The Economics of Biofuels

1. The Economics of Biofuels YICGG Rome, 20 August 2008 Paolo Paesani University of Rome “Tor Vergata” Economics Department

2. Motivation and outline • Motivation Biofuel economics is about technological progress, government subsidies, agricultural, energy, transport and environmental policies, comparative advantages and protectionism, global governance, green finance, fuel vs. food … energy security and climate change • Outline of the presentation • The global growth-transport cycle • Introductory overview • The economics of biofuels • “Biofuels: is the cure worse than the disease?”

3. The global growth-transport cycle

4. Introductory overview • Biofuels, fuels derived from sugar, animal fats and vegetable oils used mainly as a liquid energy source for vehicles, are regarded as having the potential to address many of the economic and environmental problems posed by the global growth-transport cycle. • Although used as motor fuels since the 1920s, Biofuels have started to emerge as rivals to fossil fuels within the last couple of decades, particularly so since 2003, when the price for a barrel of crude oil started rising above USD 30. • Global production of biofuels amounted to 0.8 Ej in 2005, approx 1% of total road transport fuel consumption. Technically, up to 20 Ej from conventional ethanol and biodiesel has been judged possible by 2050 (source OECD).

5. Introductory overview

6. The economics of Biofuels

7. Industry structure • Production of feedstock crops • The production of crops is carried out by hundreds of thousands of farmers across the world. • Biofuel manufacturing • Major global players include ADM, Bunge, Cargill and Louis Dreyfus (agri-business multinationals) • Ethanol manufacturing is carried out by companies already part of the agricultural industry. • The structure of the bio-diesel industry is bi-polar, with a few large companies involved in producing bio-diesel on an industrial scale, and at the other end a large number of very small, often locally or farmer owned industry.

8. Industry structure • Distribution and retail sales • The wholesale distribution (including blending) is carried out by small and medium-sized companies in some countries and by large, sometimes state-owned oil companies in others. • Usually retail distribution is guaranteed by the existing network of petrol and diesel fuel distributors. • End-users • The majority of end users of Biofuels are individual owners of private vehicles. • In some countries, government agencies, military forces (notably the US army), municipal governments and cities purchase bio-diesel for their fleet of vehicles/buses.

9. Current and future production costs • The costs of producing biofuels vary significantly from one country to another, depending on feedstock, process, costs of energy and labor and location. • Location determines access to particular feed-stocks and energy supplies, the prices of which are, to a large degree, driven by market developments at the global scale. • The basic processes currently used for producing ethanol and bio-diesel do not vary greatly, though the scale of actual plants actually does. • According to Doornbosch R. & R. Steenblik (2007) “The expansion of biofuels derived from starch, sugars or plant oils alone will hit a limit within the next decade. Any increase in supplies beyond that limit will have to come from second-generation technologies and feedstocks”.

10. Production costs: ethanol • Most of the ethanol produced in the tropics is derived from sugar-cane. The costs depend on feed-stock costs, scale of operation, ability to switch between the sugar and ethanol markets. Modern plants burn cane residue for process heat. • Costs of ethanol produced from starch depend on heat source and milling procedure. • “Further incremental cost reductions can be expected, particularly through large-scale processing plants, but no breakthroughs in technology that would bring costs down dramatically” (source IEA)

11. Production costs: bio-diesel • Currently, the main oil seed used for bio-diesel production are derived from soybeans, oil-palm fruit, coconut, rapeseed, sunflower seed. • Value of oil feed-stocks depends on yields (varying from 400-600 liters per hectare for soybeans to 4000-7000 litres per hectare for oil palm), compatibility with crop rotation/soil enrichment, value of residue after pressing. • “There remains some scope for reducing unit costs of conventional bio-diesel production by building bigger plants. Technologies breakthroughs are unlikely”. (source IEA)

12. Government support for Biofuels

13. Government support for biofuels • Policies that directly bear on the level of production are quantitatively the most relevant ones and are found to have the most distorting effects. • Domestic production of biofuels is directly supported by governments through: border protection (on average +20% on the cost of imported ethanol) and production subsidies (US, leading country in the use of these subsidies grant €0.1 per litre). Many countries support biofuel use through Regulations mandating usage or blending percentages and tax preferences tied to fuel excise taxes or sales taxes. • According to Doornbosch R. & R. Steenblik (2007) “Government policies supporting and protecting domestic production of biofuels are inefficient, cost-ineffective and contribute to creating a structural imbalance between demand and supply … Government subsidies should be re-directed towards R&D on SGBF technologies (less environment damaging)”.

