Energy 81 (2015) 696e705

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Energy
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An analysis of the impact of Flex-Fuel vehicles on fuel consumption

in Brazil, applying Cointegration and the Kalman Filter

M.A. Gomez a, b, *, Luiz F.L. Legey a, 1
Jose
a
ria, Ilha do Funda
Energy Planning Programme, Federal University of Rio de Janeiro, Centro de Tecnologia, Bloco C, Sala 211, Cidade Universita ~o, Rio de
Janeiro, RJ 21941-972, Brazil
b
leo Brasileiro S.A. (Petrobras), Brazil
Fuels Marketing Planning, Petro

a r t i c l e i n f o a b s t r a c t

Article history: The aim of this article is to analyze the impact of Flex-Fuel technology on the consumption of fuels in
Received 12 September 2014 Brazil. Applying the methodology suggested by Hall (1993), combining an Error Correction Model (ECM)
Received in revised form with the Kalman Filter (KF), we studied the influence of the relative prices of Hydrous Ethanol and
8 December 2014
Gasoline C on the consumption of these fuels. We analyzed structural breaks in the time series and the
Accepted 5 January 2015
Available online 28 January 2015
evolution of parameters over periods of time. We found that the introduction of Flex-Fuel technology
into the Brazilian fleet of light passenger and cargo vehicles had a significant impact on the pattern of
demand for fuel in the country. In particular, we noted the following: (i) the existence of a structural
Keywords:
Error correction model (ECM)
break in the time series of demand for Hydrous Ethanol and Gasoline C; (ii) the marked effect of situ-
Kalman Filter (KF) ations in which there was a reduction in the availability of Hydrous Ethanol for the fuel market; (iii) the
Flex-Fuel increasing importance, in terms of demand, of the ‘Ethanol-Gasoline C relative price’ variable. We
Cointegration concluded that all these factors are due to the technological advance in Flex-Fuel vehicles, which enables
Hydrous Ethanol-Gasoline C consumers to choose between Ethanol and Gasoline C when refueling vehicles e the decision for most
vehicle drivers being essentially based on cost-benefit considerations. We consider the findings relevant
given that several economic and climatic factors indicate that there is a strong likelihood of long term
variation in the relative price of Ethanol and Gasoline C in Brazil. Government and key players in the
energy field will consequently need to adopt a clear strategy, based on reliable data, in order to deal with
fluctuating supply and demand for both fuels. Furthermore, the methodology used in this study and the
findings obtained are relevant to future studies into the likely impact of future technological and eco-
nomic developments in the Brazilian fuel market, such as the introduction of electric vehicles.
© 2015 Elsevier Ltd. All rights reserved.

1. Introduction
The Brazilian market fuel for Otto Cycle vehicles (passenger cars,
light commercial vehicles and motorcycles) is undergoing major
technological transformation with the advent of Flex-Fuel vehi-
cles.2 The type of fuel used to power these vehicles is now defined
at the pumps rather than at the assembly plant. Drivers can choose
* Corresponding author. Av. Henrique Valadares, 28, 10A, Rio de Janeiro, RJ
20031-030, Brazil. Tel.: þ55 21 998051855.
E-mail addresses: jmagomez@gmail.com (J.M.A. Gomez), legey@ufrj.br
(L.F.L. Legey).
1
Tel.: þ55 21 25628766.
2
Flex-Fuel vehicles can use either Gasoline C or Hydrous Ethanol as fuel.
between fuels, taking into account, in particular, the relative effi-
ciency and price of Hydrous Ethanol and Gasoline C.3
The Flex-Fuel technology, implemented in Brazil on a commer-
cial scale from March 2003 onwards, uses an electronic sensor
which tells the command unit of the electronic injection system the
composition of the fuels present in the tank, so that the engine is
able to optimize the combustion of fuel whatever proportion of
Gasoline C to Ethanol the consumer chooses. The emergence of this
type of engine is capable of significantly altering the dynamics of
competition between fuels, both in microeconomic terms e in that
different products are capable of being virtually perfect substitutes
3
Gasoline C is a blend of pure Gasoline (or Gasoline A) and Anhydrous Ethanol, in
a rate of between 18 and 25% (Brazilian legislation permits a positive or negative
variation of one percentage point in the blend).

