Remaking Biofuels Policy: Neutrality and Competition

Draft for comment, April 2007
Doug Koplow, 
Comments/suggestions to

Current Biofuels Policy is Disfunctional and Creating Increasingly Serious Problems

The biofuels system in the US is not working.  True -- production capacity continues to grow at a rapid pace.  But most of that growth is in corn-based ethanol, a fuel that even ardent biofuel proponents argue is of marginal environmental benefit.  Some of the new plants to make this "green" fuel will rely on increasing inputs of coal, hardly a renewable resource. 

The downsides of this growth have been coming to the surface with ever greater frequency.  Every day brings new articles about some of the problems with biofuel production around the world:  air emissions, conversion of erodible or environmentally sensitive land to monoculture biofuel crops; concerns over water depletion; rising food prices in poor countries.  Yet, there are more than 200 subsidies to ethanol and biodiesel already in place in the US, and scores more pending before state legislatures and the US Congress.  Some of the leading presidential contenders are promoting increasingly aggressive policies to force usage of these fuels with apparently little consideration of the environmental cost of their advocacy, or of the lower impact alternatives they are marginalizing. 

A critical point often lost in the perpetual pressure for more and more subsidies (S. 23, for example, plans to add ethanol sales tax credits to already existing tax credits for producers and blenders) is that the purpose of all of the governmental intervention is not to make more biofuels.  Rather, it is to enable the United States to use less petroleum (for energy security) and emit less carbon (for climate change) per vehicle mile traveled.  These are a very different end-goals, and ones towards which there are far more paths than through the corn or switchgrass field alone.

This essay outlines a way to restructure the existing subsidies and mandates to decouple them from subsidizing corn-based ethanol or biodiesel.  Rather, the goal of the restructured policy is to generate fierce competition between all of the possible ways that the United States can reduce the amount of petroleum needed for each mile driven.  Another element of this plan is to integrate the widely differing environmental profile of various transport alternatives, differentiation that is too often missing from the current legislative small print.

This outline is a first step, and refinements are undoubtedly needed.  If you have concerns about the proposed structure, or suggestions for how to improve it, please e-mail me. Of particular interest are ideas on how to integrate vehicle efficiency improvements into the reverse auction systems described below, without watering down efforts to make baseline fuel efficiency standards more stringent over time.

Renewable Fuel Standards (RFS) Should be Competitive, and Replace the Panoply of Other Subsidies

The renewable fuel standards mandate that a pre-specified quantity of eligible fuels be consumed in the United States by a particular point in time.  Although nearly every possible stage of biofuels production is subsidized somewhere, the market entry of alternative fuels can be driven -- should be driven -- by the RFS alone.  Other subsidies, such as production and blenders credits, duplicate this function, introduce opportunities for corruption and political favors, and generally drive costs up. 

Much more effective would be to treat the mandated quantity like is done in renewable electricity portfolio standards in many states.  Using this approach, the government would qualify sources, then make them bid against each other for inclusion within the mandated quantity.  A reverse auction approach would be used with any qualifying sources able to bid.  The mandated quantity would be filled by whichever gallons bid the lowest amount of subsidy needed to fill supply.  Assuming no collusion, these bids would likely be much lower than the 51 cpg blender credit now given to all comers.  (Note that the actual subsidy is higher than 51 cpg since the tax credit itself appears not to be included in taxable income, making it much more valuable to the recipient).

The cost per unit energy subsidized would also decline over time as competition and improved technology brought costs down.  The goal is to reduce the amount of taxpayer money "left on the table" when supporting this production capacity.  However, the approach might also mitigate some of the risk to producers from feedstock price spikes.  This would occur because all bids would likely move higher as prices for the major fuel-feedstock crops rose.

Credits Under any RFS Should Award Less Credit to Dirtier Fuels

A second improvement that is greatly needed is to the exchange credits under the RFS.  The EPA final regulations award credits primarily based on heat rates of different fuels (see Section 80.1115).  This is illogical, since the stated purpose of the RFS is to expand markets for renewable fuels that displace GHG emissions.  Yet, EPA's current plan does not systematically reduce the credits available for a production facility relying on coal, for example. 

