State Intervention in the Chain of Production of Ethanol from Sugarcane in Brazil: Its Forms and Effects on the Development of the Sector Between the 1930s and 1980s

Abstract

To better understand the form and relevance of state intervention in the agribusiness of sugarcane production in Brazil, we sought to create a chronology of the major government policies adopted and of their effects on the industry. The sugarcane ethanol industry has seen alternating cycles of overproduction and oversupply. Therefore, intervention in the industry has been based primarily on maintaining the balance between production and consumption using two basic instruments: crop plans and policies designed to regulate prices and credit.

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To better understand the form and relevance of state intervention in the agribusiness of sugarcane production in Brazil, we sought to create a chronology of the major government policies adopted and of their effects on the industry. The sugarcane ethanol industry has seen alternating cycles of overproduction and oversupply.¹ Therefore, intervention in the industry has been based primarily on maintaining the balance between production and consumption using two basic instruments: crop plans and policies designed to regulate prices and credit.

State intervention in the sugar industry has been inextricably linked with the very emergence of the sector. However, our analysis of the intervention process begins with the creation of the Instituto do Açúcar e do Álcool (IAA, Sugar and Ethanol Institute) in 1933, when the government effectively began involving itself in production planning. Some phases of the intervention process are noteworthy. Between the 1930s and 1960s, there were broad, intense interventions (production levels were regulated, prices were tabulated, and marketing standards were dictated). Those interventions were implemented at the request of the producers themselves in order to resolve the severe overproduction crisis of 1930. The IAA was charged with the oversight of production planning. Sugar was a major export at the time, and the government, to some extent, controlled market risks, thereby guaranteeing the sale of the sugar produced.

The second phase began in the 1970s. The earlier measures (controls on production and pricing) remained in place, and the government set its sights on increasing exports, given the favorable conditions in foreign markets at that time. In addition, the Brazilian government imposed measures designed to stimulate both production and demand. There were programs aimed at improving productivity as well as modernizing both agricultural systems and the industrial park. This, along with incentives for the relocation and merger of facilities, was critical in enhancing external competitiveness. The government established the Programa Nacional do Álcool (Proálcool, National Ethanol Program), the primary objective of which was to stimulate the production of anhydrous ethanol. To that end, the Proálcool plan set forth well-defined rules for marketing and production, while protecting producers from market risks.

In the early 1980s, which marked the final phase of the implementation of the Proálcool plan, a new era of state intervention began. At that time, the country’s macroeconomic indicators were unfavorable, leading to a policy of containment of public spending. Therefore, government resources for investment programs began to dwindle. Some sugar mills and ethanol distilleries that relied on government resources to complete their projects were unable to do so or were forced to delay implementation. In 1989, the export of sugar, which had previously been managed by the IAA, was privatized.

In the early 1990s, during the second implementation phase of the Proálcool plan (the phase in which the government promoted the use of automobiles powered by hydrous ethanol), the demand for ethanol outstripped production, leading to an ethanol shortage, which seriously jeopardized the future of the program. The mismatch between supply and demand, the onset of disputes between the government and the private sector, and the trade liberalization initiated by the administration of then-President Fernando Collor de Mello highlighted the need for a new model of state intervention in the sector.

The last period of state intervention, from the beginning to the end of the 1990s, was characterized by a drastic reduction in the extent of that intervention. It was recognized that the government could no longer continue along the same path because the institutional environment had changed so dramatically. When the government exited in the late 1990s (relinquishing control of prices and marketing), there was an oversupply of sugarcane, sugar, and ethanol, which had plunged the industry into an unprecedented crisis. The producers, who had previously been guaranteed a market by the government, began operating in free markets, beginning a period of overproduction and consequent price reductions (1998–1999). This had an impact on the production structure, as will be seen in the following sections.

The 1930s: The Beginning of State Intervention and the Creation of the IAA

In the early 1930s, the sugarcane industry was particularly vulnerable because of the worldwide economic downturn caused by the Great Depression of 1929, and the increase in Brazil’s agricultural and industrial capacity in the early 1920s. Under those conditions, as pointed out by Szmrecsányi (1979), government intervention in the sugar sector had been established at the request of the producers themselves in order to solve the problems of oversupply and to restructure the domestic markets.

In June 1933, through Decree no. 22,789, the IAA was created. The main objectives of this new agency were to solve the problem of overproduction of the sugar industry through annual planning and production control, and to adapt the industry to the needs of internal and external consumption. In addition, the IAA was charged with promoting the production of fuel ethanol in the country.

The primary responsibility of the IAA was the determination of limits for the production of ethanol and sugar by each facility. Those limits would be based on existing stocks of sugar in the country and on projections of the upcoming harvests.

In the 1930s, after the creation of the IAA, several measures were taken in an attempt to control the supply of sugar. Those measures included the following: a nationwide ban on the establishment of new sugar production facilities, without prior authorization; mandatory registration of all facilities producing sugar, ethanol, or spirits; incentives to promote the production of fuel ethanol; and subordination of all existing refineries to the IAA. The IAA was also given the power to order the installation and operation of sugar refineries to supply the domestic market. In addition, the main measure taken during this period was the establishment of the production limits for each producing state. The limits were set by taking the annual state average for the last 5 years, and adjusting it to account for existing stocks of sugar in the country as well as sugarcane crop forecasts.

According to Szmrecsányi (1979, p. 194), the initial calculation allocated 62.8 % of the production to the northern and northeastern regions of the country, while the remaining 37.2 % was allocated to the sugarcane-producing states in the southeast (Minas Gerais, São Paulo, and Rio de Janeiro). The lion’s share of the production (37.6 %) was granted to the northeastern state of Pernambuco retaining its hegemony, giving it a share greater than that of the three southeastern states combined. Furthermore, in order to minimize conflicts between mill owners and suppliers, the government came to intervene directly in transactions involving the purchase and sale of sugarcane through Law no. 178, which came to regulate such transactions.

In 1939, the government approved the production caps set by the IAA for each sugar mill and sugar refinery in the country. From these individual limits, the IAA began to formulate annual crop plans. It also set objective criteria for increasing production caps at each facility: If sugar production increased, the corresponding increase in the quantity of raw material (sugarcane) should be divided proportionally: 70 % going to the sugarcane suppliers, farmers, and settlers and only 30 % going to the sugar mills (which grew their own sugarcane). Disputes between mill owners and sugarcane suppliers have long been noted, as described by Ramos (1991, p. 112):

… the consolidation of lands and industrial centralization occurring at that time resulted in the proletarianization of sugarcane workers and sugar mill workers, a process the workers sought to resist. This resistance evolved into direct confrontation, agents of the workers pulling up the railroad tracks leading to the mills and vandalizing the mills’ equipment. These disputes reached a state of social conflagration not only in Pernambuco but also in the state of Rio de Janeiro, where, for reasons specific to the region, small sugarcane suppliers had a strong presence. There, the process of land concentration led to a struggle for survival of those producers, who even threatened to set fire to the mills…

The 1940s: The Sugarcane Farming Statute; World War II; and the change in the Spatial Distribution of Sugar Production in the Country

The Sugarcane Farming Statute

On November 21, 1941, Decree-Law no. 3,855 established the Sugarcane Farming Statute, which strictly regulated interactions between sugarcane suppliers and the producers of sugar and ethanol. In brief, the statute imposed limitations and constraints on the agricultural activities of sugar mills, setting supply limits for the sugarcane produced by the mills themselves and established criteria for fixing the price of sugarcane.

The two most important innovations introduced by the Sugarcane Farming Statute were the establishment of the sugarcane supplier as a legal entity and the establishment of limits for such suppliers. Sugarcane suppliers were defined as any farmers who, cultivating their own lands or those of others, had supplied cane to the same sugar mill, either directly or through an intermediary, for three or more consecutive harvests. The statute also stipulated that, although up to 60 % of the sugarcane used by the sugar mills could be produced by the mills themselves, the remaining 40 % had to be obtained from official sugarcane suppliers. Therefore, the sugarcane suppliers would be certain that their share of the production would be purchased at the price fixed by the IAA (“… calculated in relation to the prices of sugar and ethanol, according to the limit for processing raw sugarcane into refined sugar or ethanol and in view of the average industrial performance of the production facilities of the corresponding state, as well as in relation to the sucrose content and purity of the sugarcane delivered…”)²

The Sugarcane Farming Statute envisioned broader assistance provided to sugarcane suppliers, not only on the technical side but also in terms of health care and formal education, with the objective of organizing rural life, especially that of small landowners. However, as pointed out by Queda (1972), the feeling in the early 1970s was that, although the statute contained important social measures and that its goal was to share with sugarcane suppliers the benefits that the sugar policy had until then conferred upon the sugar mills alone,³ it had failed in the sense that, of the sugarcane used by the mills, the proportion produced by the mills themselves had grown, to the detriment of the official sugarcane suppliers.

The fact that the sugarcane supply structure had been organized based on small farms, hindered the emergence of an important pressure group. According to Jungmann (1971), the sugarcane suppliers were unable to make the Sugarcane Farming Statute effective, probably because they were not a cohesive group: “In disputes between sugar mills and sugarcane suppliers, other suppliers of the same mill, despite having a stake in the process, rarely came to the aid of the latter, because they did not want to alienate the mill owners…”

World War II

The outbreak of World War II had an impact on the two main products of the sugarcane industry: sugar and ethanol. Because the market for ethanol is cyclical, the scarcity of petroleum products, mainly gasoline (nearly all of which was imported from abroad at the time), had a major effect on the production of anhydrous ethanol, which came to be considered strategic within the national economy.

Between 1937 and 1941, various incentives were initiated through laws and decrees aimed at increasing the production of anhydrous ethanol. In 1941, the proportion of anhydrous ethanol to gasoline was fixed at 20 %.

In September 1942, Brazilian lawmakers passed Decree-Law no. 4,722, which declared the ethanol industry to be of national interest. The new law stated that, for a period of 4 years, starting with the harvest of 1943–1944, the government would guarantee “minimum prices for ethanol and for the raw materials used in its manufacture,” thereby benefiting producers whose production reached the levels set by the IAA.

World War II limited the number of foreign markets for Brazilian sugar. European countries that were allies of Germany, or whose territory had been invaded by the Nazis, halted imports from the Americas due to the high risk involved in shipping, which was subject to the actions of enemy submarines. England and the USA, for their part, chose to reduce consumption and to use alternative sources of supply.

