Member of the Department of Strategy faculty from 2005 to 2013
Whether we like it or not, the vast majority of car and truck owners in the United States are captive consumers of the carbon-based liquid fuel we call gasoline. But we import from foreign countries a large percentage of the oil needed to produce it, and many of these nations have unstable governments that result in energy price shocks. For example, the recent social unrest sweeping Arab states in the oil-rich Middle East threatens to spike gas prices to $5 per gallon by this summer, and it is one more reminder that the United States needs to diversify its energy portfolio to buffer against wide swings in oil prices.
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Consumers are aware of this and many demand an alternative fuel that comes from a renewable resource — preferably one sourced and produced in the United States. But what exactly would consumers do if they had a choice of energy source, and if their cars were able to run the same off both?
Brazilians have had this choice for decades. In fact, they have been using ethanol, produced with their own sugarcane, since the 1970s. And most vehicles sold there today can be powered by both gasoline and ethanol, allowing drivers to flit between these fuels at a whim (Figure 1).
Figure 1. Evolution of gasoline and ethanol consumption in Brazil’s road transportation, in tons of oil equivalent from 1981 to 2008. Ethanol consumption is broken down into unblended ethanol (which has fueled ethanol-dedicated cars and, more recently, flexible- fuel vehicles) and as an additive to gasoline.
So what drives their choices at the pump? Price may be a good first guess, but new consumer-level research by Alberto Salvo, an assistant professor of management and strategy at the Kellogg School of Management, and Cristian Huse, an assistant professor at the Stockholm School of Economics, shows that life is not that simple. In fact, Salvo’s paper shows that 40 percent of flexible-fuel vehicle owners in Brazil essentially ignored price when choosing what to pump into their tanks. These consumers dug their heels in and stuck with their preferred fuel even when the alternative was priced up to 20 percent less.
Salvo and Huse examined consumer choice patterns at Brazilian refueling stations and found that even when prices swung widely, most consumers who owned flexible-fuel cars stuck with either gas or ethanol, whichever they preferred. Their choice may have stemmed from concerns about the environment, the range of miles they could get on a tank of fuel, concerns about their engines, or simple inattention to changing (or even unchanged) prices.
Fuel(s) of Choice
The researchers gathered their data by observing what customers purchased at the pump, then asked the customers to participate in a survey that probed their education level, age, reason for fuel choice, car use, and past fuel choices. By observing the flexible-fuel motorists choose between gasoline and ethanol, the researchers were able to see people “putting their money where their mouth is,” Salvo says. “It’s easy to state that you like something, but it is very different to observe motorists go about their daily business and see what they actually do. Brazil matters in this respect because it is just about the only place around today where a large share of motorists actually do have an alternative to gasoline or diesel.”
Brazil has marketed ethanol as an environmentally-friendly alternative to gasoline for many years. (Recent research has shown it may have locally-polluting effects, but that when made from sugarcane it is better for the environment on a global scale than gasoline.) Relying on ethanol also pads Brazil against fossil-fuel energy shocks imposed by other countries and boosts an established home-grown industry: sugarcane. Ethanol production in Brazil occurs very near to where the sugarcane crop is grown.
“Ethanol is a big part of the local landscape there,” says Salvo, who spent most of his childhood in Brazil. “At just about every refueling station in the nation, you will have ethanol offered alongside gasoline — sometimes in the same pump. It’s as simple as that.”
Today, nearly one third of Brazil’s private passenger vehicle fleet — 9 million cars and light-duty trucks — have flexible-fuel capabilities. But decades after ethanol was introduced as an alternative fuel, Salvo wondered what drove the flexible-fuel vehicle owners’ fuel choice. Did they go for the lowest price, or did they bring some other decision-making processes with them to the refueling stations?
In January 2010, he saw a prime chance to study his question about patterns of fuel substitution when the price of sugar spiked globally due to a failed harvest in India. This allowed Brazil’s sugarcane industry to charge more for its product, regardless of whether it was being exported, mostly in the form of sugar, or used domestically for ethanol. As a result, ethanol prices rose sharply for a few months, but gasoline prices, which are controlled by the government, stayed level.
The Ethanol Caveat
There is one wrinkle to understand about the pricing of these fuels. In Brazil, ethanol usually retails for less per liter than gasoline because a driver gets less distance out of it. For example, for a given amount of gasoline in a Brazilian cab driver’s tank he can drive 100 miles. But for that same volume of ethanol, he’d drive 70 miles. So when the per-liter price of ethanol is 70 percent the price of gasoline, “parity” is reached; this is the point at which gasoline and ethanol prices are equal in terms of cash spent per mile traveled on either fuel.
Brazilian radio stations report regularly on the fuel prices relative to each other, and workers at refueling stations can also help motorists by updating them on price fluctuations. (It is more customary for a worker to refuel a motorist’s car than for the driver to do so.) Or, drivers can just keep a calculator handy to divide the price of ethanol by the price of gasoline and compare it to the 70 percent parity ratio. Despite the various ways that drivers can keep up with the parity ratio, some may be unwilling to make the effort, uninformed, inattentive, or unable to ask about the cost conversion.
