The economics of biofuels, food and the environment David Zilberman, Deepak Rajagopal, Steven Sexton, Gal Hochman and Teresa Serra Presented in the S-1043

The economics of biofuels, food and the environment David Zilberman, Deepak Rajagopal, Steven Sexton, Gal Hochman and Teresa Serra Presented in the S-1043 regional Research Group-Impacts of trade and Domestic Polices on Competitiveness and Performance of Southern Agriculture Research leading to this study was supported by the EBI and USDA ERS

Over View Background On the relationship between oil and energy Some numbers R&D productivity and biotech Biofuels and the environment-LCA Biofuel and the future of agriculture

Biofuel And the Food Market-short term analysis Crop Quantity $ Food Demand Supply Joint Demand Biofuel Demand Ag Expansion Supply w/ GMO Market for Food and Energy Crops $ Quantity

The Basic Economics of Biofuel Introduction of Biofuels: Increased food prices; and Reduces food availability The effects can be countered by: Increased agricultural and conversion productivity Second generation biofuels Ag Biotech

Biofuel impacts depend on responsiveness of quantities to prices The less responsive fuel quantities are to fuel price changes higher will be the impact of ethanol on gasoline price The more responsive food quantities are to food price changes lesser will be the impact of ethanol on food price Therefore we estimate the impact on prices under three different scenarios of responsiveness of supply and demand

Three scenarios with three sets of elasticities

About the Scenarios High scenario: Inelastic gas demand and supply; Elastic corn, soy demand and supply Low scenario: Elastic gas demand and supply; Inelastic corn, soy demand and supply Mid scenario: In between High scenario should have the highest benefits due to biofuel consumption while the low scenario should have the least benefits

Simulating the impact of US biofuel on food and gas prices HighMidLow Change in gas price-2.3%-1.8%-1.4% Change in corn price18%24%39% Change in soy price11%15%24% Average US gasoline price in 2007 - $2.84 per gallon Average US corn price in 2007 - $4.72 per bushel Average US soybean price in 2007- $10.34 per bushel Changes show what actual prices were compared to a scenario that would have existed if there were no biofuels

Net benefits to producers of corn and soy due to US ethanol supply in 2007

Net benefits to consumers in the US from US ethanol supply in 2007 (net of subsidy)

Net benefits to ROW consumers from US ethanol supply in 2007

Net change in consumer and ag. producer surplus (net of subsidy) Note: Does not include change in surplus for gasoline producers And the environment

Impact of Opec This analysis ignored the fact that opec is a cartel of nation Considering OPEC the impacts of biofuel- The price effect is smaller (-1`%) than under competition But less gasoline is consumed- OPEC reduces supply A significant GHG reduction effect

Biofuel Policies: subsidies and mandate Subsidies- in the US,of about$.50/gallon, provide extra incentive to invest in biofuels They tend to increase demand for feed stock Increase price of food Reduce food availability Because of a tariff - the subsidy is not available to foreign provider of biofuel- Brazil But brazil subsidies is own growers When food demand is sufficiently high even with subsidy it curtails biofuel production- safety valve for food and source of instability to industry

Crop Price Oil Price Initial Breakeven line With subsidy With subsidy and increase in production efficiency P0P0 P1P1 P2P2 Gas price High subsidy will make biofuel profitable at higher food prices or lower gas prices PGPG

Biofuel is not profitable with subsidy and food shortage Crop Quantity Price Market for Food and Energy Crops Past : Elastic Biofuel Demand DFDF S0S0 DFDF E0E0 P0P0 Q0Q0 Ds

Biofuel will be produced with mandates Regard less of fuel demand Crop Quantity Now : Inelastic demand from Biofuel Mandate E0E0 E1E1 D T1 D RFS Biofuel Mandate Demand D T1 New Total Demand E 1 New Equilibrium D RFS P0P0 Q0Q0 P1P1 Q1Q1 Biofuel produced because of mandate raises crop price

Factor affecting ethanol price dynamics in US Ethanol prices will grow with corn ( sugar) prices Subsidies and supply restricting tariffs Gasoline prices Mandates size They will decline with Fuel taxes Ethanol prices may in turn affect the dynamics of gasoline and corn prices We tried to trace the dynamic adjustment between gasoline, ethanol and corn in the US

