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Jan 17, 2013 | 11:15 GMT

Brazil Considers a Shift in Transportation Fuels

Brazil Considers a Shift in Transportation Fuels

The Brazilian government is trying to reconcile the needs of state-controlled energy company Petroleo Brasileiro, commonly known as Petrobras, with its own desire to keep inflation low for the sake of the country's consumer market and manufacturing sector. As part of this goal, Brasilia appears intent on promoting ethanol consumption. According to recent media reports, the government may announce a 7 percent increase in gasoline prices as early as next week. Moreover, there is speculation that the government will soon increase the mandated blending of ethanol in gasoline from 20 percent to 25 percent.

The promotion of ethanol consumption has not been as economically viable in recent years. Increased consumption and poor sugarcane harvests have driven up the price of ethanol, which in turn has contributed to the rising demand for gasoline. As a result, Petrobras has been forced to import more gasoline to meet demand, and the company's finances have become stressed accordingly. A greater reliance on ethanol might make prices more volatile — the agriculture sector is inherently unpredictable — but it could allow Brasilia to more easily implement the gasoline price hike Petrobras has been pushing.

Brazil's economy is prone to inflation, a problem that led to the adoption of a series of conservative economic policies in 1994 widely known as the real plan, designed to minimize spending to contain inflation. Former President Luiz Inacio Lula da Silva generally adhered to the provisions of the real plan, and during his administration the Brazilian economy was fairly stable. But since the recent financial crises in Europe and the United States, Brazil's economy, after initially flourishing thanks to increased Chinese demand for raw commodities, has begun to show signs of an inability to keep pace with demand. This is due in part to currency fluctuations and changes in consumer credit availability. 

As a result, the administration of Brazilian President Dilma Rousseff has taken a much more active role in the Brazilian economy, focusing on helping the country's struggling manufacturing sector become more competitive through tax reductions and infrastructure improvements. But Brazilian companies remain relatively uncompetitive globally for a variety of reasons, including high operating costs for domestic manufacturers.

One way to help reduce operating costs, as well as consumer costs, is to reduce the price of transport fuel. The Brazilian government restricts the price at which Petrobras may sell gasoline and diesel to help limit costs to businesses and consumers. However, the price caps make Petrobras less responsive to market conditions and, simply put, have put pressure on the company's bottom line. Thus is Brasilia's dilemma: Petrobras needs money to support the country's ambitious long-term energy development plans, but the government must maintain price caps to militate against the political ramifications of price fluctuations.  

A Well-Developed Industry 

As part of an effort to meet an ambitious business plan, Petrobras is lobbying for an increase in gasoline and diesel prices. According to a June 2012 release, Petrobras' 2012-2016 business plan includes $236.5 billion of budgeted investment. Roughly 28 percent of the investment is designated for downstream projects, including new refineries, which could help meet the increased domestic demand for gasoline and diesel. But the refining capacity the company envisions — nearly 400,000 barrels per day — is not scheduled to come online before 2014. Higher gasoline prices could help Petrobras right some of its trade imbalance by discouraging consumers from purchasing so much gasoline. This, in turn, would encourage consumers to use more ethanol.

Luckily for the government and for Petrobras, Brazil has the world's most developed ethanol industry. In response to the 1973 oil crisis, Brazil sought to become self-sufficient in transport fuel by focusing on an abundant domestic resource: sugarcane. The subsidization of the ethanol industry enabled Brazil to greatly advance its ethanol production. Whereas the country produced approximately 10,000 barrels per day of the fuel in 1979, it produced 392,000 barrels per day in 2011. This development facilitated the integration of ethanol into the transport fuel market. (More than half of all passenger cars and light trucks in Brazil are either flex fuel or ethanol-only.) And by government mandate, ethanol must constitute 20 percent of all gasoline produced.

Ethanol and Gasoline Comparison

Ethanol and Gasoline Comparison

However, the fuel is not without drawbacks. It is not as energy-dense as gasoline, so more ethanol is required to accomplish what is possible with a smaller of amount of gasoline (ethanol fetches fewer miles to the gallon than gasoline). Therefore, to remain cost competitive, ethanol must be roughly two-thirds the cost of gasoline by volume. In 2011 and 2012, this ratio was not being met in many Brazilian regions.

Moreover, the price of ethanol can be volatile because of unpredictable sugarcane harvests. In recent years, sugarcane harvests have suffered from droughts and lackluster investment, causing ethanol prices to increase.

The increasing demand for gasoline can be attributed in part to poor sugarcane yields. From 2008 to 2011, ethanol production fell to 392,000 barrels per day from 466,000 barrels per day, and consumption likewise fell to 332,000 barrels per day from 337,000 barrels per day. Meanwhile, the state-imposed price caps on petroleum products enabled gasoline to compete with ethanol. Consumption of gasoline rose from an average of 327,000 barrels per day in 2008 to roughly 460,000 barrels per day in 2011.

Brazil is now forced to import to keep pace with demand. In 2011, the country imported some 60,000 barrels per day. 2012 estimates suggest that figure will increase by more than 20,000 barrels per day to an average exceeding 80,000 barrels per day.

Ethanol Over Gasoline? 

Petrobras CEO Maria das Gracas Silva Foster has focused on the gasoline price cap as a roadblock to Petrobras' ongoing and future success. In a December 2012 interview, she said the 2012-2016 business plan would require a 6 percent hike in the price of gasoline. Petrobras is operating on a very tight investment deadline; anything that can bring in more cash is a priority for the company. However, raising gasoline prices to appease Petrobras could contribute to inflation.

The plan to raise the mandated amount of ethanol to be blended into gasoline could help assuage Brazil's reliance on petroleum fuels. Notably, changing the mandated percentage of ethanol to correspond to market conditions has been done before. The amount was lowered to 20 percent in 2011 in response to a reduced supply of ethanol.

Although ethanol production has been inconsistent in recent years, sugarcane production is projected to stabilize and increase through 2014. If production rises as predicted, Brazil could control fuel prices more effectively. Using ethanol prices to regulate fuel prices overall would help promote the Rousseff administration's plans to promote manufacturing while serving the interests of Petrobras — especially if higher gasoline prices cause flex-fuel owners to choose ethanol.

Brazil Considers a Shift in Transportation Fuels
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