Impact of global ethanol market on EU: Testing for cointegration and causality among EU, USA and Brazil

Abstract

Ethanol is a renewable biofuel produced from sugar crops such as sugar cane or sugar beet, or fromcereals like wheat, barley and corn. Currently, the US and Brazil are the two dominant users andproducers of ethanol. More than half of world production of ethanol came from them. The share ofthe European countries is rather small, only representing 15% of the total share. However, it hasincreased dramatically since 2004. The main driver might come from two biofuel directives by theEuropean Commission. One is the Directive 2003/30/EC1, and the other is the one on taxation ofenergy products2 . The global price of ethanol is mainly determined by two countries, Brazil andUSA. The expanding trade volumes have created incentives to establish new marketing boards andhedging tools for increasing transparency and managing risks in the bio-fuels market. An exampleof the new and emerging hedging tools is the new ethanol futures contract designed and quoted bythe Chicago Board of Trade (CBOT) in USA. So far European marketing boards, such as theEURONEXT, have not launched new contracts for open trade and quotations for bio-fuels.Therefore, the bio-fuels market is not transparent from the Finnish traders’ and ethanol processors’perspective. The reason is that the existing open quotations represent different market regimes and,in addition to the transportation costs, they are separated from the European market by differenttariff regimes. Thus, it is not really known, what is the opportunity cost for the domestic, large scaleethanol production, and how competitive the domestic market is in the international context. Thegoal of this study is to investigate the market integration of world ethanol market with focus onthree main markets: EU, USA and Brazil, using the methodology of Granger causality and vectorauto regression (VAR). Evidence shows that there is a unidirectional Granger causation from bothUSA and Brazil to EU market. USA price of ethanol is the most influential among the three priceseries, and EU has very least on the contrary. Thus CBOT in USA may not perform as an efficientpredictor of expected spot price for EU ethanol.
 1 See Directive 2003/30/EC of the European Parliament and of the Council of 8 May 2003, on the promotion of the useof biofuels and other renewable fuels for transport2 See Directive 2003/96/EC of 27 Octobor 2003 (O.J.L283, 31/10/2003)