Harvard researcher Ricardo Hausmann argues for optimism about the future of biofuels (Financial Times, November 7, 2007). I am skeptical about some of his points or their apparent implications. Hausman’s column is reproduced below in indented segments. My comments follow.
Biofuels can match oil production
By Ricardo Hausmann
Financial Times November 7 2007

“Peering into the future seldom produces a clear picture. But this is not the case with bioenergy. Its long-term impacts on the global economy appear to be pretty clear, making many long-term predictions quite compelling, including the demise of the price-setting power of the Organisation of the Petroleum Exporting Countries and the end of agricultural protectionism.

Comment: A time frame would make this assessment more useful. In its new Annual Energy Outlook 2007, ExxonMobil forecasts that biofuels will supply only about 3 million oil-equivalent barrels per day (MBDOE) or 3% of world liquid fuel demand in 2030. Some might say EM is trying to hide its impending demise from shareholders. But EM is actually bullish about biofuels compared to the U.S. Energy Information. EIA projects that biofuels will supply only 1.7 MBDOE-about 1.4% of total liquid fuel-in 2030.

“First, technology is bound to deliver a biofuel that will be competitive with fossil energy at something like current prices. It probably already has. Brazil has been exporting ethanol to the US at an average delivery price of $1.45 for an amount with the energy equivalence of a gallon of petrol. It is doing so profitably and in increasing amounts, in spite of a 54 cents a gallon tariff to protect American maize-based ethanol producers. Many countries are following suit.

Comment: Several observations are in order. First, not all Brazilian ethanol sold in the United States is imported “in spite” of the tariff. The Caribbean Basin Initiative allows Caribbean and Central American countries to sell Brazilian ethanol to U.S. importers duty-free. The amount is capped at 7% of U.S. domestic consumption, with provisions allowing additional tariff-free imports for mostly Brazilian ethanol with specified percentages of Caribbean “domestic content.” Second, U.S. refiners might be importing very little Brazilian ethanol if Congress, in the 2005 Energy Policy Act, had not (a) mandated the sale of 7.5 billion gallons of ethanol by 2012, and (b) denied refiners liability protection from lawsuits over MTBE contamination of ground water–a policy that triggered a stampede to ethanol as a fuel additive. Third, the relative success of Brazil’s ethanol industry depends on rather special conditions including an ideal climate for growing sugarcane, abundant cheap labor, and vast tracts of unused land with scant biodiversity (see p. 15 of Dennis Avery’s paper and pp. 7-8 of Marcus Xavier’s paper). Fourth, even in Brazil, it is unclear whether ethanol could compete successfully with gasoline without policy privileges. According to Brazilian economist Edward F. de Almeida, Brazil’s national government taxes ethanol at $0.01 per liter and gasoline at $0.26 per liter. Value added taxes imposed at the state level further skew the market in favor of ethanol. In Sao Paulo, for example, the VAT for ethanol is 12% compared to 25% for gasoline. Overall, Brazilian ethanol enjoys a tax advantage over gasoline of $997 million per year.

“But ethanol is an inconvenient chemical compound that is corrosive and soluble in water, thus limiting its immediate market to that of a gasoline additive. However, this is just the Betamax phase of the industry. There is plenty of private venture capital money being poured into finding more efficient ways of extracting energy from biomass and delivering it to transport and power systems. Over time, the technology will also become more flexible, allowing more crops to be used as feedstock, not just the current choice of sugarcane, maize and palm oil. New technologies will be able to extract energy from cellulose, allowing the use of pastures such as switch grass as well as the refuse of current food production. The cheque is in the mail.

Comment: Technologies for finding, extracting, and processing oil are also not standing still. From 2004 to 2030, EIA projects that oil production from Canadian tar sands will grow more rapidly than biofuel production. I’d be more bullish on ethanol if there were less lobbying for more subsidies and mandates. After all, if ethanol is the next big thing, why do we need to laws to make us buy it? BTW, “check’s in the mail” usually means it isn’t.

“Second, the world is full of underutilised land that can grow the biomass that the new technology will require. According to the Food and Agriculture Organisation, the world has a bit less than 1.4bn hectares under cultivation. But using the Geographic Information System database, Rodrigo Wagner and I have estimated that there are some 95 countries that have more than 700m hectares of good quality land that is not being cultivated. Depending on assumptions about productivity per hectare, today’s oil production represents the equivalent of some 500m to 1bn hectares of biofuels. So the production potential of biofuels is in the same ball park as oil production today.

