Environmental Valuation & Cost-Benefit News

Link: http://www.oecd.org/dataoecd/40/25/39266869.pdf

SUMMARY AND DISCUSSION

Biofuels have been championed as an energy source that can increase security of supply, reduce vehicle emissions and provide a new income stream for farmers. These claims are contested, however. Critics assert that biofuels will increase energy-price volatility, food prices and even life-cycle emissions of greenhouse gases. This paper presents salient facts and figures to shed light on these controversial issues and asks whether biofuels offer a cure that is worse than the disease they seek to heal.

The information gathered in this paper gives rise to two fundamental questions:
1. Do the technical means exist to produce biofuels in ways that enable the world to meet demand for transportation energy in more secure and less harmful ways, on a meaningful scale and without compromising the ability to feed a growing population?
2. Do current national and international policies that promote the production of biofuels represent the most cost-effective means of using biomass and the best way forward for the transport sector?

The rush to energy crops threatens to cause food shortages and damage to biodiversity with limited benefits

Global production of biofuels amounted to 0.8 EJ in 2005, or roughly 1% of total road transport fuel consumption. Technically, up to 20 EJ from conventional ethanol and biodiesel, or 11% of total demand for liquid fuels in the transport sector, has been judged possible by 2050.

An expansion on this scale could not be achieved, however, without significant impacts on the wider global economy. In theory there might be enough land available around the globe to feed an everincreasing world population and produce sufficient biomass feedstock simultaneously, but it is more likely that land-use constraints will limit the amount of new land that can be brought into production leading to a “food-versus-fuel” debate.

Moreover, land use will be driven by the net private benefit owners can derive from their land. Any diversion of land from food or feed production to production of energy biomass will influence food prices from the start, as both compete for the same inputs. The effects on farm commodity prices can already be seen today. The rapid growth of the biofuels industry is likely to keep these prices high and rising throughout at least the next decade.

The growth of the biofuels industry is also likely to place pressure on the environment and biodiversity. Biomass feedstocks can be most efficiently produced in tropical regions, where suitable and available land is mostly concentrated, and annual yields are highest. However, as long as environmental values are not adequately priced in the market there will be powerful incentives to replace natural ecosystems such as forests, wetlands and pasture land with dedicated bio-energy crops, thus harming the environmental credentials of biofuels.

Even without taking into account carbon emissions through land-use change, among current technologies only sugarcane-to-ethanol in Brazil, ethanol produced as a by-product of cellulose production (as in Sweden and Switzerland), and manufacture of biodiesel from animal fats and used cooking oil, can substantially reduce GHG compared with gasoline and mineral diesel. The other conventional biofuel technologies typically deliver GHG reductions of less than 40% compared with their fossil-fuel alternatives. When such impacts as soil acidification, fertilizer use, biodiversity loss and toxicity of agricultural pesticides are taken into account, the overall environmental impacts of ethanol and biodiesel can very easily exceed those of petrol and mineral diesel.

In only a very few countries do biofuels have the potential to make a significant dent in dependence on imported oils. The amount of fossil fuels that can be displaced by domestic production of biofuels will be small in the great majority of countries. What’s more, an augmented biofuels market will tend to increase the positive relation between oil prices and biofuel costs. Higher oil prices will both raise the production cost of biofuels (as fossil fuels are an important input in the production process) and exert upward pressure on agricultural commodity prices as a result of the increased demand for them. This limits the possibility for biofuels to reduce transport fuel prices.

The conclusion must be that the potential of the current technologies of choice — ethanol and biodiesel — to deliver a major contribution to the energy demands of the transport sector without compromising food prices and the environment is very limited.

Second-generation technologies hold promise but depend on technological breakthroughs

The harmful consequences of many first-generation technologies have received widespread attention and are being acknowledged by an increasing number of experts (and a few countries). These concerns have not to date resulted in any effective policy response. One reason that first-generation biofuels continue to be promoted as serious solutions to the twin challenge of climate change and energy security is the notion that they will soon be supplanted by more advanced technologies now in development. These so-called second-generation technologies could, in theory, make it possible to avoid competing land use claims by growing biomass feedstocks on marginal and degraded land and using residual biomass materials. They have the potential to deliver an additional 23 EJ of biofuel energy in 2050, or 12% of total transport fuel demand, while potentially avoiding many of the negative effects of conventional fuels.

As second-generation technologies are still in the demonstration phase, it remains to be seen whether they will become economically viable over the next decade, if ever. Even with positive technological developments there are serious doubts about the feasibility of using residue material as biomass feedstock on a large scale. The logistical challenge of transporting biomass material to large production facilities is likely to impose a floor below which production costs cannot be lowered. This leads some to believe that the second-generation biofuels will remain niche players, produced mainly in plants where the residue material is already available in situ, such as bagasse (cellulosic residue from sugarcane pressing) and wood-process residues.