14. International markets • Ethanol and vegetable oils have been internationally traded for many decades: prior to the late 1970s only for industrial uses (e.g. beverages industry), from the late 1970s onwards also for Biofuel production purposes. • A reasonable estimate is that in 2005 trade covered about 10% of the world’s fuel ethanol consumption. The percentage of vegetable oils used fro Biofuels feed-stocks and bio-diesel is unlikely to have exceeded the 10% threshold. • Trade is likely to grow in the future, mostly due to limits to growth in production, particularly in Europe. • A number of barriers to trade, both tariff and non-tariff, remain and domestic production is supported even there where it should not be so.

15. Policy implications • Impacts on agricultural markets • The fundamental motivation for supporting Biofuels has always been everywhere the desire to stimulate new demand for crops in order to raise agricultural prices and incomes and the value of farm assets, particularly land. • Until recently, support policies in OECD countries provided an additional outlet for crops, without affecting end-user prices. • Energy policies • The idea that domestic Biofuels production will reduce a country’s dependence on foreign sources of energy and the “renewable energy appeal” have helped increase the political popularity of Biofuels • Questions remain: non-renewable inputs to Biofuel production, uncertainty about displacement factors (oil is used to produce Biofuels), energy efficiency as an obvious alternative.

16. Policy implications • Environmental policies • Another motivation for supporting liquid Biofuels has come from their superior emission profiles when used as motor fuels compared with (low-grade) petrol and diesel. • Whether the CO2 emitted in the various stages of Biofuel production exceeds the CO2 absorbed by the crops and saved when using Biofuels is a topic of fierce debate. • In respect of soils and water, the expansion of crops for Biofuels can actually have negative effects. • Transport and related tax policies • The largest intersection with transport policies has been the numerous exemptions from fuel tax excise. • Many policies at the local level favour flex-fuel vehicles.

17. Conclusions • Biofuels could theoretically achieve a market share of 20% of the liquid fuels market in 2050. Recent OECD calculation suggest that 13% is a more realistic figure. As the current percentage is 1%, huge resources are pouring into the biofuels industry. • High fuel prices and generous regulatory support have given the industry healthy margins and relatively short investment payback times (Caesar W., J. Riese, T. Seitz (2007)). • Biofuels potential in terms of enhanced energy security, net energy provision, GHG reduction, biosphere preservation, however, remains VERY UNCERTAIN. • Critics claim that biofuels will increase energy-price volatility, food prices and even GHG emissions and warn against potential damages to bio-diversity and the environment.

18. Conclusions • As long as oil prices stay at the present level, biofuels will continue to be regarded as a viable alternative to fossil fuels in spite of resurgent doubts and high uncertainty. • Renewable energy appeal, energy security and climate change concerns, possibility that commodity prices fall again, lobbying power of producers act in the same direction. • Rising commodity prices, lack of technological breakthroughs, contrary lobbying power, swinging government and public opinion pose downside risks to biofuel production. • Biofuels should (and are likely) to remain a useful niche energy source, ideally to be produced were it is less costly and environmentally damaging to do so and internationally traded on a reasonably free basis. Certification, control by national authorities and SGBF R&D should be strongly encouraged.

19. Bibliography • Brannlund R., B. Kristrom, T. Lundgren, P.O. Marklund (2007) “The economics of Biofuels” USBE Research Institute, Umea University, Sweden • Caesar W., J. Riese, T. Seitz (2007) “Betting on Biofuels”, The McKinsey Quarterly 2007 Number 2 • McMillen, S. (2007) “The Economics of Biofuels: A New Industrial Revolutuion? “, Connecticut Department of Economic and Community Development • Doornbosch R. & R. Steenblik (2007) “Biofuels: is the cure worse than the disease?”, Round Table on Sustainable development, available at http://www.foeeurope.org/publications/2007/OECD_Biofuels_Cure_Worse_Than_Disease_Sept07.pdf • Steenblik R. (2007), “The distorted economics of Biofuels”, Joint Transport Reserach Centre, Discussion paper 2007-3, December 2007