Research Paper no. 18 2007–08
The economic effects of an ethanol
mandate
Richard Webb
Economics Section
22 January 2008
Executive
summary
- High oil prices, increased reliance on imported oil, and
environmental concerns have led to calls for mandating the blending
of domestically-produced ethanol with petrol ( fuel ethanol ). The
most common proposal is for a blend with 10 per cent by volume of
ethanol (E10). Mandate advocates cite fuel security, a smaller
trade deficit resulting from lower oil imports, regional
development, and environmental benefits as reasons for adopting a
mandate. Concern that the domestic industry would not be able to
compete with imports is also a factor behind the calls for a
mandate.
- Reduced oil imports are only one effect of an ethanol mandate
on the trade account. Any diversion of feedstock from exports or
increased imports of feedstock needed to meet the mandate would
increase the trade deficit.
- A mandate is only one way of reducing reliance on imported oil.
Importing ethanol, for example, would be less economically costly
than a mandate, and would diversify geographic supply sources and
the composition of fuel.
- The evidence suggests that the costs of creating jobs under an
E10 mandate would be high. A mandate could also adversely affect
other rural industries.
- The Biofuels Taskforce that the Howard Government established
concluded that greenhouse gas benefits alone would not warrant
further assisting biofuels given the availability of much cheaper
carbon reduction options.
- The additional demand for feedstock under a mandate might lead
to competition for land from other uses such as food and exports.
Views differ on the potential for competition for land use in
Australia.
- A mandate could benefit the economy if domestic ethanol could
compete with imports without government assistance.
- Even though a comprehensive cost-benefit analysis of an ethanol
mandate has not been undertaken, no prima facie economic case for a
mandate has been established.
|
Contents
Introduction
Mandate objectives
How would a mandate work?
Australian Government policy
Current
Proposed policy
Biofuels Taskforce
Balance of payments and fuel
security
Regional and agricultural development
Employment
Other rural industries
Environment
Feedstock costs
Competition for land use
Economic efficiency
Infant industry
Alternatives to a
mandate
Environment
Imports
Regional development
Future
Conclusions
Introduction
High short-term oil prices,
increasing reliance on imported oil, and environmental
considerations have prompted calls for the greater use in Australia
(and elsewhere) of alternatives to petrol (and diesel). In
particular, some advocate mandating the blending of
domestically-produced ethanol with petrol (such blends are called
fuel ethanol ). This Research Paper examines some of the economic
arguments for and against a mandate.
Mandate advocates in Australia such as the Australian Cane
Growers Council[1]
and overseas[2] cite
fuel security, a smaller trade deficit, regional and agricultural
development, and environmental benefits as reasons for adopting a
mandate. In Australia, the most common proposal is a blend
containing 10 per cent by volume of ethanol (E10). An E10 mandate
would create an annual market of about two billion litres of
ethanol.[3] In
contrast, ethanol production in 2006 07 was about 130 million
litres.[4] Current
fuel ethanol use is tiny; in 2006 07, ethanol-blended fuel
accounted for only 1.5 per cent of automotive gasoline
sales.[5]
A mandate increases demand for ethanol above what market forces
(supply and demand) would otherwise determine. It generally costs
more to produce ethanol than petrol (allowing for the fact that
ethanol contains less energy than the same volume of
petrol).[6] In the
absence of a subsidy to encourage the use of ethanol, and with a
tax regime that is neutral between petrol and ethanol, motorists
would prefer to buy petrol rather than fuel ethanol because petrol
is cheaper.[7] A
mandate is thus a form of compulsory demand because it obliges
motorists to buy ethanol even when ethanol is uncompetitive with
petrol:
In the case of mandates, biofuels [ethanol and
biodiesel] do not have to be competitive with petroleum
fuels.[8]
Because it generally costs more to produce ethanol than petrol,
a mandate would increase the price of fuel in the absence of an
ethanol subsidy. The price increase is a redistribution of income
from motorists to ethanol producers. A mandate is, in effect, a
subsidy to ethanol producers paid by fuel users.
