be successful in contributing to sustainable rural development through its energy policies, it required the same commitment. Under this initiative, the Brazilian government decreed an optional 2-percent blend of biodiesel (B2) with diesel in 2004, making it mandatory in January 2008. The blending measure was raised to 3 percent (B3), effective July 2008, with a further rise to 4 percent (B4) a year later. The original legislation set a 5 percent (B5) blending regulation by 2013, but was achieved ahead of time. With this trend, and at the level of its current production capacity, Brazil could well be able to phase in a B10 blend by 2014.

Principal to the PNPB program is the inclusion of qualified family farms involved in the supply of vegetable oils, which are certified by a Selo Combustível Social (“Social Fuel Seal”). The production of vegetable oils, under the Social Fuel Seal that confers preferential loan and tax treatment to qualified producers, has increased substantially, from 736,000 liters in 2005 to 404 million liters in 2007, and to 2.4 billion liters in 2011 (Informa, 2012), with the northern and northeastern regions (accounting for half of the production in 2007) now producing under 10 percent of Brazil’s biodiesel. Given that the production of liquid fuel requires a large scale, family farms that are small and lack expertise and financial means present a challenge in these areas. On the other hand, the soybean producers of the Center-West and South—the traditional agriculture “powerhouses”—now deliver 85 percent of the country’s production of vegetable oils, with global commodity traders delivering soybean oil on a large scale for processing into biodiesel.

With the government’s implementation of its blend mandate, the sale of biodiesel is structured through auctions managed by the National Agency of Petroleum (Agência Nacional do Petróleo [ANP]). Petrobras, as the sole buyer and one of the sellers in the ANP auctions, created a subsidiary, Petrobras Biocombustível. However, with its emphasis on fuel ethanol, (through minority joint ventures with the private sector), the outcome of Petrobras Biocombustivel’s efforts on biodiesel has not fully met the objective for social inclusion. In response, the Brazilian government has encouraged Petrobras to administer the production of “social seal” certified biodiesel in the northeast (previously administered by the Federal Ministry of Agrarian Development of Brazil).

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This effort, relating to castor oil from family farms, has not been very successful. The economic value of castor oil is much higher in non-fuel applications. PNPB is still, therefore, a work in progress in this area.

A key lesson is that the combination of a solid biodiesel regulation with equally solid incentives for the participation of small family farms (which, in most cases, do not have the expertise and means to achieve the required specifications) can be an issue.

Biodiesel in Brazil costs more than the diesel fuel it is intended to replace, and the sale of this alternative fuel in Brazil depends on auctions managed by ANP. In 1975, the cost of sugarcane ethanol was higher than gasoline. It has taken 25 years for the now wellestablished sugarcane agro-industry to produce fuel ethanol competitively. It is hoped that it will not take as long for biodiesel to come to par with the cost of diesel fuel. There is a need for investment in agricultural and conversion technologies, as in the case of sugarcane. Furthermore, the looming threat of Brazil’s offshore Pre-Salt hydrocarbon resources may require a re-evaluation of the initial stakeholder consensus that first helped catapult PNPB program into effect in the first place.

The experiences illustrated above provide sound examples for governments on ways to create the framework for the development of a biofuels industry, as well as examples of the challenges that can be expected from external impacts. It demonstrates that the biofuels supply chain, from agriculture to end-user, must be in place for a framework to work. A market for biofuel can be established by making blending practices compulsory and using the infrastructure that is already in place. Moreover, as regulatory costs are off budget and the hidden costs are borne by consumers, it would be politically advantageous if the regulations were supported by the stakeholder consensus for a substantial period of time. The assurance of demand for the biofuel and clearly defined regulations could attract investments while, simultaneously, the development of the sector can be supported by the economic and fiscal incentives.

Finally, although government focus and support are fundamental for the development of the biofuels sector, it is the agreement among the relevant stakeholders— from producers to consumers—that ultimately will ensure the continuous success of biofuels. Once this has been reached, policies should again be reviewed and, as necessary, revised as conditions change. The examples of practices below can provide the

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basis for producers and policymakers to develop a country’s biofuel industry. (i) Clear vision and commitment. It is essential to inspire confidence in the market in order to attract investors. Policy and regulation should reflect a government’s intentions and commitment. (ii) Adjustment of incentives/subsidies. If support through incentives and subsidies is already in place for a particular commodity (corn, canola, sugarcane, soybeans), it is possible to develop a biofuel industry by adjusting incentives can lead to an increase demand and lower the cost of the relevant commodity. Incentives should support production, distribution, storage, and end-use throughout the biofuels supply chain. (iii) Adaptation. A review of the policy portfolio should be made in the case of policies that may have failed so as to ensure the long-term success of the program, and the as part of the learning curve for key stakeholders. (iv) Policy coordination. Policy design must take into account finance, agriculture, and energy policies. Despite the importance of coordinating all agriculture subsidies, taxes, and other financial support, the ministries of finance and agriculture must coordinate with their energy counterpart. Each country, however, should establish its own approach for coordination. (v) Stakeholder involvement. Consensus among key stakeholders (including producers, distributors, etc.) helps the process of policy making and, in a time of crisis, can provide a platform for the review and re-evaluation of policies, legislation, regulation, and incentives. (vi) Realistic goals and objectives. Although it is recommended that long-term policies be put in place, overly ambitious targets could prove negative. While it is true targets can be a good driver, they must be bought in by the relevant stakeholders.

While Latin America and the Caribbean has great potential to become a significant biofuels-producing region (particularly in terms of sugarcane ethanol), vegetable oils and animal fat also should be considered as alternatives to replace diesel fuel with biodiesel. The benefits could be significant and could offer (i) an improvement

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in energy security and the country’s balance of payments, (ii) provision of “green” electricity, and (iii) a reduction in overall emissions, resulting in the sustainability of the energy matrix, which should be kept in mind by interested member states. The existence of international standards, such as the Roundtable on Sustainable Biofuels (RSB), provides a platform for exploring the sustainability of alternative energy.1 Participation in the RSB is open to any organization working in a field relevant to biofuels sustainability.

The Inter-American Development Bank (IDB), through its Sustainable Energy and Climate Change Initiative (SECCI), is a partner of the RSB.

1

The RSB is an international initiative, coordinated by the Energy Center of the École Polythechnique Fédérale de Lausanne (EPFL), that brings together farmers, companies, non-governmental organizations, experts, governments, and inter-governmental agencies concerned with ensuring the sustainability of biofuels production, processing, and usage.

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1

Introduction

The energy sector is closely linked to the stability and competitiveness of a nation.

Energy resources provide lighting, rotary movement, heating, cooling, to name a few energy services, which are essential to development. Such services allow for the transportation of goods and people, and provide industrial, commercial, and residential electricity. Some countries in the Latin American and Caribbean (LAC) region are heavily dependent on oil and its derivatives for their transportation and electricity sectors, but lack hydrocarbon resources. Consequently, they are faced with the challenge of oil price volatility, which has a direct impact on their fiscal budget. This is the predicament many LAC countries face. In providing conditions for a better quality of life, LAC governments can help by promoting the capacity to produce energy resources domestically, or to generate sufficient funding for purchasing energy resources.

The development of a biofuels industry in the region can overcome some of these challenges. In fact, as demonstrated in previous studies, conducted by the Inter-American Development Bank (IDB), the LAC region can count on the favorable conditions on which to promote the production of biofuels based on an energy security perspective; the region’s climate conditions; the availability of arable land, human capital, and abundant natural resources; and centuries of combined experience in the production of feedstock, all of which can contribute to the potential for a domestic source of energy. In addition, for the region’s existing and prospective sugarcane producers, biofuels present an alternative to exclusive reliance on sugar in a volatile market. More importantly, they offer another avenue for agriculture to bolster social and rural development.

In spite of the benefits biofuel may bring, however, the initiative to introduce it into the domestic energy matrix, in any significant manner, has been confined to countries with endowments such as Brazil, Colombia, Costa Rica, El Salvador, Paraguay and, more recently, Argentina, Mexico, and Peru. Some sugar producers and exporters, in countries heavily dependent on imported petroleum, remain undecided. Among the reasons for the lack of development of a biofuel sector are agriculture policies that are already in place and the high cost of promoting an entirely new sector into the economy—including the production and supply chain. New technology is required to be adapted to local conditions; producers need to be trained and funded; production,

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transportation, and distribution infrastructures need to be either modified or, in some cases, built; and, lastly, there needs to be an incentive for consumer “buy-in.” While governments have a key role to play in the planning and launching of biofuel programs, it is the consensus among the relevant stakeholders that will determine success. Experience has shown that the process can take a long time.

Given the region’s natural energy resources and economic history, government policies that are well designed and carefully implemented can create the appropriate enabling environment for the development of a biofuel sector. The first challenge is to determine whether it makes sense to introduce biofuels into the economy. If there is support from relevant stakeholders, then clear objectives must be established, and a combination of fiscal and economic incentives should be put in place.

The objective of this technical note is to gather the lessons drawn from the successes and failures of the United States, the EU, and Brazil—the global leaders in the output and consumption of biofuel, particularly in connection to the implementation of their respective fiscal and economic incentives. The publication will examine the background of (i) ethanol in the United States, (ii) biodiesel in the EU, and (iii) Brazil’s pioneer work in creating an ethanol sector and its recent attempt to build a new biodiesel sector. These lessons, hopefully, will provide countries in the LAC region a platform from which they can consider the design of, or an improvement for, their own biofuel programs.

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2

Background

Over time, energy resources have included, in some way or another, wood, coal, petroleum, natural gas, hydro and nuclear power, solar and wind power, and, more recently, modern biomass and biofuels. Although biofuels are far from being the sole solution to all energy problems, the potential for new alternatives to traditional biofuel is substantial.

Latin America and the Caribbean are poised to capitalize on this potential, as the region is already home to the second-largest global producer of biofuels: Brazil. In terms of global production, the top producing countries in the LAC region are Brazil, Argentina, and Colombia, in that order. Table 1 includes the leading producers of ethanol and biodiesel in 2010–11.

Table 1. Biofuels Production – Top Producing Countries 2011–12

Country United States Brazil France Germany China Argentina Canada Spain Thailand Colombia Italy India Sweden Poland United Kingdom Guatemala• Bolivia• Cuba• Nicaragua• Mexico Ecuador* Costa Rica* Peru Panama* EU Total World Total

Fuel Ethanol, 2012 (in billions of liters) 50.3 21.6 1.0 0.77 2.1 0.25 1.7 0.3 0.65 0.36 0.03 0.58 0.23 0.23 0.17 0.11 0.11 0.10 0.07 0.02 0.05 0.05 0.15 0.01 4.2 82.9

Source: Renewable Global Status Report - 2009 Update * 2011 and 2012 data (REN21 and F.O. Licht Publications

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Biodiesel, 2011 (in millions of tons capacity 8 5.0 2.5 5.0 0.8 3.0 0.2 4.0 1.6 0.5 2.5 0.7 0.24 0.7 0.2 n/a n/a n/a n/a n/a n/a n/a 0.37 n/a 9 consumption 15 consumption est.

In order for today’s consumers to fully accept alternative fuels, however, it must be demonstrated that they can be produced sustainably. After a long period of believing that biofuel was conducive towards an improvement in the environment, two major concerns have arisen: (i) it should not compete with food production; and (ii) it should be produced far from conservation areas. There are inherent limitations for biofuels derived from existing agricultural sources. The future expansion of liquid biofuels on a large scale currently requires the use of non-food crops and agricultural, municipal, as well as industrial residues.

In Europe, biodiesel is made mostly from rapeseed (Brassica napus, L.) and in Canada, from canola, a modified rapeseed (“Canadian oil, low acid�). In the United States, soybean oil predominates as feedstock for biodiesel, but other vegetable oils are also used, such as canola and palm. Most vegetable oil imports for biodiesel production in Europe, however, originate from Malaysia and Indonesia, where palm oil is used as feedstock. Although oil palm is among the most productive oil-bearing plants for making biodiesel, those two countries are home to rainforests, which include recognized areas of biodiversity. Concern that the forests are being encroached upon by oil palm plantations has led some countries in the EU to call for a restriction on the import of palm oil for biodiesel.

Palm oil producers have responded by joining environmentalists and experts to develop global standards for the application of palm oil for biodiesel as a way in which to protect the forests and their biodiversity. The Roundtable on Sustainable Palm Oil (RSPO), formed in 2003, promotes the growth and use of sustainable oil palm products through certification and with stakeholder engagement.

An important issue that surfaces, from time to time, is the use of food crops to produce fuel. In February 2007, Mexicans saw a rise in the price of corn, which was attributed to an increased demand for fuel ethanol. The price of other grains (rice and wheat) rose even more, despite the fact that they are not normally used for fuel ethanol.

