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

Authors

  • Xing Liu MTT Taloustutkimus, Luutnantintie 13, 04410, Helsinki

Keywords:

ethanol, directives, CBOT, Granger causality, VAR

Abstract

Ethanol is a renewable biofuel produced from sugar crops such as sugar cane or sugar beet, or from
cereals like wheat, barley and corn. Currently, the US and Brazil are the two dominant users and
producers of ethanol. More than half of world production of ethanol came from them. The share of
the European countries is rather small, only representing 15% of the total share. However, it has
increased dramatically since 2004. The main driver might come from two biofuel directives by the
European Commission. One is the Directive 2003/30/EC1, and the other is the one on taxation of
energy products2 . The global price of ethanol is mainly determined by two countries, Brazil and
USA. The expanding trade volumes have created incentives to establish new marketing boards and
hedging tools for increasing transparency and managing risks in the bio-fuels market. An example
of the new and emerging hedging tools is the new ethanol futures contract designed and quoted by
the Chicago Board of Trade (CBOT) in USA. So far European marketing boards, such as the
EURONEXT, 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 different
tariff regimes. Thus, it is not really known, what is the opportunity cost for the domestic, large scale
ethanol production, and how competitive the domestic market is in the international context. The
goal of this study is to investigate the market integration of world ethanol market with focus on
three main markets: EU, USA and Brazil, using the methodology of Granger causality and vector
auto regression (VAR). Evidence shows that there is a unidirectional Granger causation from both
USA and Brazil to EU market. USA price of ethanol is the most influential among the three price
series, and EU has very least on the contrary. Thus CBOT in USA may not perform as an efficient
predictor 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 use
of biofuels and other renewable fuels for transport
2 See Directive 2003/96/EC of 27 Octobor 2003 (O.J.L283, 31/10/2003)

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Published

2008-01-31