The Howard Government s policy as contained in the 2004 energy
white paper did not support a mandate for alternative fuels such as
ethanol:
Ultimately these [alternative] fuels must compete
on their commercial merits and the government will not mandate the
use of alternative transport fuels.[9]
The Howard Government rejected a mandate on the grounds that it
would deny consumers the right not to use ethanol[10] and because domestic production
capacity was not adequate to supply a mandate.[11] The Howard Government did,
however, encourage the use of domestically-produced ethanol. In its
2001 election policy, the Government set a target of 350 megalitres
(ML) of biofuels (ethanol and biodiesel) production capacity by
2010.[12] To help
reach this target, domestic ethanol production is subsidised.
Domestic ethanol and petrol are both subject to excise of 38.143
cents per litre.[13] The excise on ethanol is offset by paying ethanol
producers a production subsidy of 38.143 cents per litre. The
subsidy reduces the cost of production and so makes ethanol
production more viable relative to petrol, thus increasing demand
for ethanol above what it would otherwise be.[14] Imported ethanol is subject to a
customs duty of 38.143 cents per litre. Unlike the excise on
domestic ethanol, the customs duty on imports is not offset.
Consequently imported ethanol bears the full customs duty.
The effect of these arrangements is to redistribute income to
domestic ethanol producers from taxpayers (via the production
subsidy), and from fuel users (who could buy cheaper imported
ethanol but are effectively prevented from doing so by the customs
duty). Whereas the cost of the production subsidy is explicit
because it is paid through the Budget it is estimated to cost about
$50 million in 2006 07 the customs duty provides an implicit
subsidy.[15] The
major beneficiary of these arrangements is the Manildra Group,
which receives about 90 per cent of the production subsidy.[16]
The subsidisation of ethanol gives it a competitive edge over
petrol, and allows retailers to sell fuel ethanol more cheaply than
straight petrol. Without subsidisation, the limited market
penetration of fuel ethanol would be even smaller than it is
now.
The Howard Government also subsidised domestic ethanol
production in the form of capital grants to increase production
capacity[17] and
encouraged service stations to sell fuel ethanol.[18] However, the cost of these
programs was relatively small compared with the cost of the
production subsidy.
The customs duty protects the domestic industry against imports.
Protection is inconsistent with the policy of Australian
governments of both political persuasions to reduce protection.
Protection is also at odds with Australia s policy of encouraging
other countries to lower their trade barriers. However, protection
will end on 1 July 2015 when domestic and imported ethanol will be
treated the same (see below). Concern that the domestic ethanol
industry will not be able to compete with imports when protection
is eliminated is a factor behind the calls for a mandate.
A difference between a mandate and current arrangements relates
to transparency. Whereas the cost of the subsidy and capital grants
is explicit and detailed in Budget papers, the cost of a mandate to
consumers would be implicit.
Under the Howard Government s fuel tax proposals, which were
contained in the energy white paper, ethanol domestic and imported
will receive a long-term advantage by being taxed less than petrol.
Under the proposals, on 1 July 2011, the effective rate of excise
on ethanol will be 2.5 cents per litre. The effective rate will
increase to 12.5 cents per litre on 1 July 2015.[19] The excise on petrol
will, however, remain at 38.143 cents per litre. The discounted
rate of 12.5 cents per litre will thus continue to advantage
ethanol relative to petrol.
Also from 1 July 2015, domestically-produced and imported
ethanol will attract the same effective rate of excise and customs
duty respectively. This will eliminate the current protection of
the domestic ethanol industry.
Biofuels Taskforce
On 30 May 2005, the Howard Government announced the formation of
a taskforce to examine, among other things, the scientific evidence
on the effects of ethanol and other biofuel use on health and the
environment.[20] In
August 2005, the Biofuels Taskforce (the Taskforce) reported to the
government.[21]
This report is the most comprehensive independent analysis of the
ethanol industry in Australia and included input from the
Australian Bureau of Agricultural and Resource Economics (ABARE).
The establishing of the Taskforce followed the release of two
earlier reports on the viability of biofuels production.[22]
As noted, fuel security is an argument advanced for a mandate.