In April 1945, it was stipulated that the issuance of new permits for the construction of sugar mills would be contingent upon the installation of refineries for the production of anhydrous ethanol. However, that did not succeed in increasing the production of anhydrous ethanol because there was a shortage of benzene, which was used as a drying agent. The importation of benzene had been interrupted by the war, and this was complicated by the fact that the supply of sugar from the northeast to the south-central part of the country had been disrupted because of the risk of shipping (submarine attacks having prevented the exchange of all goods between the north and south).

To meet the demand for sugar in the south-central region, the government decided to expand sugar production in areas that had previously been importing their sugar from the northeast. Therefore, beginning with the 1942–1943 harvests, there was a major reversal of the crop plan policy, which then came to be geared toward increasing the production of sugar. In November 1942, the federal government authorized the relaxation of the regime of production caps and allowed the construction of new sugar mills. The various measures taken at that time led not only to increased domestic production of sugar, but also to a shift in production from the northeast to the south-central region. The difficulties in transporting goods from the city of Recife to the ports of Rio de Janeiro and Santos, combined with the gap between production and consumption in the south-central region, eventually demanded the end of rationing, favoring the expansion of sugar production in that region.

The Change in the Spatial Distribution of Sugar Production

When World War II ended, the tendency to expand sugar production in Brazil did not, and sugar mill owners in the state of São Paulo petitioned the IAA to raise their caps. In September 1946, the federal government, through Decree-Law no. 9,827, ordered a re-evaluation of the sugar production caps for each state. This decree subordinated increase in the state production caps to the consumption needs of each region rather than to those of the nation as a whole, i.e., production shares began to be distributed according to the gap between production and consumption in each state, which led to an increase in the number of sugar mills in the state of São Paulo, where consumption surpassed production at the time.

Ramos (1991) pointed out that the wholesale review of sugar production caps based on regional consumption was a result of intense lobbying by the sugar mills in the state of São Paulo (pressure that nearly led to extinction of the IAA) in response to the IAA’s attempts to control their expansion. After the “liberation” of production in São Paulo, the problem faced by the IAA in the following years was exactly that: how to contain the growth of those mills. The same author also stated that, although the Sugarcane Farming Statute stipulated that all registered sugar mills must maintain “absolute separation between agricultural and industrial activities,” Decree-Law no. 9,827 introduced a certain flexibility that would allow production to expand in the state of São Paulo. The decree stipulated that only 50 % of the sugarcane used by the mills in order to increase production up to the new limits could come from their own crops. Nevertheless, if the IAA judged the production capacity of the existing sugarcane suppliers to be insufficient, the mills would be allowed to use their own crops to increase their output. Therefore, the existing sugar mills could increase their production by processing their own sugarcane. For mills under construction, there was no impediment to landowners becoming sugar producers. Consequently, landowners would become mill owners, the “absolute” separation between agricultural and industrial activities stipulated in the Sugarcane Farming Statute succumbing to reality.

According to Queda (1972), “[…] The quantitative and qualitative leap in this industrial sector [sugar mills in the state of São Paulo] occurred during the harvest of 1947–1948. Prior to then, the number of sugar mills in São Paulo had been growing steadily but slowly: there were 20 during the harvest of 1929–1930; during the harvest of 1940–1941, there were 34; and the number grew to 42 during the harvest of 1946–1947. However, by the harvest of 1947–1948, the total number of sugar mills in the state had grown to 71…” Fig. 2.1 (drawn from Queda, 1972) shows the evolution of the number of sugar mills in the states of São Paulo and Pernambuco.

Fig. 2.1

Sugar mills in the states of São Paulo and Pernambuco: 1929–1970

Various authors, including Szmrecsányi (1979), Queda (1972), and Gnaccarini (1972), have stated that the most important aspect was the profound and irreversible shift in the spatial distribution of sugar production in the country. Data presented by Szmrecsányi (1979) underscore that statement: the increase granted to the states in the south-central region in 1946 increased its share from 39.9 (the maximum allowed until the harvest of 1944–1945) to 46.8 %. Specifically, the share allocated to the state of São Paulo rose from 17.6 to 22.2 %, whereas that allocated to the state of Pernambuco dropped from 37.7 to 28.9 %. Regarding the transfer of production from the northeast to the south-central region, the author noted that the divergences between the two regions, in terms of the socioeconomic conditions, might have had a greater influence than did Decree-Law no. 9,827. Pina (1972, p. 41) stated that the decree benefited producers in the south “… due to the particular conditions (in the south), which included greater financial strength, an advantageous market position, a modern industrial park with efficient facilities, and favorable agricultural conditions. Therefore, conditions in the south were almost completely the inverse of those in the northeast, which also had other unfavorable economic indicators, starting with low purchasing power within the regional market.” These factors made the average costs of sugar production higher in the northeast. That, in addition to the shipping costs, favored the expansion of production in São Paulo, the growth of which eventually surpassed that of consumption in the state. According to Szmrecsányi (1979), between the harvest of 1946–1947 and that of 1951–1952, production in the state of São Paulo increased by 84 %, surpassing that of Pernambuco, which until then had been the largest producer in the country. However, the author points out that the growth of the sector as a whole, although induced by government incentives, was not wholly artificial, because there was an effective increase in domestic consumption, resulting from population growth, urbanization, and industrialization, which increased the demand for sugar from factories producing beverages, food, etc.

One of the consequences of Decree-Law no. 9,827 was overproduction of sugar, which was partly absorbed by the export of sugar at compensatory prices (because sugar producers in Europe and the far East had not yet recovered from the effects of the war). However, foreign demand was insufficient to reduce Brazilian stockpiles to an acceptable level.

When overseas sugar producers began to recover from the war, the international market price of sugar began to fall, making exports uncompetitive, and protectionist measures were taken in order to maintain the levels of those exports.

In January 1948, the IAA established the Sugar Price Compensation Fund, by which it subsidized exports (compensating for the differences between domestic and foreign prices) using funds raised by a surcharge to be levied on each bag of sugar manufactured in the country. Those funds would also be used in financing the production of ethanol, in order to draw down the stockpiles of sugarcane.

Also in 1948, with an eye toward solving the problems of excess raw materials and the balance of payments deficit (largely caused by the importation of automotive gasoline), the federal government again began to encourage the production of fuel ethanol. According to Szmrecsányi (1979), this time the objectives were fully achieved as early as the harvest season of 1948–1949.

The 1950s: The Consolidation of Production in the South-Central Region

The 1950s were marked by the expansion of production, encouraged by the IAA, to meet growing consumption needs. The remarkable expansion of the Brazilian domestic market during this period, due to extensive urbanization and industrialization, increased the demand for sugar, resulting in a corresponding expansion of the sugarcane industry.

Ramos (1991) stated that the fundamental problem of the Institute during the 1950s was to contain southern expansion, or viewed another way to promote production in the state of Pernambuco. The author noted that the IAA could no longer impose the rationing that it had achieved in the late 1930s and the first half of the 1940s. Strong pressure was being exerted by the mill owners of São Paulo against this containment, and many legal documents were filed in order to revise or repeal the resolutions relating to the production caps that the Institute had imposed on the states.

The hegemony of the south-central region, and especially that of the state of São Paulo was officially recognized when, in December 1957, the IAA increased the overall production limit for the country, dividing it in proportion to the increased production achieved by each sugar mill for the harvests processed between the 1951–1952 and 1956–1957 seasons.

Between the harvest of 1952–1953 and that of 1954–1955, Brazil again began to have a sugar surplus, causing the IAA to increase sugar exports significantly, although international prices were at record lows. In 1954 and 1955, the situation worsened due to rising global stocks caused by the overproduction of sugar worldwide. This situation was offset by the crop failures of 1956–1957, and by the increased consumption resulting from the new wave of industrialization and urbanization stimulated by the administration of then-President Juscelino Kubitschek.

In the 1958–1959 harvest season, sugar production was 20 % greater than in the preceding year. The surplus was earmarked for exportation. Although the international market price of sugar remained quite low, the federal government was still grappling with the balance of payments deficit. According to Szmrecsányi (1979) the exchange revenues generated by sugar in 1957 represented 5 % of the total value of all Brazilian exports. In 1958, sugar exports were surpassed only by those of coffee and cocoa, which were the two main export products.

Despite accounting for foreign exchange inflows into the country, exports of sugar were not competitive, and the IAA, due to the large quantity exported, could no longer subsidize them. Therefore, the government began to provide the resources to subsidize sugar exports. The social costs of that re-allocation of resources were overlooked because of the concerns regarding the balance of payments deficit.

Pricing Policies

The pricing policies put in place by the IAA are also considered one of the factors responsible for the displacement of sugar production from the northeast to the state of São Paulo. According to Gomes (1979), those pricing policies became effective as of 1943, having theretofore resembled minimum price policies, whereby the government set the lower limits of sugar prices and favored fiscal mechanisms to prevent prices from falling below those values. According to the author, in 1943, the government set prices with the condition of “FOB northeast” (“free on board,” or “put on the ship,” in the ports of producing states in the northeast), whereas, for the other states (with the exception of Rio de Janeiro, which was also an exporting state), consumer prices were determined by adding in the costs of transporting the product from the northeast to the producing states.

The IAA pricing policy benefited the sugar producers in the south-central region, because the sugar from the northeast (at the time responsible for most of the sugar consumed in the country) came to southern consumers at a higher price, since it incorporated the costs of production and transport. This triggered protests from producers in the northeast, because it led to the growth of their competitors to the south and ran counter to the main objective of the intervention, which had always been to protect the sugar industry of the northeast. Therefore, in 1951, that pricing policy was amended to establish a single settlement price for all sugar producers in the country (based on the price set for sugar produced in the northeast) and another price designated the “billing price.” Under this system, producers in the south-central region were charged a fee, which was redirected to the producers in the northeast. Those fees, collected by the Bank of Brazil, represented the differences between the two prices and were used in order to create a retrofit fund, administered by the IAA. According to Szmrecsányi (1979, p. 242) the retrofit fund would be used, among other things, for the following: “… to compensate for shipping costs, in order to equalize consumer prices across the various metropolitan centers (areas of high consumption), regardless of the origin of the sugar being sold; to finance the production of sugar and ethanol, as well as the expansion of the industrial park related to that production; and the costing of modern materials used in sugar production…” This resulted in a backlash of sugar producers in the state of São Paulo expressing their dissatisfaction with this policy of “adding-on” to the price. Pressure exerted by those producers led to the enactment of Law no. 4,870, which repealed the policy in December of 1965. As of 1967 (when the new law went into effect), the price of sugar came to be established on the basis of the average industrial costs in each producing region. Therefore, prices were higher for sugar produced in the northeast, where production costs were higher than they were in the south.

