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Economic Policy Drivers for Liquid Biofuels
There is a close link between crude oil prices and agricultural prices, and when fossil fuel prices reach of exceed the cost of producing biofuels, the energy market creates a demand for agricultural products, writes TheBioenergySite Senior Editor Chris Harris.
Crude oil prices are driving biofuel prices and in consequence the agricultural commodity prices.
The UN Food and Agriculture Organisation report The State of Food and Agriculture 2008 shows that this price barometer swinging between fossil fuels and biofuels together with politically proscribed policies strongly affect the markets for grains and other crops grown for both food and biofuels and they also affect the dynamics of agriculture in different countries as farmers follow the cash potential of bioenergy crops.
"In agricultural markets, biofuel processors compete directly with food processors and animal-feeding operations for commodities," the report says.
"From the point of view of an individual farmer, it is unimportant what end use a prospective buyer has in mind for the crop.
"Farmers will sell to an ethanol or biodiesel processor if the price they receive is higher than they could obtain from a food processor or a feeding operation.
"If the price of biofuels is high enough, it will bid agricultural commodities away from other uses. Because energy markets are large relative to agricultural markets, a small change in energy demand can imply a large change in demand for agricultural feedstocks.
"Therefore crude oil prices will drive biofuel prices and, in turn, influence agricultural commodity prices."
However, the report adds that the link between energy and agriculture commodity prices might not yet be fully developed as the bioenergy market still has to develop further.
As the bioenergy market starts to respond to other factors such as transportation, and new blending systems, then the energy market will become even closer to the agricultural commodity market.
At present, agricultural commodity crops not only compete with fossil fuels, they also compete among themselves.
As energy becomes more attractive, then land can be given up to growing corn for ethanol rather than wheat for bread.
At present the one factor that is helping to maintain a balance between growing crops for fuel and crops for food is the fact that the cost of converting the crops into fuel can prove too expensive.
However, this has been overcome to a large extent in some countries by the government support policies that are starting to distort the market, the FAO report infers.
"One justification made for providing policy support to a new sector is that it is needed to overcome the initial costs of technological innovation and market development required to enable a sector to become competitive. This is the "infant industry" argument for subsidies," the report says.
"But subsidies for a sector that cannot ultimately achieve economic viability are not sustainable and may serve simply to transfer wealth from one group to another while imposing costs on the economy as a whole."
The use of subsidies, which can sometimes be justified when there are social benefits, the FAO says, are also strongly linked to agricultural policies and mandates.
"Supporting the farm sector and farm incomes has been a key - if not the most important - driving factor behind biofuel policies in several developed countries," the report says.
"In countries with heavily subsidized farm sectors, the revitalization of agriculture through its role as provider of bioenergy feedstocks has been widely viewed as a solution to the twin problems of oversupply of agricultural produce and declining global market opportunities."
It is the developed OECD countries that have the strongest agricultural policies and the most subsidisation of the sector.
These countries have also introduced blending mandates requiring fossil fuels to be mixed with biofuels for transport and many of these countries are also subsidising and investing in the development of an infrastructure for the biofuels industry.
Some countries are using tariffs to protect their domestic agriculture and biofuels industries and there are also tax incentives for investing in biofuels as well as incentives for research and development.
"Different policy instruments and types of related support applied at different stages may have very different market impacts," the FAO says.
"Generally, policies and support directly linked to levels of production and consumption are considered as having the most significant market-distorting effects, while support to research and development is likely to be the least distorting."
There are four major reasons put forward for all these supports and subsidies for the biofuels industry - high fossil fuel/petrol prices, energy security, climate change and environmental concerns.
Bioenergy is seen as a way of diversifying sources of energy and reducing dependence on a small number of exporters.
However, the FAO points out that the subsidies that have been introduced in a lot of the OECD countries are now becoming very costly to the tax payer.
In the US biofuels processors and growers are receiving $6 billion a year in support and in the EU it is $5 billion. The FAO argues that the biofuels policies and subsidies are now shaping the global agricultural economy and possibly in ways that were not initially intended.
These policies are having a knock-on effect around the world in other countries - not just the ones initiating the policies.
"Biofuel policies have important implications for farm output and incomes, commodity prices and food availability, returns to land and other resources, rural employment and energy markets," the report says.
"An individual farmer will produce feedstock for biofuels if the net revenue he or she earns is greater than for alternative crops or uses."
The amount the farmer gets for biofuel crops depends on four main factors - the energy potential of the crop, the cost of converting it to fuel, the cost of transportation, both of the crops and the fuel and the value of the by-products.
The farmer also has to take into consideration the crop yields, which vary for different biofuel crops. For example, the yield for sweet sorghum is 1.3 tonnes per hectare, but for sugar cane it is 65 tonnes per hectare.
The conversion of sugar cane to ethanol is about 70 litres per tonne, where as for rice it is 430 litres per tonne.
The FAO says that in terms of production of ethanol per hectare, sugar cane and sugar beet are by far the most productive first generation biofuel crops and Brazil has the lowest of all costs for production of ethanol from sugar cane.
In Brazil the bagasse from the sugar cane is burnt for fuel, where as in the US and EU the by-products are usually sold on for animal feed.
However, with fossil fuels at present driving the biofuels market and prices, much depends on the cost of crude oil.
The FAO shows that the US found that maize ethanol was competitive when crude reached $58 a barrel. This breakeven point changes according to the changes in the feedstock price.
With crude prices at $60 a barrel, maize ethanol producers could pay up to $79.52 a tonne for maize and still remain competitive. When crude prices reached $100 a barrel, the price that could be paid for corn went up to $162.98 a tonne and the processor would still remain competitive.
There are similar parallels for other feedstocks, with the sliding scale for crude oil prices. The introduction of subsidies into the equation distorts the market even further.
The FAO concludes that with current technology US maize ethanol can "rarely and only briefly achieve market viability before the price of maize is bid up to the point that it again becomes uncompetitive as a feedstock".
And the FAO adds that crude oil prices will continue to drive agricultural prices, backed by government policies and subsidies for the biofuels market.
November 2008