In this context, fuel security is defined as reduced reliance on
imported oil (and petroleum products). Mandate advocates also argue
that a mandate would reduce the trade deficit with domestic ethanol
production replacing some oil imports.[23]
The Howard Government rejected the fuel security argument. The
Government s position with respect to fuel security and alternative
transport fuels was set out in the energy white paper:
there is currently no case for the government to
accelerate the uptake of these fuels on energy security grounds. To
do so would involve additional costs for consumers, with few energy
security benefits.[24]
A reduction in oil imports resulting from a mandate is only one
of several possible effects on the trade account. The ability to
meet mandate demand for feedstock depends on the availability of
supply. The 2002 Fuel Tax Inquiry noted:
Some submissions to the Inquiry advocated
domestically produced renewable fuels as a measure to increase fuel
security. As these renewable fuels would be derived mainly from
purpose grown agricultural crops or waste products, the inevitable
variations in weather patterns affecting agricultural output and
market conditions will reduce the certainty of supply from such
sources.[25]
A shortfall in the supply of feedstock might result in reduced
exports or increased imports of feedstock. Either would increase
the trade deficit and so counter the reduction in oil imports. The
net effect on the trade account would depend on the specific
circumstances. For example, during a drought:
if a national E10 target were to be met (eg. by
5.5 Mt of wheat as the feedstock), it could force the import of
wheat in drought years.[26]
Imports, by increasing the volume of feedstock available, would
reduce domestic prices of feedstock in short supply. However,
quarantine restrictions may prevent the import of some commodities.
This would result in domestic prices of quarantine-restricted
feedstock remaining above international prices. Under a mandate,
high domestic prices of quarantine-restricted feedstock would
increase ethanol production costs. These would flow through into
higher fuel prices and inflation unless ethanol producers were able
to substitute alternative feedstocks. Higher fuel prices would
adversely affect the competitiveness of export and import-competing
industries.
The effects of adverse feedstock supply conditions on ethanol
production could be similar to those the biodiesel industry
experienced in 2006. In this case, drought caused the price of
feedstock such as canola to rise, in turn contributing to financial
losses in the industry.[27] In periods of drought, a mandate could reduce the
availability of feedstock used for other purposes including food
production. A reduced supply of food inputs would increase food
prices and hence inflation.
More generally, a mandate is a sector-specific,
import-replacement argument. As such, it is reminiscent of
arguments advanced in the 1950s and 1960s when import replacement
was advocated as a means of coping with foreign exchange shortages
under the then system of fixed exchange rates. While
import-replacement arguments might have had some validity in the
era of fixed exchange rates, they have little validity in an era of
floating exchange rates:
Foreign exchange savings remains a frequently
cited benefit of domestic biofuel programs. However, foreign
exchange benefits are much less important today as more countries
maintain flexible exchange rates. If a country is pursuing a
market-based approach to setting the exchange rate and the official
rate reflects real economic values, then there would be no need to
distinguish between local currency and foreign exchange costs or
benefits of biofuel programs.[28]
Advocates argue that a mandate would increase economic activity
in regional areas through employment at ethanol plants and
increased demand for agricultural commodities. For example, it has
been estimated that a full-scale sorghum-to-ethanol plant would
require about 200 000 tonnes of grain annually.[29] Another study estimated
that:
The appearance of a new group of domestic grain
buyers requiring at least 2.5 million tonnes of grain would also
represent a potential increase in total domestic sorghum and wheat
use in the order of 35 per cent over average domestic use in the
period 2003 04 to 2005 06.[30]
However, as discussed below, the additional demand may be met by
diverting grain from other purposes such as exports.
As noted, the Howard Government had a production target of 350
megalitres of biofuels by 2010. In work undertaken for the
Taskforce, ABARE estimated that meeting this target would generate
an additional 648 jobs 216 directly and 432 indirectly in regional
areas.[31] The
annual cost (in 2004 05 dollars) of each of the 648 jobs was
estimated at $182 000 in government expenditure and $139 000 in
economic costs. The Taskforce noted that while these costs appear
high, they could be offset by other benefits such as emission
reductions.[32]
The high cost of job creation (in 2004-05, average weekly
ordinary time earnings were about $51 000) means that it would be
cheaper to pay each worker average weekly earnings to do nothing
than to subsidise them to produce ethanol. Given the cost of job
creation under current policy settings, the cost of creating jobs
would be likely to be even higher under an E10 mandate.
