The Economics of Alternative Energy Sources and Globalization

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Biofuel production has expanded in Brazil in part because of hidden subsidies. Likewise, ethanol production from corn in the United States has expanded in part because of ethanol tariffs and ethanol processor tax credits. Without these subsidies, ethanol production in the United States would be much smaller. Even so, subsidies from biofuels will likely continue. Biofuel production has both negative and positive effects. The net benefits from biofuels are positive, providing there are significant positive environmental impacts, as well as significant negative price impacts in the overall fuels market. Biofuels produced from wood residues could have a bright future as wood residues can be used for electric power generation.

For over 100 years, petroleum has played a key role in the global energy picture. Sharp increases in the price of petroleum can bring on recession and bankrupt industries in petroleum-importing countries, while at the same time providing huge windfalls for exporting countries. The twenty-first century, however, will see petroleum's share of the global energy portfolio diminish as global production begins to decline. A number of candidates will vie to take over as petroleum’s dominance fades. The renewable candidates include renewable distillates and ethanol. The energy investment required to produce a renewable fuel will be an important measure for determining how sustainable these fuels can be if petroleum is no longer enabling their production.

The principal reasons for using public policies to stimulate the production of ethanol in North America are to lower greenhouse gas emissions, increase farm income through the introduction of a new market for farm commodities, promote rural development and diversification, and reduce consumer reliance on imported fossil fuels. All these policy objectives are satisfied to some extent by biofuel production and consumption in North America. However, the degree to which they are fulfilled is modest at best, and there are important negative consequences.

This chapter provides optimal welfare economics policies that incorporate some of the recent developments that led to the introduction of biofuels and policies to manage biofuel, food, and fossil-fuel allocation. Our model suggests that (1) globalization contributes to higher food and fuel prices by increasing incomes, (2) the introduction of biofuels puts extra pressure on prices that can be alleviated only through the adoption of innovation and enhanced supply, and (3) optimal policies include carbon taxes and subsidies for fuel security. Policy making is not as general and comprehensive as the welfare economics model suggests. Rather, it is piecemeal and adaptable. We argue that major biofuel policies, such as biofuel mandates, tariffs on imported biofuels, and the renewable fuel standard, can be explained as the outcome of a policy that tries to maximize fuel security, subject to budgetary, behavioral, and environmental constraints. Our analysis suggests that some of the impacts of biofuels on food prices as well as deforestation can be mitigated if regulations and incentives that slow the adoption of modern agricultural technologies are modified and the capacity to adopt biofuels is expanded. Finally, biofuel policies are in a transitional stage and will need to be modified once a more comprehensive policy to address climate change has been established.

Several studies have analyzed the effect of bioenergy tax credits on agriculture and energy markets using a partial equilibrium framework. Most of these studies focus on a detailed description of the effects of bioenergy in specific commodity markets such as corn. An alternative approach used here is to analyze the effect of these policies on the economy using a general equilibrium model that directly accounts for feedback effects in the economy. These feedback effects reduce the production possibilities in the overall economy.

The subsidy component of biofuel policies is complicated because of the forward linkage to oil markets. The subsidy associated with tax exemptions is overestimated because consumers purchase fuel for mileage, but fuel taxes are based on volume. Furthermore, the policies of one country establish the link between biofuel and oil prices, so tax exemptions in other countries subsidize gasoline consumption and do not directly increase biofuel prices. The gap between the intercept of the ethanol supply curve and the oil price means part of the subsidy is benefitting no one. As a result, countries like Brazil do not subsidize ethanol production as much as it would appear.

Brazil is the world’s largest sugar producer and exporter of ethanol, and the world’s second largest ethanol producer. Hidden subsidies such as government blend ratios have added to Brazil’s ability to produce sugar and ethanol. The blend ratio has remained relatively stable over the last several years, but it likely will be changed to promote more sugar production, relative to ethanol, given the high price of sugar in 2009.