Dynamic analysis of of co-evolution of corn ethanol and gasoline prices We used an threshold-vector error correction models (TVECM) With data from Nebraska in the US. TVECM assume that the transitions are abrupt and discontinuous- affected by heterogeneity and transaction costs that results in lag structures that are estimated. They assume a evolved equilibrium The weighted adjustment function G( ) is nonlinear function depend on dynamic variation in the system

The prices of biofuel relative to fuel and food

The Relative weight of lagged corn and Gasoline price in changing ethanol prices Gasoline matters

Results of econometrics analysis The price of ethanol is positively related to corn and gasoline prices. The change in weight of corn or gasoline price is non linear in response to shocks Ethanol responses to gasoline price shocks are quicker than reactions to corn price changes. These latter however are bigger in magnitude. Weight of Gasoline prices increased in the 2000s Ethanol prices Peak when mandates are binding (MTBE 2006) During the 2000s when gasoline prices rose ethanol was priced above gasoline when corn price was declining and above it when corn prices was rising

The impact of adverse food supply shock on biofuel Adverse food market shocks (inventory demand, lower supply)-make corn biofuel unprofitable- may lead to bankruptcies- industry in inherently ubstable

Food and the Volatility of biofuels prices- Corn and wheat etahnol and palm biodiesel became unprofitable because of higher food prices in 2007-8 Sugar cane ethanol is still profitable- sugar price less volatile- essential value proposition is better Refiners lost money buying feed stocks Second generation may be competing with food crops on resources but the volatility because of multiple use may not be there But contract payment will have to take into account the price variability of competing ( in terms fo land) food crops

Short term vs long term price effects of biofuels The impacts of biofuel on food prices has been accumulating The 16-40 % increases we attribute to biofuel based on short tem elasticities are lower bounds Continuing shortages, negative supply shocks ( Australia) and expectation for higher price may push for 50-70% price effects as suggested by the world bank But small changes in supply relieving the pressure could have done wonders

Not all crops are alike

Rice yields increase in 70s because of Green Revolution; they have stagnated in recent years Look at inventories-they declined leading to price pressure

Wheat also benefited from Green Revolution and has seen little productivity growth of late. Years 1970-2007-source FAO

Sorghum is the food of the poor. It has experienced little increase in yields and a decline in inventories

Soybean has benefited from GMO Despite rise in acres yield per acre increased

Cotton sees sharp increase in productivity growth around 2000 due to GMO

Corn US:yield increased recently. GMO?

Greater Productivity Growth In Top- Producing Countries That Adopt GMO Countries that Adopted GMONon-GMO Countries Yields in India double with biotech Its no wonder Brazil sees considerable yield gains

Crops with high adoption of GMO did better Cotton and corn fare better than wheat and rice Productivity enhancement is essential to restore reasonable eqilibrium Short term use all the tools that work Long term invest more in ag research

Biofuel and Climate Change Biofuel is not fully renewable-energy is needed for producing inputs, production and processing. Processing may lead some biofuels to emits 18% more GHG than gasoline (tar sand emit 1.5 GHG that Saudi oil) US Corn ethanol meets between 40% less to 20% more than gasoline- but it better than tar sands Sugarcane ethanol emits 60% less than oil much less than corn. Wheat ethanol is worse than Corn, palm oil for biodiesel much better But impact of Biofuels on climate change is difficult to figure out leading to methodological studies with policy implication Key tool life cycle analysis which distinguished between direct and indirect effects

Based on EBAMM data of Farrell et al. (Science 2006) Direct emissions - Lifecycle of corn ethanol in US

Illustration - GHG impact of fuel switching by biorefineries ( based on Farrel et-al ) Switching to pure coal based biorefining reduces GHG benefits by 50%, while switching to pure gas based biorefining increases GHG benefits by 130% compared to average case

Illustration - GHG impact of fuel switching in fertilizer production Switching to pure coal based nitrogen fertilizer reduces GHG benefits by 63% compared to average case

Illustration Combined effect There is a net increase in GHG emissions and so there corn ethanol is worse than gasoline A greater than 100% reduction in net GHG displacement implies overall increase in emissions compared to baseline

LCA ignores behavior No induce innovation Minimal attention to heterogeneity No input substitution in response to price changes No learning by doing No capacity to deal with impacts of policies