An analysis of the price increases has shown that this was due not only to drought conditions in Australia and Ukraine, but also to an increase in the price of oil, affecting the cost of fertilizers. Furthermore, the rise in the price of corn and other grain commodities followed a boom in output of corn ethanol in the United States. It is worth

18

noting that the corn used for food in Mexico is white corn, whereas ethanol is produced from yellow corn.

As resistance to biofuel gained momentum, by 2008 studies pointed to shortcomings in the use of biofuels; some multilateral agencies have questioned the continued promotion of renewable fuels. On the other hand, those defending the use of biofuels have been able to demonstrate that biofuel could, in fact, be produced sustainably. More importantly, studies have confirmed Brazil’s assertion that not only can sugarcane ethanol be sustainable, would not encroach rainforests, nor require inordinate amounts of water, but it could also provide an improvement in the lives of hundreds of rural workers who would, otherwise, be under- or unemployed. U.S. corn ethanol producers, on the other hand, while using coal and natural gas to power distilleries, have attempted to improve their own energy consumption and have adopted more sustainable production technologies.

Scientists, experts, regulators, and practitioners continue to search for a more holistic method to compare all fuels in terms of their respective lifecycle. A technique to do so has emerged in the form of the Life Cycle Assessment (LCA), and the State of California recently enacted the California Low Carbon Fuel Standard (CLCFS), the first legislation to include a LCA. The new technique allows for the comparison of the lifecycle emissions of a number of ethanol processes, manufactured from different feedstock with varying methods. Results have shown that the average corn-ethanol product from the Midwest scored higher carbon emissions than the baseline gasoline used in California. In contrast, a lifecycle analysis of Brazilian sugarcane ethanol, manufactured using mechanized harvest methods, showed that it was the lowest carbon emitter.

U.S. producers are not likely to lag behind for too long. Substantial research is taking place to seek ways in which to improve the corn-to-ethanol process and seek sources for other biofuels. The commercial availability of cellulosic ethanol lies on the horizon. In fact, RFSII will stipulate an increasing amount of cellulosic biofuels as of 2013. Brazil, meanwhile, continues to support its biofuel industry, despite the short-term challenges the government faces as it maintains gasoline prices artificially low.

Currently, sugarcane bagasse and straw can provide 5 percent of Brazil’s electricity

19

during the processing season. In addition, Petrobras recently has announced that it would be running a three-month test, using ethanol to power an 85-MW thermo plant with a view to running it optionally on natural gas or ethanol (Carvalho, 2009). From an economic standpoint, operating a generator on ethanol is equivalent to burning gasoline, a more expensive fuel, to produce electricity.

At the municipal level, the city of São Paulo has begun to operate two “dieselcycle” buses adapted to operate on ethanol,2 with a view to substituting the use of diesel on city buses with that of locally produced ethanol fuel at a rate of ten percent per annum.

It is anticipated that, by 2018, all buses in São Paulo’s public transportation system will be operating on renewable fuel (UNICA, 2009). Furthermore, in order for ethanol to work in an engine that is manufactured for diesel, it must be blended with an ignition improver, usually a nitrogen-based explosive, at the rate of 5 percent per volume or higher.

Finally, the advance of technology in the production of biodiesel is predicted to launch sugarcane diesel on a commercial scale. The chemical derived from sugarcane to replace diesel fuel is farnesene, of higher value as a chemical than as a biofuel. It may become a component in aviation jet fuel, having been tested by Brazilian air companies in June 2012.

2

Currently, there are 600 similar buses operating in Sweden.

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3

Experiences 3.1 United States 3.1.1 Background

Although fuel ethanol industry in the United States is almost 30 years old, the sector has only emerged during the last few years. Production of fuel ethanol has catapulted from 6.17 billion liters in 2000 to 34 billion liters in 2008 and to 50.3 billion liters in 2012.

Growth has been such that, since 2006, the United States has surpassed Brazil to become the world’s largest ethanol producer and consumer. In 2004 alone, 11.2 percent of corn output was used to make ethanol, with output doubling by the 2008 harvest. Preliminary data estimate that proportion to climb to about 40 percent in 2012. In terms of land, farmers planted 32.7 million hectares of corn in 2004, with 2009 figures showing it to be at 34.8 million hectares (Wisner, 2013). In the period between September 2010 and August 2011, 44.2 percent of the corn crop was converted into ethanol.

Ethanol production started in response to the oil shocks of the 1970s and it was thanks to the U.S. Energy Tax Act of 1978, with its first subsidy of 10.6 cents a liter (40 cents a gallon) that the industry was launched. Two years later, output of the biofuel rose to 662 million liters. The subsidy continued, uninterrupted, for the next two decades with steady increases, to reach 3.4 billion liters (900 million gallons) by 1990 and 6.17 billion liters (1.63 billion gallons) by 2000. During that period, with the exception of a couple of short-term peaks, U.S. crude oil ranged at between US$10 and US$30 a barrel in nominal terms (Tyner, 2008). By the late 1990s, however, the scenario had started to shift.

The Clean Air Act Amendments of 1990 led to the implementation of a Reformulated Gasoline (RFG) program. Legislation stipulated that gasoline meet minimum oxygen content in order to reduce vehicle emissions, especially carbon monoxide (CO). Previously, the most widely used oxygenate was methyl tertiary butyl ether (MTBE), but by the late 1990s, MTBE had been found to be carcinogenic in animals (still under debate), and its use was banned in many jurisdictions. The initial restriction of MTBE in California led to a sudden market expansion for ethanol in that state, which brought in the need to import it, primarily from Brazil. However, MTBE continues to be blended in gasoline in the EU and Japan, whereas in the United States,

21

ethanol became the oxygenate of choice. The increase in the demand for ethanol could not have come at a better time for corn producers, leading to higher prices for corn.

The University of Purdue’s Wallace Tyner explains that in 2004, crude oil prices began to climb to approximately US$70 a barrel, and continued to increase, year after year, until they peaked in 2008 at US$147 a barrel. Meanwhile, ethanol subsidies were fixed, independent of oil prices, making ethanol very profitable. In 2000 there were 54 plants operating in the United States. By 2004, that number had increased to 72 and, by early 2013, there were 211, which meant “the combination of high oil prices and a subsidy keyed to oil at US$20 per barrel led to the ethanol boom” (Tyner, 2008). Ethanol prices, however, are not always pegged to the price of gasoline. As already stated, the entry of ethanol into the U.S. market was influenced by the restricted use of MTBE, and it became the only oxygenate to meet the regulatory requirement of reformulated gasoline (with oxygen from ethanol).

The development of the industry has proved costly. With forgone tax revenues (from tax exemptions to the Highway Trust Fund) and direct subsidies from 1979 to 2008, the estimate of government spending has ranged between US$37 billion and US$40 billion.3 The Highway Trust Fund is no longer a source of subsidy for ethanol, since bridges and highways have become underfunded for some time. Stakeholders subsequently have agreed to eliminate ethanol subsidies from the Trust Fund and incorporate them into a newly created VEETC, a U.S. Treasury general fund, which was later discontinued at the end of 2011.

The insatiable consumer and importer of oil that the United States is, has given it every reason for concern of its energy security. Politicians and oil industry stakeholders, alike, thus agreed to support domestically produced fuel at any price level, while waging two wars in the Middle East. In spite of its efforts, domestic and imported ethanol substituted for only less than 10 percent of gasoline. The official maximum blend level 3

According to the U.S. General Accounting Office, the ethanol excise tax exemption reduced revenues from the Highway Trust Fund by an estimated US$7.5 to US$11 billion from FY1979 to FY2000. Given that estimates for the 2001-2005 period are not available, a "back-of-the-envelope" calculation made by multiplying the total ethanol production of 13.9 billion gallons by the tax credit of US$0.51 arrives an approximate figure of US$7 billion. Further estimates from the Global Subsidies Initiative (http://www.globalsubsidies.org/files/assets/Brochure_-_US_Update.pdf) peg the 2006 subsidies at approximately US$6 billion, 2007 at US$7.5 billion, and 2008 at US$10 billion.

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stipulated by the Environmental Protection Agency (EPA) is limited to 10 percent, which has resulted in a “blend wall,” making it hard for ethanol to further penetrate the U.S. market. There are efforts, however, to increase the blend limit from E10 to E15.

The fact still remains that there has been no resolute commitment from stakeholders regarding the manufacture of biofuels—especially, in the case of ethanol.

The commitment that exists has been imbedded in RFS I and II, which ensures that a defined volume of biofuel be used, based on a defined table. While the Renewable Fuels Association (RFA)—a key stakeholder in the U.S. biofuels industry, especially relating to ethanol—pushed very hard in favor of the RFS, government policy was, and continues to be, open to a variety of options. These include hydrogen, electricity, or new alternatives yet to be developed. Success in terms of ethanol came, primarily, from the corn interest groups, led by the RFA. Its unwavering pressure over two decades eventually persuaded legislators of all parties to agree to develop and support policies in favor of the ethanol.

Counter-lobbies (petroleum, sweetener, dairy, beef, and poultry industries) are, however, coming to the fore, given the recently deployed fracking technologies that have taken place to recover natural gas and oil from large shale deposits, making the United States a potential exporter of hydrocarbons in the near future.

3.1.2 Economic and Financial Instruments 3.1.2.1 Economic Incentives Blending regulations. The Energy Policy Act of 2005 established RFS I, requiring the use of 15.14 billion liters (4 billion gallons) of renewable fuels by 2006 and raising this to 28.39 billion gallons (7.5 billion gallons) in 2012 which, considering U.S. gasoline consumption at 530 billion liters (140 billion gallons) in 2012, would correspond to a 5.3percent blending measure.

Furthermore, under the RFS, ethanol made from cellulosic feedstock—yet to be produced commercially—was granted an extra credit to a count of 9.46 liters (2.5 gallons) of renewable fuel (i.e., cellulosic ethanol at counts of 2.5 RINs for every gallon produced).4 A blending requirement of 946 million liters (250 million gallons) of 4

The RFS established a Renewable Identification Number (RIN) for EPA to monitor its implementation.

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cellulosic ethanol, starting in 2013, was then mandated. It is highly unlikely that this target will be met, as it is only now that DuPont is breaking ground to build a large cellulosic ethanol plant to begin operations in 2014.

The Energy Independence and Security Act of 2007 expanded RFS I to RFS II, requiring the use of 34 billion liters (9 billion gallons) of renewable fuels by 2008, and increasing use to 136 billion liters (36 billion gallons) by 2022. Much of this new legislation includes targets for “advanced fuels,” produced from feedstock other than corn and with 50 percent less GHG emissions in its lifecycle than in that of petroleum.

In spite of environmental and food price concerns, 57 billion liters (15 billion gallons) of corn ethanol were grandfathered into the legislation, a significant amount, with a target to be met only by 2014. This means that the 10-percent blend could be met with corn ethanol alone. There are efforts, however, against moving towards a 15-percent blend (E15), given the issue of the “blend wall”, since RFS II provides for more ethanol than required from a 10-percent blend (E10), the current legal limit for blends, according to the EPA.

Import Tariffs. In order to offset the tax credit that would otherwise accrue on imported ethanol, an import tariff, Other Duty or Charges (ODC) of 14.3 cents per liter (54 cents per gallon) was implemented in the 1980s to boost energy security and to protect domestic producers from less expensive imports. An ad valorem tariff of 2.5 percent has also been imposed.

This added import duty was introduced at a time when the tax credit was at 14.29 cents per liter (54 cents per gallon). When that tax credit decreased to 11.9 cents per liter (45 cents per gallon), the duty became, in effect, an extra protection against the lower cost of imported ethanol. The ODC expired at the end of 2011.

Note that some countries that have negotiated free trade agreements, as well as others with special arrangements in place (such as the Caribbean Basin Initiative [CBI] countries) have been granted duty-free status for ethanol exports to the United States, with a ceiling established annually by the U.S. Treasury Department. CBI provisions

RINs represent gallons of renewable fuel produced/imported.

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require that ethanol merely dehydrated in CBI countries to benefit from duty-free entry into the United States. This has led to the processing of hydrous Brazilian ethanol in dehydration facilities in CBI countries.

3.1.2.2 Financial Incentives There has been a host of federal and state programs, several of which offer either loans or price guarantees for construction of biomass projects, and the development of renewable energy. Grants and financial assistance are available for biomass crop growing, harvesting, storage, and transportation. In addition, funding is available for the purchase of surplus sugarcane production, to be resold as a biomass feedstock for biofuel production.