http://dx.doi.org/10.1016/j.energy.2015.01.015
0360-5442/© 2015 Elsevier Ltd. All rights reserved.
 J.M.A. Gomez, L.F.L. Legey / Energy 81 (2015) 696e705
for each other e and on a macroeconomic scale due to influence of
the aggregate consumption of these fuels on the country's energy
matrix.
Hydrous Ethanol has approximately 70% of the calorific value of
Gasoline C. Thus, in situations in which the price of Hydrous
Ethanol is above 70% of the price of Gasoline C, it is economically
more advantageous for the consumer to refuel with the latter.
Conversely, if Hydrous Ethanol is sold at less than 70% of the price
of Gasoline C, it generally makes more sense for the consumer to
opt for Ethanol. There are other factors which the consumer may
take into account, including environmental issues and the lower
frequency of refueling that is necessary with the Gasoline C,
compared to Ethanol. However, for most consumers the deter-
mining factor is likely to be price.
The per capita consumption of Gasoline C and Hydrous Ethanol
between 2002 and 2011 mirrored (albeit at lower levels) the overall
increase in the total consumption of these fuels. Total consumption
of Gasoline C and Hydrous Ethanol increased by 5.1% and 12.4% p.a.,
respectively, with per capita consumption increasing by 4.0% p.a.
(Gasoline C) and 11.2% p.a. (Hydrous Ethanol). Both overall and per
capita consumption in the period reflect official policies of
encouraging for flexible financial credit schemes enabling vehicle
purchase and reducing taxes on vehicle production. These factors,
combined with increasing average incomes (notwithstanding the
2008 financial crisis) enabled many lower income families to ac-
quire vehicles. The lower rates of per capita consumption compared
to overall consumption reflect the fact that the lower income
families acquiring new vehicles tended to make less use of the
vehicles (and hence consumed less fuel per capita) than the higher
income groups. Furthermore, the increasing energy efficiency of
vehicles meant lower rates of per kilometer fuel consumption.
Much has been written both in Brazil and abroad on the con-
sumption of fuels and the factors that have an impact on the evo-
lution of demand. We refer here only to the literature which has the
most bearing on our study.
Polemis (2006) [24] analyzed the variables which had an impact
on the demand land transportation fuel in Greece. He found that
overall demand increased 44% between 1990 and 2002 with an
increase in Gasoline consumption of around 4% per annum (p.a.)
from 1988 to 2001. The author applied Johansen's Cointegration
techniques (1988) in order to detect the short and long term dy-
namics for Gasoline and Diesel in a sample period running from
1978 to 2003, drawing on annual data. He applied the following
independent variables: per capita GDP; the (deflated) prices of
Gasoline and Diesel; and the per capita vehicle fleet. The model
used a trend variable in order to capture possible technological
advances. The results obtained confirmed the anticipated signals
for all elasticities. The trend variable was not, however, significant:
the models did not indicate technological development of vehicles,
at least in terms of reduction of consumption per kilometer driven.
The results did demonstrate that the long term demand for Gaso-
line was price-inelastic but income-elastic. There was also a low
level of substitutability amongst the fuels, due to the low coefficient
of cross-elasticity of petroleum products.
Eltony and Al Mutairi (1995) [10] sought to identify the variables
that had an impact on the demand for Gasoline in Kuwait. They
applied the Engle and Granger Cointegration techniques (1987) in
order to capture short and long term dynamics in a sample period
from 1970 to 1989, using annual data. The study used the real price
of Gasoline and per capita income as independent variables in the
logarithmic form. The tests indicated the presence of a unit root in
the level and rejection of this hypothesis following the first-
difference of all the time series. The study showed that the de-
mand for Gasoline was price-inelastic both in the short and long
terms. In relation to per capita income, on the other hand, demand
697
was inelastic in the short term, but elastic (elasticity close to 1) in
the long term. This last result confirmed the supposition that de-
mand for Gasoline responds with greater intensity to long term
changes in income4 than to short term changes.
Bentzen (1994) [4] sought to identify the factors that affected
Gasoline consumption in Denmark. He, also, applied the Engle and
Granger Cointegration techniques (1987) using a sample period
from 1948 to 1991. His model used the real price of Gasoline; per
capita vehicle fleet; and per capita Gasoline consumption as inde-
pendent variables and also incorporated a trend variable. The re-
sults showed that demand for Gasoline was price-inelastic both in
the short and the long term, but that short and long term elastic-
ities in relation to the vehicle fleet per capita were close to 1. This
last result was unsurprising, given that it is to be expected that
changes in fleet size will have a direct effect on Gasoline con-
sumption, but Bentzen's estimates (1994) further suggest the
presence of rapid adjustment velocity towards long term equilib-
rium, which is significant.
Using data gathered in Brazil, Alves and Bueno (2003) [1] sought
to establish the determining factors for per capita consumption of
Gasoline in this country. They broadened the analyses carried out in
the three studies referred to above in order to incorporate the in-
fluence of Ethanol on the consumption of Gasoline C, applying an
estimate of cross price elasticity. Again, they used the Engle and
Granger (1987) [12] Cointegration techniques to capture the short
and long term dynamics for Gasoline C. Their sample period ran
from 1974 to 1999 (with a reduced period of 1984e1999 for the real
price of Ethanol). The model specified the real price of Gasoline; the
real price of Ethanol; and per capita GDP as independent variables.
The variables were tested for stationarity, and the researchers
identified unit roots in each variable. They also added a quadratic
trend in order to fine tune the model.
Cointegration tests rejected the null hypothesis of a unit root in
the residues. The results demonstrated that: (1) the signs of the
parameters of the models were as expected; (2) a demand for
Gasoline was income-inelastic in the short term and there was a
high velocity of adjustment to equilibrium in the long term (albeit
that the authors of the study acknowledged that this last finding
may have been the result of the relatively small size of the sample
available); (3) the price-elasticity of Gasoline was low in the long
term and very low in the short term; (4) the cross-price elasticity
between Ethanol/Alcohol and Gasoline was positive, albeit small,
suggesting that these fuels were substitutes (but not perfect sub-
stitutes). The need to incorporate a quadratic trend into the model
was, according to Alves, the result of repeated adjustments in the
Brazilian economy during the past thirty years in response to the oil
crisis.
Ramanathan (1999) [25] studied the demand for Gasoline in
India and its effects on the balance of payments, economic growth