ABARE also estimated that there would be no net gains to
employment nationally from meeting the 350 megalitres
target.[33] This is
partly because the current subsidisation of ethanol production
transfers resources from one group (taxpayers) to another (ethanol
producers). While employment rises among subsidy recipients, it
falls in other sectors of the economy. That s because the taxes
used to subsidise ethanol production reduce consumers purchasing
power and hence spending and job creation in other sectors of the
economy. The effects of a mandate on employment could be similar,
that is, more jobs in the subsidised sector but fewer in the rest
of the economy. A difference is that, under a mandate, resources
would be redistributed from motorists rather than taxpayers.
Some rural industries claim that a mandate would affect them
negatively. The Livestock Feed Grain Users Group, for example, has
stated:
We are not opposed to the production and use of
biofuels in Australia. We are opposed to the ongoing subsidisation
of grain based ethanol in Australia; this will disadvantage our
grain dependent industries, and result in the propping up of an
essentially nonviable industry at the expense of successful
industries.[34]
The Taskforce addressed this issue:
The Taskforce considers that, on current policy
settings, there is real potential for subsidised grain ethanol
plants to have a local impact on feedgrain prices in the short to
medium term. In the longer term, fuel ethanol rates of return are
likely to drop as the policy settings reduce the subsidies and as
ethanol import competition is allowed in 2011. The fuel ethanol
industry will then be placed on a more even footing in its ability
to bid for grain against the livestock industry.[35]
A mandate could have long-term adverse effects on other rural
industries. A study by the Centre for International Economics for
the beef industry found:
Mandatory blending of ethanol at 10 per cent for
petrol and 15 per cent for diesel would permanently increase the
average price of grain in Australia by over 25 per cent. This would
be well over current export parity prices, and prices paid by
Australia s competitors. By 2010, ethanol production would demand
an additional 12.1 million tonnes of grain. This is relative to a
potential pool of feedgrain of around 28 million tonnes in 2010
If grain production fell by 50 per cent in 2010,
as it did in 2002-03, total availability of grain would fall to
around 14 million tonnes. In this situation grain prices could rise
as high as $450 per tonne. This would seriously affect livestock
industries that compete directly with other countries on world
markets and would have the potential to shut down parts of our
leading export oriented industries including beef and dairy
[36]
The report also found that, in a non-drought year, mandatory
blending of locally produced ethanol would reduce imports of petrol
and diesel but also forego exports and incur additional
imports.[37]
In short, under a mandate:
the government would be subsidising one rural
sector, the grains sector, at the expense of another, namely
livestock.[38]
While it is generally more costly to produce energy from
renewable resources than from fossil fuels, this does not take
account of the costs of negative externalities resulting from
fossil fuel use such as air pollution nor positive externalities
such as reduced greenhouse gas emissions of alternative fuels.
Advocates argue that the mandated use of fuel ethanol would result
in environmental benefits including lower air pollutant emissions
and lower greenhouse gas emissions. In 2005, transport accounted
for more than 14 per cent of carbon dioxide equivalent
emissions.[39]
Fuel use is the single largest contributor to air pollutant
emissions in Australia.[40] A study by the Bureau of Transport and Regional
Economics estimated that in 2000, motor vehicle-related ambient air
pollution resulted in an economic cost of morbidity ranging from
$0.4 billion to $1.2 billion while the economic cost of
mortality ranged from $1.1 billion to $2.6 billion.[41] This raises the
question of what contribution a mandate would make to reducing the
costs of air pollution. The Taskforce s review of the studies of
exhaust emissions from fuel ethanol found that the benefits are
mixed:
Results from studies that have been conducted
throughout the world on exhaust emissions from ethanol-blended
fuels are contradictory, making it difficult to generalise on
emission outcomes and performance of ethanol blends.[42]
For example, in the case of E10, carbon monoxide emissions are
lower but nitrous oxide emissions are higher compared with straight
petrol. Further, while E10 results in lower tailpipe emissions of
some toxic compounds, it results in higher emissions of others.