Major Subsidies. As mentioned previously, the main subsidy relating to U.S. ethanol began with the Energy Tax Act of 1978, which provided for a reduced motor fuel excise tax in favor of ethanol-gasoline blends—10.6 cents per liter (40 cents per gallon) of pure ethanol. Between 1978 and 2011, the ethanol benefit varied between 10.6 and 15.9 cents per liter (40 to 60 cents per gallon). In 2010, the federal subsidy was 13.5 cents per liter (51 cents per gallon) (Tyner, 2008). The main change in the structure of the subsidy was made in 2004, when Congress replaced the excise tax exemption—which effectively reduced the Highway Trust Fund’s revenue—with an income tax credit, VEETC. This impacted the U.S. Treasury’s general fund. This tax credit was structured to decrease to 11.9 cents per liter (45 cents per gallon) per annum following the initial production of ethanol in the United States, with imports not to exceed 28.39 billion gallons (7.5 billion gallons). The target was met in 2008, reducing the tax credit in 2009 and ending in 2011 (Yacobucci, 2009).

Advanced Biofuels Incentives. The issues relating to corn-based ethanol have increased the need for advanced renewable fuels. Millions of dollars have been channeled into research and development (R&D), including subsidies, loan guarantees, special treatment, and grants for the building of testing facilities for the manufacture of cellulosic

25

ethanol and other advanced biofuels. On the other hand, imported ethanol, made from Brazilian sugarcane, qualifies as an advanced biofuel, given its very low GHG emissions.

R&D Incentives. Grants have been made available for R&D relating to biomass and biorefinery technologies. The National Renewable Energy Laboratory (NREL), located in Golden, Colorado, plays an important role in technology development and diffusion.

Furthermore, two initiatives worth mentioning are the Biomass Research and Development Initiative,5 implemented by the U.S. Department of Agriculture (USDA), Department of Energy (DOE), and the Biomass Crop Assistance Program.6

Incentives at the State Level. Subsidies have also been extended at the state level, such as Minnesota’s blender credit (phased out in 1997), with a 10.5 cent per liter (40 cents per gallon) and a producer payment of 4 cents per liter to 5.2 cents per liter (15 cents per gallon to 20 cents per gallon) were provided to biofuel plants over a period of 10 years. In the case of plant expansion, they were extended until the plants came into operation. The maximum amount was limited to US$3 million a plant per annum. While the program in Minnesota is no longer open to new applicants, total payments to the ethanol sector were above US$20 million per annum between 1998 and 2005. Total ethanol production within the state during the same period was 850 million liters (224 million gallons) (EIA, n.d.). A study of U.S. biofuels, effected by the Global Subsidies Initiative, under Doug Koplow, Director of Research and Founder of Earth Track, shows that by 1986, state excise tax exemptions alone were costing state treasuries over US$450 million per annum (at 2006 dollars) in forgone tax revenues (Koplow, 2006). Overall, policy instruments have been fairly consistent over time: reduced fuel excise or other taxes, incentives provided for feedstock, establishment of production facilities and related infrastructure, preferential financing terms, and subsidized purchase of vehicles. In addition, there are regulatory consumption targets (note that the United States does not mandate a percentage blending, but sets a minimum volumetric measure of biofuel through RFS I and II).

5 6

See http://www.usbiomassboard.gov/index.html.

See (http://www.fsa.usda.gov/FSA/webapp?area=home&subject=ener&topic=bcap.

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3.1.3 Results and Lessons Learned The key objectives of the U.S. ethanol program were to find a way to increase supply and encourage demand in the biofuel, and provide farmers a large alternative market for corn.

The prices of feed stock commodities represent approximately two-thirds of ethanol’s, which has caused opposition by stakeholders in the U.S. dairy, beef, poultry, and sweetener industries. Indeed, corn prices increased from a 15-year low of US$75 per metric ton mt in mid-2000, to US$95 per mt in early 2005, to US$157 per mt at the end of 2007, peaking at US$287 per mt in June 2008, and averaging US$165/mt in 2009. In 2010 the price of corn ranged between US$134 per mt and US$190 per mt. In 2011 the range was between US$194 per mt and US$271 per mt, while prices varied in 2012 from US$239 per mt to US$300 per mt7 8. In March 2013 corn price was US$282 per mt. High prices have led to more land acreage devoted to corn and, according to estimates by the USDA, farmers planted 34.8 million hectares of corn in 2009–10, the third largest acreage for this product since 1949. As mentioned previously, more than 40 percent of the production of corn was used for ethanol (USDA and NASS, 2009). While corn crops are alternated with soybean, planting more corn than soybean can influence the price of the latter.

The production cost of ethanol has been, and continues to be, substantial and yet, in the absence of blending mandates, it continues to be blended with gasoline, stretching gasoline volumes and increasing octane rating of gasoline blend stock. In spite of such success, many question whether the industry for this biofuel is viable without government support. A lifecycle analysis could reveal the carbon cost of corn ethanol, its impact in terms of the broader economics, and the unintended impact of the policies in place.

Furthermore, supportive policies could prove to be the basis for an entirely new sector that will include other forms of biofuels, such as cellulosic ethanol. As mentioned previously, sugarcane ethanol from Brazil is considered to be an advanced renewable fuel, while corn ethanol is not.

7 8

See http://www.indexmundi.com/commodities/?commodity=corn&months=300 See www.ycharts.com/indicators/corn_price.

27

It is clear, nevertheless, that industry interested groups in the United States has effectively influenced government policy in the development of a biofuel sector. In the meantime, stakeholders in the oil, sweetener, dairy, beef, and poultry industries continue to maintain pressure against the policies in place that have led to the success of cornbased ethanol as a renewable energy source through fiscal and economic incentives.

Key lessons learned include the following. The adjustment of government subsidies in the development of a biofuel industry can be beneficial when related to a feedstock, such as corn, or any other commodity that may produce renewable energy. In the particular case of the United States, however, there was no shift in policy; rather, there was an additional tax exemption made to the agricultural policy subsidies, normally provided by the U.S. Farm Bill.

Moreover, blending mandates is an effective off-budget instrument to increase demand. A combination of subsidies and mandates can be effective, but costly. A holistic view is required to make a fair assessment, while recognizing that the ethanol industry in the United States has increased employment, as well as created a demand for goods and services, with tax revenue at the local and state levels. In the particular case of the United States, direct subsidies to corn farmers have slowly been adjusted in support of ethanol.

Extending blending regulations has maintained a steady increase in the demand for ethanol, leading to an increase in the demand for corn and, therefore, an increase in its price/volume. This trend has reduced the need by corn producers for direct subsidies.

Nevertheless, the price of corn has been influenced by other factors, such as the cost of petroleum-based fertilizers and drought.

That does not mean, however, that governments should stop implementing subsidies already in place; this could prove to be a politically risky. Rather, governments should adjust incentives and related instruments to generate an increase in the demand for biofuels. In the particular case of the United States, the U.S. Farm Bill, reenacted every five years and due again in 2013, is the main food and agriculture policy instrument for farm subsidies, but it faces growing opposition from relevant stakeholders.

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3.2

European Union 3.2.1 Background

Attention to biofuels in Europe dates back to the 1970s, in the aftermath of the oil crisis.

As net oil importers, European countries needed alternative fuels to contribute to the security of their energy supply. Accordingly, the Council Directive 85/536/EEC of 1985 focused on crude oil savings and authorized the blending of up to 5 percent ethanol and 15 percent ETBE, the ethanol MTBE equivalent. In Europe, methanol-derived MTBE, the oxygenate of choice, is made from natural gas and coal, and had been previously considered an alternative liquid fuel in Europe in lieu of ethanol.

It was not until the 1990s that the production of biofuels started in earnest in Europe. By then, environmental concerns had become a major force at a time when Europe was exporting gasoline surpluses and importing diesel, changing the focus from ethanol to biodiesel.

Today France, Germany, Italy, and Spain contribute to make the EU the world’s largest producer of biodiesel. According to a GSI E.U. biofuels subsidies report by Géraldine Kutas, Carina Lindberg, and Ronald Steenbik (2007), “From the beginning of the industry, biodiesel was supported through agricultural policies affecting production of feedstock, expenditure on research and development, tax exemptions, capital grants, quality standards, and eventually, targets for biofuel consumption.”

Although the EU is the driving force behind the development of biodiesel as an alternative and/or complement to hydrocarbon, buy-in from member states has been disparate. Even the modest voluntary consumption targets, decreed by the 2003 Biofuels Directive (2003/30 EC), based on energy content, of 2 percent by 2005 and 5.75 percent by 2010 have not been met by most member countries. Overall, biofuels reached only 1 percent of total fuel consumption in 2005 and official estimates showed only a 4 percent biofuel content in the fuel mix of the transport sector in 2010 (EC, 2009a).

At the core of these meager results lay the uncertainty behind EU policy thinking.

In Europe, member states are sovereign entities while, in the United States the states fall within a federal system of government. Policy consensus within the EU requires cooperation between many nations with differing views while, at the same time, attempting to

maintain

open dialogue between

29

a plethora of

transnational

nongovernmental organizations and special interest groups. Indeed, the process has been made even more difficult due to the food-versus-fuel debate and the uncertain impact of biofuels on the environment. Critics have argued that implementing regulations would increase the demand for certain commodities, thus intensifying the risk to biodiversity and creating food and water shortages. Yet others believe that sustainable biofuel would (i) create a transport sector that is environmentally friendly, (ii) reduce the EU’s dependency on oil imports, (iii) raise farm income, and (iv) pave the way for secondgeneration renewable energy (EurActiv, 2011). However, the continuing debate has not been conducive to investment in the biofuel sector.

In April, 2009, the European Commission (EC, 2009b) issued Directive 2009/28/EC, promoting the use of renewable energy and establishing mandatory national targets consistent with a 20 percent share of energy from renewable sources and a 10 percent, in energy terms, share of energy from renewable sources in transport in the Community energy consumption by 2020.” The rationale was clear: a framework that includes mandatory targets should provide the business community with the long-term stability it needs to make rational, sustainable investments in the renewable energy sector which are capable of reducing dependence on imported fossil fuels and boosting the use of new energy technologies.

The directive came as a result of a compromise between key stakeholders. The 10 percent target relating to renewable energy for the transport sector can well be met using biofuels, hydrogen, and green electricity. The regulation stipulates that it is essential to meet effective biofuel sustainability criteria and that biofuels meet a target of at least a 35 percent GHG emission savings compared to fossil fuels. The target rises to at least 50 percent by 2017 and at least to 60 percent by 2018. The legislation directs the EU to “compile a report reviewing the impact of indirect land-use changes on greenhouse gas emissions” as part of the necessary methodology needed for lifecycle analysis of European biofuels (EurActiv, 2009).

Although the obligatory mandates do provide some level of security for investors, there is still a question as to how sustainability of the biofuels sector will be assessed. It is anticipated that transparent and scientific criteria will be soon developed and adopted to address this, clearing the way for steady growth of the sector within the EU.

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3.2.2 Economic and Financial Instruments 3.2.2.1 Economic Incentives Agriculture Policy. Among the first sets of policies pertaining to the biofuels sector in the EU was the 1992 Common Agricultural Policy (CAP). Although its objective was to protect agriculture and protect the price and level of output (reducing agriculture surplus) through subsidies to farmers, it also provided an incentive for the output of feedstock for biofuel. CAP originally provided a minimum guarantee per hectare of land not cultivated.

However, farmers who were growing non-food crops in these areas were still eligible for the subsidy. The policy was revised in 2003 to support the development of biofuels in terms of feedstock.

Blending Mandates. Directive 2003/30/EC established a target, on a voluntary basis, of an increase in the market share of biofuels and other renewable energy sources to 2 percent based on energy content, by December 31, 2005, and to 5.75 percent by December 31, 2010, in order to replace petrol (gasoline) and diesel for transport. This compares with Directive 2009/28/EC, referred to previously, which sets a national target of 10 percent market share of energy from renewable sources in transport by 2020. Some countries within the EU have established their own regulations. See Table 2a for a list of these countries.

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Table 2a. National Renewable Energy Plan Targets (NREAP) in the Transportation Sector of Some Key EU Countries

France Germany Netherlands Spain Sweden United Kingdom

NREAP Target (in percent) RE in transport* Total RE** RE in transport* Total RE** RE in transport* Total RE** RE in transport* Total RE** RE in transport* Total RE** RE in transport* Total RE**

2005

2010

2015

2020

1.2 9.6 3.9 5.8 0.1 2.4 1.1 8.7 4.0 39.8 0.2 1.3

6.5 12.8 7.3 8.2 4.1 4.7 6.0 11.0 7.5 41.6 2.6 4.0

7.7 16.0 7.0 11.3 6.0 7.6 9.3 13.8 10.7 43.9 6.2 7.5

10.5 23.0 13.2 18.0 10.3 14.0 13.6 20.0 13.8 49.0 10.3 15.0

Source: European Environment Agency (2011). * Percentage in energy content [ktoe] relating to the share of renewable energy in the sector’s final gross energy consumption (additional energy efficiency scenario); includes Article 21.2 modifications, in double counting, of certain biofuels and green electricity in road transport. ** Percentage in energy content [ktoe] relating to the share of renewable energy in the final gross energy consumption total. For the years 2005 and 2020, the market shares are defined as per Directive 2009/28/EC, Annex I. For the years 2010 and 2010, the market shares refer to the 2011–12 and 2015–16 trends.