A Sugary Shock
Given the ubiquity of ethanol, and its constancy in Brazilians’ lives, Salvo saw the global sugar-price surge as the perfect moment to pounce on ripe, living data.
He selected six major cities as locations for his study. Three of the cities were in sugar-producing states (São Paulo, in the state of São Paulo; Curitiba, Paraná; and Recife, Pernambuco) and three cities were in non-sugar producing states (Rio de Janeiro, in the state of Rio de Janeiro; Belo Horizonte, in Minas Gerais; and Porto Alegre, in Rio Grande do Sul). At least twenty refueling stations within each city were used for observations. Field representatives made 12 observations per visit to each station, and some cities were surveyed over multiple weeks that were spaced apart. In all, 2,160 observations of individual consumers were made at the 180 different stations in the study. (Salvo says the fuel prices varied more widely between cities than within them.)
During the sugar-price surge, the price of a liter of ethanol peaked at 75 percent of gasoline in São Paulo, and 90 percent in Porto Alegre, which imports ethanol from out of state and taxes the alternative fuel more heavily relative to São Paulo. Only two months later, by late March, the price of ethanol in São Paulo had sunk to below 60 percent that of gasoline.
During this rise and fall from parity, Salvo found that 20 percent of flexible-fuel vehicle owners stuck with ethanol even when it was 20 percent more costly per mile traveled than gasoline — and another 20 percent stuck with gasoline when it was gasoline’s turn to be priced 20 percent higher. In other words, price was simply not an important factor for 40 percent of the motorists.
“We may need to make the alternative much, much cheaper than the traditional technology or fuel to drive voluntary adoption, at least initially.” — Salvo
Surveyed motorists were asked, “What was the main reason for your choice of fuel today?” Those who said they were concerned for their engines more frequently selected gasoline and were around 25 percent less likely to buy ethanol, while motorists who expressed concern for the environment were around 40 percent more likely to buy ethanol. Motorists worried about the range a tank of fuel would give them were 25 percent less likely to select ethanol. Salvo and Huse found that while motorists were generally aware of the sugar industry’s three-decade-long advertising campaign about ethanol’s “greenness”, renewability, and provision of local jobs, they seemed to be less accepting of carmakers’ insistence that flexible-fuel vehicles are equipped to operate similarly on either fuel.
The researchers also found that motorists who preferred ethanol tended to be younger, college-educated, and live in sugar-producing states, while those who preferred gasoline tended to be older and to be heavy commuters.
“In a way it’s not surprising that the older drivers tended to be slower to adopt a new technology,” Salvo says. “But we also interpret this finding to mean that older people will require deeper price discounts to voluntarily switch to a new fuel technology. Gasoline is their comfort zone.”
Overall, the consumer switching that happened between ethanol and gasoline during the study period occurred over a much wider range of prices versus the comparatively narrow range around parity that Salvo anticipated. “What also surprised me was the willingness to pay by certain consumers for what they perceive to be a greener fuel,” Salvo says. On average, such motorists were willing to shell out the equivalent to an additional 10 cents (U.S.) per mile for ethanol over gasoline, the study found.
Consumer Behavior and Alt-Fuel Adoption
At the heart of it, though, Salvo says his findings have implications for other countries, like the United States, that are searching for policies to help drive adoption of energy sources or technologies that are alternatives to gasoline.
“We may need to make the alternative much, much cheaper than the traditional technology or fuel to drive voluntary adoption, at least initially,” Salvo says. “We also need to equip consumers with the tools to easily compare across the energy sources in terms of prices and non-price characteristics. What this study shows is that consumer choice and behavior is just as important as supply.”
In other words, having an alternative that can be delivered to our existing cars using an existing fuel-delivery infrastructure will not be enough for consumers to voluntarily switch en masse; prices may have to be subsidized steeply in order to sway consumers who are more likely to prefer sticking with a conventional fuel or technology.
“I would dare to say the issues we find with ethanol in Brazil are likely to become compounded in the U.S. when it tries to drive adoption away from gasoline, say toward electricity-powered cars,” Salvo says. “People choose between these types of fuels even when you think they would not.”
Related reading on Kellogg Insight
Member of the Department of Strategy faculty from 2005 to 2013
T. DeLene Beeland is a science writer based in Asheville, NC.
Salvo, Alberto and Cristian Huse. 2012. Build It, But Will They Come? Evidence from Consumer Choice Between Gasoline and Sugarcane Ethanol. Working paper, Kellogg School of Management.
Salvo, Alberto and Cristian Huse. 2011. Is arbitrage tying the price of ethanol to that of gasoline? Evidence from the uptake of flexible-fuel technology. Energy Journal, 32(3): 119-148.
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