Consequently, the Taskforce was unable to quantify the health costs
and benefits of E10:
Given the uncertainties surrounding the level of
particulate reduction from E10, it is not possible to quantify the
health costs and benefits of E10 use.[43]
It is likewise not possible to be definitive about the benefits
of a mandate in terms of reduced greenhouse gases because the
benefits would depend on many factors:
The net impact on greenhouse-gas emissions of
replacing conventional fuels with biofuels depends on several
factors. These include the type of crop, the amount and type of
energy embedded in the fertilizer used to grow the crop and in the
water used, emissions from fertilizer production, the resulting
crop yield, the energy used in gathering and transporting the
feedstock to the biorefinery, alternative land uses, and the energy
intensity of the conversion process In practice, the amount and
type of primary energy consumed in producing biofuels and,
therefore, the related emissions of greenhouse gases, vary
enormously.[44]
With respect to greenhouse gas emissions from the use of fuel
ethanol, the Taskforce review of studies found that:
On life-cycle analysis, savings in greenhouse gas
emissions from E10 over neat petrol are generally from 1-4%,
depending on feedstock. However, the taskforce considers that a
recent life-cycle analysis for a proposed ethanol plant has
suggested that savings of between 7 and 11.55 can be achieved with
optimum use of non-ethanol products.[45]
These orders of magnitude are similar to those reported in
another study:
When used in an E10 blend, greenhouse gases
(compared to unleaded petrol) are lower by 1.7 % (from wheat) to
5.1% (C-molasses using co-generation).[46]
The Taskforce concluded that the cost of obtaining greenhouse
gas benefits from subsidising biofuels is high in terms of lower
gross domestic product (GDP). Consequently:
Greenhouse gas benefits alone would not warrant
further assisting biofuels, given the availability of much cheaper
carbon reduction options.[47]
This suggests that a fuel ethanol mandate would also be a
relatively costly way of reducing greenhouse gas emissions. This is
consistent with the findings of other studies:
The overall cost-effectiveness of biofuels seems
to be low in almost all cases. Costs are relatively high per unit
of fossil energy or per unit of CO2 emissions reduced
The implication of these calculations is that one could have
achieved far more reductions for the same amount of money by simply
purchasing CO2-equivalent offsets at the market price.
[48]
As it is, the environmental benefits of ethanol are being
increasingly questioned because the production of ethanol also
generates negative externalities. An OECD roundtable on sustainable
development concluded:
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 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 greenhouse gases compared with gasoline and
mineral diesel. The other conventional biofuel technologies
typically deliver greenhouse gas 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.
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.[49]
The cost of feedstock is a major factor in the viability of
ethanol production: an OECD study found that feedstock accounts for
more than half the total cost of production.[50] In Australia, feedstock costs
typically represent 60 to 70 per cent of operating costs.[51] In Australia, ethanol
is produced from C-molasses and starch. Both are relatively
low-value by-products (of sugar and wheat milling respectively).
Scope for using these feedstocks to expand ethanol production seems
to be limited. CSR, for example, has stated that it is unlikely
that molasses will supply the industry:
The reality of molasses, though, is that it is
expensive to transport and it is not produced in quantities large
enough at one site to economically produce ethanol So it is
unlikely that molasses will supply the industry.[52]
For the time being, CSR has ruled out using sugar as a
feedstock:
it is our view that sugar is too valuable as sugar
under current and historic scenarios, relative to the price or
likely price of oil (or more specifically gasoline) to be viable as
a source of fuel ethanol.[53]
What the additional feedstock needed for a mandate might be is
unclear but grains (such as sorghum, wheat and barley), oilseeds,
and non-food inputs (notably lignocellulose) have been mentioned.
These sources may, however, be more costly than C-molasses and
wheat starch. The Australian Cane Growers Council, in its
submission to the Senate inquiry into Australia s future oil supply
and alternative transport fuels, shows a rising supply cost curve,
that is, additional ethanol supply would be forthcoming only by
using progressively more expensive feedstock.[54]
An issue in the mandate debate is whether the capacity exists to
supply the additional feedstock needed for a mandate from domestic
sources. In particular, a question that arises is whether it is
possible to meet demand for feedstock resulting from a mandate as
well as for food crops and exports. This could possibly be done by
expanding the area under crops. However, meeting mandate demand
could result in land being diverted from food crops and
exports.[55] The
International Energy Agency has noted:
production of biofuels can draw crops away from
other uses (such as food production) and can increase their price.