Table 2b. 2020 Targets by Renewable Energy Technology in the Transport Sector (in percent)* in Some Key EU Member States Type of Biofuel

France

Germany

Netherlands

Spain

Sweden

United Kingdom

Ethanol – ETBE

1.5

1.8

2.7

1.3

5.7

4.2

Biodiesel

6.8

9.2

5.2

9.8

3.1

5.9

1.0

1.4

0.7

1.2

2.4

0.6

0.4

0.0

0.0

0.0

1.2

0.0

Renewable electricity Other biofuels

Source: European Environment Agency (2011). * Percentage in energy content [ktoe] and relating to the market share of biofuel/renewable energy in the transport sector’s final gross energy consumption (additional energy efficiency scenario).

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Biofuels Standards. Parallel to developments in the agriculture sector has been the development of technology used to produce diesel from a variety of feedstocks. In 1991, Austria published the first standard for biodiesel relating to rapeseed oil methyl ester (RME). France, Germany, Italy, and Sweden followed suit with their own standards. By the end of the 1990s, Austria had broadened its standards to incorporate other raw materials. Standards in the biofuels industry have historically provided for consistency and quality of products in order to attract consumer confidence. For example, Arbeitsgemeinschaft Qualitätsmanagement Biodiesel e.V. (AGQM) is a German firm with global outreach that focuses on the quality of biodiesel, including the biodiesel formulations such as anti-oxidant additives. However, these standards, aimed at the European agriculture feedstock, have sometimes brought about protectionism against0 foreign competition.

A challenge to the development of biofuels is an EU directive on fuel quality in 1998 (EC, 1998), the Fuel Quality Directive and its amendment (Directive 2009/30/EC), which limits the blend of biofuels in fossil fuels to 5 percent, and eventually to 10 percent. As previously discussed, however, many countries in the EU are placing their own energy security and environmental concerns first in terms of renewable energy, and it is not cost effective. To increase the blend percentage of biofuels in the fossil fuels used for transportation requires the development of specific infrastructure in each country. In order to minimize costs and still reach their objectives, many countries have opted to provide incentives for the sale of biofuels to vehicular fleets, which have their own fuel distribution networks (such as buses, public authority transportation, and company cars).

Import Tariffs. The tariff on biodiesel imports is only 6.5 percent while the tariff on pure vegetable oils used for the production of biodiesel ranges between 0 and 3.2 percent.

Although the EU imports vegetable oils, in spite of the low tariffs, EU producers have been effective at meeting the demand for biodiesel. Nonetheless, in 2006, imports from the United States surged. This was an anomaly: global producers had found a loophole that allowed them to receive a 26 cent/liter subsidy from the U.S. government if they added a small amount—a “splash”—of petroleum diesel to biodiesel in that country

33

(whether produced locally or imported). Subsequently, they exported the “splashed” mix to the EU, where it was exempt of import duty in some member states. This transshipment of biodiesel became known as “splash and dash.” Once the loophole was eliminated, imports into the EU resumed normally.

3.2.2.2 Financial Incentives Tax Exemption. Tax exemptions, particularly in the form of deductions on fuel excise, continue to prevail as a means to subsidize the biofuels sector. An attempt to grant tax exemption was made by the European Commission’s Law on Protection and Information for Consumers of 1992, the so-called “Loi Scrivener,” but member countries did not grant approval for the exemptions. The law, however, did allow for tax relief on biofuels pilot projects.

Tax exemptions were first applied in France, but only relating to use of specific feedstock, produced exclusively on farm areas set aside for non-food growing foodstuff (Kutas, Lindberg, and Steenblik, 2007). The production of ETBE from bioethanol has benefitted from this scheme, despite the fact that the size of the processing plants used did not comply with pilot specification, and commercial factories were used instead.

France later revised its policy after BP, a large producer of ethanol, won a case against it in the European Court of Justice in 1997.

Other countries within the EU have since applied subsidies, including Austria and Germany, which exempted pure biodiesel, otherwise known as B100. Furthermore, Germany used the revenue from its Eco tax towards its manufacture.

A significant modification to the tax-relief mechanism was the establishment of quotas for biofuels that will receive the tax relief, limiting the total amount spent while protecting those producers who receive the quota. France and Italy were the first countries within the EU to use quotas. Since 2007, Germany implemented a hybrid system of regulations, combining mandatory use with quotas and tax exemptions, thus limiting budgetary pressures created by subsidies. According to analysts, biodiesel sales declined sharply after the change in policy (Kutas, Lindberg, and Steenblik, 2007).

France’s quotas and subsidies were introduced in phases, providing deadlines as incentives for sales competition.

34

These tax incentives (tax exemptions) are likely to continue to be used widely.

The introduction of regulations in parallel to the latest renewable fuels legislation, Directive 2009/28/EC, authorizes member states to offer tax exemptions to comply with the new mandates.

Capital Grants. Many EU member countries support schemes for the production of biofuels in a similar manner as in the United States. Some of the incentives are tied to the use of local feedstock, while others bolster the creation of second-generation biofuels.

Research and Development. Funding for research and development (R&D) is being provided by a number of specific projects, with more than half of the EU having fullyfunded R&D programs in place on a national basis. It is almost impossible, however, to establish how much funding is dedicated to biodiesel as opposed to the production of biofuels in general. The budget for two of the EU’s principal research programs (Sixth Framework Programme (2002–2006) and Seventh Framework Programme (2007–2013) totaled EUR 70 billion. To complement these programs, the EC’s Competitiveness and Innovation Programme (CIP) supported innovation, provided for better access to finance, and delivered business support services to the region. The Intelligent Energy Europe Program (IEEP), a pillar of CIP, subsequently introduced one of three initiatives, ALTERNER, covering new and renewable energy sources (including biofuels research).

Infrastructure and Consumption Support. Most of the incentives for transportation and infrastructure in the EU are conducive towards the introduction of biodiesel into the fuel mix, and the infrastructure for biodiesel is supported in only certain member countries.

To summarize, every aspect of the biofuels sector receives some support at the EU and/or national level(s). Based on annual calculations made in 2007, subsidies for biodiesel were estimated at US$2.4 billion (EUR 2 billion) (Kutas, Lindberg, and Steenblik, 2007). Although the EU has become a global leader in the production of biodiesel, for the EU as a whole, the goals to increase energy security and improve the sustainability of the energy matrix have yet to be realized. Only a few countries, such as

35

France and Germany, can claim success. The commitment now—as in the United States—is to develop alternative energy and renewable fuels, in lieu of concentrating only on the latter.

3.2.3 Results and Lessons Learned i.

The coordination of agriculture and bioenergy policies has allowed farmers to

plan what crops to grow, based on the overall food and energy needs of the EU. ii.

The use of quotas with tax exemptions can provide a mechanism for governments

to limit their budgetary expenditures while, at the same time, provide the incentives to guarantee production to fulfill mandated requirements. iii.

If costly infrastructure needs to be developed, starting with a program aimed at

captive vehicular fleets can be an effective way in which to boost demand without having to provide substantial subsidies. iv.

Directive 2009/28/EC (RED), mandating the use of alternative fuels, shows that

the EU found that, to attract investors, all countries—including developed countries— need to maintain some regulatory stability.

3.3

Brazil: Ethanol 3.3.1 Background

Brazil is at the forefront in the Latin American region to have spearheaded the production of ethanol from sugarcane. This has been a natural move, given its growing trend for biofuel blending from the 1920s. However, the discovery of large hydrocarbon resources offshore in the Pre-salt layer could pose a new challenge to the biofuel industry in Brazil.

The first oil crisis of the early 1970s caused a four-fold increase in the price of oil in less than six months.9 The impact on the Brazilian economy, which only produced 22 percent of the crude oil it consumed, was substantial (de Castro Santos, 1985). In 1974, the balance of trade account registered a US$4.69 billion deficit, and inflation jumped to 34.5 percent from 15.5 percent the year before (Ferraz Dias de Moraes and Rodrigues, 2006). The only solution was to find a domestic source of fuel, and if there was one 9

Crude oil prices went from US$3.29/barrel in 1972 to US$11.58/barrel less than a year later.

36

product Brazil knew how to produce, it was ethanol from sugarcane. In fact, in the 1930s, Brazil had experimented with blending ethanol with gasoline. Parallel to the sudden and dramatic increase in oil prices was the extreme volatility in sugar prices, which spiked in 1974 only to collapse a year later. By 1975, Brazilian producers called for government support because of an oversupply of sugar. The country had to (i) improve its balance of payments, (ii) find a substitute for imported petroleum, (iii) create a secondary market for sugar, and (iv) maintain demand for its growing automobile industry.

Phase One: 1975–79 The National Alcohol Program (Proálcool), launched in 1975, provided a response to the above dilemma, with the objective of increasing the level of ethanol production to 3 billion liters by 1980. The program addressed the sugar producers’ demands by providing a par price for ethanol and sugar, guaranteeing the sale of ethanol, and offering favorable financing terms, such as a low interest rate and long repayment schedules, for new distilleries.

Measures. A 20-percent blending target was set in terms of demand. Although the initial objective was only to increase the production of blended gasoline, the program extended to a second phase, which was prompted by the Iran-Iraq conflict, and the worsening of the oil market. This subsequent phase included the use of hydrous ethanol as the sole fuel for vehicles adapted to its use. To this end, incentives were provided for the development of vehicles that could run on hydrous ethanol.

Results of Phase One. The implementation of Proálcool was fraught with problems. The first was controversial control of the program by several government ministries. To resolve the issue, a new government entity, the National Alcohol Commission, was established for the implementation of the program. Internal conflict continued, however, which, in turn, delayed the rollout of the program, particularly with respect to the approval of new distilleries. In addition, the inadequacy of the storage and distribution infrastructure resulted in serious bottlenecks. In spite of these challenges, the initial target

37

was met in that ethanol production in Brazil’s 1979/80 harvest year amounted to 3.4 billion liters (Biodieselbr Online Ltd. n.d).

A ramp-up of the program to a second phase was considered to be a challenge. To be successful, it required considerable resources to finance the commercial production of an ethanol-fueled vehicle, to attract consumer buy-in and, of course, to resolve the problems that the first phase had not been able to address. By the late 1970s, however, developments in the Middle East once again provided the climate to push forward.

Phase Two: 1980–85 In 1979, the Iranian revolution, followed by Iraq’s invasion of Iran, caused another dramatic jump in the price of oil, from US$14 per barrel in 1978 to US$36 per barrel in 1980 (BP, 2009). Although Brazil had managed to reduce its use of crude oil by 2 percent compared to the early 1970s, oil imports still made up the bulk of the country’s demand.

Furthermore, in spite of a 20 percent growth in exports, the balance of payments plunged from a surplus of US$4.3 million in 1978 to a deficit of US$3.2 million a year later (de Castro Santos, 1985).

The Brazilian government responded by establishing a National Energy Commission to design programs that would increase the exploration and production of hydrocarbons, deliver new hydroelectricity, and strengthen and widen the Proálcool objectives. Within the latter program, and in addition to the continuation of the main objectives of Phase One, was a new production target of 10.7 billion liters by 1985 and a decision to invest up to US$5 billion to primarily finance sugarcane crops and new distilleries.10 Other initiatives included an agreement between the automobile manufacturers and government to produce up to 250,000 vehicles for hydrous ethanol use by 1980, 300,000 by 1981, and 250,000 by 1982, with the government to hand over all transportation and storage matters to the national oil company, Petrobras.

The next two years saw substantial volatility relating to the implementation of the program. An initial achievement was linked to public perception that the government would ration gasoline and increase the price at the pump, thus influencing a substantial 10

No details of where these funds would come from were provided.

38

number of consumers towards the new hydrous ethanol cars. By December 1980, 76 percent of vehicles sold in Brazil were using hydrous ethanol (de Castro Santos, 1985).

Furthermore, new technology was provided for the conversion of existing gasoline engines to run on hydrous ethanol.