Because the new pricing policy resulted in the fixed price of sugar being higher in the northeastern region, it was necessary to enact strict legislation that would prevent the transfer of sugar between the regions (because of the lowest production costs—and consequently lower prices—in the state of São Paulo and other producing states in the south). That allowed sugar to be sold at a competitive price in northeastern markets, even if the cost of transport between the regions was taken into consideration. This pricing policy remained in force until the price control regime ended, in February 1999.

The 1960s: The Encouragement of Exports and the Crisis Caused by Overproduction in the 1965–1966 Harvest Season

In the 1960s, various situational factors altered the prospects of the sugar industry in Brazil, which in turn influenced government intervention that has always come in reaction to economic and social processes. The perception of the IAA (despite the dramatic short-term fluctuations in supply and international market prices) was that the exportable surplus of sugar from the northeast would not be sufficient to meet the growing domestic and foreign demands for the product. Therefore, the Institute again adopted an expansionist policy, aiming to increase exports and expand the industrial park as well as to increase the sugarcane crop.

One of those situational factors was the occurrence of the Cuban Revolution. The establishment of the socialist regime in 1959 resulted in Cuba losing its access to the USA market, which was the most lucrative and therefore, the preferred market. This opened the doors for Brazilian exports of sugar (previously restricted to the less lucrative free world market), which allowed Brazil to reduce its stockpiles of sugar produced in the northeast, a process that was still dependent on the consumer market in the south-central region as well as on external markets.

In the 1960s, during the administration of then-President Jânio Quadros, various measures were taken in order to increase Brazilian exports of sugar, which came to be regarded as a source of foreign exchange earnings. In April 1961, the government issued rules for the centralization and coordination of sugar exports, and creating an Export Division within the IAA. Planning for the sugar subsector then took on new meaning, and there were attempts to adapt sugar policy to the nationwide socioeconomic planning underway at the time. Decisions made by the IAA began to take into consideration the strategic and dynamic aspects of exportation, the focus being on replacing sugar production controls with substantial, scheduled increases in that production. Special attention was given to overcoming the problems of the agricultural sector, which had a low productivity index.

In 1971, optimistic expectations and the possibility of gaining access to the lucrative USA sugar market prompted the promulgation of the National Sugar Industry Expansion Plan, aimed at achieving the goal of producing 100 million bags in that year. To increase sugar production in the country to that level, the government allocated additional production shares to the states of São Paulo and Paraná. Consequently, those two states collectively came to account for 40 % of the total national production.

In 1964, the symptoms of a new sugar overproduction crisis began to appear in Brazil. At that time, sugar prices were declining on the free world market (which made Brazilian exports uncompetitive, even considering the profits obtained from gaining access to the lucrative USA sugar market), and there had been a considerable increase in domestic production. Those factors, combined with difficulties in the domestic market, made solving the problem of the surplus of Brazilian sugar a difficult equation. The situation grew worse when the sugar harvest of 1965–1966 far exceeded the production forecasts made by the IAA, more than doubling the stockpiles. The Brazilian sugarcane industry thus entered into one of its worst crises ever. The effects of the lower prices paid to producers were felt immediately. In September 1966, in the south-central region, a bag of sugar sold for less than half of the tabulated value.

The sugar crisis that peaked in 1966 was caused by multiple factors. The overproduction of the 1965–1966 harvest was attributed to the excellent weather conditions during the growing season. In addition, given its limited resources, the IAA was unable to intervene effectively with the legal and administrative instruments available to it. Furthermore, the government had erred in its evaluation of international market trends, which led to overstimulation of agricultural and industrial expansion, especially in the south-central region. This was especially true in the state of São Paulo, where the area planted with sugarcane had increased by 22 % between 1964 and 1965.

Sugarcane Remuneration Based on Sucrose Content

In December 1965, major conflicts between sugarcane suppliers and sugar mills prompted the federal government to enact Law no. 4,870, which many consider to have been a milestone in the evolution of the sector. The law introduced certain significant innovations, mainly related to the production, price, and supply of sugarcane, and some of those interventions remained in place until the harvest season of 1997–1998. The new law gave the northeastern region priority for exports to preferred markets, i.e., sugar exports from that region would be able to obtain the best prices in the United States market, which was means of compensating the region for the permanent loss of consumer markets in the south-central region.

Prior to the enactment of Law no. 4,870, remuneration for sugarcane was linked to the price of sugar and ethanol, as well as to the industrial yield of sugar mills (as regulated by the Sugarcane Farming Statute and Resolution no. 109/45). The major innovation introduced by the new law was linking that remuneration to the sucrose content and purity of the sugarcane supplied by the producers. The sucrose content and purity of sugarcane, which are quality parameters, began to be measured, and the higher the quality of the product, the larger the bonus that the sugarcane producers received in relation to the price of a standard sugarcane, dictated by the government. This new system sought to encourage improvements in the quality of sugarcane.

That policy remained in effect until the harvest of 1997–1998. Therefore, the price of sugarcane came to be calculated from a basic value, adjusted for agricultural production costs. The IAA commissioned the Getúlio Vargas Foundation⁴ to conduct a survey designed to determine those costs in the major sugar-producing regions of the country. On the basis of the results, the IAA adjusted the remuneration, on a state-by-state basis, by the mean portion of the sugarcane suppliers’ industrial income that was above the average income for the state. This mechanism was intended to provide incentives for the production of better quality sugarcane (forcing business owners to streamline their production and use sugarcane with a higher sucrose content), as well as to unlink the price of the raw material from that of the final product, thereby preventing the supply of sugarcane from being subject to fluctuations in sugar prices, which had led to the crises of over and under production.

The enactment of Law no. 4,870 resulted in sugar prices being fixed on the basis of the average regional production costs. That meant higher prices for sugar produced in the northeastern region, where production costs were higher. In a way, this ensured that sugar production in that region would remain comparatively less efficient, and that consumers in the poorest regions would pay a higher price for the product. Although, there was an earlier law designed to prevent the sugar produced in the south-central region from entering into the northeastern markets, the new pricing system encouraged the sale of sugar produced in the south, where production costs and wholesale prices were lower, in those markets. Therefore, in 1971, the sugar pricing system was again changed and producers in the northeast began to receive what amounted to a subsidy,⁵ through so-called “price equalization.” Through Decree-Law no. 1,186, enacted in August 1971, the government once again established a single, nationwide price for sugar. However, to compensate for the differences between the southeast and northeast in terms of the costs of production, northeastern producers would receive an allowance that would decrease annually over the seven following seasons.⁶

Law no. 4,870 contained two important articles: Article 5, which allowed the IAA to set monthly limits for sugar production; and Article 51, which provided that sugarcane suppliers participate in the valuation of inventories stemming from the setting of monthly marketing limits. After those articles had gone into effect, the IAA passed Resolutions no. 2,004 and no. 2,009, which stipulated that, as of the 1969–1970 season, sugarcane suppliers would also take part in any price increase on sugar that was stockpiled for sale, in predetermined quantities, on a monthly basis.

The Division of the Country into Two Sugar-Producing Regions

In August 1966, the government issued Decree-Law no. 1,974, which divided the country into two major sugar-producing regions: northeast⁷ and south-central.⁸ The transfer of sugar between those two regions could then occur only with the prior authorization of the IAA. As stated by Ramos (1991), this law sought to protect the sugar production in the northeast (because sugar produced in the south-central region reached the northeast at a lower price)—not to allow northeastern sugar producers access to markets in the south-central region, but rather to protect their production in their own territory.

As of 1968, prices on the free world market began to recover, because consumption had surpassed production. After a new International Sugar Agreement went into effect, in January 1969, Brazil consolidated its position as a sugar exporter, because global stockpiles of sugar were low and because it had maintained access to the lucrative United States sugar market.

After Artur da Costa e Silva was elected president, new directions were plotted in relation to the recovery of the sugarcane industry in Brazil after the crisis of the 1965–1966 harvest season. The government took long-term measures, such as the construction of sugar warehouses in the cities of Recife and Maceió, and the establishment of an agreement with the Development Bank of Minas Gerais to finance projects that were aimed at streamlining the sector, a concern that persisted throughout the 1970s.

In 1968, various strategies were adopted in order to further increase the development of Brazil. One of those strategies was the promotion of Brazilian exports as a whole. The sugarcane subsector was included in this context, and sugar exports then came to be a permanent fixture.

To meet the objectives of the national policy to increase exports, it became necessary to analyze certain factors related to product availability within the subsector represented by the sugarcane ethanol industry. Such factors included the current capacity and the degree to which that capacity was being utilized, as well as the efficiency of production and the structure of the marketing system.

The first real step taken in that direction was the creation, in May 1969, of the Agroindustrial Laboratory, in the city of Piracicaba, and the Experimental Sugarcane Station (which would develop new varieties of sugarcane and would study the most appropriate production methods), in the city of Araras, both located in the state of São Paulo.

The 1970s: Promoting Exportation, Improving Productivity, and Streamlining Production; the Oil Crises; and the Development of the Proálcool Plan

Promoting Exportation, Improving Productivity, and Streamlining Production

In the early 1970s, several programs aimed at improving the indices of agricultural and industrial productivity were launched, with the aim of making domestic production more competitive and boosting exports.

To increase agricultural productivity, the IAA instituted a new entity, the National Program for the Genetic Improvement of Sugarcane, which operated under the auspices of an agency designated the National Sugarcane Ethanol Plan (Planalsucar). In addition, a number of new agronomic research stations were set up in the states of São Paulo, Rio de Janeiro, Pernambuco, and Alagoas.

Along with the implementation of the Planalsucar, other programs were developed by the IAA as part of the plan of technological modernization. One was the Program for Streamlining the Sugarcane Industry, which sought to improve productivity and modernize the agricultural and industrial parks, and to construct new sugar warehouses.

In May 1971, the government established a new national sugar production cap of 100 million bags per year, altering the concept of the overall limit of production, which came to be the sum of the two regional limits (from sugar mills located in the northeastern and south-central regions), each corresponding to the sum of the shares of the sugar mills in the respective producing regions. That allowed the expansion of sugar production by the states and sugar mills that had the best agribusiness conditions.

