Lecture17 Biofuels

7/28/2019 Lecture17 Biofuels

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Economics of Biofuels

Lecture 17

Economics of Food MarketsAlan Matthews


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Why governments are interested inbioenergy?

Climate change CO2 abatement

Energy security High energy dependence on politically unstable

regions (Russian gas, Middle East) Rising price of fossil fuels; crude oil


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The EU perspective

Source: Commission, Fact Sheet on Biofuels, 2006


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A US perspective

Source: Franci, American Fram Bureau Federation, 2007


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Source: Commission, Fact Sheet on Biofuels, 2006


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Source: Banse, 2007


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Main questions

What is economic viability of biofuel production?

What polices are in place to promote productionand use of biofuels?

What will be effect of biofuels on agriculturalland use and markets?

Are current biofuels policies sensible?

In terms of economic efficiency, climate change,world hunger, trade and the environment

What are challenges for the future?


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Reading suggestions

Vast and growing literature

Commission documents

NGO and interest group documents

Impact on agricultural markets(Schmidhuber, OECD, IFPRI)

Surveys (Bamire et al., World Bank)

Reviews of policies (Global SubsidiesInitiative, Commission annual progressreports)


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Some definitions

Bioenergy is energy of biological origin, derivedfrom biomass, such as fuelwood, livestockmanure, municipal waste, energy crops

Biofuels are fuels produced from biomass,usually of agricultural origin Bioethanol Biodiesel Biogas

Energy crops are crops specifically cultivated to

provide bioenergy, mainly biofuels but also(miscanthus, short rotation coppice, eucalyptus)other forms of energy

In these lectures we concentrate on biofuel

policies


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Main bioenergy feedstocks

Wood Forest management residues

Fuel timber

Crops Annual (cereals, oilseed rape, sugarbeet) Perennial (miscanthus, reed canary grass, short

rotation coppice)

Wastes Straw Animal manure

Source: Mortimer, 2007


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Source: Karp, Rothamsted Research, 2007


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Biofuel transformation processes

First generation

Second generation


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Biofuel uses

Bioethanol Used as neat ethanol (E95, blend of 95% ethanol and

5% water) Used as E85 (85% volume ethanol with petrol) in flex-

fuel vehicles Used as blend smaller than 5% volume (E5) inordinary petrol or as its derivative ETBE

Biodiesel Current maximum 5% in diesel blends, otherwise can

only be used in modified diesel engines Current 5.75% EU target cannot be met with

ordinary blends of petrol and diesel Need for separate infrastructure (pumps, storage,

delivery for E85 and biodiesel or pure plant oil)


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Production and trade trends

Brazil (sugar) and the US (maize) are theleading producers of ethanol

EU (esp. Germany) is leading producer of

biodiesel (rapeseed) although productionin the US (soybean) is rising

Malaysia and Indonesia are increasing

production of biodiesel from palm oil Very limited trade in biofuels to date,

mainly some Brazilian bioethanol to EU


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Source: von Lampe, OECD, 2007


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I. Viability of biofuel production


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Economics of biofuel production

The rise in oil prices is the most important factorboosting the competitiveness of alternative fuels,including biofuels. future outlook for oil prices?

Feedstock costs are the most significant cost of biofuelproduction, up to 40-50% for US corn based ethanol,80% for EU biodiesel from rapeseed.

Energy is also a major cost component, up to 20% ofbiofuel operating costs in some countries.

The sale of byproducts, such as dried distillers grains,also contributes to a biofuel plants profitability.

The ratio of crude oil prices to feedstock prices offers asimple indicator of the competitiveness of biofuel madefrom various feedstocks.


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Economics of biofuel production

Past economics very influenced by subsidycontribution

but higher crude oil prices make competitive

production more likely Qualifications Increased biofuel production as well as higher energy

costs will push up feedstock costs

As production grows, the market contribution of by-products may diminish as outlets become satiated

The difficulties facing German biodiesel production in2007 provide a cautionary example
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Parity prices for various firstgeneration feedstock


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Parity and break-even prices

Parity prices measure the crude oil or petrol price atwhich particular feedstocks become competitive forbiofuel production calculated for very specific production and conversion

environments as well as feedstock prices Sensitive to US dollar exchange rate Schmidhubers parity prices are based on average feedstock

prices from early 2000s

May make more sense to think in terms ofbreak-evenprices for biofuel producers Given crude oil price, how much can biofuel producers afford to

pay for feedstock? Comparing break-even price with current price for sugar, maize

etc. indicates potential for further growth in biofuel production,but need to factor in risk and uncertainty discounts

Next slide shows how competitiveness of biodieselvaries with likely scale of biodiesel demand (and thusprice of rapeseed feedstock)


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Competitiveness of biodiesel underalternative scenarios

S-1%, S-7% and S-9% represent targets for biofuel share of transport fuels

Source: Bamire et al., 2007


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II. Policies to support biofuels


