This report – “Policies for biofuels in Brazil and the US - An analysis of innovation framework, actors and governance” – focuses on biofuel policies in Brazil and the US over the period 1970-2012, and in particular on ethanol production – ethanol being the most widely used biofuel in the world.

Ethanol is used as an additive in gasoline and has several positive effects as such: it serves (i) to prevent air pollution from carbon monoxide and ozone; (ii) as an octane booster and (iii) as a replacement of gasoline – in its purer forms to 100 percent. Another pro is that when ethanol is mixed with gasoline to various propor­tions in effect lowers the total carbon content of the fuel and subsequently leads to a re­duction of transportation-related CO2-emissions.

Ethanol is currently produced from mainly two types of feedstock – corn (US) and sugar cane (Brazil). This means that there is an important connection between ethanol production on the one hand, and farmland use and food markets on the other. Traditionally, ethanol policy has been driven by several different factors relating to rural development, environ­ment and energy supply. According to the International Energy Agency biofuels – and mainly ethanol – are projected to constitute up to 27 percent of the world’s transportation fuel by 2050. This, is however, based on the development of other feedstock – primarily cellulose which would, in turn, require substantial technological development.

Although ethanol production is an old and established technology, there is nevertheless a lot of room for innovation. In part in terms of change in energy markets towards a larger use of renewable fuels, in part in terms of technological development in order to make the production of such fuel sustainable in the long term.

Main topics

This report elaborates on three broader themes. One concerns the conditions that ultimately influence the formulation of an innovation policy in our respective areas. What are the challenges guiding policies and politics in this particular sector? What are the current pro­posals to solve identified problems? What are the current policy objectives? A second theme concerns the subsequent administration of policies. How are policies implemented? Who does what and when? Finally, we were also asked to discuss the current situation in the light of past and present policies. What is the current level of innovation? To what ex­tent is it a function of explicit policy interventions? What are the opportunities and chal­lenges going forward?

The principal focus of the project, as well as this particular study, is thereby the policies supporting innovation, rather than the innovations themselves. In this context, our discus­sion on biofuels provides an important piece of the puzzle. Apart from providing increased knowledge about the ethanol industry itself, it also illustrates the particular conditions of stimulating innovation in an already existent production system based on a relatively ma­ture technology. The term innovation, therefore, by necessity assumes a rather broad, yet policy target based definition, meaning change that is not necessarily new everywhere, but that lead to an overall improvement of the “way of doing things” related to a number of goals, not always economic.

To sum up, the present study sets out to answer three questions: (i) what are the principal policies in the Brazilian and North American biofuel sectors respectively?; (ii) what were the principal factors driving policy formation processes?; and (iii) what are the opportuni­ties and challenges going forward?

Both public policy and market forces has driven innovation

Public policy has without a doubt been the key actor in the development of the Brazil and US ethanol industries. The push for ethanol was initially made by the governments of these countries as a response to the oil crises of the 1970-s. Rapid economic growth during the 1950-s and 1960-s drove petroleum demand growth until, finally, in the early 1970-s, the demand level began to surpass supply levels. Between 1970 and 1973 the market price for oil doubled, and between October 1973 and March 1974 the Arab oil embargo against the US caused severe gasoline shortages and reshaped the world oil market with the rise of the powerful OPEC-cartel. Most importantly from an ethanol-policy perspective, it became clear to the US and Brazilian governments that they would no longer sufficiently control domestic oil supply. This assessment was further fortified in 1978 when Iran – the world’s second largest oil exporter at the time – experienced serious disruption in production and exports following the Iranian revolution.

An opportunity was also present early on to simultaneously support rural economic devel­opment in the US and the nationally important sugar industry in Brazil. As our study shows, this policy-driver, which was initially more or less a by-product of energy security policy, eventually became a key driver in its own right and actually carried policy for ex­tended periods of time in which oil supply stability led to lower energy security incentives. In this sense, the sugar and corn industries became important actors.

Environmental concerns also important – when they are urgent

Environmental issues such as smog and other local air pollution led to changes in vehicle requirements that added the automaker industry as an important player. The indus­try itself has not been as important actor as the farming industry however, but vehicle reg­ulation legislation turned out to have critical impact on the ethanol market – mainly through regu­lation making ethanol a more or less compulsory additive to gasoline. Some serendipitous events also played a key role – most notably the fact that the original anti-knocking agent lead turned out to counteract catalytic converter metals and that the origi­nally used oxy­genating agent MTBE turned out to be a health hazard and had to be re­placed. Ethanol in this sense benefited to a high extent from policies that initially were not targeting ethanol but rather other substances that later had to be replaced by ethanol.

In the last decade, ethanol production grew exponentially due to a resurgence of the energy security issue, coupled with rising awareness about CO2-emissions. In the latter case au­tomakers have recognized an opportunity and have introduced more flexible fuel vehicles, and this has further boosted the market.

Ethanol is now seen as a major contributor to sustainable energy security of the future. However, in relation to its present feedstock it is being challenged by a lack of farmland, its tendency to augment food prices – causing hunger, and ethanol policy is also being criticized for lowering innovation in the farming sector by providing extensive subsidies to old technologies.

In order to deliver on its promise to make up a significant share of future fuel markets eth­anol producers need to move from sugar-based first generation ethanol production to cel­lulosic based second generation production. This poses a serious technological challenge and it is questionable if the right incentives are in place for the necessary investment to take place. As mention, ethanol policy has created strong feed stock lobbies and it will likely be politically difficult to make changes to established legislation. At the same time many observers note that such change is necessary not only to achieve a more sustainable production method but indeed to save the entire flexible fuel vehicle industry – since it is not yet ready to live on its own, especially in light of new alternatives like electric and gas being introduced.

Main observations and lessons for Sweden

For Swedish concerns there is an important general lesson to be learned from the develop­ment of ethanol industries in Brazil and the US – namely that the Swedish model of inno­vation based economic growth policy works. The ethanol case shows that change is almost exclu­sively related to innovation pressure. Such pressure is in this case created by three factors.

First, oil supply fluctuations may either increase or lower the pressure by simply lowering or increasing the return on investment time for investments in alternative fuel capacity. When oil supply drops and gasoline prices soar, it makes sense to invest in ethanol and vice versa. And this effect is much stronger than that of tax credit legislation and the like.

Second, environmental issues matter, when they are urgent. The smog problem in US cit­ies was a key driver, as well as health hazards related to other fuel additives. Global warming seems to be of much less importance, perhaps for the very fact that it does not seem urgent to most people and the automaker industry formulate market strategy thereaf­ter.

Third, economic development policy may lower innovation pressure by subsidizing old technologies. This is also true for energy policy. The Swedish model has always built its success on avoiding price competition for the benefit of first-mover competition and other forms of innovation-based competition. In the US and Brazil case, it is clear that policy easily falls into short-sighted behaviour that clearly undermines future competitiveness. Most evidently so in relation to oil in Brazil and in relation to shale gas and the farming sector in the US. It would be very unfortunate for Sweden to make similar mistakes.