In August 1971, pursuant to Decree-Law no. 1,186, the government began to offer incentives for the merger, consolidation, and relocation of sugar mills around the country (within the same geo-economic region). Entities that merged under this new system, sugar mills, and sugarcane suppliers alike, would receive benefits and incentives, which had the effect of encouraging the trend toward industrial concentration that already existed in the sector.

In addressing the evolution of the consolidation process, Ramos (1991) noted that the legal changes brought about by Decree-Law no. 1,186, reinforced a trend toward concentration that had been observed since the late 1950s. According to Szmrecsányi (1979), the intention of the law was to give sugar mills the ability to increase their productivity and reduce their production costs. This would be made possible through economies of scale resulting from mergers, and by the savings accrued from the relocation of sugar mills to areas that had better infrastructure and were more suited for production.

After the creation of the Planalsucar and the Program for Streamlining the Sugarcane Industry, annual sugar exports out of Brazil totaled more than 1.2 millionmetric t (providing the third greatest foreign exchange earnings of all Brazilian exports), which corresponded to 6 % of all sugar on the international market (Szmrecsányi, 1979). Between October 1971 and January 1972, a reduction in the global stockpiles of sugar caused the international market price to increase by almost 100 %, benefiting exporting countries, especially Brazil, which became the leading supplier of cane sugar produced by centrifugation, the second leading sugar exporter, and one of the only countries having the capacity to manufacture more than 2 million metric t per year. The international market price of sugar remained high between 1971 and 1975. In 1972, limits on sugar exports to the free world market were repealed, which made it possible for Brazil to draw down the stockpiles accumulated from previous harvests and to utilize its idle production capacity. Figure 2.2 (drawn from Santos, 1993, p. 287) shows the evolution of the sugar industry from 1935 to 1982. Note that exports peaked in 1973 and declined thereafter.

Fig. 2.2

The evolution of the sugar industry: 1935–1982

According to Szmrecsányi (1979), Brazilian sugar exports grew 180 % between 1969 and 1973. In monetary terms, the total value of sugar exports in this period increased from US $ 112 to US $ 600 million, and the average price per metric ton increased from US $ 105.00 to US $ 202.00. Because the IAA handled all sugar exports from Brazil and paid producers a price lower than that received, the balance of the reserve known as the Special Export Fund increased considerably, allowing the Institute to expand its activities related to the modernization of the sector, allocating resources for modernizing sugar mills, for consumer price subsidies, for mergers, and for the consolidation or relocation of sugar mills, as well as making more working capital available to sugar producer cooperatives. The IAA offered financing to companies in the sector on extremely favorable terms.⁹ However, this policy was not universally accepted by mill owners and sugarcane suppliers, who complained about the way in which the production limits were distributed and about domestic prices. They claimed that the prices of sugarcane and sugar were not in line with their production costs, requesting that the pricing system take into consideration the revenue generated by the export sector, improving the real remuneration of producers and preventing their undercapitalization. At that time, many sugarcane suppliers had abandoned the planting of sugarcane, planting their fields with other crops. Some had even leased or sold their land to the sugar mills.

Gomes (1979) noted that, although the Getúlio Vargas Foundation had been conducting surveys of the costs related to the production of sugar in the two major sugar-producing regions since 1975, the results of those surveys were apparently not taken into account in the establishment of sugar prices, and that the existing distortions were really created in order to set prices below those costs. This suggests a paradox: how could the sugarcane industry be expanding if the prices of their products were set below their production costs? The author goes on to explain that the real remuneration of the sugarcane industry was sufficient for its expansion, because of the various types of credit and subsidies made available to it: “the delay of payments, suspension of deductions, interest subsidies, ample grace periods, lack of indexation, price subsidies…” (Gomes, 1979, p. 140). Therefore, government intervention operated on a low-price basis, producers being paid unevenly due to differences in productivity. The government offset the liquid loss related to the low price with a paternalistic policy of subsidized credits.

Although the international market prices for sugar remained high until the mid-1970s, it was an unstable situation in the medium term, and those trends were therefore reversible as they were in 1975. Figure 2.3 shows the evolution of the international market price for sugar between 1970 and 1982. From its peak in November 1974, the price of sugar began to fall. By May 1975, the price paid to sugar producers had fallen to almost one fourth of that reported for December of 1974.

Fig. 2.3

International sugar prices: 1970–1982. (Source: Santos 1993, p. 285)

Chief among the many factors that contributed to falling prices were consumption declines in importing countries and the forecast increase in world supply. The effects on the Brazilian economy were not immediate, because of the supply contracts previously signed by the IAA. However, as of 1975, the balance of the Special Export Fund began to dwindle, weakening the political power of the Institute. At the same time, high oil prices, resulting from the pricing policy of the Organization of Petroleum Exporting Countries (OPEC), together with Brazil’s growing foreign debt, became important factors to be considered in defining the energy policy to be adopted in the country, resulting in renewed interest in the production of ethanol by both the government (which was dealing with the balance of payments deficit) and the sugar mill owners (who had expanded their facilities to sell sugar on the international market and were faced with declining external prices for their product). Thus, the situation of the two markets (sugar and oil) determined the national policy for fuel ethanol.

The First Oil Crisis and the Development of the Proálcool Plan

In the 1970s, the global economy accelerated rapidly, due to the expansionist policies of the United States in the mid-1960s, and the heavy reliance on oil imported from the Middle East. At the end of 1973, OPEC sharply increased the price of a barrel of oil, which had a significant impact on the economies of all oil importers.

Figure 2.4, drawn from Santos (1993, p. 279), shows the evolution of oil prices between 1973 and 1982. Note the large rise in prices between October 1973 and January 1974. The price of a barrel of oil paid by the then state-owned energy company Petróleo Brasileiro (Petrobras, Brazilian Petroleum) increased by 225 % between 1973 and 1974.

Fig. 2.4

Evolution of oil prices on the international market: 1973–1982

According to Santos (1993), the effects on the trade balance were intense: in 1971 and 1972, the deficit was low (US $ 530 and US $ 2,430 million, respectively); and the surplus achieved in 1973 (US $ 2,179 million) became a deficit of US $ 4.69 billion in 1974. In that same period, there was a jump in the inflation rate. Santos (1993) also noted that although the high price of oil was not solely responsible for that jump, it certainly contributed to worsening the trend caused by the structural factors that were responsible. The annual inflation rate (percentage increase in the general price index) increased 122.6 % in a single year, increasing from 15.5 to 34.5 % between 1973 and 1974.

It was during this period of inflation and problems related to the balance of payments deficit that the Presidency of Brazil (at that time under the military regime that had come to power in 1969) changed hands. In March 1974, General Emílio Garrastazu Médici (president since 1969) was succeeded by General Ernesto Geisel. Under the effects of the oil crisis, the question posed was how to maintain the gross domestic product at its current rate of growth (which was the choice made by the military regime), and at the same time to achieve equilibrium in the balance of payments and keep inflation in check. Although the energy policy was considered strategically important, it was considered within the context of a broader goal, which was to maintain rapid growth while keeping inflation and the balance of payments under control, in order to reduce the country’s dependence on external sources of energy.

Santos (1993) noted that, in 1974, fuel ethanol received little attention in decisions regarding the energy policy, and even the use of the fuel mixture (the addition of anhydrous ethanol to gasoline) would not be given weight until late 1975. In addition to oil shale, the emphasis in 1974 was on nuclear energy. In that same year, Brazil and Germany negotiated the Brazil-Germany Nuclear Agreement, which was signed on June 12, 1975.

Although it had been authorized in the early 1970s by the Conselho Nacional do Petróleo (CNP, National Petroleum Council), the 15 % limit on the proportion of ethanol that could be added to gasoline was never reached, because of insufficient production of anhydrous ethanol. In addition, the export of ethanol was left to the initiative of producers, and those producers were offering their product to whichever market (domestic or foreign) was more convenient at any given time. That led to shortages on the domestic market.

Despite the effects that high oil prices had on the balance of payments and on the inflation rate, few concrete government actions were taken in 1974. It was believed that the mechanisms put in place to combat inflation, the dynamism of exports, and the inflow of external funds would be sufficient to solve any problems that arose. In addition, the discovery of oil in the Campos basin (off the coast of the state of Rio de Janeiro) at the end of 1974 increased official optimism, and it was even thought that Brazil might achieve oil self-sufficiency.

In late 1975, the macroeconomic imbalance worsened considerably: the external debt continued to increase, foreign exchange reserves were reduced, exports behaved more poorly than foreseen, and the influx of external resources was not sufficient to cover the account deficits. On October 9, 1975, President Geisel made a speech to the nation in which he announced a series of drastic measures aimed at reducing the balance of payments deficit as much as possible (Santos, 1993, p. 51). Among those measures was the creation of Proálcool.

Among the persons and entities involved in the formulation phase of the Proálcool plan, there were those of a public nature and those of a private nature, as described by Santos (1993). Public entities included the following: President Ernesto Geisel; the Ministry of Industry and Commerce (MIC)¹⁰; the Ministry of Mines and Energy (MME); the Secretariat for Planning (SEPLAN); the Ministry of Agriculture; the IAA; Petrobras; the CNP; the Ministry of Aeronautics Aerospace Technology Center; and the MIC Secretaria de Tecnologia Industrial (MIC/STI, Department of Industrial Technology). The private entities involved were as follows: the Cooperative of Sugar and Ethanol Producers of São Paulo (Copersucar); the São Paulo State Ethanol Producers Association; the Fluminense (Rio de Janeiro State) Cooperative of Sugar Producers (Coperflu); the Association of Sugar Refiners in the States of Rio de Janeiro and Espírito Santo; the various associations of sugarcane suppliers and producers; and the Brazilian Association of Chemical Industries. During this stage, the automobile industry played only a secondary role.

The effects of high oil prices on the balance of payments were well known. However, the extremely favorable conditions for the exportation of sugar in 1974 imposed itself as a relevant issue to be considered in decisions regarding the Brazilian national ethanol policy. Sugar production for the export market served the interests of the government (because the influx of currency from sugar exports could be used in order to reduce the balance of payments deficit), and those of the sugar industry. Those interests converged to influence ethanol policies, and it was decided that such policies should be designed in such a way as to not have a negative effect on sugar exports.

