Wednesday, November 07, 2007

The Biofuel Boondoggle

A great article in yesterday's Wall Street Journal highlighting more aspects of the idiocy of biofuels (e.g. biodiesel, and ethanol). From "Biofuel Costs Hurt Effort to Curb Oil Price" it seems that the costs of biofuel feedstocks, namely corn and oils such as palm oil are increasing with the increased demand for these products, preventing them from achieving cost-effectiveness in the face of rising crude oil prices.

A few years ago, many energy economists predicted that higher oil prices would ensure the success of alternative energies such as biodiesel or wind power by making them more financially attractive. In many cases, though, the opposite has occurred: Even as crude-oil prices approach $100 a barrel, some alternatives look less attractive than in the past.

One reason: Energy demand is now so intense that supplies of just about every kind of fuel are in short supply, driving up prices of the raw materials involved in making many alternative energies. Some biofuels also rely on agricultural commodities that already are facing higher demand as foodstuffs, a situation which drives up prices further.

Hmm, who'd have though that the price of corn would go up. Oh, wait, we forgot about a little thing called supply and demand. Not only that, but these feedstocks are commodities, meaning small changes in demand past the total industry supply capacity result in big changes upward in pricing (known as it's price elasticity). Biodiesel accounts for less than 1% of transportation-based fuel supply and already it's causing supply demand and pricing upset in the agricultural sector. Which also means the price of foodstuffs containing corn is going up as well.

What does this mean? Simple, the biofuels sector will stall. It will do so before it ever gets the levels of contribution predicted. Already, plants that were on the drawing boards are not getting built and government subsidies which are what made the entire sector even marginally attractive in the first place will dry up.

In Malaysia, an important center for palm-oil biodiesel production, the government has held back on plans to require biodiesel blends at petrol stations because of a fear it could drive palm-oil prices too high, imperiling the country's nascent biodiesel industry.

Malaysia issued roughly 90 permits for biodiesel refineries in the past three years, but only about five are in operation. It appears that most of the others will remain on hold until palm-oil prices come back down.

In Europe, officials are still committed to a plan to meet 10% of the region's transportation needs with biofuels by 2020. But Germany has cut back on some tax incentives for biofuels, and some EU officials have questioned whether subsidies for biofuel crops are necessary in the future. Spanish energy company Abengoa SA recently suspended production at one of its biofuel facilities in Spain because of high grain prices. Similar projects have stalled elsewhere, including Hungary.

The U.S. has its own alternative-fuel woes. The price of corn, a key raw ingredient, has increased even as the market price for ethanol has been held down by oversupply. That has squeezed the profitability of ethanol producers and forced new players to cancel or delay construction of more facilities.

Oh, and the final tidbit that folks haven't yet understood. Biofuels are energy neutral at best. This means that the total energy required to produce a unit of energy of biofuels is a similar unit of energy. And the energy used to produce it is: you guessed it, fossil fuels.

There is a raging debate on the exact level of energy neutrality, with many environmental types applauding studies that show that fuels such as biodiesel have reached the threshold of being energy positive. However, this threshold is useless. Why? because at energy neutrality, biofuels are still tied directly to the price of fossil fuels. If it takes 1 unit of fossil fuel to produce 1 unit of biofuel, then as the price of fossil fuel goes up, so too will the price of the biofuel produced from it, and by a commensurate amount. Again, this economic fact will contribute to the stall in share of biofuel. This doesn't account for the supply-demand driven increase in the feedstock which adds to the problem. Even a slightly energy positive profile for biofuels will not change the fact then that they are useless as a hedge against rising fossil fuel costs.

When biofuels are an economical alternative to fossil fuels, the market will not need cajoling or prodding to accept them, it will do so. Until then the only effect that mandated biofuel usage, such as California's recent law requiring 5% of the states needs to come from biofuels, will have one effect. It will drive up your costs of fuel, and it will do so as much if not more than the rising costs of fossil fuels. Government policy is not helping in this matter. It is only hurting.

When it comes to biofuel policy (and any other economic policy for that matter) you should advocate one and only one policy: laissez faire!

3 comments:

Galileo Blogs said...

Yes, I agree with you fully, and have said so on my own blog.

I recommend shorting the ethanol stocks, in particular. I am.

It is a delight to actually make money by betting on the failure of a government economic intervention, in this case subsidies for an uneconomic fuel. To do so requires good timing, because when the subsidies are first enacted there is a euphoria that will drive the stocks higher. But reality always catches up, sooner or later. That is when it is time to go short.

(Sometimes it can be decades before reality catches up. That is why timing is so important. In the case of ethanol, it is such a dramatically uneconomic boondoggle, in my opinion, with so many harmful effects on other segments of the economy such as corn syrup makers and cattle producers who have to buy overly expensive corn, that the crash was bound to happen quickly. It looks like it is.)

Monica said...

Environmentalist policies are so irrational. They're not even good for the environment. Besides the fact that this can't currently work economically apart from government subsidies, who wants the entire country covered in cornfields? Bo Ring.

Ethanol stinks.

Kendall J said...

Monica,

It stinks figuratively and literally. Ever been downwind of an ethanol plant. Peeeyew !