The success of the program caught both the government and manufacturers by surprise. Whereas, previously, the concern was a surplus of hydrous ethanol, it quickly became a potential shortage in the supply of ethanol. To clarify, hydrous ethanol is used to fuel specially manufactured cars, while anhydrous ethanol is used as a blend with gasoline for vehicles that use gasoline. Later, in 2003, with a new technology, Brazil began producing flex fuel vehicles (FFV), which can use both, in any proportion, in the same vehicle.

Maintaining a balance between supply and demand proved to be challenging.

However, with the Brazilian government in control of gasoline and ethanol prices and a regulation already in place for mandatory blending of ethanol, there was a possibility that if the government lowered the blend content, anhydrous ethanol could be hydrated in order to supply the hydrous ethanol market. Additional regulations were put in place to discourage the excessive demand for hydrous ethanol, and the price ratio of hydrous ethanol/gasoline rose from 54 percent to 64 percent.

No sooner had consumers embraced the use of hydrous ethanol than they abandoned it by mid-1981. While there were many reasons for this, the easing of oil prices and increased public confidence, with no fear of shortages, were determining factors. Moreover, the newly adapted car, which, in many cases, had been converted to use ethanol in inadequate service stations, were not only ridden with problems, but also performed poorly. The main reason, however, was the rise in the ratio of ethanol and gasoline prices. As a result, ethanol vehicle sales plummeted and remained low until a series of new incentives were enacted in early 1982, when the original equipment manufacturers (OEMs) started to mass produce the vehicles. By 1986, the share of hydrous ethanol vehicles soared up to 90 percent of all vehicles sold, until the sharp decrease of oil prices.

39

Measures. The first step was to reintroduce the 20 percent ethanol-blending mandate.

Other policy measures included a decrease of the ethanol/ gasoline price ratio from 64 percent to 59 percent, an increase in the tax on the manufacture of gasoline-only vehicles, and a corresponding tax reduction on the production of hydrous ethanol automobiles. In addition, a concession was granted from manufacturers on the price parity of for ethanol and gasoline cars, in spite of the fact that hydrous ethanol-only vehicles were more expensive to produce (Ferraz Dias de Moraes and Rodrigues, 2006). However, the largescale production of ethanol cars evened up the cost differential with that of the production of FFVs.

Results of Phase Two. Consumers responded favorably to these efforts, and the sale of ethanol vehicles rose substantially. The enactment of multiple tax exemptions,11 combined with generous financing terms for vehicular fleets, such as taxis that ran on hydrous ethanol, reignited the demand for ethanol-only cars. By the end of 1982, ethanolonly vehicles accounted for 38 percent of total lightweight vehicle sales. In addition, Petrobras’s purchase, storage, and distribution facilities helped resolve the infrastructure bottleneck. As an example, the number of fuel stations capable of dispensing hydrous ethanol in 1982 rose from 3,587 to 10,009 in 1980 (Ferraz Dias de Moraes and Rodrigues, 2006). Today, an overwhelming majority of service stations in Brazil dispense hydrous ethanol, as well as gasoline.

Brazil’s economic situation as a whole, however, remained fragile. The country’s balance of payments was subject to heavy loans, which now had to be repaid, and funds for projects under the Proálcool became scarce. In 1982, the only projects approved were funded by a US$250 million loan from the World Bank, which included an R&D component. The success of Proálcool depended on close collaboration among ethanol producers, the automobile industry, government, fuel distributors, and other relevant stakeholders, especially the end-users.

11

Tax on Industrial Goods – full tax exemption valid for one year, as well as sales tax.

40

Phase Three: 1986–90 The balance for consensus among stakeholders was more or less maintained for the next four years, leading to a peak in the production of ethanol of 12.3 billion liters in 1986.

Simultaneously, oil prices bottomed out at US$14.46 per barrel, and the Brazilian government’s priorities shifted from energy security to inflation and the budget deficit.

Petrobras took advantage of this climate to squeeze the demand for ethanol in exchange for gasoline to regain its market share.

This lack of focus had many consequences, one of which was Petrobras’ refusal to adhere, in mid-1987, to regulations that required Petrobras to purchase the amount demanded plus a limited quantity of surplus ethanol production. The government agencies responsible for setting the price that ethanol producers receive were pressured to put in place anti-inflationary measures instead, leading to a decrease in the loss of ethanol. This created bitterness among producers, who lost market share and were left with an economically unviable price for their product. Their complaints, however, were left unheard and it was then that the ethanol market began to unravel.

The price drop in ethanol led to an increase in consumption and a decline in production. By the end of 1989, consumers were facing long lines at the pump. In an effort to contain the situation, the government lowered the anhydrous ethanol blending requirement from 22 percent to 13 percent, and approved the importation of not only ethanol (including petrochemical ethanol from Saudi Arabia, corn ethanol from the United States, and coal-based ethanol from South Africa), but also methanol and MTBE. The measures proved to be in vain. Once more, consumers turned their back on ethanolonly vehicles. Sales, accounting for an average of 90 percent of total sales from 1983 to 1988, dropped significantly to 60 percent in 1989, plummeting to 13 percent the following year. This turn of events marked the end of an era. Nevertheless, although the resilience of the ethanol market was no longer there, Brazil found itself left with an infrastructure to produce and distribute the product.

Phase Four: 1991 to the present The decade that followed Phase Three brought about a different mindset. Support for a free market, little government intervention, and deregulation became the norm. In step

41

with the times, a liberalization of the sugar and ethanol markets began in 1996 and, by the end of 1999, the process had been completed.

What now remains are government incentives that relate to blending mandates and a varying differential tax rate for ethanol and/or vehicles, Contribuição de Intervenção no Domínio Econômico (CIDE).

Results of Phase Four. Brazil has recently experienced a revival of the ethanol industry.

The drivers of the market from 2003 were private enterprise and the development of FFV technology. In 2009, 89 percent of vehicles sold were FFVs. However, inconsistency between public policy and the lack of clear support for the use of fuel ethanol is hurting the industry. The price of gasoline—a benchmark for the price of ethanol—had been maintained low so as to avert inflation. Not only was this detrimental to Petrobras’ profitability, but it spurred demand, and thus increased the import of petroleum and oil products (gasoline and diesel). Biofuel producers, Petrobras, and relevant stakeholders are currently aligned—for now.

Up until four years ago, the Brazilian sugarcane ethanol market was destined for success. Investment in the sector was at an all-time high, productivity was on the rise, and consumer buy-in for FFVs was significant, with hydrous ethanol and anhydrous ethanol blended with gasoline surpassing the volume of gasoline sold at the pump. Statistics, however, are more indicative of a peak rather than an upward trend, given that, since 2009, the sector had floundered. Although the causes may have been many, the principal one was the determination of the Brazilian government to contain inflation by maintaining the price of gasoline low, regardless of consequences.

Since 2005, the low price of fuel in Brazil has remained relatively stable. Not surprisingly, this has increased the sale of vehicles and, thus, consumption of oil. To meet this growing demand and to complement domestic production, energy imports have increased from 9,000 barrels per day in 2009 to 80,000 barrels per day in 2012. On one hand, given that regulations required a 20 to 25 percent anhydrous ethanol blend in gasoline, an increase in Brazilian gasoline consumption would benefit ethanol producers.

On the other hand, blended fuel only accounted for 30 to 35 percent of ethanol output, with the balance being sold as hydrous ethanol. For hydrous ethanol to be competitive,

42

the reduction in mileage that comes with it should be conducive towards prices not exceeding 70 percent of the price of gasoline. Simply put, low prices at the pump, an increase in production costs (40 percent over the last five years), bottlenecks due to coordination, and unusual weather patterns present a challenging business climate for ethanol.

Reaction from biofuel producers led to decreased investment in ethanol and an increase in the production of sugar, which, at the time, was fetching a good price on the international market. This led to a shortage of ethanol in Brazil, turning it into a net importer of ethanol (in 2011, Brazilian exports were 655,889 cubic meters vis-à-vis imports at 1,150,113 cubic meters). However, this trade was primarily influenced by the classification of Brazilian sugarcane ethanol as an advanced biofuel—and the only one on the international market. As a result, the United States now imports it from Brazil to satisfy RFS II regulations and Brazil, to compensate for the export of sugarcane ethanol and to satisfy its own domestic demand, imports U.S. corn ethanol.

While supplies may have returned to Brazil’s market and the government has eased taxes on gasoline (freeing the way for Petrobras to raise refinery prices), the adjustment to consumer prices has been minimal (8 percent). In the meantime, tax on ethanol has remained unchanged. This policy proved to have serious consequences. From the introduction of FFVs in 2003 to early 2008, ethanol production grew at an average of 10.4 percent per annum. During this period, over 100 new ethanol production plants came into operation. However, since the 2008 global financial crisis, growth has declined to 3.5 percent per annum, and the construction of new production plants dwindled from 21 in 2009–10, to 9 in 2010–11, with only 3 planned for 2012, and 2 for 2013. In 2011, sugarcane production declined to 18 percent. Four years ago, Shell, BP, and trading firms, Noble and Bunge, competed with other multinationals and wealthy investors for a slice of the Brazilian ethanol market, but today, India’s Renuka; Spain’s Abengoa Bioenergia; and Singapore’s Noble are selling or considering to sell their Brazilian ethanol assets.

This cannot be considered the end of ethanol in Brazil, however. As this note has illustrated, this is not the first time that the country’s ethanol sector has been under threat.

What has made Brazil so successful in the long term has been the government’s ability to

43

identify and correct adverse policies and possess the foresight to improve conditions and develop alternative markets. It will be interesting to see whether the present government will follow the pattern that has taken place to date.

3.3.2 Economic and Financial Instruments 3.3.2.1 Economic Incentives Blending Mandates. Mandatory blending of anhydrous ethanol into gasoline has varied between 20 and 25 percent since 1975. As already mentioned, this requirement has sometimes been lowered for short periods of time in an effort to ease the shortage of hydrous ethanol.

Price Parity, Controls, and Support. Until deregulation took place in the 1990s, the Brazilian government controlled the supply and demand of ethanol in terms of pricing, and sugar and ethanol prices were maintained at a par to ensure production. Furthermore, ProĂĄlcool producers have, for the most part, benefited from price guarantees, which included a subsidy. To administer the subsidy, an Alcohol account was created in 1976, which evolved into many forms and nomenclatures over time. A subsidy was granted on volume capacity, on a state-to-state basis. The Alcohol account was administered in parallel to a Petroleum account, with the government controlling producer and consumer prices, as well as the margins of the intermediary suppliers. Depending on government policy objectives, deficits and surpluses accumulated in either or both accounts, creating controversy over the total amounts spent. One view was that when the Alcohol account was considered in relation to the Petroleum account, and both production and consumer prices were entered into the calculation, there was an income transfer from producers to consumers (Kojima and Johnson, 2005). The income transfer mechanism on the demand side was the ethanol/gasoline price ratio that varied between 66 and 53 percent. These instruments were phased out two decades ago.

Import Tariffs. An excise tax of 20 percent on the importation of ethanol imports was imposed in compliance with Mercosur’s Common External Tariff (CET). However, Brazil has periodically exempted the import duty of ethanol, when necessary.

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Importations of ethanol have now, however, been suspended until 2015. As mentioned previously, since sugarcane ethanol is considered an advanced fuel under the U.S. RFS II, a swap exists between the importation of U.S. corn-based ethanol and Brazilian ethanol exports.

In terms of production, direct loans from banks, such as Banco do Brasil, Banco Nacional de Desenvolvimento Economico e Social (BNDES), Banco do Nordeste do Brasil, and others, were key to the development of the ethanol sector. In spite of inflation during the 1980s and early 1990s, when access to finance was limited and rates were high, the Brazilian banks offered attractive terms. While raising equity finance in the stock market was also an option, the family-owned ethanol businesses were more into debt financing than equity financing.

As a result of these attractive terms offered by the local banks, the output of crop increased and large-scale production assets were established, which increased the output of ethanol at a more rapid rate than was otherwise possible for a developing country.

Access to finance also extended to supporting ethanol trade, as well as the cost of storage.12 At the consumer level, special terms on loans were made available for the purchase of ethanol-using vehicles, such as Brazil’s taxi fleet from 1982. The incentive to purchase hydrous ethanol vehicles was due to the reduction and/or elimination of excise tax on vehicles, which could sometimes reach 50 percent of the price of the vehicle. In addition, during the times when weekend restrictions were imposed on the retail sale of gasoline, hydrous ethanol was readily available at service stations.

3.3.2.2 Financial Incentives Tax Exemptions. In line with most developing countries, Brazil has a range of differing taxes on goods and services, which can be managed, from time to time, to incentivize a specific sector or product. Exemption to these taxes has been implemented throughout the development of the fuel ethanol industry, and has remained in the form of a subsidy.