This may translate into higher prices for consumers.[56]
An OECD study of the effects of the production of biofuels in
the US, Canada and the European Union on agricultural markets
found:
The results of these calculations suggest that the
three OECD regions, the US, Canada and EU (15) would require
between 30% and 70% of their respective current crop area if they
are to replace 10% of their transport fuel consumption by biofuels,
assuming unchanged production technologies, feedstock shares and
crop yields, and in the absence of international trade in biofuels
or use of marginal or fallow land. However, only 3% would be
required in Brazil.[57]
Whether land availability in Australia would limit growth in
biofuels production based on sugar, grain and other crops may be
another matter. The potential for land diversion under a mandate
would depend on factors such as the feedstocks used, the
availability of suitable land, and the size of the mandate (for
example, E5 or E10). The Taskforce found:
While the feedstock for a 350 megalitre biofuel
target can be sourced from existing crops, further expansion of the
industry may require farming of additional land However, to the
degree that biofuels will draw feedstock away from current uses
such as export, there need be no significant additional land
use.[58]
Views differ on the potential for competition for land use under
a mandate in Australia. The Howard Government s position, as set
out in the energy white paper, was that land would have to be
diverted from other uses to meet the extra feedstock demand:
Supplying a substantial proportion of fuel
requirements from biofuels would be difficult and require the
transfer of land use from other productive purposes. For example,
converting the total national oilseed crop to biodiesel would only
produce 6 per cent of Australia s current diesel needs.[59]
In the case of sugar, Rabobank has stated:
Sugar cane production in Australia is,
essentially, stable. There is limited scope for increases in land
area planted to cane because of constraints imposed by regulation
and geographical suitability. There is scope for some conversion of
land from other agricultural uses to cane, depending on the
relative price of commodities; however, this potential is limited.
Were an ethanol industry to be established based on sugar, there is
not the scope to increase cane production substantially. Ethanol
would therefore have to compete with the sugar industry for
available cane and the pricing of ethanol feedstock would have to
be at a sugar export parity price.[60]
On the other hand, the Manildra Group argues that:
Australia has the capacity to produce all the
agricultural products which are required as feedstock for the
production of renewable fuels such as ethanol. Major industry
participants such as The Grains Council and Australian Wheat Board
Ltd have indicated their strong support for the development of a
renewable fuels industry.[61]
Renewable Fuels Australia argues that competition for land would
be limited. This argument holds that the supply of agricultural
commodities is now demand-constrained and, in particular, a lack of
export demand has limited domestic production. The additional
demand under a mandate would, in effect, activate idle
land.[62]
A mandate could increase domestic grain prices by increasing
demand for grain. Whether the increase could be sustained is
another matter. Australia is generally a price taker on
international markets for agricultural commodities, so farmers can
export as much as they can sell profitably at international prices.
After rising initially, domestic grain prices could fall back to
international prices (allowing for factors such as shipping costs)
for several reasons: the domestic supply of grain could
increase,[63]
imports could rise (assuming no quarantine restrictions), and
supplies could be diverted from exports to the domestic market. If
higher grain prices were sustained, this would drive up ethanol
feedstock costs.
Some have likewise questioned whether a mandate would increase
sugar prices in the long term:
even if sugar were the main feedstock, the price
paid by ethanol producers would be just sufficient to bid product
away from the export market; cane growers would see little or no
benefit.[64]
That s because domestic sugar prices are determined on world
markets that is, Australia is a price taker and domestic ethanol
producers would not pay above the world (export) price for sugar to
obtain feedstock.
A key issue is whether a mandate would result in an ethanol
industry that is competitive without on-going government
assistance. As stated by the Taskforce:
Some submissions argued that biofuels benefit the
Australian economy by improving the balance of trade. Substituting
locally produced biofuels for imported petroleum products could
benefit the Australian economy only if they could be produced and
sold competitively with imported alternatives without significant
government assistance.[65]
Australia s experience of industry assistance is that it can
result in small-scale, fragmented industries unable to compete with
imports or export because of high cost structures. The cost to the
economy of such assistance is the production foregone by employing
resources in the assisted industries rather than in the more
productive activities in which Australia has comparative advantage.
In other words, GDP is below its potential. ABARE concluded that
assisting the biofuels industry to meet the 350 megalitre target
will reduce GDP:
modelling by ABARE forecasts a reduction in GDP of
$90 million in 2009 10 for 350 ML biofuels market
penetration, dropping in steps each year to $72 million in
2015.[66]
An E10 mandate would require a volume of ethanol about 5.5 times
the 350 megalitre target.[67] In short, while the current system of government
support for biofuels can be expected to result in economic costs to
the community,[68]
an E10 mandate could result in an even bigger reduction in GDP.
