Issues Magazine

Biofuels: At What Cost?

By Derek Quirke, Tara Laan and Bob Warner

In recent years, governments of numerous countries have promoted industrial-scale production and use of liquid biofuels and backed that commitment with financial support. What form is such support taking in Australia, and is it cost-effective?

Biofuels have attracted particularly high levels of assistance in some countries given their promise of benefits in several areas, including agricultural production, greenhouse gas emissions, urban air quality, energy security, rural development and economic opportunities for developing countries. Such alleged benefits have enabled those promoting biofuels to assemble unusually broadly based support for fiscal and regulatory relief.

But the ability of biofuels to deliver against these objectives may be questioned. Biofuels can have unintended effects that undermine the fiscal and environmental goals they are purported to support. Scrutinising the extent of government support for biofuels highlights the opportunity cost of financial assistance to biofuel industries over other options available to policymakers. It also questions whether such levels of support are justified in the context of long-term viability of the industry in the absence of subsidies.

In the 2006–07 financial year, Australian federal and state governments spent around A$95 million supporting the production and consumption of biofuels. This number could grow to several hundred million dollars per year, despite a recent downturn in the Australian biofuel industry. The expected completion of new ethanol and biodiesel manufacturing plants over the next 2 years will lead to higher production- and consumption-related support.

Biofuels make up only a fraction of the nation’s fuel supply: less than 0.5% of the 19 billion litres of automotive petrol (gasoline) consumed each year, and perhaps 1% of the 17 billion litres of automotive diesel consumed. Although both total transfers (see box) and effective support per litre are roughly similar for ethanol and biodiesel, support per gigajoule, a standard unit of energy, is higher for ethanol than biodiesel.

Australia’s biofuel industry is heavily supported compared with other industries. The effective rates of assistance (ERAs) for most biofuels 100% or more (i.e. government assistance is at least as large as the value added through producing the fuel). For some feedstock–fuel combinations, without that assistance most biofuel producers would only be able to cover the variable costs of production, and some not even that. The ERA for biofuels is significantly higher than the ERAs for agriculture and manufacturing as a whole, which now averages around 5%, while the most-assisted industries (dairy cattle farming and textiles, clothing, footwear and leather) had ERAs, respectively, of 15% and 13% in 2006–07.

The largest element of assistance for biofuels in Australia is an excise tax rebate, provided as a per-litre grant to producers that exactly offsets the A$0.38143 fuel excise duty. The grant is not available for imported ethanol but it covers both imported and domestically produced biodiesel. Domestic production of biofuels (as well as imported biodiesel) will continue to be effectively excise-free until 30 June 2011. After that, excise duties for both biofuels will rise until, by 2015–16, they will be equivalent to 50% of the excise payable on petrol and diesel on an energy-equivalent basis.

Complementing favourable tax treatment and production assistance, producers of fuel ethanol and biodiesel have also benefited from numerous grants tied to investment in fixed capital provided mainly by the federal government. The biggest was the Biofuels Capital Grants Program, which awarded A$37.6 million to three ethanol and four biodiesel producers in 2004. But other grants, worth tens of millions of Australian dollars in total, were also awarded between 2001 and 2006 in order to support investment in biofuel plants under programs designed to promote innovation, restructure the sugar industry, or reduce greenhouse gas emissions.

In 2001, the federal government set a non-binding target for biofuel production of 350 million litres per year by 2010 (equivalent to approximately 1% of the nation’s transport fuel consumption). In contrast with many other national governments, the Australian federal government has so far resisted calls from the industry to mandate particular volumes or blending ratios in the nation’s transport fuels.

A state-level parliamentary inquiry in Victoria released a final report in February 2008 that recommended against a biofuel mandate in that state. In contrast, in 2006 New South Wales and Queensland established requirements that petrol in their respective jurisdictions contain at least 10% and 5% ethanol, respectively, by 2011. The NSW government is currently reviewing this commitment. Other states are also considering the establishment of their own volumetric or blending mandates.

Is such government intervention in the fuels market, and assistance to biofuel production and use, warranted? While biofuels can provide some benefits both through the displacement of petroleum and fossil fuels, and (under certain restrictive conditions) through reducing greenhouse gas emissions, these gains are relatively small in comparison with their subsidy cost. To measure assistance per unit of fossil fuels avoided through the use of biofuels, one has to take into account the (non-renewable) energy used to plant, fertilise and harvest (in the case of plant-derived biofuels), transport and process their feedstocks into fuel. Such a calculation yields subsidies for fossil fuels avoided that are in the same range as the wholesale prices of the petroleum-derived fuels that they displace. In other words, the government could have obtained the same fossil-fuel displacement by buying equivalent quantities of petroleum fuels on the open market. The substantial petroleum-based fuel input to biofuel production leads to marginal benefits in terms of energy security.