These tax exemptions were mostly restricted to goods and services, such as the 12

Ethanol production took place only during 6 to 8 months of the year, while it was used throughout the year, requiring surplus stocks.

45

manufactured products, sales, and road tax. The following three taxes applied to biofuels: (i) Contribution to Intervention in the Economic Domain (Contribuição de Intervenção no Domínio Econômico, CIDE); (ii) contributions to the Program of Social Integration (Programa de Integração Social, PIS) and to the funding of Brazil’s social security program (Contribuição para o Financiamento da Seguridade, COFINS), Brazil’s social security program; and (iii) Operations Tax on the Circulation of Goods and Services of Interstate and Intermunicipal Transportation and Communication (Circulação de Mercadorias e Prestação de Serviços de Transporte Interestadual e Intermunicipal e de Comunicação, ICMS). The first two are federal taxes, while the third is a state tax and, in all cases, the rate varies from state to state. Of the three, ethanol receives full exemption only from the CIDE tax. The use of differential rates on goods and services relating to FFVs is now restricted to ICMS tax and only applied in some states.

Research and Development. The sugar and ethanol industries in Brazil have been regulated for some time by the Sugar and Alcohol Institute (Instituto do Açúcar e do Alcool, IAA), especially during the implementation of the Proálcool program, when it was also involved in Proálcool’s research and development activities. A public-private partnership between the Technological Institute of Aeronautics (Instituto Tecnológico de Aeronáutica, ITA), Secretariat of Industrial Technology (Secretaria de Tecnologia Industria) of the Ministério da Indústria e Comércio, and the automobile industry led to the development of the ethanol-only vehicle.

On the other hand, the impact of technology on improving agriculture has been incremental. It has taken the combined efforts of the Brazilian government and private sector to develop the various technologies required to increase the sugar cane yield of 46.5 tons per hectare (t/h) in 1975, to 57t/h in 1980, to 61.5t/h in 1990, to 73.5t/h in 2005, and up to 85 t/h in 2008 (Ferraz Dias de Moraes and Rodrigues, 2006). With respect to the government, the Brazilian Enterprise for Agricultural Research (Empresa Brasileira de Pesquisa Agropecuária, EMPRAPA) and the National Sugarcane Improvement Program

(Programa

Nacional

de

Melhoramento

da

Cana-de-Açucar,

PLANALSUCAR)—funded by an export foundation—have been catalytic in the development of the sector (Guevara Abarca, 1999).

46

In terms of the private sector, Copersucar, once a powerful cooperative formed primarily by the State of São Paulo’s sugar and ethanol producers (and now one of the largest sugar and ethanol a commodities trader in the world), created a sugarcane research center, Centro de Tecnologia Canavieira (CTC). CTC became the technology benchmark relating to innovative technology in the development of ethanol as a biofuel. Prior to CTC, the Institute of Agronomy of Campinas (Instituto Agronômico de Campinas, IAC), University of Sao Paulo’s College of Agriculture “Luis de Queiroz” at Piracicaba (Escola Superior de Agricultura "Luiz de Queiroz," Universidade da São Paulo, ESALQ), and EMBRAPA all played a role in supporting the development of sugarcane agriculture.

Another organization within the LAC region that can be considered similar is the Colombian Sugarcane Research Center (Centro de Investigación de la Caña de Azúcar de Colombia, CENICANA).

Information on overall subsidies to the sector was officially made available only until 1985. The available data show that, in 1976, approximately US$4 billion (at 1992 dollars) was invested in Proálcool (Ferraz Dias de Moraes and Rodrigues, 2006).

Although substantial in terms of a developing country, few would argue that Brazil, itself, has not benefited from this investment. Government expenditures between 1975 and 1990, during the implementation of Proálcool, amounted to US$1.5 billion in subsidies for the building of distilleries and revenue foregone, totaling US$7 billion.

The original objectives aimed towards improving Brazil’s balance of payments, developing a substitute for imported oil, creating a secondary market for sugar, and keeping the automobile industry running proved successful. Brazilian experts estimate that, between 1976 and 2004, ethanol used as a fuel has saved the country US$60.74 billion in oil imports (at 2005 dollars). With interest on external debt at a rate of 2 percent per annum, savings have reached US$111.14 billion.13 Today, Brazil can be considered self-sufficient in oil due to existing reserves close to its shores; however, the development of a biofuel sector has helped. The shift of 50 percent relating to gasoline corresponds to

13

Kojima and Johnson (2005) claim the total savings were approximately US$121.24. However, 2 percent per annum on 60 billion amounts to 1.2 billion per annum for 28 years, which equals USUS$50.4 billion.

By adding the service costs to the original amount, it totals US$111.14 billion.

47

a shift of 10 percent in oil consumption, since Brazilian crude slate is dominated by use of diesel.

Finally, Brazilian sugar producers have become global leaders in sugar and ethanol productivity, as well as in the technological advancement of sugarcane in other sectors (e.g., generation of electricity). In terms of the latter, there is now a significantly growing need for sugar and ethanol derivatives in the manufacture of higher grade sugar and ethanol chemicals. Brazil inaugurated in 2009 the largest ethylene plant based on ethanol in the world, creating a global market for environmentally friendly polyethylene.

3.3.3 Results and Lessons Learned The success of the ethanol program in Brazil has been largely due to the fact that its goals were clearly defined since inception, and although the program itself changed according to the circumstances, its commitment to its mission never wavered. With commitments translated into policy support in place and room for flexibility, the investment climate improved significantly. Nevertheless, it is apparent that there will be a number of policy shifts down the road and, what appears to be a growing lack of clearly defined public regulation, has now hampered the biofuel industry in Brazil into stagnation.

It takes time for producers, policy makers, and the stakeholders concerned within the entire supply chain to work together. Consensus is a key element for continued success and with this comes patience and perseverance. Once this has been reached, it requires periodic reassessment. i.

The design of a program should initially take into account the agriculture and

energy policies already in place. With limited funds available, it is crucial for a government to make a rational judgment on which programs should be funded. In the case of Brazil, an existing void was filled by providing loans to farmers and the agroindustry (e.g., building new distilleries) at preferential rates so as to maintain a limit on total expenditure. In addition, direct subsidies were applied only to volume as opposed to production. ii.

Government control of the entire hydrocarbon supply chain, through Petrobras,

made it easy to avoid a costly infrastructure investment by using existing infrastructure of

48

the state-owned enterprise. Moreover, it allowed the program to combine ethanol and oil subsidies, as well as to transfer income between producers and consumers. iii.

The willingness of Brazil to recognize the failures in the program and the courage

to change course has opened the door towards progress.

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3.4 Brazil: Biodiesel 3.4.1

Background

Although biodiesel research in Brazil dates back to the 1960s and, like ethanol, benefitted from the national ProVeg program in the early 1980s, the program never gained traction and was discontinued. It was only towards the end of the 1990s, when biodiesel production in Europe had become well established, that Brazil’s interest revived.

In mid-2003, Brazil established a working group from various government agencies to prepare a viability study on the economic, social, and environmental feasibility of biodiesel production. The working group consulted extensively with public and private stakeholders—from research institutions to vehicle manufacturers, as well as with federal and state officials—before presenting its recommendations. As a result, in December 2003, Brazil established, within the Ministry of Mines and Energy, the Executive Inter-ministerial Committee on Biodiesel (Comissão Executiva Interministerial de Biodiesel) for policy development and the Managerial Biodiesel Group (Grupo Gestor de Biodiesel) to implement the policies.

A year later, in December 2004, the PNPB program was launched. In contrast to the Proálcool, which main objective was to provide an indigenous source of biofuel, PNPB put in place an energy framework with social objectives for rural development, including (i) the promotion of social inclusion among rural workers and farmers; and (ii) a reduction in the dependency on the imports of petroleum-derived diesel oil in order to generate hard-currency savings, and a means to protect the environment (Governo Federal – Brazil, n.d.). The blending mandates set by PNPB were explicit for creating the framework for production of biodiesel that eventually, through various subsidies, would support social and rural development.

In 2003, diesel accounted for 57.7 percent of all liquid fuels in Brazil. The domestic output of 34.5 billion liters per annum was complemented with 3.7 billion liters of imported diesel in order to fulfill a total demand of 38.2 billion liters. By 2005, demand had increased to 40 billion liters. With this ambitious project, the new regulations set an optional 2-percent blending mandate (B-2) in 2004, and later made it mandatory in January 2008. The blending mandate was raised to 3 percent (B-3), effective July 2008 and, a year later, was further increased to 4 percent (B-4). The

50

original legislation had set a regulation of 5 percent blending mandate (B-5) by 2013, which was achieved by 2010.

PNPB estimated that biodiesel would be produced mostly from (i) castor bean, oil palm, and babassu (feather palm) in the Northeast; (ii) oil palm and soybean in the North; (iii) soybean, castor bean, and cotton seed in the Center-West; (iv) soybean, cotton seed, and sunflower seeds in the South; and (v) soybean, cotton seed, and sunflower seeds in the South-East of Brazil. Most importantly, social inclusion was to be achieved, and to this end, a certification program was put into effect, the “Social Fuel Seal,” which would provide eligible biodiesel producers preferential access to finance, tax benefits, and sales guarantees. Eligibility was restricted to those who were able to produce a specific percentage of biomass from small family farms, thus moving towards rural sustainability, particularly in the North and Northeastern regions of the country. To qualify for the Social Fuel Seal, a biofuel producer was required to purchase (i) 10 percent of its biomass material from small farms, if producing biodiesel in the Center-West; (ii) 30 percent, if in the South or Southeast; and (iii) 50 percent if located in the Northeast. In addition, certificate holders were obligated to provide technical assistance to their suppliers.

The outcome of this scheme was the exact opposite from what was originally intended. Although the participation of small family farms in the soy production chain in the Center-West was not significant, it accounted for at least 10 percent of output; hence biodiesel producers from those regions had no problems qualifying for the Social Fund Seal. In contrast, producers in the North and Northeast were saddled with introducing a new crop to poorly trained farmers who, often with very little education, had to account for at least half the output. In an attempt to correct the situation, the Social Fund Seal’s regional production requirements were revised to 30 percent for the Northeast, Southeast, and South. The North and Center-West were to maintain their 10 percent of output for the 2009/2010 harvest, and increase it to 15 percent the following year.

One of the benefits of the Social Fund Seal is tax exemption, which provided a majority of soy producers with significant tax credits. This made them more competitive in relation to the producers in the North and Northeast.

While these are only a few of the challenges PNPB is facing, they serve to illustrate the current scenario of the Brazilian biodiesel industry. Output of the biodiesel

51

has increased substantially, from 736,000 liters in 2005 to 404 million liters in 2007, and to 1.3 billion liters in the end of October 2009. Capacity, however, substantially exceeds production at up to 5 billion liters. Although the North and Northeast accounted for half of the production of biodiesel in 2007, they produced only 12 percent two years later. The soybean growers of the Center-West and South—the traditional agricultural commodities powerhouses—now contribute to 85 percent of the country’s production. This outcome not only defeats PNPB’s rural social development objective but also puts into question the environmental benefits that the Brazilian biodiesel industry was to contribute. Even though the lifecycle carbon assessment for biodiesel derived from soybean has yet to be determined, Brazil can easily quench any judgment that biodiesel-producing food crops compete for arable land, simply by demonstrating that there are still over 150 million hectares of arable land that can be used. Nevertheless, the yield of soybean is far less than that of oil palm, castor bean, babassu, and sunflower seeds, with soybean oil (80 percent) and animal fat (20 percent) being the principal feedstock in Brazil today. Castor oil, as a lubricant feedstock, is much higher in value than as a raw material for biodiesel.

For the most part, the few who invested in the Northern and Northeastern regions of the country have now withdrawn and Petrobras now stands in their place. The nationally powerful company has now become the region’s main producer of biodiesel through its subsidiary Petrobras Biocombustível (PBIO).

PBIO maintains two experimental units in Rio Grande do Norte, which have been operating since 2005/06, and commercial units in Bahia, Minas Gerais, and Ceará, respectively, with a total capacity of 772 million liters per annum. The sale of biodiesel through auctions by ANP illustrates the difficulties that Brazil is encountering in expanding its biofuel industry.

Petrobras and Vale both play a key role in the manufacture of biodiesel from palm oil in Pará state. Vale absorbs its own output, while Petrobras exports palm oil to Portugal where, through a joint venture with the latter’s Galp Energia (an oil and natural gas distributor), it is processed into biodiesel.