and the fiscal deficit. Gasoline consumption in the country
increased by around 7% p.a. between 1981 and 1984. Ramanathan
applied the Engle and Granger (1987) [12] Cointegration techniques
in order to determine the short and long term elasticities in the
sample period of 1972e1994 on the basis of annual data. The model
he proposed used the real price of Gasoline; per capita GDP; and
per capita consumption of Gasoline as independent variables, all in
logarithmic form. Ramanathan performed stationarity tests which
indicated the presence of a unit root in the level and Cointegration
tests which rejected the null hypothesis of unit root in the residues.
The results obtained showed that: (1) the price of Gasoline was
inelastic both in the short and long term; (2) the velocity of the
adjustment of demand for Gasoline to long term equilibrium was
4
The pace (velocity) of adjustment to long-term equilibrium is 52%, in one year.
698 J.M.A. Gomez, L.F.L. Legey / Energy 81 (2015) 696e705
Fig. 1. Consumption of Gasoline C, Hydrous Ethanol and Compressed Natural Gas (CNG) as Gasoline C equivalents and the real monthly payroll in Brazil (converted to US dollars);
data from ANP and IBGE.
28% in the first year; (3) the short and long term price elasticities
were lower in India than in Denmark or Kuwait, whilst income-
elasticity was much greater in India5; and (4) income-elasticity
was high, albeit that e as expected e it was higher in the long
term than the short term.
Finally, Schünemann [26], also relying on the Engle and Granger
(1987) [12] Cointegration techniques, constructed models to
analyze fuel consumption in Brazil for the 1970e2005 period, using
as independent variables the per capita fleet; average age and
average efficiency of the fleet; fuel prices; and per capita GDP. The
results obtained demonstrated that: (1) the per capita fleet and the
per capita GDP were significant variables, provided they were not
used jointly. This was also the case for the average age and average
efficiency of the fleet variables6; (2) the variables of price of Hy-
drous Ethanol and Compressed Natural Gas (CNG) were not sig-
nificant; (3) in the Gasoline consumption model, the dummy
variable representing the introduction of Flex-Fuel vehicles into the
fleet was (relatively) significant7; (4) for Gasoline consumption,
income-elasticity was high in the long term and low in the short
term e again, as expected; and (5) price-elasticity, although greater
in the short term than the long term, was low in both cases.
The main characteristics which distinguish our study from those
referred to above are as follows: (1) we used monthly data covering
a period of over 11 years; (2) we analyzed the sensitivity of demand
to the relative price of Hydrous Ethanol-Gasoline C, applying the
methodology of Hall (1993) [14] and the Kalman Filter [18]; and (3)
5 9
Possible explanations for this include the low levels of Gasoline consumption in
India and the strong growth of the Indian economy.
6
This probably occurs because these variables reflect trends which are strongly
correlated, leading to their colinearity.
7
This “relative significance” may be the result of the short period of time that has
elapsed since the introduction of Flex-Fuel vehicles into the fleet, so that it is not
possible to categorically state, at this stage, that there have been changes in the
parameters of the model for Gasoline consumption.
our study presents greater precision in the projection of Gasoline C
consumption for the twelve months following the analyzed sample
(the year being 2012) (Mean Absolute Percentage Error e MAPE of
4.80%).
In the following section we set out an overview of the market for
fuels in Brazil. In Section 3 we present a model for the analysis of
the effects of Flex-Fuel vehicles on the demand for Gasoline C. In
Section 4 we set out the results obtained in the model and in
Section 5 we set out our conclusions.
2. The fuel-market in Brazil: the effect of Flex-Fuel vehicles
In Brazil, the Otto-cycle segment (light passenger and cargo
vehicles and motorcycles) is powered by Gasoline C, Hydrous
Ethanol and Compressed Natural Gas (CNG). We set out the
(monthly) evolution of the market share of each of these fuels, in a
period running from July 2001 to December 2011, in Fig. 1, which
also features the real monthly payroll8 over the same period.9
Fig. 1 shows that the evolution of consumption of the three
Otto Cycle fuels (Gasoline C, Hydrous Ethanol and CNG) followed
a very similar pattern to the evolution of the real (monthly)
wages (i.e. the real monthly payroll) throughout the observed
period taking into account the impact of specific Brazilian
8
The total value of salaries (minus inflation) paid in Brazil. The Portuguese term
for ‘real monthly payroll’ is ‘massa salarial real’.
We obtained the information on the consumer sales of C Gasoline, Hydrous
Ethanol and CNG from the Brazilian National Agency for Petroleum, Natural Gas and
Biofuels e ANP. We obtained data on the real monthly payroll (an indicator which
based on the number of people employed and the mean nominal income they
normally receive) from the Brazilian Institute for Geography and Statistics e IBGE.
We deflated this variable applying an Extended Retail Price Index e IPCA, again
provided by the IBGE and converted the result into US dollars applying the Brazilian
Central Bank (Bacen) Ptax average monthly rate. The sample size was 126 periods.
 J.M.A. Gomez, L.F.L. Legey / Energy 81 (2015) 696e705
Fig. 2. Evolution of the Brazilian production of Total Ethanol (Anhydrous þ Hydrous), Million m3 and Brazilian Production of Sugar, Million Tons; data from MAPA (Brazilian Ministry
of Agriculture) [21].
legislation which requires employers to pay mandatory end of
year bonuses in December10.
From 2002 to 2011, the consumption aggregate increased at a
rate of 6.2% p.a. whilst real wages (calculated in Brazilian currency)
increased at a rate of 4.0% p.a. In fact, the Brazilian currency
appreciated considerably during this period, so that, in US dollar
terms, real wages increased by 10.3%. The fact that the consumption
of fuel evolved at a higher rate than real wages (when calculated in
local currency) was due to the Brazilian government's reduction of
interest rates during this period in order to stimulate economic
activity, allied with the introduction of further credit and fiscal
policies which favored the purchase of vehicles.
In relation to Hydrous Ethanol, it can be seen that following a
rapid expansion in consumption (Fig. 1) and in Ethanol production
(Fig. 2) between 2002 and 2009, no clear pattern emerges. The lack
of a clear pattern is particularly marked post 2010. Possible ex-
planations for this fact include: (1) the impacts of the 2008 financial
crisis, which led to a reduction in the capital available for invest-
ment and financing of Sugar-Ethanol activities [8]; (2) the increase
in the price of sugar on the international market, which led to Sugar
becoming more financially attractive than Ethanol; and (3) climate
problems which affected the production of the main raw material
for Ethanol (Sugar-Cane).
The climate problems referred to in (3) above, can be traced to
the following: (1) abnormally heavy rainfall (which, despite stim-
ulating vegetative development, hampered the concentration of