Direct emissions Baseline: Emissions from Farrell et al. (Science 2006) Scenario 1: Coal based biorefining all else equal to Baseline Scenario 2: Natural gas based biorefining all else equal to Baseline Scenario 4: NG gas based biorefining, 39% improvement in corn yield, 25% reduction in energy for processing and all else equal to Baseline Learning by doing result in increased numbers of with highre processing efficiency so average emission is declining for the same mix of fuel Gasoline 94 gCO 2 e/MJ

Indirect Emissions Emissions accompanying induced expansion or intensification of agriculture Example of extensification is induced conversion of non-cropland such as pastures or forestland to agriculture Example of intensification is greater use of energy-intensive inputs like fertilizers in response to increase in output prices Unlike direct emissions they cannot be traced to a single biofuel producer and they may occur at locations far away from a biofuel production site

Indirect Emissions These effects arise from interaction of markets for several commodities and across the globe Land may not be converted directly to be planted with bioenergy crop but planted to a crop displaced by biofuel crop Corn displaces soy in US Reduction in soy exports from US Increase in soy acreage in Brazil displacing pastures Forest cleared in Brazil for pasture land Results in release of carbon stored in trees/soil

Mandate of 56 billion liters of ethanol in US (assumed to be corn based) 140 million tonnes of corn @ 2.7 gallons of ethanol per bushel of corn Global agricultural acreage to expand by 10.8 million hectares Searchinger et al.s estimate

Between 1950 and 1998, global agricultural output increased 150% while harvested acreage increased only 13% implying elasticity, i.e, historically when output increased by 100% land under agriculture increased by 9% Using this value, expansion is 3.3 million hectares Alternative calculation Land use change can be hypothesized using historical data on elasticity of acreage with respect to output

Indirect emissions *: Back of envelope calculation based on aggregate elasticity of acreage between 1950 and 1998. Disaggregating elasticities into smaller time periods and for different crops actually shows variation in elasticities. Needs further investigation

Biofuels and GHG emission Scenario 1: Coal based biorefining (increases direct emissions) Scenario 2: Natural gas based biorefining (lowers direct emissions) Scenario 3: NG based biorefining and Indirect emissions equal to 1/3rd of Searchinger et al.s estimate Scenario 4: NG gas based biorefining, 39% improvement in corn yield, 25% reduction in energy for processing and indirect emissions equaling 1/3rd of Searchinger et al.s estimate Gasoline 94 gCO 2 e/MJ Controlling direct & indirect emissions is crucial

There are many indirect effects of biofuel OPEC effect -biofuel reduces OPEC productionmor- reduces GHG Tar-sand effect-biofuel reduces price of oil reduces incentives to Tar sand- and GHG Learning by doing improved technology Concentrating on one indirect effect is not good policy

GHG of biofuel depends on policy Low carbon fuel standards (LFCS) generates less GHG than Renewable fuel standards (RFS)+ Mandates LCFS may reduce introduction of tar sand Carbon taxes or cap and trade-are more efficient- Will induce adoption of biofuel if carbon price is high ALSO-Trigger Pollution reducing innovations But require Political will Monitoring and enforcement effort

Lifecycle numbers are function of policy A policy such as carbon tax that increases the relative price of coal could lower the intensity of coal use in production of biofuel and lower the carbon footprint * Baseline is direct emissions for corn ethanol from Farrell et al. (Science 2006)

First and Second Generation biofuels If processors have to meet higher environmental standards it will reduce the amount paid for biofuel. Payment for environmental contributions at the farm level (carbon sequestration, residue reduction) is likely to affect crop and technology choicesand the geographic distribution of biofuel crops But whatever we do, productivity matters. Except of sugar cane, sweet sorghum, and some oil crops, the first generation of biofuels have limited capacity to address climate change concerns. We need to be able to process celluloids.