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3.4.2 Economic and Financial Instruments 3.4.2.1 Economic Incentives Blending Mandates. Regulations were implemented for the blend mix to be 2 percent (B-2) by January 2008 and 5 percent (B-5) by 2013. The B-2 mandate was raised to 3 percent (B-3) in July 2008 and 4 percent (B-4) in July 2009. The B-5 goal already has been achieved ahead of schedule but, due to the current economic environment, the blend mix of B-10 will be hard to achieve, despite adequate capacity.

Social Fund Seal. This certification is awarded to those registered biodiesel producers who can guarantee an established percentage of biomass from small farms. The size of a farm is defined by the National Support Program for Strengthening Family Agriculture (Programa Nacional de Fortalecimento da Agricultura Familiar, PRONAF). The fund’s qualifying blend mix measures were modified to 30 percent for the Northeast, Southeast, and South of Brazil, while the 10 percent blend mix regulation for the North and CenterWest, maintained through the 2009/2010 harvest, was increased to 15 percent the following year.

Specifications and Commercialization. ANP is charged with setting regulations relating to biodiesel specifications, licensing, and monitoring for compliance. In addition, the agency is responsible for coordinating the auctions where certified biofuel producers are given preferential treatment to enable them to secure up to 80 percent of the demand for biofuel.

3.4.2.2 Financial Incentives Tax Exemptions. Preferential tax treatment on biofuels, in general, is offered through the CIDE and PIS/COFINS programs. Biodiesel, however, is eligible for tax exemption only under CIDE. Certified producers under the Social Fund Seal using castor bean or palm oil are exempt under PIS/COFINS, while those using other biomass material qualify for a 68 percent reduction in PIS/COFINS. Non-certified producers, on the other hand, using castor or palm oil receive a 32 percent discount on the same tax, and pay R$0.222 per

53

liter on the remainder of their production, compared to the CIDE and PIS/COFIN rate of R$0.218 per liter for petroleum-based diesel.

Loans and Grants. In 2004, small farms were provided access to finance at attractive rates and with long-term repayment schedules, when the Brazilian government allocated R$100 million (US$37 million) to PRONAF. BNDES offered new credit lines for biodiesel investments with special conditions. First, BNDES would be a shareholder of up to 90 percent of Social Fund Seal-certified biodiesel projects and 80 percent of noncertified projects. Second, interest rates based on Tasa de Juros a Longo Prazo (TJLP) plus 1 percent was offered to certified small- and medium-sized enterprises, plus 2 percent for those that were uncertified. Large certified companies were offered a TJLP plus 2 percent, while those that were not certified were offered TJLP plus 3 percent.

Third, the loan on the purchase of equipment for biodiesel projects was set at a 25 percent longer repayment schedule.

In spite of its good intentions, it took BNDES some years before these loans were allocated. The bank’s reason for this was that there was a delay in the issuance of environmental licenses necessary for eligible producers (Teixeira de Sousa et al., 2008).

Research and Development. Embrapa was given the responsibility of processing the 2005/06 harvest of castor bean seeds, and was provided with technical assistance to ensure maximum production. It is also responsible for the climate change risk assessment needed for the allocation of finance and crop insurance. The Leopoldo Americo Miguez de Melho Research Center (Centro de Pesquisas e Desenvolvimento Leopoldo Américo Miguez de Mello, CENPES) of Petrobras is conducting studies on technological innovations related to the production of biodiesel. There has been no indication related to the funding of its research and development activities.

3.4.3 Results and Lessons Learned It is would seem unfair to judge the results of a program that is barely five years old. It is, nevertheless, interesting to note that, despite Brazil’s experience in the biofuel sector, it has encountered great difficulty in establishing a new biofuels program that can achieve

54

the goals it aimed for. Indeed, while PNPB has managed to increase Brazil’s biodiesel production, many objectives remain outstanding. Moreover, with soybean producers having gained a major foothold in the supply of biodiesel feedstocks, it may become even harder for small enterprises to become competitive.

Lessons learned from what has not worked. i.

The combination of a dynamic biofuel regulation with an equally strong rural

social inclusion objective has proved to be ineffective. The production of fuel, in general—including that related to biodiesel—requires scale, quality control, and reliability, among other factors, which make it complicated for small enterprises. The introduction of new crops makes it even more difficult for them. ii.

Placing the burden of technical assistance (and its lack of funding) on the

producer, especially in relation to small farmers, is not an effective way in which to educate growers. iii.

While certifying Petrobras under the Social Fund Seal program may have been a

political move, it is a concern not only to the company itself, but also to many of the producers. Petrobras has become the only buyer of biodiesel and, therefore, dominates the market. Once it becomes a manufacturer of the biofuel, it will control the entire supply chain. Sound regulation and strict enforcement will be necessary to ensure prudence and transparency, with the Brazilian government—as a controlling shareholder of Petrobras—in a position to defend the public good while, at the same time, protect the interests of the company. It is difficult to anticipate how such a company as Petrobras will manage to focus, not only on the exploration and development of Brazil’s newly found Sub-salt oil reserves, but also on the task of supporting small family farms by manufacturing biodiesel, even via its own subsidiary, Petrobras Biocombustível.

Actually, the subsidiary’s main interest is in local joint ventures related to ethanol.

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4

Points of Reference from Lessons Learned

The background experiences provided above relating to the development of biofuel in the United States, the EU, and Brazil, have provided substantial insight. Although it is difficult to isolate a single policy or development due to the cultural and political differences that helped shape it, there are some valuable indicators that can be drawn from them.

A. Clear vision and commitment. Although neither the United States nor the EU had clear-cut objectives for the development of a biofuel market, Brazil—as a developing country—has demonstrated the opposite. Its success in having developed a biofuel sector has depended much on a crystal clear vision.

Nonetheless, clear objectives are not sufficient. These three examples have illustrated that solid commitment to remain on course has provided an enabling climate for investment.

B. Adjusting incentives/subsidies. It is possible to develop a biofuel sector through policies that allow for the adjustment of incentives and/or subsidies relating to agricultural commodities, such as corn, canola, sugarcane, and soybeans, in order to increase demand and decrease the cost of the commodity. Incentives/subsidies should encourage production, distribution, storage, and sales throughout the biofuel supply chain and should be phased out once they have met their purpose.

On the other hand, mandates are off-budget whose costs are hidden and borne by consumers.

C. Adaptation. It is important to learn from the failure of some policies, and revise them to ensure the long-term success of a program. Reassessment of the policy portfolio is an important part of the learning curve, and involves all relevant stakeholders.

D. Policy Coordination. Policy design must take into account both the agricultural and the energy sectors. Despite the importance of coordinating agricultural subsidies, taxes, and other financial mechanisms, the ministry of agriculture must also liaise with its energy counterpart. It is, however, up to each country to decide which approach to take, although it appears that, with the increasing relevance of ethanol and biodiesel, a larger role must be played by the energy sector.

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E. Stakeholder Involvement. Common agreement among relevant stakeholders, including the farmers, producers, distributors, and workers, will aid the process of policy making and in a time of crisis, could provide insight into the evaluation of policies, legislation, regulation, and incentives.

F. Realistic goals and objectives. Although a long-term strategy should be implemented, overly ambitious targets could result counterproductive. While realistic targets can be conducive to reaching objectives, they should include input from the stakeholders.

In certain countries in the LAC region, the option to develop ethanol has been explicit (e.g., Bolivia, Brazil, Colombia, Paraguay, and Venezuela). In other cases, biodiesel was the first biofuel choice or was added to the ethanol initiative at a later stage (e.g., Argentina, Bolivia, Brazil, Colombia, Peru, Uruguay, and Venezuela).

Other LAC countries could adopt a strategy, incorporating the lessons and recent developments that Brazil, the EU, and the United States, as well as other countries, have brought to the field. There is vast opportunity for the transfer of relevant technology, and existing infrastructure can manage the blending process of ethanol and biodiesel with gasoline and diesel, respectively.

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5

Conclusions

Latin American and the Caribbean have a great potential to become a significant biofuelproducing region, for example, in relation to sugarcane ethanol. It should also be recognized that vegetable oils and animal fat could be used for biodiesel. The benefits that a biofuels industry could provide to a country are vast. They range from an improvement of the country’s energy security and balance of payment to the provision of “green” electricity and an improvement in overall emissions, and sustainability of the energy matrix.

The knowledge drawn from this technical note provides the tools for countries to establish the framework for a successful biofuels industry. Mandatory blending options can also be conducive to a strong market without the need for a specific infrastructure.

Confidence in demand and supply, as well as clear-cut regulations, will attract investment, while economic and fiscal incentives will help support development of the sector. Furthermore, producers will embrace biofuels if there are subsidies, tax incentives, and attractive loan terms for crops and distillery/mill construction, as well as parity between the price of the commodity and the end-product (biofuel). All have proved to be instrumental in the development of the biofuel sector in the regions examined herein.

As the production of biofuel is being established, the infrastructure for its distribution must be developed. Special incentives for specific vehicular fleets can maintain the cost of the biofuel, while increasing demand. Once the distribution network is in place, in the case of hydrous ethanol, the introduction of FFVs into the vehicular fleet can attract consumer buy-in.

Finally, although government focus and support are fundamental to the development of the biofuel sector, it is common agreement among of all stakeholders— from producers to consumers—that will ultimately ensure the continuous success of biofuels. More important is the economic basis for the long-term sustainability of a biofuel sector.

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6

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Josling, Tim, David Blandford, and Jane Earley. 2010. “Biofuel and Biomass Subsidies in the U.S., EU and Brazil: Towards a Transparent System of Notification.” IPC Position Paper, Washington, DC: IPC. Adapted from OECD. 2008. Biofuels Support Policies: An Economic Assessment. Paris: OECD.

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Annex I Comparison of Key Characteristics between the Ethanol Industries in the United States and Brazil Characteristics

Brazil

U.S.

Units/Comments Main cash crop for ethanol production, the United States has less than 2 percent ethanol from other crops.

Main feedstock

Sugarcane

Maize, corn

Total ethanol fuel production (2011)[1] Total arable land [61]

5,573 (21,100) 355

13,900 Million U.S. liquid gallons (52,612) Million Liters 270(1) Million hectares. Excludes Alaska

Total area used for ethanol crop (2006)[20][61]

3.6 (1 percent)

10 (3.7 percent)

Million hectares (percent total arable)

Productivity per hectare [20][55][61][62]

6,8008,000

3,8004,000

Liters of ethanol per hectare. Brazil is 727 to 870 gallons per acre (2006), US is 321 to 424 gallons per acre (2003–05)

Energy balance (input energy productivity) [20][20][57][63]

8.3 to 10.2 1.3 to 1.6 Ratio of the fossil energy saved from ethanol/fossil energy expended in its production

Estimated GHG reduction[2][15][20]

86-90 percent(2)

Percent GHGs avoided by using ethanol instead of 10-30 gasoline, using existing crop land, without percent(2) ILUC** effects.

EPA's estimated 2022 GHG reduction for RFS2.[92]

61 percent(2)

21 percent

Average percent GHGs change as compared to gasoline and considering direct and ILUC.

CARB Full life-cycle carbon intensity[12][64]

73.40

105.10(3)

Grams of CO2 equivalent released per MJ produced, includes ILUC.[15]

Estimated payback time for greenhouse gas emission[13]

17 years(4)

93 years(4)

Brazilian “cerrado” (savannah) for sugarcane and U.S. grassland for corn. Land use change scenarios by Fargione et al. [14]

Flexible-fuel vehicle fleet (includes autos, light trucks and motorcycles)[7][94][95]

14

All fleets as of December 2011. The Brazilian fleet includes 1.5 million flex-fuel motorcycles.[96][97][98] 16.3 million

10 million14

Source: Motavalli (2012).

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USDOE estimates that in 2009, only 504,297 FFVs were regularly fueled with E85 in the United States.[48]

Ethanol fueling stations in the country

35,017 (100 percent)

2,749 (1.6 percent)

As percent of total gas stations in the country.

Brazil by December 2007,[99] United States by May 2011.[13] (170,000 total.[43])

Ethanol's share within the gasoline market [70][71][72][73] [5][100][101][102]

50 percent(5)

10 percent

As percent of total consumption on a volumetric basis. Brazil as of April 2008. United States as of December 2010.

Cost of production (US$ per gallon)[55]

0.83

1.14

2006/2007 for Brazil (22¢/liter), 2004 for U.S. (35¢/liter)

0.

U.S. federal subsidy expired from January 2012, together with 54 cents per gallon duty. But RFS II guarantees a volumetric market for renewable fuels. Brazilian ethanol production is no longer subsidized,(6) but enjoys mandated market.

0

As of January 2012, US$0.54 per gallon duty expired. Despite the Brazilian import duty, whenever Brazil imports fuel ethanol the duty is waived.