sucrose in the Sugar-Cane) during most of the cultivation cycle,
particularly in the South Central Region, which is responsible for
around 90% of the production of Brazilian Sugar-Cane; (2) crushing
of Sugar-Cane at levels below the installed capacity of the mills,
leading to losses for farmers due to reduced production of Sugar
and Ethanol during this period; (3) the heavy rainfall meant that a
10
There has been a law in Brazil, since 1962, granting all workers the right to
receive a ‘thirteenth’ salary, normally paid during the month of December.
699
significant amount of Sugar-Cane could not be harvested (because
the machines used for harvesting cannot be used on Sugar-Cane
fields when the soil is extremely wet). This un-harvested Sugar-
Cane remained in the fields, increasing re-sprouting and the
quantity of aerial roots, which in turn reduced the Total Recover-
able Sugar (TRS), affecting the performance of the industry; (4) in
the Northeastern region (responsible for approximately 10% of
Brazilian Sugar-Cane production) rainfall was lower than average,
both during the vegetative development phase and during the
harvest, which hampered the development of cane left as seeds for
the next harvesting season [7].
The 2009/10 harvest was dominated by the demand for Sugar,
because of crop failures in the main Sugar producing countries.
India, for instance, ceased exporting and began importing Sugar.
The pressure on supply opened up fresh trade opportunities for
Brazil and led to record price increases. In fact the price of Sugar
increased 80%, on average, as compared to the previous harvest
(ibid.). These consolidated factors induced a considerable increase
in the 2010/2011 Brazilian production of Sugar, to the detriment of
Ethanol (Fig. 2). There was then lower availability of Hydrous
Ethanol and higher prices.
Consumption of Gasoline C grew minimally between 2002 and
2009. This was largely due to the weak performance of the Brazilian
economy up until 2003. The introduction of flex fuel vehicles, in
March 2003, then enabled the consumer to decide which fuel to use
based on cost-benefit factors, which, during this period, favored the
use of ethanol. It can also be seen from Fig. 1 that there was,
however, a marked increase (over 30%) in the consumption of
Gasoline C between end 2009 and end 2011. The Gasoline C prices
on the Brazilian internal market did not increase at the same pace
as prices on the international market. This was due to the com-
mercial pricing policies of the state-owned oil company Petrobras
(which is the largest producer of petroleum products in Brazil -
holding approximately 99% of the market). These Petrobras policies
were aimed at reducing the impact on the domestic market of in-
ternational price volatility.
700 J.M.A. Gomez, L.F.L. Legey / Energy 81 (2015) 696e705
Fig. 3. Comparison between the real prices of Gasoline C, Hydrous Ethanol and CNG in US$/km; data from ANP.13
CNG has a relatively minor share of the Otto Cycle market
(approximately 5% overall). The data shows accelerated growth of
the consumption of this fuel up until 2007 (21.1% p.a., since 2002)
followed by a sharp decline until 2011 (6.3% p.a.). This was caused
by turmoil in gas supplies from Bolivia (the country which sup-
plied 57% of the natural gas available in Brazil in 2007) [23].11 The
problems with Bolivia led to an increase in the price of CNG which
was almost double the corresponding price increase for
Gasoline C.
Fig. 3 presents the relative competitiveness of Gasoline C, Hy-
drous Ethanol and CNG, drawing on an energy efficiency ratio be-
tween these three fuels, based on the BEN 2012 [3] (Brazilian
National Energy Bulletin) and the price of domestic fuels multiplied
by the monthly US dollar exchange rate. In fact, the use of CNG has
various disadvantages such as the need for conversion equipment
(which became more expensive following the introduction of more
stringent safety rules); reduced performance; limited autonomy
and the reduction in the re-sale value of the vehicle. These limi-
tations dampen consumer interest in CNG, which is more
commonly consumed by intensive use vehicles such as taxis.12,13
CNG prices increased at almost the same pace as Gasoline C
prices from 2007 until 2011 (CNG prices increased 1.8% p.a. and
Gasoline C prices increased 1.0% p.a.) so that the reasons for
decreased CNG consumption during this period were the factors
11
By 2011, the share of Bolivian gas in Brazilian consumption had decreased to
approximately 44%, according to the MME (Brazilian Ministry of Mines and Energy),
2013.
12
Flex-Fuel vehicles can be modified so as to use CNG, in addition to Gasoline C
and Hydrous Ethanol. However, contrary to the use of any mix of Gasoline C and
Hydrous Ethanol, the consumer has to select either CNG or the mix.
13
We obtained the information on the consumer prices of C Gasoline, Hydrous
Ethanol and CNG from the Brazilian National Agency for Petroleum, Natural Gas and
Biofuels e ANP. These variables were deflated applying an Extended Retail Price
Index e IPCA provided by the IBGE and converted into US dollars applying the
Brazilian Central Bank (Bacen) Ptax average monthly rate. The sample size was 126
periods.
referred to above. During the same period the price of Hydrous
Ethanol increased about 3.8% p.a. And at the earlier period of
2002e2007, Gasoline C prices had increased 2.5% p.a. whilst
CNG prices grew at 4.4% p.a. and Hydrous Ethanol prices at 1.2%
p.a.
As can be observed in Fig. 3, Hydrous Ethanol is competitive and
this may explain the success of Flex-Fuel vehicles, which accounted
for 67% of total vehicle sales between 2003 and 2011. By 2011, Flex-
Fuel vehicles made up 51% of the total fleet, as can be seen in Fig. 4.
We based our estimates as to the evolution of the fleet (set out in
Fig. 4) on the study undertaken by Mattos & Correia (1996) [22].
This study drew on data relating to the sale of vehicles, correlated to
the type of fuel used [2], in conjunction with a Gompertz type
vehicle-scrapping curve, based on 1988 data from the Brazilian
Institute for Geography and Statistics (IBGE) National Sample Sur-
vey of Households (PNAD).
As stated earlier, according to the ANP, the price of Hydrous
Ethanol needs to be below 70% of the price of Gasoline C in order
to be an attractive alternative, given that Hydrous Ethanol has
lower calorific power than Gasoline C. Fig. 5 represents the price
ratio of these fuels between July 2001 and November 2011. The
Figure shows that in the later periods of the sample, Ethanol
breached the 70% barrier so that its competitiveness was
undermined.
In the following section we set out a model representing the
evolution of the Brazilian fuel market, in order to analyze the extent
of the impact of Flex-Fuel vehicles.
3. A model for the analysis of the effect of Flex-Fuel vehicles
A Cointegration analysis between the possible variables of the
model (following the methodology of [17] and [12]) requires, first of
all, that all the variables of the model be of the same order of
integration. The second condition is that the linear combination of
the model must result in a series which has an order of integration
lower than that of the original series [15,16].
 J.M.A. Gomez, L.F.L. Legey / Energy 81 (2015) 696e705 701