To ensure the supply of raw materials, the government encouraged the expansion of sugarcane production. In addition, the basic problems of the sector were addressed through measures such as the establishment of minimum prices for sugarcane and sugar. However, while there was consensus on the need to expand cultivation, disputes arose between the IAA and Copersucar regarding how to achieve that goal. The IAA wanted the expansion of sugarcane cultivation to be linked to the production of independent ethanol plants that were located outside the traditional sugarcane-producing areas. The idea was to prevent the sugar mills from diverting sugarcane intended for the production of sugar to that of ethanol at their convenience, thus failing to honor international commitments for sugar exports, which would increase the balance of payments deficit and reduce revenues flowing into the Special Export Fund,¹¹ thereby affecting the revenues of the IAA itself. According to Santos (1993), the MME supported the IAA in its policy of protecting revenues resulting from the export of sugar and its byproducts. For its part, Copersucar officials argued that it would not be possible to establish ethanol as an alternative energy source as long as it continued to be considered a byproduct of sugar. Their suggestions for the expansion of ethanol production were to use the idle capacity of existing ethanol plants; to modernize and expand such plants; and to co-locate ethanol plants with sugar mills that currently had no ethanol-producing capacity.

During the 1974–1975 growing season, the idle capacity of the ethanol plants in the state of São Paulo was at 45 %, due to the increases in capacity resulting from the modernization projects undertaken earlier in the decade. This justified the position of Copersucar in defense of the two-fold idea that ethanol should be produced primarily by using the excess capacity already available and that the ethanol produced should be used as a fuel.

According to Santos (1993), lobbyists for the sugar producers in the state of São Paulo were quite active and visible in the 1970s. Beyond using their access to senior decision-making circles (even leaving aside the institutional channel of communication, the IAA), Copersucar disseminated various technical studies on the subject, and making extensive use of the media and public forums to defend their positions.

Throughout 1974, there were various studies and discussions regarding the proportion of anhydrous ethanol to be blended into the fuel mixture, regarding the parity between sugar and ethanol prices, and especially about whether ethanol should be produced at stand-alone ethanol plants or at plants co-located with sugar production facilities.

In July 1975, Decree-Law no. 75,966 set the parity for anhydrous ethanol at 44 L of ethanol per 60 kg bag of “standard” raw sugar (which corresponds to the coefficient of conversion of sugar into ethanol), i.e., the anhydrous ethanol would be acquired by the IAA at a price equivalent to 44/60 cents of the price of a kilo of standard raw sugar. The ethanol produced would be sold to Petrobras, and the IAA would be involved only in monitoring the production and marketing of ethanol (of all types) nationwide.

Decree-Law no. 75,966 also stipulated that anhydrous ethanol should be produced primarily at ethanol plants co-located with sugar mills (which would be granted funding from official credit sources, or through the Special Export Fund, to adapt their facilities for the production of ethanol). According to Szmrecsányi (1979, p. 313), this indicates that the main objective of the decree was “… to ensure that the sugarcane industry of Brazil would maintain a certain level of activity, doing so by creating a new, alternative market, in case any more difficulties arose on the international sugar market.” Because few sugar mills had ethanol production facilities, new lines of credit were opened so that sugar mills could construct or expand such facilities, as well as for the construction of stand-alone ethanol plants. The financing terms stipulated by the Decree were as follows: initially, up to 100 % of industrial investments (for co-located or stand-alone ethanol plants) would be financed; the annual interest rate would be 15 % for projects undertaken in the northeast and 17 % for those undertaken elsewhere in the country; borrowers would have a grace period of 3 years, with up to 12 years to repay the loans; for the purchase of sugarcane and other raw materials, the annual interest rate would be 7 % per year, with a grace period of 2 years, and up to 5 years to repay. In addition, none of the loans would be subject to indexation. As of 1977, such financing accounted for 70–90 % of industrial investments in the sector, depending on the type of ethanol plant and the raw material used, and required indexation equal to 40 % of the variation in the value of Brazilian National Treasury inflation-linked securities. Interest rates were reduced to 6 % for co-located ethanol plants and 5 % for stand-alone ethanol plants, an exception being made for plants located in areas overseen by the Superintendência do Desenvolvimento do Nordeste (SUDENE, Office for Development of the Northeast), or the Superintendência de Desenvolvimento da Amazônia (SUDAM, Office for Development of the Amazon), where the interest rates were lowered to 4 % for co-located ethanol plants and 3 % for stand-alone ethanol plants.

Initially, all financing of ethanol plants included a 3-year grace period. However, in 1982, it was stipulated that grace period would be 3 years for co-located ethanol plants and 4 years for stand-alone ethanol plants. That same year, the financial burden of the loans went to a fixed annual interest rate of 5 %, plus indexation, which was calculated as follows: in the areas overseen by the SUDAM or SUDENE, up to 60 % for ethanol plants and up to 55 % for stand-alone ethanol plants; in other regions, up to 70 % for co-located ethanol plants and up to 65 % for stand-alone ethanol plants. In addition, the sum of indexation and interest could not exceed 55 %.

Santos (1993) highlighted the leadership of the MIC at this stage of ethanol policy management. The author also credited then-President Ernesto Geisel with playing a courageous role in the promulgation of Decree-Law no. 75,966, given that the decision parameters at this time were still unfavorable to the development of fuel ethanol—the international sugar market was still favorable for Brazilian sugar exports, the revenues from those exports exceeding the savings the country would have made had it stopped importing oil. In Geisel’s speech to the nation on October 9, 1975, he not only formalized the idea of establishing Proálcool but also announced that the proportion of ethanol to be added to gasoline would now be fixed at 20 %. He also stated that sugarcane would be used as an industrial raw material, and that financial incentives would be provided for the expansion of sugarcane production and the construction of ethanol-producing facilities (co-located and stand-alone plants), as well as announcing stimulus programs for the production of ethanol from other sources (sweet potatoes and cassava).

The ongoing conflict for control of Proálcool was still raging. For the IAA, the reduction in revenues coming into the Special Export Fund made it essential to control a program that would become another source of funding,¹² whereas the MIC envisioned a special fund to finance the production of ethanol, and to subsidize the selling price of the product when it was to be used as automotive fuel or by the chemical industry.

The draft of the bill that created Proálcool greatly strengthened the position of the IAA, putting it in control of Proálcool in terms of the promotion of ethanol production, the modernization, and expansion of existing ethanol plants, as well as the construction of new plants, which had to be registered with the IAA. The Institute also retained its monopoly on the marketing of ethanol of all kinds and of the residual sugar, both domestically and externally, and Proálcool resources would come from difference between the price paid to producers and the resale price.

The reaction of sugar and ethanol producers (as expressed through Copersucar, Coperflu, the São Paulo State Ethanol Producers Association, and newspaper editorials by growers and producers in the south-central region) was aimed at preventing the nationalization of the sugarcane industry. Although the producers accepted the IAA monopoly on the marketing of anhydrous ethanol (as it had since the creation of the Institute), it did not accept the idea that the marketing of industrial ethanol should also be controlled by the IAA alone. This resulted in a test of wills between Copersucar and the MIC, the latter, predictably, coming down on the side of government involvement in the economy. Lobbying by Copersucar provoked a reaction from federal bureaucrats, who announced that the government would not allow itself to be influenced by external pressure.

According to Santos (1993), the intense Copersucar lobbying against the government monopoly on the marketing of ethanol intensified the struggle among bureaucratic agencies for control of Proálcool. Competition between the IAA and Petrobras, regarding the marketing of ethanol, became quite intense, the IAA being backed by the MIC, and Petrobras being backed by the MME. After a number of meetings and multiple delays, the interested parties remained resolute in their stances.

Finally, on November 14, 1975, then-President Ernesto Geisel issued Decree-Law no. 76,593, officially creating Proálcool, the coordination of which was handled by an Inter-Ministerial Standing Committee, chaired by the Secretary General of the MIC and comprising representatives of the Ministry of Finance; the Ministry of Agriculture; the MIC; the MME; the Ministry of the Interior; and the SEPLAN. The most significant outcome of this process was that the IAA monopoly on the marketing of ethanol was greatly weakened.

The IAA was charged with receiving the funding proposals for the construction, modernization, or expansion of ethanol plants and delivering the technical evaluations of those proposals to the newly established National Ethanol Commission; with establishing parity prices for ethanol (except for fuel ethanol and the ethanol used for industrial purposes) and setting the value of the residual sugar; with laying down the technical specifications for residual sugar and residual ethanol from any source; and with the registration of ethanol plants. However, it was the CNP, rather than the National Ethanol Commission, that was charged with ensuring the application of the parity prices for fuel ethanol and for ethanol used in the chemical industry, as well as with coordinating a program for allocating anhydrous ethanol among the various oil distribution companies, who would receive it at a price set by the CNP. Although Decree no. 76,593 described the distribution of power in detail, the IAA and Petrobras both continued to pursue their respective interests. Both succeeded in gaining more important roles within the bureaucratic structure of Proálcool.

The Proálcool plan was implemented in phases, the first two of which were especially noteworthy: the first implementation phase began in 1975, with the promulgation of Decree-Law no. 76,593, and ran through 1978, corresponding to the period during which the anhydrous ethanol-gasoline blend came into use, co-located ethanol plants were constructed, and the automotive industry was encouraged to begin producing ethanol-powered automobiles; during the second implementation phase, which began in 1979, there was large-scale production of hydrous ethanol to be used in automobiles running on ethanol alone. In the first phase, the goal was to increase the annual production of ethanol to 3 billion L in order to achieve the proportion of 20 % anhydrous ethanol in the fuel mixture. According to Santos (1993), although this goal was reached in 1977 (3 years ahead of schedule), a proportion of 20 % ethanol in the fuel mixture was not achieved nationwide until 1983.

The primary goal of Proálcool had been to reduce Brazil’s dependence on imported gasoline by diluting gasoline with nationally produced ethanol. However, despite higher prices, the oil market remained stable from 1975 onward.

The modest decline in the growth rate of gasoline consumption in Brazil notwithstanding, the relatively stable international scene seemed to indicate to the government that, rather than changing the structure of the national energy policy, the focus should be on adapting the economy to the effects of higher prices, by controlling inflation (the annual inflation rate having reached the 40 % threshold in 1975) and reducing the balance of payments deficit. This slowed the pace of the implementation of the Proálcool plan. Although President Geisel and the ministers in the area of economics claimed to have the goal of reducing oil consumption in the country, effective changes in the country’s energy profile would not occur until after the second oil crisis, in 1979.

