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We have seen significant volumes of intra-industry trade in ethanol between the United States of America and Brazil. A trend which started in 2010 and accelerated in the second half of 2011 with large quantities of ethanol crossing paths in trade between the two countries. While intra-industry trade of homogenous products is not new, it is typically explained by factors such as seasonality or cross-border exchanges caused by transportation cost differentials. None of the traditional market factors can explain the volumes of intra-industry trade in ethanol between the US and Brazil. Instead, it appears to be driven by differential environmental policy that aims to capture differences in production methods of the underlying feedstocks and processing methods based on credence attributes of biofuels. Environmental legislation is inducing the product differentiation that invites arbitrage between the two countries resulting in the two-way trade of an otherwise physically homogenous product; in so doing, additional fossil energy is consumed in the mutual exchange of ethanol along with associated GHG emissions and the policy costs to consumers are raised which may suppress demand further reducing the displacement of fossil fuels, both of which are in direct conflict with environmental objectives of many biofuel programmes. With tighter environmental constraints on biofuel production written into EU policy, the potential for competition for classes of renewable fuels increases and could extend its reach from bioethanol to include biodiesel and/or the underlying feedstocks in the EU, the US and Brazil. This would create additional opportunities for arbitrage among the regions as a result of disparate policy differentiation of biofuel products. We submit options to mitigate this through the use of a 'book and claim' system under which each country could pursue its own policy objectives while acting in a coordinated fashion to reduce costs and emissions.


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