This raises the question of whether the production of ethanol
can be viable without on-going assistance. The International Energy
Agency, in commenting on the outlook for biofuels globally,
stated:
Higher oil prices have made biofuels more
competitive with conventional oil-based fuels, but further cost
reductions are needed for most biofuels to be able to compete
effectively without subsidy.[69]
Brazil is the lowest-cost ethanol producer.[70] Hence, in economic terms,
Australia should import ethanol from Brazil rather than try to
produce it domestically. Moreover, it seems likely that Brazil will
continue to have comparative advantage in ethanol production for
some time:
While technical progress in agricultural and
biofuel production as well as land use changes are likely to
improve efficiencies of biofuel production processes, both
production costs and area requirements suggest a substantial
comparative advantage of Brazil relative to OECD countries.[71]
This suggests that Australian ethanol will not be able to
compete against Brazilian ethanol without assistance.
Assistance to ethanol production might be justified on infant
industry grounds. This argument holds that assistance can help to
establish a new industry. As the industry develops, its costs fall
so that it can eventually compete without government assistance.
But it is sometimes overlooked that this argument also requires
that assistance be temporary lest the assistance result in an
uncompetitive industry. A permanent mandate could have such
consequences.
There is no comprehensive assessment of the economic
consequences of an ethanol mandate in Australia. An evaluation of a
mandate would also examine alternatives. As noted, a mandate seeks
to attain multiple objectives. An assessment of a mandate would
examine whether these objectives could be attained by other means
and evaluate the relative costs and benefits of each alternative.
For example, an alternative to a mandate would be to expand current
arrangements. The cost to the Budget of subsidising the volume of
ethanol equivalent of an E10 mandate, at the current rate of
subsidy, would be in the order of $758 million annually.[72] Direct payments
through the Budget would be the most transparent form of subsidy,
and would allow spending on subsidies to be weighed against other
social priorities.
The principle of examining alternatives to a mandate applies to
environmental outcomes. A cost-benefit analysis of a mandate would
take account of all externalities, including the additional
greenhouse gases generated from growing additional feedstocks and
ethanol manufacture as well as any reductions resulting from the
increased use of ethanol.[73] As noted, the net environmental benefits of ethanol are
increasingly being questioned.
Further, an assessment of a mandate would examine which method
is the least-cost means of obtaining environmental benefits. As the
Taskforce observed:
Any confirmed air quality benefits from biofuels
need to be evaluated side by side with the costs and benefits of
other approaches to reducing emissions.[74]
For example, to reduce greenhouse gas emissions, an alternative
is to tax petrol more heavily. The Fuel Taxation Inquiry
concluded:
The strong relationship between fuel consumption
and greenhouse gas emissions makes fuel tax an appropriate
instrument for charging for the costs of climate change
attributable to fuel use.[75]
Another alternative to a mandate is to import ethanol. At
present the cost of imported ethanol is cheaper than domestically
produced ethanol and hence is likely to be less costly in broader
economic terms than a mandate. Imports might also help to ensure
consistency of fuel supply[76] while diversifying geographic sources of supply and the
composition of fuels. Further, the cheaper ethanol is, the more
likely it is that motorists will use fuel ethanol. In the United
States, where imported ethanol is subject to a tariff, it has been
argued:
if ethanol is truly to succeed as a motor fuel, it
will have to be the cheapest ethanol globally available. And
consumers would benefit most if the market, not special-interest
politics, decided how much ethanol to use and where it should come
from. If lawmakers really want drivers to use ethanol, they must
allow free trade in this alternative fuel.[77]
One study found that if the tariff were removed, ethanol prices
in the United States would fall by fourteen per cent.[78]
As noted, the Taskforce found that the cost of creating each job
in regional areas under current policy settings is high at $182 000
in government expenditure and $139 000 in economic costs (in 2004
05 dollars). The high cost of job creation raises the question of
whether there are less costly ways of creating jobs in rural areas,
that is:
whether assistance to biofuels represents the most
cost-effective and best-targeted option for assisting regional
development.[79]
For example, an option might be to produce ethanol from
lignocellulose from trees. A study by the Bureau of Transport and
Communications Economics found that the feedstock with the best
potential to reduce overall greenhouse gas emissions is wood, and
an extensive program to produce ethanol from wood could increase
employment in regional areas. Further, potential supplies of
lignocellulose in Australia are large. However, the cost is
uncertain.[80]
In the future, whether ethanol is competitive with petrol
without government assistance will depend on the cost of ethanol
production relative to the cost of petroleum-based fuels. High oil
prices provide an incentive to develop new technologies for
alternative fuel production. But high oil prices are a twin-edged
sword because they also increase agricultural feedstock production
costs:
The analysis also shows that commodity markets are
strongly influenced by crude oil prices. Higher oil prices as
currently observed increase production costs in agriculture, but
also create higher incentives for biofuel production, thus
stimulating demand for feedstock products. The degree to which
biofuel quantities would increase strongly depends on parameters
that are yet unobserved. Nevertheless, the results of this analysis
suggest that the impacts of high oil prices on agricultural markets
may well be dominated by their direct effects on agricultural
production costs rather than by the increased demand for
agricultural commodities.[81]
Fluctuations in crude oil prices, which make it difficult to
discern price trends, may also contribute to a reluctance to invest
in ethanol production capacity. The following chart shows how real
oil prices have fluctuated since 1970.
