Evaluating the economy embedded in the Brazilian ethanol–gasoline flex-fuel car: a Real Options approach

Abstract

The introduction of the flex-fuel cars in the Brazilian market in 2003 changed considerably the consumer decision-making process. Prior to this date, it was necessary to choose the automobile type only by gasoline or by ethanol fuel; today it is possible to choose a car type with both fuel options. This flexibility generates economic advantages for his owner, but what are the financial benefits of a flex-fuel car in comparison with a car using only gasoline? Geographically, where is the owner of the benefits from this flexibility located? This article presents an empirical application of the Real Options Theory in the analysis of the flex-fuel car option for five geographic Brazilian regions: Northern, Northeastern, Central-Western, Southeastern and Southern. The regional price differences as well as the consumer preferences of these regions were met. For this purpose, historical fuel prices were considered stochastic and following a Mean Reverting Stochastic process. The prediction and option values were generated by a Monte Carlo simulation. The results indicated that the option embedded on the Brazilian flex-fuel car adds considerable value to the owner in all regions and car models considered, with the Southeastern Region receiving most benefits by the flex option.

Keywords:

• Real Options
• stochastic processes
• flex-fuel car
• Monte Carlo simulation
• ethanol

JEL Classification:

• C15
• D81
• G13
• O14
• O31

Notes

¹ Centro de Estudos Avançados em Economia Aplicada, CEPEA – USP, in Portuguese.

² Agência Nacional do Petróleo, Gás Natural e Biocombustíveis, ANP, in Portuguese.

³ Imposto sobre Circulação de Mercadorias e Serviços, ICMS, in Portuguese.