US and Global Energy Prospects, Biofuels, Climate Change, and Future Policy

Alternatives

Wally TynerChris Hurt

George Horwich

Increased Fuel Economy• The 2007 Senate Energy Bill requires a 4 percent

increase in fuel economy each year starting in 2010. • By 2020, we would be saving 1.3 million barrels of oil

per day or 20 billion gallons of gasoline per year.• This measure also would result is considerable GHG

emissions reductions• The House Energy bill does not contain a CAFÉ

provision.

CFL Lighting for Your Home

• CFL bulbs Use only 25% of the energy of incandescent bulbs • If every American home replaced just one light bulb

with an ENERGY STAR qualified bulb, we would save enough energy to light more than 3 million homes for a year, more than $600 million in annual energy costs, and prevent greenhouse gases equivalent to the emissions of more than 800,000 cars.

• Energy savings calculator – Google Energy Star

Market Failures and Policy Pathways

• Both energy security and GHG emissions are examples of situations when markets alone cannot deliver an optimal solution.

• Economists call these externalities, and suggest using taxes, subsidies, or some form of regulation to correct the market failure

• In the U.S., we do not generally use of taxes in this situation, so I will focus on subsidies and renewable fuel standards

Energy Security

• U.S. imports over 60% of our oil, and half of our imports come from sources that many consider to be unreliable, unstable, or unfriendly

• Recent estimates put the cost to our nation of our high dependence on oil at around $3/gal. of liquid fuels

• Consumers do not pay this security cost at the pump

Global Warming

• The U.S. now recognizes that global warming is real and is caused by human intervention

• Renewable fuels may lead to a reduction in greenhouse gas (GHG) emissions

• Cellulosic based fuels especially contribute to reduced greenhouse gas emissions

• These emissions reductions cannot be captured in a pure market system

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Demand and Supply Side Options

• On the demand side, the major options are a fuel or carbon tax and stronger fuel economy standards – In the State of the Union message, President Bush proposed

a small increase in CAFÉ standards • On the supply side, government support of domestic

alternatives to oil can take many forms – The President proposed alternative fuel mandates

• The key is risk reduction for private investments

Policy Historyfor Ethanol in the US

• The US has subsidized ethanol since 1978 with a subsidy ranging between 40 and 60 cents per gallon.

• The current federal subsidy is 51 cents per gallon, and there are some state subsidies as well.

• The price of crude oil ranged between $10 and $30/bbl. between 1982 and 2003

• With these crude prices, the ethanol subsidy did not put undue pressure on corn prices.

Crude Oil Price History

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Policy Alternatives

• Stay the course with current policy• Reduce the fixed subsidy• Variable subsidy• Two part subsidy designed to include energy

security and GHG emission reductions• Special incentives for cellulose ethanol• Alternative fuel standard• Combination of alternative fuel standard and

variable subsidy

Alternative Fuel Standard• In his State of the Union message, the President

proposed a 35 billion gallon alternative fuel standard by 2017. The Senate passed 36 bil. By 2022:– Current production is about 5.5 billion– Seven fold increase in 10-15 years

• The administration estimates this would replace 15% of projected 2017 gasoline consumption

• With a binding mandate in place, it would no longer be necessary to subsidize alternative fuels

Difference Between a Fuel Standard and a Subsidy

• The fundamental difference between a fuel standard and a subsidy is who pays:– With a subsidy, the taxpayers pay the tax credits received

by fuel blenders – it is part of the government budget– With a fuel standard, consumers see changes in prices at

the pump depending on what the alternative fuel costs relative to gasoline from crude oil

• If we wanted to capture the higher GHG impacts of cellulose ethanol, the standard would need to be partitioned with cellulose receiving a higher proportion

Fuel Cost Change from a Fuel Standard

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$61 alternative $47 alternative $83 alternative $102 alternative

Thanks very much!

Questions and Comments

For more information:http://www.ces.purdue.edu/bioenergyhttp://www.agecon.purdue.edu/papers/

Stay with Current Policy• Staying with the current fixed 51 cent per gallon

subsidy would likely result in markets keeping the corn price high and stimulating investment in ethanol until the corn price chokes off profitability

• There would be some food cost increases due to higher corn prices

• Global impacts are very important and quite difficult to estimate

Breakeven Corn and Crude Prices with Ethanol Priced on Energy and Premium Bases

Plus $0.25 Ethanol Subsidy

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Price premium for octane/oxygen

With 0.25 fixed subsidy and price premium

Variable Subsidy• The energy security externality can be handled through

either a fixed or variable subsidy.• A subsidy that varies with the price of crude oil would be

a means of reducing the cost of the government subsidy while still providing a safety net if crude oil prices fall significantly

• The variable subsidy has two parameters:– Crude price at which it begins ($60)– Increase in the subsidy for each $1 crude falls below

that price (2.5 cents/$)

Breakeven Corn and Crude Prices with Ethanol Priced on Energy and Premium Bases

plus Variable Ethanol Subsidy

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Two-Part Subsidy

• To handle both the energy security and global warming issues, we could have a subsidy that incorporated both

• According to Hill and Tilman, corn ethanol reduces GHG 12.4%, soy biodiesel 40.5%, and cellulose ethanol as much as 275%, depending on production conditions.

Two-Part Subsidy

• Biodiesel contains 1.5 times the energy of ethanol, so it would receive an energy security credit 1.5 times ethanol based on imported oil displaced.

• The next chart illustrates how such a two part subsidy might work with components for each fuel for energy security and GHG reductions

Two Part Bioenergy Subsidy

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Cellulose Ethanol Incentives

• One of the issues with our current system is that investors will continue to prefer corn ethanol over cellulose because cellulose is riskier

• We may need to consider other options for cellulose ethanol at the beginning to stimulate investment:– Investment guarantees or purchase contracts (reverse

auction) – Tax credits to ethanol producers for each ton of cellulose

used to produce ethanol or other liquid fuel

Combination of Fuel Standard and Variable Subsidy

• An iron-clad fuel standard may be difficult to legislate, yet potential investors need some assurance the standard will hold

• The fuel standard combined with a variable subsidy might be a viable option

Cost of A Fuel Standard with a Variable Subsidy

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Variable subsidy would begin if crude oil fell below $45

Policy Impacts• The current subsidy can lead to very high corn prices –

beneficial to corn farmers but not to livestock producers or consumers

• With this year’s ethanol production at 8 bil. gal., the subsidy will cost $4 bil., but CBO estimated in January that commodity payments will fall $4 bil. in 2007

• The variable subsidy, two-part subsidy, targeted cellulosic subsidies, or alternative fuel mandates are options

• Various combinations of these options could be evaluated

Summing Up• Today’s high oil prices are largely demand driven• Global recession could lead to significant oil price drops• Investments in alternative energy sources are risky in

the face of future potential price falls without policy measures that insure against major price drops

• If we want to reduce dependence on foreign oil, we must develop policy pathways that will lead us towards greater reliance on alternative energy

• The policy choices we make will be critical