Source: International Monetary Fund, World Economic
Outlook, April 2006, p. 72.
Whether ethanol is uncompetitive with petrol without government
assistance will also depend on new technologies. In the future,
feedstock for ethanol production may be derived from
non-traditional sources. The International Energy Agency has
observed:
New biofuels technologies being developed today,
notably enzymatic hydrolysis and gasification of woody
ligno-cellulosic feedstock, could allow biofuels to play a much
bigger role than that foreseen in either scenario. Ligno-cellulosic
crops, including trees and grasses, can be grown on poorer-quality
land at much lower cost than crops used now to make biofuels. They
may also be more environmentally benign. But significant
technological challenges still need to be overcome for these
second-generation technologies to become commercially
viable.[82]
Similarly, the US National Commission on Energy Policy:
believes that ethanol produced from cellulosic
(i.e. fibrous or woody plant materials) should be the focus of
near-term research cellulosic ethanol offers substantial energy
security, environmental, and long-term cost advantages compared to
corn-based ethanol.[83]
The Senate Standing Committee on Rural and Regional Affairs and
Transport, in its final report on Australia s future oil supply and
alternative transport fuels, commented:
The committee does not consider that there is any
point at this time in mandating a minimum percentage of ethanol in
petrol. Unless lignocellulose technology becomes viable with
unexpected speed, supply will not be sufficient to produce the
necessary quantities of fuel.[84]
An ethanol mandate would have economic costs and benefits. Their
precise nature and magnitude would depend on many factors including
the specific feedstock, its availability, the effects on other
industries including other rural industries and the technology
used. In the absence of an evaluation of these factors, it is not
possible to say exactly where the balance of costs and benefits of
a mandate would lie.
A feature of the mandate debate is the lack of discussion of
alternatives. As noted, there are other ways of attaining a mandate
s objectives. These include increasing fuel taxes and eliminating
the tariff on imported ethanol. It would be prudent to evaluate the
costs and benefits of a mandate, and the relative merits of
alternatives, before adopting a mandate.
The expansion of ethanol production in other countries notably
Brazil and the United States is sometimes seen as something that
Australia should follow. However, it is important to recognise that
the existence of ethanol industries in both countries is, to a
large extent, the consequence of government assistance. Moreover,
the circumstances in other countries differ from those in Australia
and it can not be assumed that they can somehow be reproduced here.
In the United States, for example, it would be difficult for
ethanol to compete with petrol without government assistance:
rising fossil fuel prices improve renewable energy
s market competitiveness; however, significant improvement of
existing technology or the development of new technology still is
needed for current biofuel production strategies to be economically
competitive with existing fossil fuels in the absence of government
support.[85]
Further, the merit of government support policies in other
countries has been questioned.[86] Among the reasons is that:
a review of available data suggests that
farm-based energy production is unlikely to be able to
substantially reduce the nation s dependence on petroleum imports
unless there is a significant decline in consumption. Also, other
uses (food, animal feed, industrial processing, etc.) of biomass
feedstocks are likely to be adversely impacted by rapid growth in
use for bioenergy.[87]