Fueling Change: How Price Sensitivity and Location Shape Ethanol Demand in Brazil

The IMF study reveals that consumer demand for ethanol in Brazil is highly responsive to price and location factors, suggesting that targeted fuel pricing policies and competition regulation could encourage cleaner energy use. This approach could reduce greenhouse gas emissions while supporting sustainable energy transitions.

The IMF’s recent Working Paper by Simone Maciel Cuiabano, presents a nuanced look at consumer demand for ethanol, emphasizing how spatial differentiation among fuel retailers can significantly shape consumer choices in Brazil’s flex-fuel vehicle market. This research, authorized by Ali Alichi and released under the IMF’s Institute for Capacity Development, leverages data from Londrina and Cambé in southern Brazil to reveal how price sensitivity, location, and retailer characteristics influence consumer decisions between gasoline and ethanol, especially for flexible-fuel vehicles (FFVs) that can run on both. Using a nested logit model, the study examines how retailers’ branding, proximity, and other factors like storage capacity affect the choice of fuel, with findings pointing to the high price sensitivity of ethanol, which proves more elastic than gasoline. This means that consumers tend to shift quickly to ethanol when it is priced lower than gasoline, but the opposite can also occur if ethanol prices rise. These findings reflect the intricacies of fuel choice in a flex-fuel environment and highlight the challenges of driving consumers towards cleaner energy sources through pricing alone.

How Flex-Fuel Vehicles Influence Consumer Choice

In Brazil, where the government has long encouraged ethanol as an alternative to gasoline, the demand dynamics have developed in a context where flex-fuel vehicles are widespread, allowing drivers to choose based on market price advantages. The study incorporates the spatial characteristics of fuel retailers in Brazil, where cartel activities in Londrina previously led to gasoline price manipulation and heightened local price sensitivity. Cuiabano’s research, following the work of economists like Anderson (2012) and Houde (2012), applies a consumer choice framework that accounts for retailers' geographic positioning and other characteristics, recognizing that location significantly affects competition and consumers’ fuel choice. The research found that consumers prioritize price and location when choosing between fuels, suggesting that, in a highly urbanized area like Londrina, proximity to fuel stations and relative prices create defined consumer patterns that contribute to higher demand elasticity for ethanol. Houde’s model, which showed that retail gasoline demand in Quebec responds strongly to regional competition and commuting patterns, inspired Cuiabano’s approach in Londrina, where fuel stations’ distances from city centers and retailer density in specific regions influence consumer decisions.

Exploring Regional Differences in Fuel Demand

Through extensive data analysis, including price and volume information from 154 fuel stations collected over 36 months, Cuiabano identifies significant differences in how ethanol and gasoline are consumed depending on retailer positioning within six identified regions in Londrina and Cambe. These regions, characterized by varied consumer traffic and price structures, showed that ethanol prices tend to be more elastic in regions with heavy consumer mobility, like the western and northern areas of Londrina while remaining relatively inelastic in Cambe. This finding suggests that consumers’ switching behaviors, impacted by regional traffic flows and station proximity, result in marked price elasticity differences. To illustrate these trends, the research collected weekly data on ethanol and gasoline prices, volumes, and brand-specific features, then applied a nested logit model to explore consumers' utility maximization when selecting fuel. The model indicates that a consumer's first choice is selecting a region, and then choosing a station within that area, driven by factors such as relative ethanol prices, fuel station brand, and storage capacity. Additionally, elasticity estimates reveal that, on average, a 1% rise in the relative price of ethanol results in a decrease in ethanol sales of about 1.07% across all regions, while a similar increase in gasoline prices would see a higher decline of around 1.33% in gasoline sales.

Fuel Pricing and Environmental Policy Implications

The research further explores the policy implications of its findings, especially concerning climate change mitigation through fuel taxation and price structuring. Given that ethanol is often marketed as a greener alternative, policies that raise gasoline prices or lower ethanol costs could encourage consumers to opt for ethanol, aligning with broader environmental objectives. However, the study notes that ethanol's higher elasticity means that even a slight increase in its price could prompt consumers to return to gasoline, potentially offsetting climate gains. The research underscores that a balanced approach in taxation and fuel price policies could support a stable ethanol demand, thus reducing greenhouse gas emissions without compromising fuel affordability. Cuiabano’s findings, which resonate with the broader literature on ethanol and gasoline demand elasticity, underscore the complexity of influencing consumer behavior in the fuel market. The policy recommendations include implementing targeted taxes on gasoline and exploring ways to subsidize ethanol without causing market volatility. In countries with similar climates and agricultural bases, like West Africa, there is also potential to adopt ethanol as a feasible, locally produced fuel source, thus reducing reliance on imported oil and supporting trade balance objectives.

The Role of Competition and Cartel Behavior

The study concludes that spatial competition among fuel retailers should be carefully considered in energy and environmental policy, particularly where fuel choices can impact air quality and carbon footprints. In Londrina’s case, cartel-driven price increases for ethanol led to a 12% rise, which in turn pushed more consumers toward gasoline, highlighting the environmental cost of anti-competitive practices in the fuel market. By viewing ethanol pricing through both a competitive and ecological lens, Cuiabano’s research makes the case for including spatial differentiation and consumer mobility in fuel demand models, emphasizing that consumer price sensitivities can be leveraged for effective climate policies. This approach could shape policy both in Brazil and in other nations aiming to adopt ethanol as a primary or supplementary fuel source in the transition to cleaner energy solutions.

Looking Ahead: Future Policy Directions for Cleaner Fuel Options

The insights from Cuiabano’s study suggest that spatial differentiation and localized consumer behaviors must be factored into future fuel policies to promote ethanol successfully. By carefully balancing fuel taxes and subsidies and discouraging anti-competitive behaviors among retailers, governments could create an environment where ethanol becomes a more accessible and attractive option. These approaches are essential for Brazil and other countries looking to reduce dependence on fossil fuels and move towards cleaner energy solutions. As policymakers strive to meet climate goals, Cuiabano’s findings provide a valuable framework for making strategic decisions on fuel pricing and competition, enhancing the role of ethanol in reducing greenhouse gas emissions on a broader scale.