The rapid growth of ethanol production, contrasting with the slow pace of official action, can be explained by declining sugar prices on the international market. In 1976, despite the lower sugar prices, the president of the IAA did not see fit to reduce sugar production. Nevertheless, the ethanol program proved to be important safety valve for the sector. Therefore, as described by Ramos (1991), the production of ethanol was the “lifeline” alternative for sugar mill owners that had expanded their facilities in order to produce their limit of sugar for export, those limits having been based on the mistaken expectation of growing global demand. The IAA understands that low prices was a temporary situation, and decided to keep the sugar quantity to be produced. However, the ability to produce sugar or ethanol from sugarcane (which is possible in sugar mills that have annex ethanol plants) would enable producers to redirect part of the sugarcane for the production of ethanol, under the Proálcool Program¹³.

According to Santos (1993), although there were large stockpiles of sugar (representing 12.2 % of production) at the end of 1977, the IAA did not curtail sugar production, believing that greater production capacity translated to greater power in the international sugar market. In addition, Proálcool had emerged as a solution to any potential crisis of sugar overproduction. In fact, after the harvest of 1977–1978, the government granted an IAA request to convert 15 million bags of sugar into ethanol directly. In the following growing season, the IAA curtailed sugar production (because demand and international market prices remained low), reducing the authorized production limit by 15 million bags. In addition, of the 120 million bags produced, an estimated 35 million were processed into ethanol directly. Figure 2.5 (drawn from Santos, 1993) shows the evolution of ethanol production in Brazil between 1930 and 1983. As can be seen in the figure, the approximate total production of ethanol (including ethanol produced directly and ethanol produced as a byproduct of sugar) was approximately 550 million L in the 1975–1976 season, reaching approximately 664 million L by the 1976–1977 season and jumping to approximately 1,407 million in the following season.

Fig. 2.5

Evolution of ethanol production in Brazil: 1930–1983

In 1976, the manufacturers of equipment for ethanol plants and sugar mills readily acceded to the Proálcool plans, declaring themselves able to meet the demand for their products (Santos, 1993). However, according to Santos (1993), the major automobile manufacturers, including Volkswagen, General Motors, Volvo, Mercedes-Benz, Ford, and Fiat (the last having begun operating in the country only recently), as well as the Associação Nacional dos Fabricantes de Veículos Automotores (Anfavea, National Association of Automobile Manufacturers), were cautious regarding the viability of the program, apparently doubting the commitment of the government. The author also reported that the funds used in order to implement the Proálcool plan, in its initial phase, came from federal budget allocations (approved annually) and from the profits obtained from the sale of the anhydrous ethanol.

In March 1976, through Resolution no. 304, Brazil’s Central Bank published the regulations for the industrial operations of Proálcool, which stated that the construction, modernization, and expansion of ethanol plants would be funded by revenues from the sale of fuel ethanol—through provisions made by the Conselho Monetário Nacional (CMN, National Monetary Council) and from the returns and net earnings from operations already carried out—provided that the projects had previously been approved by the National Ethanol Commission. The conditions for rural credit operations were set forth by the Central Bank in June 1976. Initially, the financed amount corresponded to 100 % of the budgeted amount, with an annual interest rate of 7 % and payment terms ranging from 2 (two seasons) to 12 years, depending on the type of activity. As can be seen, Proálcool was regulated by various institutions: the CNP regulated the marketing and distribution of ethanol; the National Ethanol Commission standardized the technical and economic aspects; and the CMN and the Central Bank were jointly in charge of financial aspects. These institutions formed a group that was often less than harmonious.

Because of the complex structure of the decision-making process related to the implementation of the Proálcool plan,¹⁴ delays were common, which prompted complaints from individuals interested in constructing, modernizing, or expanding ethanol-producing facilities. Applicants complained of losses resulting from raw material procurement, and from ethanol plant idle time, while awaiting the release of financing from the Bank of Brazil. Even direct intervention by President Geisel did not speed the process, and the wait time for the approval of ethanol plant projects (from the submission of the proposal to the National Ethanol Commission to the signing of the contract with the financial agent) was 7 to 12 months. Santos (1993) considered this fragmentation of the decision-making process and the contradictions between the various agencies to constitute the main cause of the delay in implementing the widespread use of the anhydrous ethanol-gasoline blend.

For the harvest of 1977–1978, to minimize the effects of the sugar overproduction crisis and to stimulate the production of ethanol, measures other than the direct conversion of sugarcane into ethanol were taken. One such measure was the financing of marketing costs (referred to as “guaranteeing”), especially costs related to product storage (at that time, harvests were only 6 months long and sales were, as now, made throughout the year). For sugar producers, this amounted to 60 % of the total value of their production, compared with 80 % for ethanol producers. In addition, to maintain uniform pricing nationwide, the government compensated producers for the cost of transporting ethanol, thereby increasing the viability of ethanol production at sites located far from the large commercial centers.

Obviously, profiting from the production of fuel ethanol was an essential stimulus for producers to adhere to the Proálcool plan. However, the price of fuel ethanol was considered to be non-compensatory and was the object of constant demands. Whereas Decree no. 75,966 (issued in July 1975) had set the parity for ethanol at 44 L of ethanol per 60 kg bag of sugar, Copersucar claimed that (based on the respective production costs of the two products) it would be more appropriate to set it at 37.5 L per bag. This relationship, which was amended several times by MIC ordinances, was finally fixed at 38 L per 60 kg bag of sugar, which, according to Santos (1993), was quite satisfactory at the time, especially for producers in the south-central region.

As the first implementation phase of the Proálcool plan drew to a close, the most serious problem it faced was that of the storage of ethanol. Although Petrobras had theretofore been unreceptive to the program (even having questioned the economic viability of Proálcool, declaring, in August 1978, that Petrobras would take no responsibility for it because it had not been included), the company agreed to be responsible for controlling the tanking and distribution of ethanol over the following years.

The lack of infrastructure for drawing down ethanol stocks was evidenced by the large stocks of anhydrous ethanol produced under the Proálcool plan. In the states of Pernambuco and Alagoas, approximately 65 % of the anhydrous ethanol produced in the 1977–1978 harvest year was unmarketable because there was no drawdown and no local storage. Neither the owners, the IAA, nor the CNP took responsibility for the distribution and marketing of the product. Petrobras and the petroleum products distribution companies, with the support of the MME and the MIC, began to jockey for control of the ethanol distribution system. Through Resolution no. 18, passed in November 1978, the distribution companies were made responsible for purchasing ethanol directly from the producers (in accordance with the monthly levels set by the CNP), and transporting it to one of the blending facilities. Petrobras would participate in this process only through its distributor. Thus, the IAA lost yet another of its assignments. Therefore, the second implementation phase of the Proálcool plan (focusing on the introduction of automobiles running exclusively on ethanol), began with certain difficulties inherited from the first phase (Santos, 1993): the long processing times for the approval of the ethanol plant proposals; the lack of indexation on loans granted to applicants; the problems related to the storage and distribution of ethanol; the fact that ethanol producers considered the price they were receiving to be too low; the lack of resources to finance the expansion of agricultural and industrial capacity; the fragmented decision-making structure; the need to develop the technology required to produce engines that run exclusively on ethanol; and the reluctance of the automobile industry to participate in the implementation of the Proálcool plan.

The Second Oil Crisis and the Sudden Rise of the Proálcool Plan

The Proálcool plan took on added importance and relevance when the second oil crisis hit during the first half of 1979. The period of relative stability in the oil market (between 1976 and 1978) was followed by another in which the OPEC members—especially Saudi Arabia, Iran, and Iraq—jockeyed for control of the market, differing on prices and volumes to be exported. Some oil-producing countries chose to increase production while others chose to decrease it, and the effects on oil prices were quite dramatic. At the end of 1979, following several price hikes over the course of the year, the price of oil on the Rotterdam spot market was US $ 36.80 per barrel, compared with the US $ 24.00 per barrel set by OPEC. At the end of 1978, those same prices had been US $ 12.58 and US $ 12.70, respectively (Fig. 2.4).

The successive increases in the international market price of oil in 1979 coincided with the Iran-Iraq Crisis (and the consequent reduction in the quantity of oil supplied by Iran), which refocused attention on the supply of oil. Although Brazil had already experienced one oil crisis, the energy profile of the country had changed little, and it remained economically vulnerable from that standpoint.

The transfer of power from the administration of President Ernesto Geisel government to that of newly appointed President João Figueiredo (still under the military regime), was therefore marked by the challenge of dealing with the effects of the second oil crisis. The second oil crisis was more devastating than the first had been, because, although the magnitude of the price increase had been greater during the first crisis, the price of oil was already high (US $ 12.70 per barrel) before the second crisis had even begun. The second oil crisis had a devastating impact on Brazil’s trade balance. Mainly due to the influence of oil, the value of goods imported into Brazil grew by 32 % from 1978 to 1979, nearly tripling the trade deficit (at that time, foreign oil still accounted for 41.6 % of all energy consumed in Brazil, down only slightly from the 43.6 % reported for 1973). Therefore, despite the abundance of foreign loans available, 1979 closed with a balance of payments deficit of US $ 3.2 million, whereas there had been a surplus of US $ 4.3 million in 1978. Between 1978 and 1979, the net external debt grew by 27 % (from US $ 31.6 to US $ 40.2 billion), whereas inflation, which had already surpassed the 40 % mark in 1978, jumped to 77 % in 1979 (Santos, 1993).

The resolution of the energy issue and the fight against inflation both became target issues at this stage. The policy of replacing petroleum products with alternative energy sources was an important tool used by the government to reduce oil consumption. Therefore, the Proálcool plan gained momentum, the second phase of its implementation being accelerated.

In June 1979, during a meeting of the Economic Development Council, chaired by President Figueiredo, the new target for ethanol production was set at 10.7 billion L per year, scheduled to be achieved by 1985. The Council decided to invest US $ 5 billion in the program during the term of President Figueiredo (although there was no agreement on how to obtain those funds), in order to increase the amount of land planted in sugarcane and to expand the capacity of ethanol plants, as well as to finance a program of technological development to improve the raw material, to develop the technology involved in the production process, and to expand the tanking system, which was one of the bottlenecks in the Proálcool plan.

After the second oil crisis hit, the Brazilian government sought to reformulate not only Proálcool but also the entire national energy policy. In July 1979 and December 1981, respectively, the government created the National Energy Commission and the SEPLAN Energy Commission. Those two institutions were jointly charged with administrating and distributing Proálcool resources, although decisions regarding energy issues would be handled by the latter.

Because the fragmented nature of the decision-making process related to ethanol policy had hindered the implementation of the Proálcool plan, there was a push to centralize that process. According to Santos (1993), the resumption of the Proálcool plan again brought the struggle for its control to the fore. The MIC and the MME even debated the issue publicly, until President Figueiredo stepped in to announce that Proálcool would now be controlled by the MIC.