Comment: Brazil can dramatically increase ethanol production without clearing rainforests or taking farmland out of production for food crops, as Dennis Avery explains (see reference above). Nonetheless, food vs. fuel and fuel vs. biodiversity are real concerns (see, e.g., here, here, and here). Hausmann barely touches on them.

“Third, even if only partially used, this large potential biofuels supply will cap the price of oil because its supply is much more elastic than the supply of oil. This will cause the price of oil to be set at the marginal cost of bio-energy, independently of the production decisions of OPEC. If OPEC tries to raise prices above the price at which biofuels become highly profitable, it will only crowd in more biofuels. Oil producers will still be rich, but they will not have incentives to form a cartel.

Comment: Ethanol prices might end up putting a ceiling on oil prices, but ethanol producers will still sell at what the market will bear. Brazilian ethanol this summer, for instance, was selling at $80 per barrel, or $120 per barrel of oil equivalent. It may be quite a while before the tail (ethanol prices) wags the dog (oil prices).

“Fourth, the price of agricultural land will be influenced by its potential use for bio-energy. As farmers choose what crop would suit them best, they will change what they produce and hence the whole system of relative prices of agricultural produce. This will imply a very large increase in the demand for agricultural land. Its price and that of the products that use it intensively - such as food and cotton - will go up. By how much? This will depend not only on the cost of bio-energy but also on how much additional land is put to use and the degree to which food crops will be complements or substitutes of bio-energy: they would be substitutes if switch grass were planted instead of soybeans; they will be complements if biofuels are made out of wheat stalk. My bet is that they will tend to be more substitutes than complements and the relative price of food will go up.

Comment: In other words, Hausmann bets that biofuel from cellulose will soon become economical. Time will tell. I’m betting that biofuels become another government-coddled “infant” industry that never grows up. Consider money-losing, subsidy-sucking Amtrak! Trains have been around for quite a while–although not as long as corn liquor.

“Fifth, the increase in the price of agricultural land and of food will relieve governments from the current political pressure to protect the agricultural sector. Governments that, as a consequence of the land glut, have been protecting and subsidising farmers will see them grow rich either because they “plant” biofuels themselves or because other producers switch into them, lowering the supply and increasing the price of other crops.

Comment: As Martin Wolf observed in an earlier Financial Times column, current biofuel programs are farm subsidies masquerading as climate and energy policy. He observes: “U.S. evidence strongly suggests that these subsidies are being piled on top of existing farm subsidies, not replacing them.”

“By contrast, consumers will be less enthusiastic and demand that something be done about the price of food. The obvious solution will be to cut back on protectionism and liberalise trade in agriculture.

Comment: Obvious, yes, but will a farm lobby enriched by biofuel programs have more or fewer resources with which to defend that status (statist) quo?

“Sixth, the countries that have the largest endowment of under-utilised lands are in the developing world, especially Africa and Latin America. Putting that land into production will require a type of infrastructure that–as opposed to the dedicated variety required by extractive industries–usually crowds in other forms of investment by lowering transport costs in ample regions of the country. Bio-energy will make those infrastructure investments socially profitable, creating a possible stepping stone into other industries.

Comment: Farming helps grow infrastructure-another reason to abolish agricultural trade barriers, not to skew capital markets in favor of bio-energy crops.

“Some policy action in industrialised countries will be required to make this world possible. Biofuels policy needs to stop being seen through the prism of agricultural support policy-which justifies a 54 cents a gallon US tariff on Brazilian ethanol-and instead become the purview of energy and environmental policies.

Comment: Biofuel policy will “stop being seen through the prism of agricultural support policy” when farm policy stops being seen through the prism of domestic politics!

“Standards will have to be developed to allow the energy and automotive industries to co-ordinate technologies. To make this scenario appealing, the impact of the expansion of the agricultural frontier on the environment and biodiversity, and the distributive effects of the rise in food prices will have to be addressed. But these problems seem solvable given the expected political benefits in terms of lower net carbon emissions, more energy security, more efficient agricultural policies and greater opportunities for sustainable development.” The writer is the director of Harvard University’s Center for International Development Copyright The Financial Times Limited 2007