Fig. 4. Evolution of the share of Flex-Fuel vehicles in the Brazilian fleet of light vehicles; data from ANFAVEA (the Brazilian National Association of Automobile Manufacturers) and
Mattos & Correia (1996).

We applied the procedure suggested by Johansen (1988) [17] in
conjunction with the guidelines set out by Enders (2004) [11]. The
methodology we used also enabled us to test restricted versions of
the Cointegrating vectors and to analyze the parameter that in-
dicates the pace of adjustment between short and long term dy-
namics of the time series, thus making it possible to establish the
chain of causality between the model's variables, using the Granger
Causality Test [27].
We then analyzed the possibility of a structural break in the
consumption of Gasoline C series, using the techniques employed
by Chow (1960) [6] and the Kalman Filter [18], as in the method-
ology proposed by Hall (1993) [14]. This approach uses a Time
Varying Parameter - Error Correction Model (TVP-ECM), which al-
lows for a flexible analysis both of the long term relationship be-
tween the variables and the short term dynamics [5]. Two
equations are estimated simultaneously by the Kalman Filter state

Fig. 5. Comparison of the real prices (Brazilian averages) of Hydrous Ethanol and Gasoline C ratio; data from ANP.
702 J.M.A. Gomez, L.F.L. Legey / Energy 81 (2015) 696e705

space algorithm: an observation equation and a space equation. The Table 1

latter demonstrates the evolution over time of the parameters of Tests of unit root in the variables (logarithmic transformation).

the first equation. Variable Optimal t-stat (critical values: p-value

The specification of the model is as follows: lag length 5%: 3.445877 1%: 4.032498)
Observation Equation: Gasoline C 12 1.198766 0.9999
Hydrous Ethanol 1 2.539419 0.3090
DCgct ¼b1 þ b2 DSubstt1 þ b3 DMassat1 CNG 12 3.023041 0.1302
(1) Real Gasoline C price 1 3.260314 0.0779
þ aðCgct1 þ sv1t Substt1 þ b4 Massat1 þ b5 Þ Real Hydrous 3 4.656900 0.0013
Ethanol price
State Equation: Real CNG price 1 1.680993 0.7540
Real Monthly Payroll 12 2.157158 0.5088
sv1t ¼ sv1t1 þ vt (2) Subst 6 2.587743 0.2867

where:
 Cgct is the Consumption of Gasoline C, in m3, at time t;
 a is the Adjustment Coefficient between Long and Short terms.
 Substt is the price ratio between Hydrous Ethanol and the price
of Gasoline C at time t;
 Massat is the Real Monthly Payroll, in Brazilian currency, at time
t;
 DSubstt is the first difference in the price ratio of Hydrous
Ethanol and Gasoline C, at time t;
 DMassat is the first difference in the Real Monthly Payroll at time
t;
 sv1t is the (variable) parameter of the price ratio of Hydrous
Ethanol and Gasoline C, at time t;
 vt is the vector of error terms at time t.
The considerations that guided the specification of this model
are the following:
particular, since sugar and Ethanol are almost perfect sub-
stitutes in terms of sugar-cane products, their total production
vary in accordance to their relative prices in international
markets. Thus, the influence of global fuel markets is (indirectly)
present in the model.
7. However, over the past 5 years, the domestic price of Gasoline
has evolved at a slower rate than the prices of Hydrous Ethanol
and sugar, as a result of the pricing policy of Petrobras, which is
the principal player in the fuels market in Brazil. Petrobras has
sought to protect this market from international volatility,
which is in contrast with what happens in other countries, like
for example the USA, where gas station prices are heavily
influenced by daily fluctuations in the international price of oil.
Such a policy causes a marked disparity between international
price fluctuations and their Brazilian counterparts. For this
reason, we decided not to include explicitly international price
indicators in the model.

