Martin Wolf, the Financial Times’ highly regarded economics editor, has an usually blunt article today, “Biofuels: a tale of special interests and subsidies.” While the main target is the way special interests are turning biofuels into yet another agricultural pork barrel, he makes a number of important observations: biofuels are only marginally cleaner than conventional energy sources; many of the incentives are counterproductive (witness the discussion of “flexible fuel” vehicles); the policy “rationalisations” are bogus: and of course, biofuels make food more costly.
Wolf also has an important observation buried in the piece, perhaps because it was the subject of a Financial Times editorial, namely, that what is needed is a clear and predictable price for carbon. That would give manufacturers, users, and investors long enough planning horizons to decide themselves among the various options. And perhaps most important, it would put greater focus on energy conservation, which is far and away the most productive near-term step, and less on various schemes that enrich promoters on a current basis and give the public at large the false hope that they can simply switch to a clean energy source and life will continue as before.
From the Financial Times:
Energy security and climate change are two of the most significant challenges confronting humanity. What we see, in response, is the familiar capture of policymaking by well-organised special interests. A superb example is the flood of subsidies for biofuels. These are farm programmes masquerading as answers to energy insecurity and climate change. Not surprisingly, they have the depressing characteristics of such programmes: high protection, open-ended support to producers, and indifference to economic rationality.
Already the support in members of the Organisation for Economic Co-operation and Development costs about $13bn to $15bn a year. But this sum generates much less than 3 per cent of the overall supply of liquid transport fuel. To bring the biofuel share to 30 per cent, as some propose, would cost at least $150bn a year and probably more, as marginal costs rose.
Someone needed to take a close look at the rationality of all these supports. An excellent report from the Global Subsidies Initiative of the International Institute for Sustainable Development does just that*. It does not tell a pretty story.
Policy is extraordinarily complex. It can also be highly irrational. Brazil is, for example, the most efficient supplier of bioethanol, but confronts tariffs of at least 25 per cent in the US and 50 per cent in the European Union. A smaller example is the advantage given to production of “flexible-fuel vehicles” in US corporate average fuel-efficiency standards. Because the fuel-economy credit is biggest for the least energy-efficient models, manufacturers concentrate on sport utility vehicles and light trucks. Yet almost all the drivers of these vehicles use ordinary petrol. The result is greater consumption of petrol, not less.
The cost of support per litre of ethanol varies between $0.29 and $0.36 per litre in the US and $1 in the EU (see chart). Support for biodiesel varies between $0.2 per litre in Canada and $1 in Switzerland. But the cost of petrol, in terms of equivalent energy units, is $0.34 and of diesel is $0.41. Thus, the subsidy to biofuels is often greater than the cost of the fossil fuel equivalent. Not surprisingly, the production costs of subsidised biofuels are also generally much higher (see charts).
Does this costly shift to biofuels at least deliver reductions in net emissions of greenhouse gases? Not by as much as one might suppose, is the answer. The net greenhouse gas emissions of expensive European rapeseed oil-based diesel are a mere 13 per cent less than those of conventional diesel. Similarly, net emissions from US corn-based ethanol are only 18 per cent less than conventional petrol.
This highly subsidised source of demand is also having a big impact on demand for foodstuffs. In 2007, for example, the increase in US demand for corn-based ethanol will account for more than half of the global increase in demand. Much the same is true for US and EU use of soyabeans and rapeseed in biodiesel. The rising price of food is good for producers. It is dreadful, however, for consumers, particularly for those in poor food-importing countries. Increased production of biofuels also adds stress on existing land and water supplies.
Is it possible to justify this cornucopia of complex and expensive subsidies, mandates and protectionist measures? No. But that does not stop people from trying. Indeed, they point to a host of different (and often changing) justifications, as is too familiar from the history of farm policies. Here are just five of them.
Rationalisation one: biofuel subsidies reduce farm support payments. But, in fact, US evidence strongly suggests that these subsidies are being piled on top of existing farm subsidies, not replacing them.
Rationalisation two: mandating biofuels will lower petrol prices. But it is obviously mad to try to lower the price of a commodity by subsidising the production of more expensive alternatives.
Rationalisation three: subsidising biofuel is an efficient way to reduce reliance on risky fossil fuels. But biofuels are, under current technologies, complements to, rather than substitutes for, fossil fuels and are also vulnerable to their own risks of weather and disease.
Rationalisation four: subsidising biofuel is an efficient way to reduce greenhouse gas emissions. According to the report, the cost of eliminating a tonne of carbon dioxide equivalent through biofuels varies from a low of about $150 to as much as $10,000. Even the lower of these figures exceeds almost all estimates of the marginal benefit of reducing a tonne of emissions. It certainly much exceeds the cost of many alternative ways of doing so.
Rationalisation five: subsidies are only needed to establish the infrastructure. But if biofuels are to be competitive, it will be unnecessary to subsidise the infrastructure. Investors can do that for themselves.
This then is a classic farm programme: a costly system of transfers looking for a rationale. Or, as the report puts it: “The bewildering array of incentives that have been created for biofuels in response to multiple (and sometimes contradictory) policy objectives bear all the hallmarks of a popular bandwagon aided and abetted by sectional vested interests.”
So what should be done? Here are some simple negative suggestions: eliminate increasingly popular (because apparently costless) mandates to use specific quantities
of biofuels, since these shift all the risk of fluctuations in demand and supply of foodstuffs on to their use as food; discipline the stacking of subsidies on one another; and eliminate all open-ended supports for production before these become impossible to reverse.
Here, also, are some positive ideas: define the objectives and instruments of policy precisely, in terms of the overall goals of energy security and reductions in emissions of greenhouse gases; create a single global price of carbon that governs all activities; make producers compete for any support that is offered; let the markets decide on sale of flexible-fuel vehicles (and indeed the energy efficiency of vehicles); and, above all, move to free trade in biofuels.
We should at least try to learn from painful experience with a century of farm policies. I know that is naive. But is it impossible to respond to the big challenges of energy policy and climate change by applying a little intelligence, for a change?
*Biofuels – At What Cost? Global Subsidies Initiative, www.globalsubsidies.or