Valuing the switching flexibility of the ethanol-gas flex fuel car

Abstract

Renewable energy sources are becoming more important as the world's supply of fossil fuels decrease and also due to environmental concerns. Since 2003, when the ethanolgasoline flex fuel car became commercially available in Brazil, the growth of this market has been significant, to the point where currently more than 50% of the fuel consumption of cars in Brazil is from renewable biofuels (ethanol). This has been made possible due to the success of the flex fuel car, which can run on ethanol, gasoline, or any mix of these in the same fuel tank, and which is sold at a premium over the non-flex models.Flex fuel cars, on the other hand, provide the owner with the flexibility to choose fuels at each refueling stop. Given the uncertainty on future prices of ethanol and gas, this option adds value to the owner since he can always opt for the cheaper fuel whenever he fills up his car. We use the Real Options method to analyze the value of the flex fuel option assuming both a Geometric Brownian Motion and Mean Reverting diffusion processes for the prices of gasoline and ethanol and compare the results arising from both methods. We conclude that the flex option value is significant using either method and twice as high as flex premium charged by the car manufacturers, which helps explain the success that this type of automobiles have gained in Brazil since 2003. Our results also indicate that consumers should be willing to purchase flex fuel cars even if manufacturers increase the flex premium.

Consumer value of fuel choice flexibility - a case study of the flex-fuel car in Sweden

“…The results in this paper differ somewhat from those presented in Bastian-Pinto et al [2]. They also found a higher option value with GBM than with MRM, although the total fuel cost was higher with MRM simulation.…”

“…In section 4 we perform the analysis of the switching option based on the time series properties of ethanol and gasoline prices. The approach we use follows closely the analysis by Bastian-Pinto et al [2]. Our findings indicate a considerable value of fuel choice flexibility, ranging between 7,500 and 37,800 SEK, depending on the underlying stochastic process we assume that fuel prices follow.…”

“…The flex-fuel car has previously been analyzed by means of option valuation in Bastian-Pinto et al [2]. In this paper we try to establish whether the results previously found will hold even in the European car market, where Sweden is the largest market for flex-fuel cars.…”

“…Compared to a so-called bifuel-driven car, the flex-fuel engine allows for differing proportions of ethanol in the fuel [2]. The idea was to demonstrate that the technology existed and that it worked in practice [7].…”

Valuing flexibility in electro-intensive industries: the case of an aluminum smelter

“…They use a bivariate binomial discrete model for both stochastic prices and show that GBM models tend to overestimate the switch option value when modeling commodity prices. Bastian-Pinto et al (2010) analyze the switch option available to flex fuel car owners, who can choose between the use of ethanol or gasoline as auto fuel for their vehicles. The authors use both GBM and MRM models and find that this flexibility has a significant value with either one.…”