1. The variables consumption, prices and payroll - income proxy)

are in line with previous studies undertaken both in Brazil and
abroad [1,4,10,24e26]. 4. Results and discussion
2. The “price of CNG” variable was not used due to the peculiarities
of CNG (see Section 2) and also because of its relatively minor In this section we set out the results obtained from the appli-
importance in the fuel market for Otto Cycle vehicles (less than cation of the model described in the above section. Tables 1 and 2
5% of the total). set out, respectively, the results of the unit root tests for the
3. The model employs a variable related to income (payroll) rather several variables analyzed and the results of the Cointegration tests
than the fleet size, because the latter, despite being a well- (trace and maximum eigenvalue) amongst the model variables,
known and frequently used indicator, is based on a survey with a significance level of 5%. All the tests and estimates were
taken more than 25 years ago [22] and does not reflect short obtained by means of the E-Views software.
term fluctuations in fuel consumption d in particular for the It can be seen from Table 1 that, with the exception of the price
month of December14 d, which are captured by the payroll of Hydrous Ethanol, it is not possible to reject the hypothesis of the
variable. In addition, monthly payroll data is the result of sound existence of a unit root in any of the series. Table 2, in turn, indicates
surveys regularly updated by IBGE. Therefore, they are more
adequate to the purposes of the model than an estimation of the Table 2
fleet size. Results of the Johansen Cointegration test (equation (1)). Trace Test and Maximum
Eigenvalue Test.
4. Brazilian income levels are considerably lower than those in
developed countries, a fact that implies comparatively higher Unrestricted Cointegration Rank Test (trace)
income-elasticity of Gasoline C in Brazil. Consequently, our Hypothesized Eigenvalue Trace 0.05 critical Prob.**
analysis had to take into account such characteristic. no. of CE(s) statistic value
5. Instrumental variables were not used in the model because our None* 0.141052 29.11256 24.27596 0.0114
main objective was to assess the behavior over time of the cross- At most 1 0.063527 10.41079 12.32090 0.1024
price elasticity between Hydrous Ethanol and Gasoline C, as well At most 2 0.018826 2.337681 4.129906 0.1491
Trace test indicates 1 co-integrating eqn(s) at the 0.05 level
as its impact on the consumption of Gasoline C. Instrumental
variables would probably explain consumption changes but not Unrestricted Cointegration Rank Test (Maximum Eigenvalue)
the evolution of the cross-price elasticity. Hence our decision to Hypothesized Eigenvalue Max-Eigen 0.05 Critical Prob.**
use the TVP-ECM approach. No. of CE(s) Statistic Value
6. The effects of the global fuels market price variations are present None* 0.141052 18.70177 17.79730 0.0365
in the prices of Gasoline, Hydrous Ethanol and also sugar. In At most 1 0.063527 8.073109 11.22480 0.1698
At most 2 0.018826 2.337681 4.129906 0.1491
Max-eigenvalue test indicates 1 co-integrating eqn(s) at the 0.05 level
14
As mentioned before, the December monthly payroll is strongly affected by the *Denotes rejection of the hypothesis at the 0.05 level.**MacKinnoneHaugeMichelis
so-called 13th salary. p-values.
 J.M.A. Gomez, L.F.L. Legey / Energy 81 (2015) 696e705 703

Table 3 Table 4
Long term elasticities (equation (1)). Short term elasticities (equation (1)).

Cgct b5 Substt1 Massat1 DCgct1 DSubstt1 DMassat1 b1 a

1.00000 3.237168 0.93460 0.71599 0.73264 0.05366 0.34465 0.00829 0.02551
[5.31479] [6.87059] [6.69693] [0.40764] [3.27951] [1.44883] [0.29576]

Note: The numbers in square brackets correspond to the t-statistics of the estimated Note: The numbers in square brackets correspond to the t-statistics of the estimated
parameters. parameters.

