Economics of Biofuels
NCEE Topic Pages
Replacing fossil fuels with biofuels—fuels produced from renewable organic material—has the potential to reduce some undesirable aspects of fossil fuel production and use, including conventional and greenhouse gas (GHG) pollutant emissions, exhaustible resource depletion, and dependence on unstable foreign suppliers. Demand for biofuels could also increase farm income. On the other hand, because many biofuel feedstocks require land, water, and other resources, research suggests that biofuel production may give rise to several undesirable effects. Potential drawbacks include changes to land use patterns that may increase GHG emissions, pressure on water resources, air and water pollution, and increased food costs. Depending on the feedstock and production process and time horizon of the analysis, biofuels can emit even more GHGs than some fossil fuels on an energy-equivalent basis. Biofuels also tend to require subsidies and other market interventions to compete economically with fossil fuels, which creates deadweight losses in the economy.
First generation biofuels are made from sugar crops (sugarcane, sugarbeet), starch crops (corn, sorghum), oilseed crops (soybean, canola), and animal fats. Sugar and starch crops are converted through a fermentation process to form bioalcohols, including ethanol, butanol, and propanol. Oils and animal fats can be processed into biodiesel. Ethanol is the most widely used bioalcohol fuel. Most vehicles can use gasoline-ethanol blends containing up to 10 percent ethanol (by volume). Flexible fuel vehicles can use E85, a gasoline-ethanol blend containing up to 85 percent ethanol. There were more than 2300 E85 fueling stations located throughout the US in 2013 (US Department of Energy).
Second generation biofuels, or cellulosic biofuels, are made from cellulose, which is available from non-food crops and waste biomass such as corn stover, corncobs, straw, wood, and wood byproducts. Third generation biofuels use algae as a feedstock. Commercial cellulosic biofuel production began in the US in 2013, while algae biofuels are not yet produced commercially.
Potential Economic Benefits of Biofuel Production
Replacing fossil fuels with biofuels has the potential to generate a number of benefits. In contrast to fossil fuels, which are exhaustible resources, biofuels are produced from renewable feedstocks. Thus, their production and use could, in theory, be sustained indefinitely.
While the production of biofuels results in GHG emissions at several stages of the process, EPA’s (2010) analysis of the Renewable Fuel Standard (RFS) projected that several types of biofuels could yield lower lifecycle GHG emissions than gasoline over a 30 year time horizon. Academic studies using other economic models have also found that biofuels can lead to reductions in lifecycle GHG emissions relative to conventional fuels (Hertel et al. 2010, Huang et al. 2013). Second and third generation biofuels have significant potential to reduce GHG emissions relative to conventional fuels because feedstocks can be produced using marginal land. Moreover, in the case of waste biomass, no additional agricultural production is required, and indirect market-mediated GHG emissions can be minimal if the wastes have no other productive uses.
Biofuels can be produced domestically, which could lead to lower fossil fuel imports (Huang et al. 2013). If biofuel production and use reduces our consumption of imported fossil fuels, we may become less vulnerable to the adverse impacts of supply disruptions (US EPA 2010). Reducing our demand for petroleum could also reduce its price, generating economic benefits for American consumers, but also potentially increasing petroleum consumption abroad (Huang et al. 2013).
Biofuels may reduce some pollutant emissions. Ethanol, in particular, can ensure complete combustion, reducing carbon monoxide emissions (US EPA 2010).
It is important to note that biofuel production and consumption, in and of itself, will not reduce GHG or conventional pollutant emissions, lessen petroleum imports, or alleviate pressure on exhaustible resources. Biofuel production and use must coincide with reductions in the production and use of fossil fuels for these benefits to accrue. These benefits would be mitigated if biofuel emissions and resource demands augment, rather than displace, those of fossil fuels.
Potential Economic Disbenefits and Impacts of Biofuel Production
Biofuel feedstocks include many crops that would otherwise be used for human consumption directly, or indirectly as animal feed. Diverting these crops to biofuels may lead to more land area devoted to agriculture, increased use of polluting inputs, and higher food prices. Cellulosic feedstocks can also compete for resources (land, water, fertilizer, etc.) that could otherwise be devoted to food production. As a result, some research suggests that biofuel production may give rise to several undesirable developments.
Changes in land use patterns may increase GHG emissions by releasing terrestrial carbon stocks to the atmosphere (Searchinger et al. 2008). Biofuel feedstocks grown on land cleared from tropical forests, such as soybeans in the Amazon and oil palm in Southeast Asia, generate particularly high GHG emissions (Fargione et al. 2008). Even use of cellulosic feedstocks can spur higher crop prices that encourage the expansion of agriculture into undeveloped land, leading to GHG emissions and biodiversity losses (Melillo et al. 2009).
Biofuel production and processing practices can also release GHGs. Fertilizer application releases nitrous oxide, a potent greenhouse gas. Most biorefineries operate using fossil fuels. Some research suggests that GHG emissions resulting from biofuel production and use, including those from indirect land use change, may be higher than those generated by fossil fuels, depending on the time horizon of the analysis (Melillo et al. 2009, Mosnier et al. 2013).
Regarding non-GHG environmental impacts, research suggests that production of biofuel feedstocks, particularly food crops like corn and soy, could increase water pollution from nutrients, pesticides, and sediment (NRC 2011). Increases in irrigation and ethanol refining could deplete aquifers (NRC 2011). Air quality could also decline in some regions if the impact of biofuels on tailpipe emissions plus the additional emissions generated at biorefineries increases net conventional air pollution (NRC 2011).