Productivity Matters CROPHarvest- able Biomass (tons/ acre) Ethanol (gal/acr e) Million acres needed for 35 billion gallons of ethanol % 2006 harvested US cropland 5 Corn grain 1 45007025.3 Corn stover 2 330010538.5 Corn Total78004015.3 Prairie220021075.1 Switch- grass66006020.7 Miscanthus171700185.8 Source:Steve Long

Food security is the major concern Solutions Food aid fund Smaller ( flexible mandates) Supply expansion in a sustainable (and non exploitive way) High food prices will lead to supply expansion Eastern Europe where yields are half than the west Africa and Latin America has regions of unutilized ag production potential May lead to introduction of second generation biotechnology (Gates) and enhanced development of second generation biofuel

The Future of Biofuel is Dependent Upon Innovation Need better feedstock Cleaner processing Higher productivity agriculture Dissemination and access to technology Lessons of electronics and biotech: Emergence of educational industrial complex Public/private partnership in R&D and infrastructure Technology transfer, start-ups Evolution of industry affected by IPR and regulation IPR: access, sharing arrangement and enforcement Regulations: land use, carbon content

Cheap and clean fuel and food Require more R&D investment and sound regulations Ag research has been deemphasized and over regulated in recent year Food productivity- except of some crop stagnating Expansion of food and fuel with small or no expansion of land base will be feasible with Increased productivity of underperforming regions and crops Increased agricultural knowledge and investment Improved policies and institutions Introduction and Adoption of new technologies

The bottom line Biofuel already contributes to reduced fuel prices ( 20%, maybe up to 50%) Largest price increases are in rice and wheat, perhaps due to under-use of new technologies Recent growth in agriculture has not been linear in land. Incentives and technologies led to increased food supply with much less than proportional land expansion There is ample under-performing or abandoned farmland and degraded or under-utilized land that would allow expansion w/o significant GHG and resource consequences. It all depends on policy, which reflects our commitment to meeting food, fuel and environmental objectives. We must consider alternatives: what will happen if we abandon biofuel opportunities

Integration of Agricultural, Energy and Environmental Policies Traditional commodity support program becomes redundant Biofuel mandates and support: Should be examined critically- in many cases should be eliminated Should be linked to environmental performance and food situation ( differentiate based on emissions) May provide insurance Government may help establish biofuel industry, then it must compete. Food security funds Certification of biofuel sources- at both micro and macro levels Emphasis on innovation

Can you return the genie to the bottle? NO- you can have smaller mandates But people will prefer their gas tank over other people stomachs Political economy- cheap food and fuel are cornerstone deliverable of many governments- oil is subsidized Biofuel is seen as a opportunity to increase agriculture and rural well Feasible Intervenetions Improved technologies Less market distortions More correction for environmental side effects

Biofuel in bigger context Biofuel is a part of a bigger puzzle Its importance stems from importance of liquid fuel Battery development will change it direction (emphasis on feed for power) Progress of other power sources Introduction of incentive for conservation Sound pricing of GHG and the Environment Investment in Public transit Change in building codes and population spread Will affect value and design of biofuel sector and policies

Biofuel and developing countries Not every country needs biofuel policy It has no place when biofuels can not compete with existing crops or imposes high environmental costs (net social benefit is negative ) It can help countries with underutilized appropriate resources- if introduced with a sound regulatory framework Many concerns can be addressed refineries can buy from cooperatives of small farmers Pollution control polices can control emission etc Second generation crop can reduce cost and increased gains

Whats next-in biofuel research: Industrial organization Economics of biofuel and other fuels OPEC response to biofuels Biofuels and other renewables Alternative supply chain design and their implications The innovations systems (R&D,IPR) and their impacts on biofuels and other fuels Pricing and product and networks design

Adoption and contracts Adoption of Biofuels varies by locations and according to economic and biophysical conditions Depends on contractual features Legal framework Research needs to quantify these relationships Come up with superior contract features (from various perspectives) Sound principles for policy design under various conditions Emphasize risk management issues

Biofuels in the context of global economy Biofuels and the macro economy Sensitivity to business cycles and financial conditions Attitudes and acceptance Biofuels in the developing world Case studies Distributional impacts under alternative designs Biodiversity and environmental issues

Combining economics and geography Using GIS to identify where biofeul can be working Using CGE to assess prices and quantities Assessing various policies to help Poor-food bank Environment-Carbon tax- LCA Based regulations Producers-insurance contracts

Thanks Research leading to this presentation was supported byEBI USDA ERS World Bank We thank them all EBI THE EBI ERS -USDA The World Bank We thank them all SDA ERS World Bank We thank them all EBI USDA ERS World Bank We thank them all

Instability of prices of biofuel relative to fuel and food Corn is most volatile Ethanol is high when MTBE mandate binds Now less profitable

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The economics of biofuels, food and the environment David Zilberman, Deepak Rajagopal, Steven Sexton, Gal Hochman and Teresa Serra Presented in the S-1043