that there is only one Cointegration vector between the model months. The structural break in January 2010 is a consequence of
variables; in other words, there is a relation of long term equilib- Flex-Fuel vehicles. Without them the unavailability of Hydrous
rium between the variables Subset (price of Hydrous Ethanol/ Ethanol during this period would not have caused a structural
Gasoline C), real monthly payroll and the consumption of Gasoline break in Gasoline C consumption. In fact, if vehicles were not Flex-
C. This means that it is appropriate to use the Ordinary Least Fuel, but rather powered only by Hydrous Ethanol, its shortage
Squares Method (OLS) to estimate the parameters of equations (1) would have caused a fuel crisis d as occurred in the late 1980s early
and (2). 1990s d and not a structural break.
Tables 3 and 4 set out, respectively, the long and short term In order to analyze the influence of the introduction of Flex-Fuel
parameters we estimated for equation (1). vehicles, we applied to these parameters changes a methodology
The results of the estimated long and short term parameters proposed by Hall (1993) [14]; based on the Kalman Filter [18].
were as expected. They were also statistically significant. The long We set out the results of the application of the Hall methodology
term price-elasticity of the Substt variable was positive and almost in Fig. 6, which demonstrates the evolution of the long term
equal to 1, which means that an increase in the price ratio of Hy- parameter of the Subst (price of Hydrous Ethanol/price of Gasoline
drous Ethanol to Gasoline C leads to an almost equivalent increase C) brought about by the introduction of Flex-Fuel vehicles into the
in the consumption of Gasoline C. Similarly, the coefficient of the Brazilian fleet of light passenger and cargo vehicles. It can be seen
Real Monthly Payroll variable indicates that changes in this variable that there were significant variations in the magnitude of the
affect the consumption of Gasoline C in the same direction, albeit parameter, particularly from 2010 onwards. We observe from Fig. 4
with less intensity than the changes in price-elasticity. that the estimated Flex-Fuel fleet for this year was 45% of the Total
The adjustment coefficient between long and short terms was Fleet and with a trend towards increase. In other words, the impact
relatively small, indicating a slow adjustment between short and of Flex-Fuel vehicles on the consumption of Gasoline C is increas-
long term parameters. This result may be a reflection of the long ingly significant.
term fuel price policy adopted in Brazil which restricts price vari- The final value of the long term parameter of the Subst variable
ation on fuel prices (particularly for fuels derived from petroleum was 2.77, which is three times higher than the estimated value for
and natural gas) to minor adjustments, even in the face of major July 2001 to December 2011. In April 2011, the value of the
oscillation on the international market, especially since 2007. The parameter reached approximately 4.00, probably due to the lack of
aim of this policy, as stated above, is to protect domestic consumers Hydrous Ethanol on the market for Flex-Fuel vehicles. It is therefore
from the effects of international volatility and its potentially infla- reasonable to conclude that Flex-Fuel vehicles, which use tech-
tionary effects. nology that enables the consumer to take advantage of the price
It is possible to perceive, in the results of the Granger Causality ratio of Hydrous Ethanol and Gasoline C, have a significant impact
Tests [27] set out in Table 5, a bi-directional influence between real on the Brazilian fuels market.
monthly payroll and the consumption of Gasoline C. In other words, In order to check the quality of the projections of the model we
these two Granger variables cause each other, as might be expected. carried out a projection for the JanuaryeDecember 2012 period on
On the other hand neither the price of Hydrous Ethanol nor the the basis of the adjustment of the model using data from July 2001
price of Gasoline C is Granger caused by an increase in the real to December 2011. We used the MAPE (Mean Absolute Percentage
monthly payroll or by the volume of Gasoline C. The explanation for Error) metric to measure deviations between the projected values
this may be the influence of the reduced offer of Hydrous Ethanol, and those actually observed. The result was a value of 4.80%.
due to the shift of the use of Sugar-Cane to the production of sugar, In order to further gauge the reliability of the findings of this
the export price of which rose 109% (2008e11) in relation to the study, we examined MAPE data from other relevant research
comparable average prices between 2008 and 2011 (source: contained in specialist literature, so as to compare such data with
MAPA). our MAPE reading of 4.80%. We did not find, in the literature, any
It can be seen from Fig. 1, in Section 2 that the consumption of
Gasoline C between December 2009 and December 2011 increased
by around 36%. This suggests possible variation in the estimated Table 5
parameters for the equation which describes consumption of Gas- Granger causality (equation (1)).
oline C. We analyzed this possible structural break by applying a Excluded Chi-sq df Prob.
Chow test [6], taking January 2010 as the reference month.15
Dependent variable: D(LGASOLINAC)
As can be seen in Table 6, the Chow test indicated a rejection of
D(LSUBST) 1.090773 2 0.5796
the null hypothesis of non-existence of a structural break for the D(LMASSASALARIALREAL) 18.31809 2 0.0001
month of January 2010. Nevertheless, in order to see whether there All 18.92651 4 0.0008
were structural breaks for other periods we set Chow Tests for Dependent variable: D(LSUBST)
January 2008 and January 2009. The results showed non rejection of D(LGASOLINAC) 4.978490 2 0.0830
D(LMASSASALARIALREAL) 2.130855 2 0.3446
the null hypothesis of non-existence of a structural break for these All 6.192854 4 0.1852
Dependent variable: D(LMASSASALARIALREAL)
D(LGASOLINAC) 32.61838 2 0.0000
15 D(LSUBST) 1.135263 2 0.5669
We chose January 2010 on the basis of our observation of the consumption of
All 32.80019 4 0.0000
Gasoline C series, set out in graph 1.
704 J.M.A. Gomez, L.F.L. Legey / Energy 81 (2015) 696e705
Table 6
Chow breakpoint test e consumption of gasoline C e January 2010.
Chow breakpoint test: 2010M01
F-statistic 11.37733 Prob. F(5,116)
Log likelihood ratio 50.27979 Prob. Chi-Square(5)
Wald Statistic 56.88665 Prob. Chi-Square(5)
projection accuracy metric for the fuel segment and we therefore
analyzed studies on other segments, especially the electricity
sector. We noted, in particular, the following studies: Li (2013) [19]
proposed a model for the projection of electricity consumption in
the North-Eastern Region of the United States and obtained a
