Economics of Biofuels

1. Economics of Biofuels Lecture 18 Economics of Food Markets Alan Matthews

2. IV. Evaluation of biofuels policies

3. Controversies over environmental benefits • Subsidisation might be justified where positive CO2 effects exist • Wide range of estimates on actual GHG emission reductions • Depends on feedstock, location, lifecycle effects • More recent studies less positive than initial evaluations • Contribution to reduction in GHG emissions will be very small • Transport sector contributes 25-30% of GHG emissions • Mandatory target is 10% of transport fuel in 2010 • Favourable GHG reduction factor might be 30% reduction • Overall impact on GHG emissions = 30 * .10 * .03 or around 1% of EU emissions

4. Controversies over environmental benefits • Subsidy efficiency depends not only on GHG reduction but also economic viability • At previous energy prices, cost of avoiding CO2 usually greatly exceeds price of carbon offset • US study estimated minimum subsidy cost per tonne of CO2 equivalent reduced over the 2006-12 period is $295 for corn ethanol; $239 for biodiesel, and $109 for a hypothetical cellulosic ethanol case. This can be compared to price of carbon offsets on Chicago Climate Exchange (CCX), where it would have bought 89, 75 and 33 carbon offsets, respectively (GSI, 2007) • Does oil at $100/bl or more change this?

5. Conventional C02 benefits Source: Renwick and Reader, AES One Day Conference, January 2007

6. Reduction in GHG emissions compared with fossil fuel emissions (percentage reduction if positive) Source: Bamière et al., 2007

7. Feedstock-to-biofuel pathways Source: Delucchi, 2006

8. Approximate typical overall results of lifecycle GHG emission analyses of biofuels Source: Delucchi, 2006

9. Issues in life cycle analysis • Impact of estimation within a dynamic general equilibrium framework which takes role of price changes into account • Uncertainty about energy use and emission factors • Representation of changes in land use • Treatment of energy cost and market impacts of co-products • Development of CO2 equivalency factors for all compounds emitted

10. Cost vs potential for CO2 avoidance Source: Eurcar/Concawe 2005

12. Trade issues • Trade between efficient tropical producers and OECD countries will be mutually beneficial • But is mostly absent due to high import tariffs and production subsidies • Recall EU has low tariffs on biodiesel but high (45-65%) tariff on bioethanol • Whether to allow easier bioethanol imports divides EU countries. • Those in favour point to the more favourable energy and GHG balances of Brazilian ethanol • Those opposed (France and Germany) put more emphasis on the potential gains to their own farmers

13. Trade issues • Tariff classification for biofuels under the HS system used by the WTO is currently inconsistent and in need of resolution. • Ethanol falls under HS chapter 22 classification as an agricultural good and there is no distinction made between non fuel and fuel uses. • Biodiesel on the other hand falls under HS Chapter 38 as an industrial good. • The EU like other WTO members is currently looking into the advantages, disadvantages and legal implications of having separate customs codes for biofuels. • The question of subsidies for feedstocks could become contentious in future. So far this has not been an issue, because biofuel trade has been small, and most countries have used subsidies. But could become an issue in future.

14. Impacts on world hunger • UN Special Rapporteur on the Right to Food • Biofuels “a crime against humanity” • has called for 5-year moratorium on increased biofuel production • While the landless poor – net food consumers – are likely to be hurt by higher commodity prices, many poor farmers stand to benefit from increased bioethanol demand • Would all farmers fare equally? • Benefits will depend on a farmer’s ability to increase production; whether a farmer produces crops or livestock (livestock producers could suffer from higher feed prices); and what type of crop or livestock the farmer produces (poultry and swine producers could see a rise in feed prices), among other factors.

15. Environmental impacts • NGOs have expressed concern about potential negative environmental impacts • In EU, concerns over water resources, additional fertiliser use, loss of biodiversity from increased arable cultivation • Raises opportunity cost of agri-environmental measures • In tropics, loss of rain forest

16. Environmental impacts • In response, the European Commission plans to introduce legislation for a sustainability scheme aimed at encouraging the use of biofuel production systems that are produced in a sustainable way. • setting of minimum sustainability standards for biofuels • only biofuels that meet these standards will count towards the 10% target • only these biofuels will be eligible for tax exemptions and only they will count towards biofuel obligations • rules will apply equally to domestic and imported biofuels • But how can sustainability standards for biofuels be defined? How can they be implemented without interfering with free trade? How can they be implemented in an effective way?

17. V. Future challenges

18. Concluding reflections • Economic research needs • Improved understanding of viability of biofuels at higher crude oil prices • Improved estimates of the GHG benefits and other environmental effects of biofuel production in order to estimate appropriate level of subsidy payments for environmental externalities (+ve and –ve) • Improved modelling of impacts on agricultural markets • Improved understanding of impacts on world poverty and hunger • Despite uncertainties, bioenergy production will become a major income source for EU farmers in the medium term

19. Concluding reflections • Mandatory targets vs tax reliefs • Mandatory targets may conceal economic cost of subsidies, but have advantages of certainty and that they limit over-compensation to producers when crude oil prices are high • Neither intervention distinguishes between biofuels according to their feedstocks or production methods, despite wide differences in environmental costs and benefits • Domestic production vs trade • If EU insists on meeting biofuel targets through local production, there would be significant impacts on food markets and environment

20. Concluding reflections • Prospects for second generation biofuels • But still quite land-intensive, even if non food producing land can be used • Some doubt if they will ever be economically viable given the logistical challenge of transporting low value biomass material to large production facilities • Biomass for energy or biofuel • Raising crops to produce biomass for energy can reduce GHG emissions by much more than biofuels • However, biofuels are most obvious (only?) current alternative to fossil fuels which account for up to 25% of GHG emissions