Economic models show that biofuel use can result in higher crop prices, though the range of estimates in the literature is wide. For example, a 2013 study found projections for the effect of biofuels on corn prices in 2015 ranging from a 5 to a 53 percent increase (Zhang et al. 2013). The National Research Council’s (2011) report on the RFS included several studies finding a 20 to 40 percent increase in corn prices from biofuels during 2007 to 2009. An NCEE working paper found a 2 to 3 percent increase in long-run corn prices for each billion gallon increase in corn ethanol production on average across 19 studies (Condon et al. 2013). Higher crop prices lead to higher food prices, though impacts on retail food in the US are expected to be small (NRC 2011). Higher crop prices may lead to higher rates of malnutrition in developing countries (Rosegrant et al. 2008, Fischer et al. 2009).
U.S. Policy Approaches to Support Biofuel Production
The Energy Policy Act of 2005 used a variety of economic incentives, including grants, income tax credits, subsidies and loans to promote biofuel research and development. It established a Renewable Fuel Standard mandating the blending of 7.5 billion gallons of renewable fuels with gasoline annually by 2012.
The Energy Independence and Security Act of 2007 (EISA) (PDF, 310 pp., 828K, About PDF) included similar economic incentives. EISA expanded the Renewable Fuel Standard to increase biofuel production to 36 billion gallons by 2022. Of the latter goal, 21 billion gallons must come from cellulosic biofuel or advanced biofuels derived from feedstocks other than cornstarch. To limit GHG emissions, the Act states that conventional renewable fuels (corn starch ethanol) are required to reduce life-cycle GHG emissions relative to life-cycle emissions from fossil fuels by at least 20 percent, biodiesel and advanced biofuels must reduce GHG emissions by 50 percent, and cellulosic biofuels must reduce emissions by 60 percent. EISA also provides cash awards, grants, subsidies, and loans for research and development, biorefineries that displace more than 80 percent of fossil fuels used to operate the refinery, and commercial applications of cellulosic biofuel.
In addition to EISA, numerous other policies have encouraged the production and use of biofuels in the US in recent decades. Tax credits currently support advanced biofuels, including cellulosic and biodiesel.
Condon, N., H. Klemick, and A .Wolverton. 2013. “Impacts of Ethanol Policy on Corn Prices: A Review and Meta-Analysis of Recent Evidence.” NCEE Working Paper 2013-05. http://yosemite.epa.gov/EE/epa/eed.nsf/WPNumber/2013-05?OpenDocument (Accessed Sept. 12, 2013)
Hertel, T., A. Golub, A. Jones, M. O’Hare, R. Plevin, and D. Kammen. 2010. “Effects of US Maize Ethanol on Global Land Use and Greenhouse Gas Emissions: Estimating Market-mediated Responses.” BioScience 60: 223–231.
Fargione, J., et al. 2008. “Land clearing and the biofuel carbon debt.” Science 319: 1235–1238.
Fischer, G., E. Hizsnyik, S. Prieler, M. Shah, and H. van Velthuizen. 2009. Biofuels and Food Security. OPEC Fund for International Development.
Huang, H., M. Khanna, H. Onal, and X. Chen. 2013. “Stacking low carbon policies on the renewable fuels standard: Economic and greenhouse gas implications.” Energy Policy 56 (May 2013): 5-15.
Melillo, J., J. Reilly, D. Kickligher, A. Gurgel, T. Cronin, S. Paltsev, B. Felzer, X. Wang, A. Sokolov, and C.A. Schlosser. 2009. “Indirect Emissions from Biofuels: How Important?” Science 326 (5958): 1397-1399.
Mosnier, A. P. Havlik, H. Valin, J. Baker, B. Murray, S. Feng, M. Obersteiner, B. McCarl, S. Rose, and U. Schneider. 2013. “The Net Global Effects of Alternative U.S. Biofuel Mandates: Fossil Fuel Displacement, Indirect Land Use Change, and the Role of Agricultural Productivity Growth.” Energy Policy 57 (June 2013): 602-614.
National Research Council. 2011. Committee on Economic and Environmental Impacts of Increasing Biofuels Production. Renewable Fuel Standard: Potential Economic and Environmental Effects of U.S. Biofuel Policy. Washington, DC: The National Academies Press.
Rosegrant, M.W, T. Zhu, S. Msangi, T. Sulser. 2008. “Global Scenarios for Biofuels. Impacts and Implications.” Review of Agricultural Economics, 30(3), 495-505.
Searchinger, T., et al. 2008. “Use of US croplands for biofuels increases greenhouse gases through emissions from land-use change.” Science 319: 1238-1240.
US Department of Energy, Alternative Fuels Data Center. Ethanol Fueling Station Locations. http://www.afdc.energy.gov/fuels/ethanol_locations.html (Accessed Sept. 10, 2013)
US Environmental Protection Agency. 2010. Renewable Fuel Standard Program (RFS2) Regulatory Impact Analysis. http://www.epa.gov/otaq/renewablefuels/420r10006.pdf (PDF) (Accessed Sept. 10, 2013).
Zhang, W., E. Yu, S. Rozelle, J. Yang, and S. Msangi. 2013. “The impact of biofuel growth on agriculture: Why is the range of estimates so wide?” Food Policy 38: 227–239.