In mid-1979, President Figueiredo decided to separate the formulation of ethanol policy from its implementation. By Decree-Law no. 83,700 (issued in July 1979), he replaced the National Ethanol Commission with the National Ethanol Council, making the new agency responsible for formulating policy and setting guidelines for Proálcool. The decree also created the Comissão Executiva Nacional do Álcool (CENAL, National Executive Commission on Ethanol), which, among its other responsibilities, was charged with implementing decisions made by the National Ethanol Council. Under this new institutional arrangement, the president of the IAA became a constituent of the CENAL, giving the IAA an important role in the decision-making process. This was expected to streamline the construction of new ethanol plants, delays in the process having frequently been the target of complaints from private enterprise. The financial institutions to be involved in Proálcool were also identified, the National Monetary Council being charged with defining the sources of funds to be used and the terms of the financing. According to Santos (1993), a “single” roadmap was established for the submission and analysis of ethanol plant proposals, immediately after which complaints regarding delays in the process ceased almost entirely. However, in 1980, new complaints arose, this time regarding delays in the release of funds, caused by the worsening economic crisis facing the country.

Regarding the guidance that CENAL provided to funding applicants, Ramos (1991) pointed out that the former attempted to impress upon the latter the importance of designing projects that integrated agricultural and industrial activities in order to ensure the supply of raw material. As sugarcane is an asset with important specificities, it was necessary to ensure its supply to the industrial units, which was done through the requirement that ethanol production be vertically integrated, i.e., in order for it to have access to funding and the license to build an ethanol distillery, it was necessary that part of the sugarcane belonged to the distilleries. This way, Proálcool plants born vertically integrated as well as the holders of land (mostly farmers from western state of São Paulo) have become producers of sugarcane and of ethanol. In the case of sugarcane obtained from suppliers, project proposals should predict the supply for the life of the industrial equipment. In the case of ethanol plants co-located with sugar production facilities, financing could be granted provided that the increase in production would be accounted for, by the direct production of ethanol and that the proposal demonstrated the potential for expansion of the cultivated area, which would make it possible to increase the size of the sugarcane harvest.

The author also documented the fact that the structure of the production complex as a whole was maintained and bolstered by Proálcool, and that it was land ownership that opened access to state funding and the construction of ethanol plants. The expansion of ethanol production in states other than São Paulo followed the same integrated production structure, which was based on land ownership.

In the second implementation phase of the Proálcool plan, the automobile industry requested a guarantee of the government’s commitment, and that it would create the infrastructure necessary for the distribution of hydrous ethanol, given that the appropriate tanking and distribution of ethanol were key to the success of the program.

As previously mentioned, Resolution no. 18 had made the distributors responsible for purchasing ethanol from the ethanol plants and transporting it to the blending facilities. However, in this new phase, given the larger scale of production, this system was no longer practical. According to Santos (1993), it was necessary to build a network of storage tanks and collection centers, together with a transport system (consisting of pipelines, railroads, highways, and coastal waterways), to move the ethanol from the plants to the collection centers and from there to the blending facilities. Petrobras and the distributors (mostly multinational corporations) fought fierce battles for control of the new tanking and distribution system. Santos (1993) analyzed the actions taken by Petrobras in order to achieve total control (of the production and distribution) of the new fuel. The author pointed out that the government even suggested the creation of a new subsidiary—to be known as Álcool Brasileiro (Alcobras, Brazilian Ethanol)—causing negative reactions not only from the distributors but also from Anfavea and from the liberal press.

After much discussion, the government withdrew its bid to become directly involved in the production of ethanol and concentrated its efforts on controlling its storage and distribution.

The 1980s: The Final Implementation Phase of the Proálcool Plan; the Depletion of Government Resources; and the Mismatch Between Ethanol Supply and Demand

In the early 1980s, questions remained in relation to the implementation of the Proálcool plan, including those regarding the tanking and distribution of hydrous ethanol, as well as those regarding the technology surrounding the development of ethanol-fueled engines.

In March 1980, a National Ethanol Council resolution stipulated that the primary means of transport used for hydrous ethanol should be by pipeline, followed by (in order) coastal waterways, railways, and roadways, the last not to be used for distances over 300 km. According to Santos (1993), this decision clearly favored Petrobras, because the state already had an extensive system of transportation (pipelines, tankers, and trucks) for petroleum products, whereas the distributors had only trucks.

Regarding the tanking system for hydrous ethanol, four subsystems were established: producer tanks (located at the ethanol plants, with a storage capacity equal to at least 3 months of production); operational tanks (owned by the distributors, with a storage capacity equal to at least 15 days of consumption in their sales district); collection tanks (owned by Petrobras or other distributors, located at the collection centers, with the capacity to store large amounts of ethanol); and reserve tanks (to be used in critical situations, with a capacity, if added to 50 % of the capacity of the collection tanks, equal to at least 65 days of consumption in the surrounding area). Therefore, control of the collection tanks translated to control of the tanking system. In August 1983, by Decree no. 88,626, Petrobras was given the power to procure the volume of ethanol required to meet demand, as long as it could transport that ethanol via its own transportation system, as well the quantity required to establish the reserve stocks, together with one ninth of the total authorized volume of ethanol produced per harvest, intended for energy use and reserve stocks.

At the end of 1983, as described by Santos (1993), the government was close to having monopsony power over ethanol, because it was authorized to purchase the volume that exceeded consumption, plus the reserve stocks and approximately 50 % of all ethanol (hydrous and anhydrous) consumed in the country. In the Metropolitan Area of São Paulo, this proportion reached 100 %. In addition, Petrobras (then a state-owned company) had control of a significant proportion of the collection tanks (corresponding to 23.5 % of the total storage capacity, or approximately 1.3 million m³) and the largest network of hydrous ethanol filling stations in the country. Nevertheless, the problems of tanking and distribution, which had been considered bottlenecks to the implementation of the Proálcool plan, were resolved. In 1989, the CNP issued the order allowing all of the filling stations in the country to install ethanol pumps. The problem of developing the technology to produce efficient ethanol-fueled engines remained to be solved. The technology needed in order to manufacture automobiles running on hydrous ethanol was developed jointly by the Ministry of Aeronautics Aerospace Technology Center and the automobile industry, under the supervision of the MIC/STI. Although the major manufacturers (Volkswagen, Ford, General Motors, and Fiat) had been producing ethanol-powered vehicles since 1978, the engines in those vehicles were not efficient.

Decree no. 83,700, issued in July 1979, stipulated that the revenues needed to expand ethanol production capacity would be generated from the sales of fuel ethanol and from appropriations by the federal government. However, it was necessary to find another source of funding, given the deteriorating economic conditions of the government. The MIC proposed using foreign capital to leverage Proálcool (so that the target of 10.7 billion L of ethanol could be met in 1985), which put considerable pressure on national capital and provoked nationalist reactions from the more conservative members of the military, who argued that allowing multinational corporations to become involved in this sector was a threat to national security. Other interested parties (sugarcane suppliers, Anfavea, sugar producers, and ethanol producers) also expressed their opposition and assured the government that they would be able to meet the target without the need for foreign capital. According to Santos (1993), although the then-Minister of Planning, Delfim Netto, and the then-Minister of Mines and Energy, César Cals, both advocated the procurement of foreign capital for the production of ethanol, it seems clear that their main objective was to reduce the country’s balance of payments deficit, via direct foreign investments and foreign loans. Still motivated by the need to reduce the balance of payments deficit, Minister Delfim Netto engaged in a campaign to raise foreign funds in order to finance Proálcool. Consequently, in December 1980, an agreement was signed between the International Bank for Reconstruction and Development and Brazil’s Central Bank. Although, the agreement provided the program with an additional US $ 250 million, that represented only 4 % of the resources needed. Given the cuts in public spending, the funds from this agreement, although insufficient, represented the only source of funding for the projects approved from 1982 onward. This scarcity of resources during the second implementation phase of the Proálcool plan was attributed to the critical economic situation in which the country found itself. Because of this situation, the deadline for meeting the production target of 10.7 billion L of ethanol per year was moved forward (from 1985 to 1987), and came to be an obstacle to the expansion of the program. As of 1982, the projects approved by CENAL were carried out by private initiative, which relied on foreign loans in order to finalize the construction of the ethanol plants.

Another important issue for the expansion of Proálcool was consumer acceptance of ethanol-powered automobiles, given that the investment decisions of the automobile industry in relation to this new production line were based on consumer behavior. Therefore, the demand for ethanol-powered automobiles would be the primary issue. The position of the automobile industry was to await the reaction of consumers before beginning mass production. There were various meetings between the automakers and the government. The pressure that the government exerted on the automakers to support the program had its counterpart in the need to create greater demand for ethanol-powered automobiles. Therefore, before the automakers would agree to meet the quota of ethanol-powered automobiles, the government had to agree to stimulate demand. Among the incentives offered by the government were, attractive pricing (the price of ethanol was initially set at 65 % of that charged for gasoline), a lower highway fee for owners of ethanol-powered automobiles, longer-term financing for the purchase of such automobiles, and the opening of fueling stations for ethanol sales on weekends (when they were closed for gasoline sales). In addition, after negotiations with the Inter-Ministerial Pricing Council, Anfavea agreed to sell ethanol-powered automobiles at the same price as gasoline-powered automobiles (despite the higher production costs of the former), as a way of stimulating sales of the new product line (Santos, 1993).

However, in May 1980, the production of ethanol-powered automobiles was well below the target established, and that of hydrous ethanol exceeded the storage capacity, resulting in the government authorizing the exportation of ethanol. The main exporters were Copersucar, the large producers in the state of São Paulo, and even Petrobras, the ethanol being sold to Japan and the United States.

Between August and December 1980, consumer behavior in relation to ethanol-powered automobiles changed completely. The demand for ethanol-powered automobiles increased by 114 %, and the demand for gasoline-powered automobiles decreased by 75 %. This was attributed to the expectation that gasoline would soon be rationed, due the Iran-Iraq war, which had begun in September of that year, had cut the supply of oil coming out of Iraq. According to Santos (1993), a series of emergency meetings held by the government and the lack of consensus coming out of those meetings, together with contradictory statements made by authorities, led consumers to frantically seek out ethanol-powered automobiles.