MAPE of 5.60% for the winter season, which was in fact lower than
the MAPE he obtained in projections for other seasons. Conejo
(2005) [9] undertook a similar study in Spain, obtaining a 4.78%
MAPE for the winter season (which, again, was lower than the
MAPE of other seasons) and Lora (2007) [20], again examining
electricity consumption in Spain, obtained a MAPE of 8.45%. The
aim of these comparisons is to show that MAPEs obtained in other
studies are higher than that have found. Thus, we consider our
model's MAPE of 4.80% to be a positive indicator of its forecasting
reliability.
5. Conclusions
Our aim in this study was to evaluate the impact of the intro-
duction and evolution of Flex-Fuel vehicles on the consumption of
fuels in Brazil. We conclude, from the results obtained that there
has been a significant impact on the demand for Hydrous Ethanol
and Gasoline C. This is mainly due to the fact that Flex-Fuel vehicles
enable the consumer to choose which fuel to buy and that, in most
cases, the consumer will base this decision on comparative cost-
benefit considerations. In some (limited) areas of the country it is
a common practice to use posters to publicize the price relationship
between Hydrous Ethanol and Gasoline C. However, in most places
Fig. 6. Variation of the Subst variable (sv1) in the sample period of July 2001 to December 2011 and the interval of two mean square errors (rmse) of the coefficient (sv1).
consumers have to make this calculation by themselves at the time
of purchase.
The results obtained show the impact on the Brazilian market of
0.0000
the penetration of Flex-Fuel vehicles, which reached a rate of
0.0000 around 40% by the end of 2009, as observed in Fig. 4. This impact
0.0000 can be quantitatively evaluated by the variation of the long term
coefficient for relative prices between Ethanol and Gasoline C,
which had a final value of 2.77, i.e., three times higher than the
estimated value for July 2001 to December 2011. We consider the
probable reasons for this variation to be: (1) a shortage of Hydrous
Ethanol due to adverse climatic events affecting Sugar-Cane pro-
duction; (2) the greater demand for Sugar on the international
market, further reducing the availability of Sugar-Cane for Ethanol
production; (3) economic-financial problems encountered by
Ethanol producers; and (4) the loss of the competitiveness of Hy-
drous Ethanol against Gasoline C (the price of which remained
relatively stable, particularly when compared with the sharp in-
creases in the price of Hydrous Ethanol in recent years). These
problems, which affect the availability of Hydrous Ethanol, are of
increasing relevance given the growth of the proportion of Flex-
Fuel vehicles in the fleet of passenger and light commercial
vehicles.
In Section 2 we provided details on the possible causes for the
variation of the long term coefficient for relative prices between
Ethanol and Gasoline C, concerning explanations (1) and (2) above.
As for the economic-financial problems mentioned in (3), the major
culprit is the international economic crisis flared up in 2008 that
led to an increase in interest rates and lower availability of bank
credit lines. This credit squeeze created financial difficulties for
several economic groups and particularly for businesses d such as
the Brazilian sugar and ethanol industry d that had taken on an
amount of debt disproportional to their assets, in an attempt to
accelerate an increase in production and boost their market share.
In the case of sugar cane, price forecasts had been influenced by the
positive returns from the 2005-6 and 2006-7 harvests, which gave
rise to very optimistic and somewhat unrealistic expectations as to
the near future [8].
 J.M.A. Gomez, L.F.L. Legey / Energy 81 (2015) 696e705
Finally, in terms of the competitiveness factor mentioned in (4),
it is important to note that the price of Ethanol is influenced not
only by supply, but also by official price policies on Gasoline C,
which, as explained earlier, represent a ceiling for the price of
Hydrous Ethanol. As such, the prices of Hydrous and Anhydrous
Ethanol are affected by government policy on maintaining the
stability of Gasoline C prices [13].
The results obtained suggest that the Brazilian fuels market has
been more unstable in recent periods than was previously the case
and that this is probably due to the advance of Flex-Fuel vehicles in
the Brazilian fleet. In fact the percentage share of the market sales
held by these vehicles has been over 80% since July 2008 and
currently corresponds to over half of the total fleet of light pas-
senger and cargo vehicles.
As stated above, the MAPE reading (4.80%) for the projection of
the consumption of Gasoline C for the following year indicates that
the model proposed is reliable and compares well with other
similar studies [9,20] and [19].
The findings reinforce the need for Brazilian energy planners to
adopt long and short term strategies to deal with the impact on the
fuel market of new technologies. There is a need for government
action to build up stocks and make provision for financing the
production of Hydrous Ethanol, given the volatility of supply as a
resulting from the impact on production caused by climatic factors.
Furthermore, there is a need for developing new varieties of Sugar-
Cane, which are more productive in terms of Hydrous Ethanol yield
and more resistant to adverse climate factors. This is particularly
relevant given the increasing uncertainties due to apparently
changing weather patterns and related difficulties of accurately
forecasting climatic conditions for more than fifteen days in
advance.
Oil companies develop fuel supply projections well in advance.
Thus, any unforeseen adverse climatic event that affects the pro-
duction of Hydrous Ethanol, is likely to lead to a change in pro-
duction planning and to the import of Gasoline A. It is unlikely
however that such a short term strategy will be able to adequately
compensate for the changes in the consumption. This suggests a
need to stockpile Gasoline A, which in turn involves significant
storage costs.
The model we used to study the dynamics of transformation
in the Brazilian fuels market brought about by the introduction
of Flex-Fuel technology may be relied upon as a parameter in
the analysis of further technological innovation in the transport
sector e such as the development of plug-in hybrid vehicles. It
will be necessary to adapt such vehicles to reflect the price
competition between the currently available fuels and electricity.
The introduction of new technology is, in fact, likely to signifi-
cantly alter energy consumption patterns in several countries
worldwide, posing major challenges for companies operating in
the field of fuel supply. The model we applied may be a relevant
tool in further research into such changes, both in Brazil and
abroad.
705
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