Subsidising ethanol at current rates is generally less cost-effective than subsidising biodiesel as a means to reduce greenhouse gas emissions. In addition, subsidising biofuels from whole crops is less cost-effective than subsidising biofuels from low-grade or “waste” materials, such as C-molasses, waste starch or used cooking oil. Even so, the subsidy cost of obtaining a 1-tonne reduction of carbon dioxide through biodiesel production from used cooking oil could purchase more than 5 tonnes of carbon dioxide-equivalent offsets on the European Climate Exchange, or more than 30 tonnes on the Chicago Climate Exchange.

Although there is currently little biofuel production in Australia from higher value products, such as grains and oil seeds, many new plants are designed to use these feedstocks, which would increase the subsidy price of any carbon dioxide reductions. For example, the subsidy cost of obtaining a 1-tonne reduction of carbon dioxide through ethanol production from wheat could purchase more than 20 tonnes of carbon dioxide-equivalent offsets on the European Climate Exchange, or around 140 tonnes on the Chicago Climate Exchange.

Industry assistance is sometimes justified as being necessary to support infant industries that will later be economically viable and generate employment. But experience has shown that assistance to the biofuel industry is unlikely to be temporary. More established biofuel industries, including those in Brazil, the United States and the European Union, remain dependent on mandates or subsidies, or both, after decades of public support.

Australia’s agricultural system and climate may also be unsuitable to sustain a large biofuel industry based on annual crops, due to the cyclical patterns of drought that dramatically reduce crop yields in some years. This was demonstrated in 2007 when several biodiesel plants suspended production due to high feedstock prices, and plans for proceeding with the construction of several new ethanol and biodiesel facilities were cancelled. Uncertainties about biofuel markets, government legislation and consumer acceptance in the Australian market were also contributing factors for some companies cancelling investments.

The industry and its proponents had hoped for new pledges of support from the major political parties during the 2007 federal election, but no such commitments were made (see On the contrary, the federal government has signalled that the rate of assistance for biofuels provided by the federal government in the future will be less than it is today. First, as a result of low production and uptake f biofuels, the federal government forecast savings in biofuel-related expenditure totalling A$15.8 million for the 2008–09 Budget. Second, no new grants for capital construction are planned. Third, the production bounties that fully offset the excise duties on both ethanol and biodiesel will be phased out over a 4-year period, starting in July 2011.

The new excise duties on biofuels will, nonetheless, still contain a significant element of subsidy, as they will be set at half (or less) of the rate they would be charged were they set proportional to the energy value of these fuels relative to their petroleum-derived counterparts. The cost to the federal government of reduced revenues from excise duty, should the volume of biofuels consumed rise substantially over the next decade, could therefore be significant in future years. The threat remains that, even with these announced curbs on subsidy growth, the ethanol tariff or production bounties could very well be extended in response to industry or other interest-group pressure. Some excise-duty differential might be appropriate for biofuels, related to their tailpipe emissions and life-cycle greenhouse-gas emissions, but the current regime does not discriminate on this basis.

Several recommendations for the federal government are to:

  • continue to resist calls for instituting national blending mandates for biofuels, at least without first undertaking a thorough examination of the costs and benefits;
  • avoid providing new specific subsidies to the industry, and do not prolong the phasing-out of the existing production grants and the phasing-in of the final excise duty;
  • re-evaluate the arbitrary decision to set the final excise duty for biofuels at no more than 50% of the energy-weighted excise duty applied to petrol and biodiesel;
  • remove barriers on trade in ethanol;
  • adopt neutral policies favouring all options to reduce reliance on petroleum in the transport sector or greenhouse gases;
  • improve the information available on transfers provided to the biofuels industry and the effects of such assistance; and
  • establish a transparent evaluation process to assess:
    • the cost-effectiveness of support policies at all levels of government in attaining the declared objectives behind biofuels policy, and
    • the long-term economic viability and international competitiveness of an Australian biofuels industry in the absence of assistance and trade protection.

Adapted with permission from the executive summary of Biofuels: At What Cost? Government Support for Ethanol and Biodiesel in Australia. Prepared by the authors for the Global Subsidies Initiative of the International Institute for Sustainable Development, Geneva, Switzerland, April 2008.