Government subsidy (in U.S. dollars)[59][74]

Import tariffs (in percent)

[57][58]

0(6)

20

* Megajoule. **Indirect land-use changes.

Notes: (1) Only contiguous United States, excluding Alaska. (2) Assuming no land use change.[15] (3) CARB estimate for Midwest corn ethanol. California's gasoline carbon intensity is 95.86 blended with 10 percent ethanol.[12][64] (4) Assuming direct land use change.[14] (5) If diesel-powered vehicles are included and due to ethanol's lower energy content by volume, bioethanol represented 16.9 percent of the road sector energy consumption in 2007.[75] (6) Brazilian ethanol production is no longer subsidized, but gasoline is heavily taxed favoring ethanol fuel consumption (~54 percent tax). By the end of July 2008, the average gasoline retail price at the pump in Brazil was US$6.00 per gallon, while the average price was US$3.98 per gallon.[76] The latest gas retail price increase in Brazil occurred in late 2005, when oil price was at US$60 per barrel.[77] Source: http://en.wikipedia.org/wiki/Ethanol_fuel_in_the_United_States#cite_note-Veja_30_04-60 Note that the 2008 numbers quoted for 2008 Brazilian ethanol production were incorrect and have been revised in this table.

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Annex II Summary of Government Incentives for the Biofuels Sector United States: Ethanol Classificatio n of program Support for production of corn

Support for fuel ethanol production and distribution

Instruments used Direct subsidies for corn production

Indirect subsidies for corn production Trade policies on corn Reduction of capital and infra- structure costs Reduction of production costs Direct subsidies for production of fuel ethanol Guaranteed prices paid by distributor Trade policies on fuel ethanol

Reduction of distribution costs Quantitative promotion

Examples Biomass Crop Assistance Program (BCAP): - 2008 Farm Bill - Farm Service Agency, USDA - Support for production, collection, storage, and transport of energy crops - Direct payments; matching payments Crops http://www.fsa.usda.gov/FSA/webapp?area=home&subject=ener&topi c=bcap Fuel, fertilizer, and water subsidies; crop insurance and income subsidies to biomass producers.

Food, feed corn exports unimpeded.

Originally, capital grants for biofuel plants; concessional loans for ethanol producers in the United States; “enhanced capital allowances” under the tax code Tax Credits: U.S. Energy Policy Act (2005) - The US$0.45 per gallon Volumetric Ethanol Excise Tax Credit VEETC (blenders): EXPIRED on January 8, 2012 after some 30 years.

- Small producers: EXPIRED - Cellulosic producers: EXPIRED December 31, 2012 Originally, subsidies per unit of production in different states.

Minimum volumes dictated by mandates. Prices cleared by markets.

- Ad Valorem tariff: 1.9 percent (denatured), 2.5 percent (undenatured).

- Other Duty or Charges – ODC: US$0.54 per gallon, applicable to fuel use: EXPIRED. - CBI dehydration origin quota (7 percent of U.S. consumption): LESS EFFECTIVE WITH EXPIRATION OF ODC. - Duty drawbacks (became more restrictive in 2008): LESS RELEVANT WITH EXPIRATION OF ODC. - FTAs and Preferential Trade Agreements: PTAs. Fuel excise tax credit VEETC to blenders in U.S EXPIRED.

- Renewable Fuel Standard RFS II quota obligation requires 36 million gal biofuels in transport by 2022, about 25 percent of penetration in transport fuels market then. By 2022, 15 billion gallons corn ethanol grandfathered plus 21 billion gallons advanced biofuels, of which 16

65

Support for consumption of biofuels

Price reductions for fuel ethanol and vehicles

billion gallons of cellulosic derived biofuels. The balance of advanced biofuels likely to originate from imports from Brazil, other sources of advanced biofuels.

- California Low Carbon Fuel Standard - LCFS, from E-5.7 to E-10 http://www.arb.ca.gov/fuels/lcfs/workgroups/workgroups.htm#pa thways http://www.arb.ca.gov/fuels/lcfs/reportingtool/registeredfacilityin fo.htm Court challenge: LCFS may violate Commerce Clause of US Constitution - Originally, excise tax exemption of US$0.40 per gallon ethanol, income tax credit. Later VEETC. Presently, only mandatory volumes are established through RFS I and II. - Subsidized purchase of FFVs.

Quantitative requirements for blending

Support for Research and Development

Clean Air Act Amendment 1990 - Reformulated gasoline with oxygen content requirement provided by MTBE first and then by ethanol Renewable Fuel Standard – RFS I and II - Energy Independence and Security Act of 2007 - EISA - Volume mandates (36 billion gallons by 2022). E-10 “blend wall”.

- Renewable biomass requirement (land use restrictions) - Advanced biofuels focus (21 billion gallons by 2022) Nested categories with feedstock restrictions (non-corn starch; cellulosic) Greenhouse gas reduction requirements based on carbon lifecycle analysis (well-to-wheel; indirect land use effects) Complex Renewable Identification Number accounting system (RIN) http://www.epa.gov/otaq/fuels/renewablefuels/compliancehelp/rfsdata.ht m Registration of facilities is required http://www.epa.gov/oms/regs/fuels/producers.htm Support for R&D grants and loans (biomass; processing; infrastructure): research into - Biomass R&D (BRDI): biofuels - 2003 Farm Bill; Energy Policy Act of 2005; 2008 Farm Bill - National Biofuels Action Plan (October 2008) - Interagency Working Groups (feedstocks, logistics, conversion, support; OSTP, EPA, NSF, DOE, USDA, DOI, DOT, DOD) http://www.usbiomassboard.gov/index.html - Rural Energy for America Program REAP (from the 2003 Farm Bill energy title: Flex-fuel pumps Sources: Newman (2012); Josling, Blandford, and Earley (2010).

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EU : Biodiesel Classification of program Support for production of biomass

Support for biofuel production and distribution

Instruments used Direct subsidies for biomass production

Examples 1992 EU Common Agriculture Policy CAP. Updated in 2003 (subsequently removed); eligibility of biomass for conservation payments.

Indirect subsidies for biomass production

Fuel, fertilizer, and water subsidies; crop insurance and income subsidies to biomass producers.

Trade policies on biomass Reduction of capital and infra-structure costs

Tariff concessions; export restrictions; 0-3.2 percent duty on imported vegetable oils for biodiesel making; non-tariff import restriction, Capital grants for biofuel plants, from different levels of government, tied to the use of local feedstock or second-generation (cellulosics) biofuels.

Reduction of production costs

Direct subsidies for production of biofuels Guaranteed prices paid by distributor Trade policies on biofuels

- Tax exemptions, e.g. pilot demonstration schemes.

- Tax relief for B100 in Austria and Germany.

- “co-tax” relief to B-100 in Germany.

- Member states may offer tax exemptions as an incentive to comply with the new mandates of Directive 2009/28/EC. Quotas and subsidies per unit of production, with sunset dates.

Quotas for biofuels that will receive the tax relief.

Minimum price for biofuels; “feed-in tariff”; “green bonus” for biofuels.

Biodiesel duty at 6.5 percent.

Ethanol (Harmonized Schedule HS ch. 22): • undenatured—19.2 E/hl • denatured—10.2 E/hl

Reduction of distribution costs Quantitative promotion

Support for consumption of biofuels

Price reductions for biofuels Quantitative requirements for blending

Fuel mixtures (HS ch. 38)—6.5 percent ad valorem.

ETBE—5.5 percent ad valorem.

Customs classification change pending—blends down to E70 in HS Chapter 22’ Direct subsidies for fuel ethanol distribution (Sweden).

- Quota obligation schemes and infrastructure (e.g. fuel pump) mandates; subsidies for infrastructure.

- Fuel Quality Directive (April 2009):  Low carbon fuel standard—reduce carbon intensity 6 percent by 2020;  E10 phase-in;  Coordinates with RED; Excise tax exemption, VAT exemption; income tax credit.

Renewable Energy Directive - RED (June 2009) Directive 2009/28/EC - National Action Plans and Mandates - Target of 10 percent renewable energy in transport sector by 2020 (energy basis)

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- Greenhouse gas emission reduction (35 percent in 2012;  50 percent in 2017;  60 percent in 2018 for new plants (>Jan. 1, 2017);  grandfathering for old plants (<Jan. 23, 2008) until April 1, 2013.

- Sustainability criteria, certification requirements  (biodiversity, carbon stocks of concern; forests, grasslands, peatlands).

- ILUC* effects still under consideration.

Support for Funding support - Seventh Framework Program for Research (FP7): Research for research into - Community Research and Development Information Service – and biofuels CORDIS (cordis.europa.eu/) Development - European Strategic Energy Technology Plan SET-Plan - European Industrial Bioenergy Initiative - EIBI).  ALTERNER (part of Competitiveness and Innovation Program – CIP).  Nationally funded R&D programs.

Sources: Newman (2012); Josling, Blandford, and Earley (2010); Kutas, Lindberg, and Steenblik (2007).

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Brazil: Sugarcane Ethanol Classification of program Support for production of biomass

Support for biofuel production and distribution

Support for consumption of biofuels

Support for research and development

Instruments used Direct subsidies for biomass production Indirect subsidies for biomass production Trade policies on biomass Reduction of capital and infrastructure costs Reduction of Production Costs Direct subsidies for production of biofuels Guaranteed prices paid by distributor Trade policies on fuel ethanol Reduction of distribution costs Quantitative promotion Price reductions for Biofuels Quantitative requirements for blending Cost reduction of ethanol fueled vehicles Support for research into biofuels

Examples Lavish at the outset of the “ProAlcôol” program. Preferential loan crops. Now reduced to agricultural financing by Banco do Brasil.

Irrigation financing (MODERINFRA).

Not applicable.

Project financing via preferential loans (BNDES; FINEM; BNDESPAR; FINAME); use of Petrobras infrastructure.

Existing at the outset of the “ProAlcôol” program. Phased out over time.

Existing at the outset of the “ProAlcôol” program. Phased out over time.

Regulated prices controlled up until the late 1990s. Market prices since then.

Import tariff: 20 percent ad valorem: -SUSPENDED UNTIL 2015 National Petroleum Agency (ANP) regulation of ethanol market (Medida Provisioria 532); supply contracts, intercrop inventory financing; mandatory inventories.

Mandated ethanol sales outlets (neat hydrous) Preferential tax treatment vs. gasoline (CIDE, PIS/COFINS) Mandated blend in gasoline (18-25 percent) from 1975: currently 20 percent Sales tax incentive for FFVs (14 percent vs. 16 percent) R&D funding (CNPAE; EMBRAPA; FINEP; FUNTEC; BNDES; MCT)

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Brazil: Biodiesel Classification of program Support for production of Biomass

Support for biofuel production and distribution

Instruments used Direct subsidies for biomass production Indirect subsidies for biomass production Trade policies on biomass Reduction of capital and infra-structure costs Reduction of production costs

Direct subsidies for production of biofuels

Support for consumption of biofuels

Support for research and development

Guaranteed prices paid by distributor Trade policies on biodiesel Reduction of distribution costs Quantitative Promotion Price reductions for biofuels Quantitative requirements for blending Cost reduction of diesel fueled vehicles Support for research into biofuels

Examples Subsidized financing from PRONAF and BNDES for “Social Fund Seal” projects of small-scale with preferential crops, based on “family” agriculture in specific regions of the country, e.g. castor in northeast Brazil.

Preferential loans for “Social Fund Seal” crops, e.g. castor.

Not applicable.

Project financing via preferential loans (BNDES; PRONAF); use of Petrobras’ infrastructure.

Preferential loans. “Social seal” projects, based on castor or palm oil are exempted from PIS/CONFINS tax.

“Social Fund Seal” projects, using other feedstocks, get a 68percent reduction in PIS/CONFINS. Projects without “social seal,” but using castor/palm oils, get a 32 percent PIS/PASED discount.

“Social seal” projects, based on castor or palm oil, are exempted from PIS/CONFINS tax. “Social Fund Seal” projects, using other feedstocks, get a 68-percent reduction in PIS/CONFINS. Projects without “Social Fund Seal,” but using castor or palm oils, get a 32 percent PIS/PASED discount.

Prices set by ANP-managed auctions. Quotas of up to 80 percent of auctioned volumes for “Social Fund Seal” biodiesel.

Not applicable.

Roles of Petrobras (Petrobras Biocombustível) and National Petroleum Agency (ANP) in biodiesel auctions.

Mandated B-5 for all sales outlets.

All biodiesel production exempted from CIDE. Mandated blend in diesel - currently B-5 (5 percent).

Not applicable.

R&D funding by private and government entities (Embrapa and Petrobras’ CENPES research center).

Sources: Newman (2012); Josling, Blandford, and Earley (2010).

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