Between September and December 1980, monthly consumption of hydrous ethanol increased by approximately 60 %. In December, sales of ethanol-powered automobiles accounted for 76 % of all new passenger car sales. The unexpected increase in ethanol consumption raised concerns about a potential ethanol shortage. Although the government had guaranteed an adequate supply of ethanol, the National Energy Commission, through Resolution no. 10 (issued in May 1981), had reduced the proportion of anhydrous ethanol to be used in the ethanol-gasoline blend from 20 to 12 %, set a ceiling on the production of ethanol-powered automobiles (of 350,000 units for 1981), and maintained the existing limit on the conversion of engines from gasoline to ethanol.

Santos (1993) stated that the change in consumer behavior toward ethanol-powered automobiles was dramatic. Over a period of 8 months, the trend in the sales of such automobiles reversed itself twice. In September 1980, at the outset of the Iran-Iraq war, sales of gasoline-powered automobiles accounted for 66 % of all new car sales. In December of the same year, the situation had completely reversed, sales of ethanol-powered automobiles accounting for 76 % of all such sales. Five months later (in May 1981) sales of gasoline-powered automobiles were back up to 71 % of all new car sales.

The drop in the sales of ethanol-powered automobiles in 1981 can be attributed to a number of factors. The effects of the war between Iran and Iraq were less profound than expected, the supply of oil on the international market becoming abundant in the first half of 1981. In addition, investments in domestic oil production had begun to pay off. Furthermore, the critical economic situation in the country and anti-inflationary policy adopted by Planning Minister Delfim Netto, who claimed that the Proálcool plan exerted inflationary pressure on the economy, had slowed the pace of the implementation of the program. These issues, together with media reports about related topics (the conversion of ethanol from anhydrous to hydrous, the suspension of ethanol exports, and the request made by the president of Petrobras to reduce the production of ethanol-powered automobiles until the supply of hydrous ethanol returned to normal), convinced consumers that there was (or soon would be) an ethanol shortage, turning the trend back toward a consumer preference for gasoline-powered automobiles. In addition, Santos (1993) cited the high price of ethanol-powered automobiles, pointing out that, as of December 1980, the prices of such vehicles were no longer controlled by the Inter-Ministerial Pricing Council. The author also cites the technological problems that began to emerge in the first generation of ethanol engines. In a survey conducted by Copersucar and the Society of Sugar and Ethanol Producers, such technological problems were found to be the main reason for the rejection of ethanol-powered automobiles.

On June 15, 1981, CENAL handed down a decision that temporarily suspended all credit agreements for ethanol plant projects, because of lack of funds. At this time, ethanol stocks began to increase (despite the fact that the proportion of anhydrous ethanol added to gasoline had previously been raised back to the original 20 %). By the end of 1981, inventories of hydrous ethanol had reached 1.3 billion L. In early 1982, the potential ethanol glut became a cause of concern for bureaucratic agencies and the various interest groups. The major producers of sugar and ethanol, as well as refinery equipment suppliers, automobile makers, and refitters involved in the conversion of engines, requested that the government again take measures to encourage the sales of ethanol-powered automobiles. In March 1982, the government responded by passing Resolution no. 14, which established measures aimed at their recovery of the market for ethanol-powered automobiles. Those measures included lowering (from 65 to 59 %) the price ceiling applied to the relationship of the price of ethanol to that of gasoline; increasing the Industrialized Products Tax (an excise tax) levied on the sale of gasoline-powered automobiles, and reducing that levied on the sale of ethanol-powered automobiles; and installing hydrometers at filling stations so that consumers could check the quality of the ethanol being sold. For their part, the automobile makers again agreed to sell ethanol-powered automobiles for the same price as gasoline-powered automobiles. Consumers responded favorably to those measures, and sales of ethanol-powered automobiles increased by 59.7 % in April, by 20.2 % in May, and by 46.9 % in June (see Fig. 2.6). It is of note that consumers reacted immediately to Proálcool policies of incentives and disincentives (causing the trend to reverse in only a few months, with a major shift in demand), which indicates the importance of the role that consumers play in the success of the program.

Fig. 2.6

Evolution of the sales of ethanol-and gasoline-powered automobiles: 1980–1994

Another measure that had a great impact on the recovery of sales of ethanol-powered automobiles was Decree no. 1,944 (issued in June 1982), which declared that, for a period of 1 year, passenger vehicles running on ethanol, with engines of up to 100 HP in power, would be exempt from the Industrialized Products Tax if they were to be used as taxis. This stimulation of the taxi market revitalized sales of ethanol-powered automobiles, finally prompting automobile makers to express their faith in the product line.

Near the end of 1982, sales of ethanol-powered automobiles were quite strong, representing 38 % of total passenger car sales in the last quarter of the year and peaking at 67 % of that total in December. Beginning in 1984, it became clear that consumers had accepted ethanol-powered automobiles. Figure 2.6 (drawn from Sugarcane Industry Association data), shows the evolution of the sales of all automobiles between 1980 and 1994.

Note that sales of ethanol-powered automobiles accounted for an average of 90 % of all new car sales between 1983 and 1989. As of 1989, this proportion began to decline (probably due to the ethanol shortage that occurred at the time), dropping to 11 % in 1990. By 1995, this dropped even further (to only 2 %), and it is currently less than 1 %. In 1998, the size of the vehicle fleet in Brazil was estimated at 15 million automobiles, of which only 3.8 million were running exclusively on ethanol.¹⁵ The estimated useful lifespan of the vehicles powered exclusively by ethanol that were still in circulation in 1998 ended, on average, in 2005, and current production is nil, such vehicles having been replaced by the so-called “flex-fuel” vehicles.

Between 1975 and 1983, annual ethanol production increased from 580 million to 7.95 billion L, and the seasonal capacity of the ethanol industry increased from 904 million to 11.1 billion L.

The production of ethanol as an alternative fuel had caused sugarcane crops to be redirected from the production of sugar to that of ethanol. According to Santos (1993), 96 % of the ethanol produced in the early 1970s was obtained by indirect methods (as a byproduct of sugar production). After the creation of Proálcool, ethanol production came to play a greater role in the sugarcane industry. For example, more than 60 % of sugarcane harvested in the 1985–1986 season was used for the production of ethanol.

After 1986, various factors contributed to the perception that there was a need to re-assess the Proálcool plan. According to Santos (1993), as of January of that year, international oil prices began to decline; increasing domestic oil production decreased the country’s dependence on imported oil; and the economic plans of the government prioritized the control of inflation and of the deficit. It became clear that expansion of the Proálcool plan would have to occur through increased productivity of the agricultural and industrial sectors, because government financing to expand the existing capacity had been suspended. The depletion of official resources highlighted the difficulty that the government was having in intervening in the sector, and conflicts between producers and the government indicated the need for a new model of government intervention. In October 1987, due to this “ethanol accounts deficit,”¹⁶ Petrobras decided to stop buying any ethanol stocks exceeding demand, halting payments to producers, despite the fact that Decree-Law no. 94,541, issued in July 1987, had made it mandatory to purchase the ethanol required in order to replenish the reserve stocks (which had been drawn down), and the volume exceeding demand, in accordance with the rules laid down. Ethanol producers, in turn, complained not only about the difficulties caused by the measures Petrobras had adopted but also about price gaps. Although the prices had been based on cost surveys conducted by the Getúlio Vargas Foundation, they were determined jointly by the CNP and the government agencies responsible for the economic policy of the day, which was an anti-inflationary policy of containment of public prices.¹⁷ As of the harvest of 1985–1986, the confluence of those factors created stagnation in the production of sugarcane and ethanol, while consumption grew by 12 %, resulting in the previously mention drawdown of the reserve stocks of ethanol.

According to Santos (1993), during the 1989–1990 harvest season, 28 Proálcool-funded stand-alone ethanol plants had closed, corresponding to a reduction in ethanol production of 500 million L. In that same year, sugarcane suppliers and ethanol producers threatened to halt production. In addition, conflicts arose between sugar mill owners and sugarcane suppliers, as did accusations of illegal sales of ethanol. The situation worsened further when Petrobras radically reduced its stocks of ethanol, which led to an ethanol shortage. At the end of 1989, consumers faced long lines at filling stations.

Although the government had taken certain steps to alleviate the ethanol supply crisis—reducing the proportion of ethanol used in the anhydrous ethanol-gasoline blend (which had risen to 22 % and was now cut to 13 %); importing methanol, and replacing anhydrous ethanol with methyl tertiary butyl ether (MTBE)—long lines were again seen in the 1990 offseason, when again there was another ethanol shortage. Consequently, there was another reversal in consumer behavior. In 1988, sales of ethanol-powered automobiles, which had, for 4 years, accounted for 90 % of all new car sales, begin to decline, as illustrated in Fig. 2.6. The reduction in the demand for ethanol-powered automobiles and the economic crisis facing the country, together, succeeded in balancing out the fuel ethanol market.

The crisis caused by the ethanol shortage in 1989 and 1990 was largely attributed to the actions of Petrobras in relation to anhydrous ethanol, which was (and still is) mixed with gasoline as a substitute for tetraethyl lead (thus ensuring a high octane rating), and its advocacy of the use of MTBE in lieu of anhydrous ethanol. While the conflict between Petrobras and the ethanol producers grew, environmental issues began to enter the public consciousness, strengthening the position of the ethanol producers, because ethanol is considered a “clean” fuel. The use of oxygenated fuels—with the goal of reducing CO₂ emissions—has been a trend in developed countries since the mid-1990s. In Brazil, pollutant emissions are monitored by the São Paulo State Environmental Protection Agency, which became a major proponent of the use of fuel ethanol.

Proálcool was successful in terms of its effect on ethanol production (in the first implementation phase of the Proálcool plan, the production of hydrous ethanol increased considerably, from 323 million L in the 1975–1976 harvest season to more than 8.6 billion L in the 1985–1986 season, reaching approximately 10.8 billion L in the 1991–1992 season). However, in August 1990, then-President Fernando Collor de Mello, although he did not terminate the program, acknowledged the limitations of using ethanol as a substitute for all petroleum products, opting to maintain ethanol production capacity at its current level. As for oil, he stressed the need to provide resources to Petrobras to increase domestic production. The coexistence of two types of fuel in the country, competing and with opposing interests (Petrobras and the ethanol producers), created a need for government intervention as a mediator of conflicts in order to design a fuel policy that was in keeping with the interests of the country.

In the early 1990s, the opening of foreign markets to trade, promoted by the Brazilian government, together with the failures of the state in regulating the energy markets, made it clear that the previous model of state intervention was unworkable. This was especially true if one considers the changes in the institutional environment of the country, which was headed for consolidation of democratic rule.