We discuss the impacts of future energy prices and biofuel production levels on agricultural market prices, production, and trade, and present the results of a partial equilibrium model of international agricultural trade with interconnected markets. The results of the model suggest that the long-term trend of declining real agricultural commodity prices has been reversed. A key result in this regard is that the price of energy has become a major driving force of agricultural world market prices. For instance, until 2016/18 the price of wheat is expected to increase by about 16 percent, 35 percent, and 91 percent based on oil prices of US$45, US$70 and US$102 per barrel, respectively. The 2016/18 baseline projection shows an increase in total world production from 10 percent for wheat to 30 percent for oilseeds. Variations in energy cost have the biggest impact on sugar production in the European Union, corn production in North America, other grains production in Brazil and Australia, sugar production in China, and corn production in the Commonwealth of Independent States (CIS). Increased bioenergy demand has the biggest impact on corn production, followed by sugar and oilseeds production. The impacts and importance of energy prices and biofuel production for agricultural trade varies between commodities and regions. Future long-term biofuel scenarios could change considerably, depending on technology and bioenergy production pathways.

The development of first-generation biofuels has strengthened the linkage between agricultural commodity markets and energy markets. This chapter analyzes the implications of U.S. domestic and trade policies for ethanol in the face of year-to-year fluctuations in the domestic supply of feedstock (corn) and petroleum prices. The current U.S. policy mix involves a prohibitive tariff on imported ethanol, a fixed subsidy for blending ethanol with gasoline, and a blending or consumption mandate. We find that as the likelihood that the mandate is binding increases, the variability of ethanol use declines; the impact of corn supply variations on corn prices is increased due to greater inelasticity in demand, but the impact of oil price variations on corn prices is reduced. Tariffs could be reduced to allow ethanol imports, given a modification of the subsidy mechanism, which would reduce the impact of corn supply fluctuations on corn prices. But, if the minimum supply-inducing price for imported ethanol is sensitive to petroleum prices, corn prices could be affected by petroleum price fluctuations even when the U.S. mandate is binding. With freer trade, the impact of U.S. domestic and trade policies for ethanol on the variability of domestic corn prices depends on the relative magnitude of external shocks as well as on ethanol policies in supplying countries. In addition to examining a reduction in the current specific tariff, the implications of using an ad valorem tariff or a variable tariff are assessed.

Fuel-ethanol expansion contributed to the recent volatility in agricultural commodity prices, causing a price bubble. Results indicate decentralized competitive markets will mitigate any persistent price volatility. Policies should then be directed toward preventing the occurrence of price bubbles and, if they do occur, diminishing their magnitude.

Key U.S. biofuel policies mostly target domestic use but indirectly affect agricultural markets. Biofuel support increases demand for U.S. agricultural commodity feedstocks, particularly corn and soybean oil given current practices, and consequently increases prices for these commodities. Unintended global responses may include higher food prices and greater land conversion to agricultural uses. However, past research is uncertain about the magnitude of effects of different U.S. biofuel policies and suggests that their effects depend on market conditions. Our contribution is to test systematically the link between petroleum prices and the effects of biofuel policies on U.S. agricultural commodity prices and exports. Using a partial equilibrium model of U.S. agricultural and biofuel sectors, we vary petroleum prices and other external factors over hundreds of combinations during a ten-year projection period. Comparing results with and without U.S. biofuel support programs to identify how these policies affect markets, we find that removing these policies reduces corn and soybean oil prices and exports substantially when petroleum prices are low, but have less pronounced effects when petroleum prices are high. The effects on other commodity markets follow a similar pattern for directly complementary or substituting goods, but are more attenuated for goods that are less directly related to the main biofuel feedstocks in the medium-term future. Our results highlight the sensitivity of U.S. minimum biofuel use mandates, particularly for petroleum prices, and the interaction of mandates and other biofuel policies.

We examine the long-run effects of increased U.S. ethanol production on the agricultural economy and worldwide food insecurity. Overall, we find that moderate increases in ethanol production would result in relatively modest changes after a (potentially lengthy) adjustment period. Significant improvements in cellulosic ethanol production technology would substantially reduce the magnitude of such changes, as increases in ethanol production could be fueled by previously unutilized agricultural wastes. Changes in food insecurity caused by increasing ethanol production would tend to be most painful in Africa, the Far East, and Central and South America (excluding Brazil).