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Instruments for supporting biofuels

biofuel blending obligations (mandates)

excise duty exemptions

tariff protection crop (feedstock) subsidies

R&D and investment supports

fuel standards


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EU objectives for biofuels

1997 12% renewable energy target by 2010

2003 Biofuels use directive 2% target for biofuels in transport fuels by 2005 (1%

achieved); 5.75% by 2010 Not mandatory, but annual reports required

2003 Energy taxation directive Allowed MS to grant tax reductions and exemptions

on biofuels 2007 Energy Policy for Europe package Mandatory target of 10% of biofuels in transport fuels

by 2020


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EU supports for biofuels

EU has authorised MS to grant tax relief on biofuels Energy crop payment of45/ha introduced in 2003,

but limited to 2 million hectares on non setasideland

Energy crops can also be grown on setaside land High tariffs on ethanol (up to 63% AVE) but with

preferential access for many developing countries

Tariffs on biodiesel are low (6.5%) and even lower

(0-5%) on oilseeds and vegetable oils for industrialuses

Relatively limited EU interventions has encouragedMS to implement their own action plans and

instruments


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Drivers of US demand forbioethanol

Oil price increases

Fuel tax incentive for ethanol blends

Sudden replacement of MTBE with ethanol in

2006 because of pollution worries Renewable Fuels Standard mandated use of

7.5 billion gallons ethanol

2007 increase in RFS to 22 billion gallons by

2022, of which 15 billion to come from corn by2012

Tariff protection against cheaper imports


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Current Irish policy

Excise tax relief on selected biofuel projects (cost200mover 2006-2010 period)

VRT relief for flexible fuel vehicles Announced move towards biofuels obligation from 2009,

with targets of 5.75% for 2010 and 10% by 2010 publicconsultation underway.

Energy crop premium of80/ha (on top of EU premiumof45/ha) to incentivise supply of raw materials cost6 million 2007-09 period

Bioenergy Action Plan published March 2007 commitspublic bus companies to move to 5% diesel blends andnew vehicle purchases must be capable of using higherblends

Other measures target biomass use for energy and heat

Source: DCENR, National progress report on biofuels use, 2007


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Subsidies to liquid biofuels

Source: Global Subsidies Initiative, US Update, 2007


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Source: Global Subsidies Initiative, Synthesis Report 2007


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III. Impacts on land use and

agricultural markets


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EU land constraints

EU biofuel directive: 5.75% of EU fuel supply byend 2010

24 mio t biofuels to reply about 18.6 mio t offossil fuels (due to lower energy content)

European Commission estimates 16-18 mio ha needed if all biofuels feedstocks grown

in EU Which is about 17% of total arable area: 103.6 mio ha

Area reserve: About 2.8 mio ha obligatory set aside not yet grownwith biofuel crops

3 mio ha arable land currently not used.

Source: Banse, 2007; see also Bamire et al. 2007


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Impact on agricultural markets

How large will be potential demand fromenergy markets for agricultural products?Will it be large enough to reverse the

secular decline in real food prices? While large technical potential for biomass

exists, food prices cannot rise faster than

energy prices in the longer term (ceilingprice effect)


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Floor and ceiling price effects(Schmidhuber 2006)

Agricultural prices always affected by energyprices

Initially largely through higherinput costs Butas fossil fuel energy prices reach or exceed the

energy equivalent of agricultural products,energy market creates demand for agriculturalproducts

Higher energy prices now affecting outputprices

OECD estimates show that the effect of oilprices on production costs is comparativelymuch stronger than that on increased demandfor biofuel, but results are sensitive to oil price.


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Floor and ceiling price effects(Schmidhuber 2006)

Given large (elastic) demand from energymarket with competitive agricultural feedstocks,energy market creates a floor price foragricultural products

Fossil fuel prices also create a ceiling forcompetitive feedstocks whose price cannot risefaster than energy prices without pricingthemselves out of the energy market

Floor and ceiling prices together create a pricecorridor for agricultural products

Market integration is not complete in practicedue to logistical and technical problems Apart from Brazilian cane-ethanol complex


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Sugar prices track oil prices aboveUS$35/barrel

Source: Schmidhuber 2006


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Differential price effects onagricultural markets

Food price increases will be neitheropen-ended noruniform

Agricultural products will be affected differentlydepending on Their break even or parity point

Balance of energy and protein content

Bioenergy demand is limited to the energy content offeedstocks, creating additional supply of protein-rich

by-products Protein prices are likely to rise less rapidly than

energy prices and could even fall in absolute terms


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Differential price effects of differentbioenergy scenarios

Source: Schmidhuber 2006


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Agricultural market effects

With greater share of maize and othermarkets characterised by inelastic demand(e.g. through biofuel mandates) which is

also tied to crude oil prices, together withsmaller stocks, increased agricultural cropprice and market volatility can be

expected


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Agricultural market effects

Various empirical studies

Commission, Impact assessment of 10%biofuels target

See review of studies in Rajagopal andZilberman, 2007

Specific results no longer very valuable

because of low crude oil priceassumptions


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Food price effects

First round impact approximated by (change inprice of raw ingredient) x (share of food itemprice represented by that ingredient)

Example (US data) Maize is 38% of cost of producing pigmeat, and

pigmeat is 28% of final retail price of pork

Suppose ethanol demand increases maize price by50%

Price of pork would then increase by 5.3% Overall, doubling of feed grain and oilseed prices

would increase food prices by less than 4%

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