The economic outlook for biofuels seems fragile

Biofuels could thus theoretically achieve a market share of nearly a quarter of the liquid fuels market in 2050 (11% from conventional and 12% from advanced technologies). However, it seems unlikely this potential will be realised, as concerns over food prices and environmental degradation caused by first generation technologies suggest that the potential of conventional technologies might be closer to current production levels. Furthermore, commercialisation of second-generation technologies is still a (distant)
possibility with only several pilot and demonstration plants currently being built.

But this is only part of the reason. The unfavourable economics of biofuels also suggests that the market share of nearly a quarter is unlikely to be realised. More realistic is the roughly 13% market share in 2050 calculated by the IEA (2006a) — an estimate that takes relative fossil fuel prices into account. If that target were to be met, the avoided CO2 reduction from increased biofuels would be almost 1.8 Gt, or 3% of energy-related CO2 emissions in a business-as-usual scenario. Given the projected growth in demand for transportation fuels, this will not reduce overall petroleum fuel consumption below current levels but only moderate the growth in demand.

Though the IEA scenario is more realistic it should still be considered a best-case scenario, as the analysis behind it is based on prices of biofuels falling below fossil-fuel alternatives and aggressive government mandates and targets. Although there is scope for production costs for biofuel feedstocks to decline as a result of improvements in yields, it is not clear that such improvements will be enough to compensate for rising prices due to production factors and the combined pressures on prices of rising demand for food, feed and biofuels. Increasing competition with biomass feedstocks — woody material as well as agricultural products — is actually pushing feedstock prices and production costs up. Higher oil prices will have the effect of increasing biofuel production costs while simultaneously making fossil fuel alternatives such as tar sands and coal-to-liquids increasingly competitive.

Government policies supporting and protecting domestic production of biofuels are inefficient…

Government policies play a large role in the financial attractiveness of biofuels production and trade. Domestic production is supported through both border protection and production subsidies.

Production subsidies are difficult to quantify, but are running in the billions of dollars per year (over $7 billion in United States alone). The leading OECD countries producing ethanol apply import tariffs that add at least 25% to the cost of imports. As a result, current trade is only about 10% of the world’s biofuel consumption. This is an inefficient outcome, as biofuels produced in tropical regions from sugarcane and vegetable oils have a considerable cost advantage over those derived from agricultural crops in temperate zones.

Regulations mandating usage or blending percentages and fuel-tax preferences to stimulate production are used by many countries. In most cases these policy measures do not distinguish among biofuels according to their feedstocks or production methods, despite wide differences in environmental costs and benefits. This implies that governments could end up supporting a fuel that is more expensive and has a higher negative environmental impact than its corresponding petroleum product.

Neither should current biofuel support policies be championed for their supposed capacity to reduce GHGs or improve energy security. The cost of obtaining a unit of CO2-equivalent reduction through subsidies to biofuels is extremely high, well over $500 per tonne of CO2-equivalent avoided for corn-based ethanol in the United States, for example, with other researched countries not performing much better. The score is also not very favourable in terms of displacing fossil fuels. In most cases the use of biofuels roughly doubles the cost of transportation energy for consumers and taxpayers together.

Indeed, most current policies fare poorly when measured by their cost effectiveness, and thus court public backlash. Biofuel policies may appear to be an easy way to support domestic agriculture against the backdrop of international negotiations to liberalise agricultural trade, but to measure their cost effectiveness a clear definition of the desired policy objectives is needed.

The current policy response to the environmental consequences of biofuel production is to develop criteria designed to ensure a sustainable production of biofuels. However, biofuel mandates are still targeting ambitious market shares without an in-depth understanding of a sustainable production level and from where this biofuels could be supplied. There is a serious risk that biofuel quotas for demand are higher than potential sustainable supply, creating a strong incentive to ‘cheat’ in the system.

Liberalising trade in biofuels is difficult but essential for global objectives

Ethanol from sugarcane grown in Brazil is by far the cheapest biofuel today. South America and Africa have a large potential to increase biofuel production. Ethanol may also be efficiently produced in South-East Asia and Australia, though the availability of suitable land will place tighter constraints on production there. Production in North America and Europe is considerable in the current market but its long term potential is not sufficient to realise the objectives set.