This model evaluates the potential success of a cellulosic ethanol plant in Florida. Critical economic factors of the plant were simulated to assess the feasibility of this project. These critical factors include the feedstock to be used, the cost of the facility, transportation costs, and the discount rate for the net present value (NPV). Results and observations are presented in this chapter.

This chapter examines the impact of varying energy price paths (reference, low, and high petroleum prices) on continued biofuel expansion and the implications on global agricultural commodity markets. It uses PEATSim, a dynamic, partial equilibrium, multi-commodity, multi-region global trade model of the agriculture sector. Continued biofuel expansion spurred by alternative energy programs will lead to higher agricultural commodity prices and to changes in the trade patterns in biofuel feedstocks. The ability of countries to achieve their alternative energy goals are largely determined by the future path of energy prices. With low energy prices, biofuel demand will fall (absent mandates), which means reduced biofuel production costs to keep biofuel competitive with petroleum-based fuel. If energy prices increase, biofuel use likely will exceed country-specific energy targets and will result in much higher agricultural commodity prices. In either event, technological innovation (which lowers biofuel feedstock production cost and increases biofuel conversion efficiency) will be key in achieving biofuel expansion while mitigating impacts on agricultural commodity markets.

This study explores the economic feasibility of bio-energy generation from agricultural waste biomass in order to complement local nucleus business by meeting specific market demand for electricity. With GIS maps combined with production location analysis, we identify the locations of appropriate sites (groups) and associated volumes of cotton gin waste (CGW). Based on the Bayesian Markov chain Monte Carlo (MCMC) method, we estimate the probability distribution of CGW supply, which is an important factor in economic models to search optimal firm scales. Sensitivity analysis and cost/benefit analysis also are conducted. We find convincing evidence that onsite gasification has positive profit margins for generating electricity to meet higher-valued peak power contracts, self consumption, and incidental sale, but bio-oil production using pyrolysis may be too expensive for generating electricity using bio-oils in the study region.

This chapter adopts a case study approach to study the impact of voluntary carbon and bioenergy markets on the profitability of non-industrial private forest landowners. How an acre of intensely managed slash pine (Pinus elliottii) impacts on the optimal rotation age of a plantation is also assessed. A carbon plantation in the southern United States is selected as a representative case. The payment guidelines from the Chicago Climate Exchange were followed. A life-cycle analysis was conducted to ascertain the emissions from various silvicultural activities. It was assumed that only logging residues available from forestland will be utilized for bioenergy production. It was found that land expectation values increased by about 49 percent (with thinning) and 50 percent (without thinning) by including payments for net carbon sequestered in the live biomass and logging residues, but the optimal rotation age of 22 years did not change.

This chapter evaluates the potential impacts on the Florida economy of substituting woody biomass fuels for fossil fuels to generate electricity. The analysis uses a computable general equilibrium (CGE) model coupled to an Input-Output/Social Accounting Matrix (IO/SAM), representing the Florida economy in 2007. At a biomass supply of 40 million tons (green basis), representing approximately 13 percent of the energy needs for current electric generation in Florida, GDP would increase 0.32 percent (US$2.2 billion) above the current level. The forestry sector output would increase 69 percent above the base to meet new demands for woody biomass fuels, while the electric power sector output would decrease 0.33 percent and the forest products manufacturing sector output would decrease 6.7 percent due to higher costs for woody biomass fuels. Prices for timber would increase by up to 43 percent if the economic model were modified to limit capital investment and disaggregate timber production and logging/forestry support services. Annual imports of fossil fuels would decrease 2.5 percent ($1.14 billion). The policies and incentives for bioenergy development could have an overall positive impact on Florida's economy. Overall, the forestry sector would benefit from increased demand and prices.

Biofuel expansion can create positive conditions for improving food security and environmental performance in two significant ways: (1) it would create higher commodity prices that would allow investments within the agricultural sector for poverty reduction, food security, and greater environmental performance and (2) it would accentuate the benefits of properly designed climate policy. In both circumstances, we emphasize that the policies enacted along with biofuel expansion must be designed to create positive benefits. POLYSYS, an economic model of the U.S. agricultural sector, is used to show an example of implementing correctly designed climate policy in conjunction with biofuels policy to lead to greater carbon reduction than with either policy alone.

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