It would seem relatively straightforward to assign each production facility a GHG displacement value, so that the more fossil-intensive (and therefore GHG-intensive) ethanol or biodiesel production facilities get less credit per gallon produced than would those reliant on cleaner production processes.  This approach wouldn't capture full life-cycle impacts, but would be far better than the gross heatrate-based exchange.  It would address the erosion of renewable attributes that will follow decisions such as Archer Daniels Midland's massive 275 million gallons per year plants that are supposedly to be coal fired.  They are not alone.

The system could work like this:

1)  Total mandate.  7.5 billion gallons per year of renewable fuel is put out for reverse auction. (This amount set by statute, and there are many efforts underway to increase it substantially).

2)  Bid for inclusion in mandate.  Producers bid for inclusion for their required subsidy per credit-gallon, not per physical gallon.

3)  Differentiating credits from physical gallons.  A credit gallon would vary from a physical gallon based on its GHG displacement.

a)  Plant A:

GHG displacement ratio:  30% (this is a plant-specific value, not an industry average)

Gallons ethanol produced:  100 mmgy

Subsidy per gallon output:  $0.25

Subsidy per credit-gallon output:  $0.25/0.3 = $0.83

  Plant B:

GHG displacement ratio: 10%

Gallons ethanol produced: 100 mmgy

Subsidy per gallon output:  $0.25

Subsidy per credit-gallon output:  $0.25/0.1 = $2.50

In this scenario, Plant A would have the winning bid.  In the current proposed system, there is no differentiation between the two sources, dramatically reducing the likelihood of biofuels production focusing directly on reducing its carbon footprint.

The bid penalty could disappear once real carbon constraints are introduced in the US, as the GHG aspects would be dealt much more efficiently through that system.  As with all carbon-intensive industries, there is a risk of gaming strategies at the outset of any allocated credit system, as producers overstate eligibility for initial credits.  Thus, careful oversight regarding  how this transition is managed and how initial rights are allocated is needed. 

Technical analysis might also indicate that feedstock production method is a critical determinant of the sustainability of the fuel source, in which case eligible facilities for the reverse auction might need to agree to implement certain monitoring and minimum standards in feedstock sourcing; or for the use of certain crops or cropping methods to reduce their credit-gallon value. 

The RFS Auction System Will Not be Effective Unless it Integrates the Demand Side

The RFS is still a supply-based system, though clearly displacing demand should be the preferred outcome wherever possible.  Integrating efficiency into the bid process is critical, though somewhat difficult to structure.  One option would be to assign "credit-gallon equivalents" to vehicle manufacturers if they exceeded their CAFE mandates.  Measurement and gaming problems are significant with such an approach, so additional thought would be needed on this element.

Some Existing Policies Work Counter to Petroleum Displacement in Transport; These Need to be Eliminated 

  • CAFE exemptions for Flex-Fueled Vehicles (FFV).  Under existing law, firms are allowed to meet less stringent CAFE mandates if they produce vehicles able to run on alternative fuels.  This exemption exists whether or not the vehicles actually use the fuels in their daily operation.  Few of them do, and the result is that the FFV fleet loophole has actually increased  the amount of oil we need to import.  According to the Union of Concerned Scientists, this increase is roughly 80,000 barrels per day.  To the extent that vehicles in Brazil can already burn fuel mixtures with no efficiency penalty, the rational for retaining this subsidy in the US grows even weaker.
  • Energy security.  Too many policies skewing the market towards FFVs may actually reduce the level of energy security achievable.  In terms of diversity of the transport fleet, FFV and biofuels generally means 10-20% can be mixed in (the lower level applies to ethanol; the higher to biodiesel) without major fleet modifications.  In contrast, plug-in hybrid systems offer much greater potential fuel diversification, since you can still blend in some biofuels to the gasoline portion, plus you've opened up access to all source fuels now feeding into the electrical grid.
  • Import barriers to alternative fuel.  A quick way to diversify US reliance on oil imports is to import biofuels to supplement existing domestic production.  The major biofuels producing countries are not the main OPEC countries, so the imports reduce rather than exacerbate issues associated with petroleum imports.  Yet, the US has a specific tariff of 54 cents per gallon on ethanol imports from most countries.  In practice this falls primarily on Brazil.  While some imported fuels are produced in environmentally destructive ways, fuels that are produced sustainably should be able to access the US market without punitive tariffs.  Those that are produced in a sustainable manner should be able to participate in at least part of the RFS auction. 
  • Subsidies to oil.  Existing subsidies to oil erode the price signals to adopt all sorts of alternatives to petroleum-fueled transport, including improved efficiency.  These subsidies should be eliminated.