Trade between the efficient producers and OECD countries is therefore mutually beneficial. Nevertheless, it is also mostly absent as a result of the import tariffs and production subsidies that protect domestic consumers and keep prices artificially high. Liberalising the market will prove extremely difficult given the Gordian knot with agricultural markets that has since long been characterised by agricultural subsidies, high import tariffs, export subsidies and preferential treatment arrangements. A lack of progress on this front should be translated into a lowering of ambitions.

At the same time, according to Jacques Diouf, Director-General of FAO (Financial Times, August 15, 2007), bioenergy provides a chance to enhance growth in many of the world’s poorest countries by bringing about an agricultural renaissance and supplying modern energy to a third of the world’s population. This means not only improving export opportunities for developing countries to the industrialised world but, perhaps more importantly, helping them to use biomass to produce their own electricity.

Certification of biofuels is useful for promoting good practices but cannot be trusted as a safeguard

Certification of biofuels is a useful tool for promoting sustainable practices, as reliable certification could provide a way to discriminate between the ‘good’ and the ‘bad’. There are, however, serious questions that must be raised about the effects and effectiveness of certification schemes. First, enforcement and chain-of-custody control could prove to be an enormous challenge, as recent experiences with the certification of wood products has shown. Second, the effectiveness of certification could be undermined by displacement of biofuel products. As long as certification is not a multilateral requirement but conducted on a country by country basis, it will merely lead to a segmentation of the market, not a reduction of unsustainable practices. Third, without a uniform certification scheme exporters will face increasing costs and bureaucratic complexity. A final limitation is that certification schemes do not easily capture knock-on effects on agricultural markets.

Moreover, discrimination of trade on the basis of production methods is highly contentious and has been the nub of several precedent-setting trade disputes at the WTO. Misuse of certification schemes and sustainability standards regulations provide a continuing challenge to fair and indiscriminate trade. The question of if, and under what design criteria, trade rules should be allowed to exclude fuels that fail to meet minimum performance levels from mandatory schemes or preferential tax treatments should be addressed urgently. From an environmental perspective, only worldwide certification that is effectively enforced stands a chance of making a difference. Selective certification gives the appearance of sustainable production to some while allowing the practice of unsustainable production to continue for others. Though theoretically possible, reliance on certification schemes to ensure the sustainable production of biofuels is not a realistic safeguard.

Policy implications for the near future

To harness the real potential of bio-energy and biofuels an important shift in current expectations and policies is necessary. Based on the findings in this paper, the following policy directions could be debated:
• The strategic importance of and objectives for first generation biofuels need to be refocused and refined. International organisations such as the IEA, OECD, FAO and World Bank need to continue to adopt a soundly-based, common understanding of the limits of both traditional and second-generation biofuels in their analysis of energy futures.
• Priority should be given to research into second-generation biofuels — not only their technologies, but also the assumptions regarding the cost and long-term availability of feedstocks. Domestic policy efforts should be redirected from (subsidy) instruments aimed at the deployment of biofuels in general back to the R&D and demonstration phase of advanced biofuel technologies.
• Further research is needed to verify the environmental benefits for each biofuel production pathway, feedstock and location.
• Current biofuel support policies place a significant bet on a single technology despite the existence of a wide variety of different fuels and power trains that have been posited as options for the future. National governments should cease to create new mandates for biofuels and investigate ways to phase them out, preferably by replacing them with technology-neutral policies such as a carbon tax. Such policies will more effectively stimulate regulatory and market incentives for efficient technologies.
• Policy efforts to develop certification of biofuels must be unified. Only a global and coherent approach stands a chance of making a positive difference.
• Certification of biofuels - and the design criteria to use them in combination with GHG emissions reduction regulations and preferential tax treatments — should be urgently placed on the WTO agenda. A special committee on trade and environment has been created to channel these discussions and could possibly be used to this end.
• The WTO should also be used to step up efforts to lower trade barriers to biofuels imports, allowing developing countries that have ecological and climate systems more suited to biomass production to use their comparative advantage.
• More work needs to be done to assess the relative importance of biofuels in developing countries as an export commodity and as a means to provide excess to modern, more efficient and less polluting energy sources. It may be that in many developing country circumstances it would be more productive to channel efforts to developing other forms of bioenergy than liquid fuels.

More help should be provided to developing countries in identifying opportunities to use biofuels to enhance economic progress.

by Richard Doornbosch 1 and Ronald Steenblik
1. Principal Advisor; Round Table on Sustainable Development, OECD Tel: +33 (0)1 45 24 14 57; E-mail: Richard.DOORNBOSCH@oecd.org

Organisation for Economic Co-operation and Development www.oecd.org
General Secretariat; Round Table on Sustainable Development
September 11-12, 2007
http://www.oecd.org/dataoecd/40/25/39266869.pdf