Use Biofuels Eu

ARTICLE IN PRESS

Energy Policy 34 (2006) 3184–3194 www.elsevier.com/locate/enpol

Stimulating the use of biofuels in the European Union: Implications for climate change policy Lisa Ryan, Frank Convery, Susana Ferreira Department of Planning and Environmental Policy, University College Dublin, Richview, Dublin 14, Ireland Available online 28 July 2005

Abstract The substitution of fossil fuels with biofuels has been proposed in the European Union (EU) as part of a strategy to mitigate greenhouse gas emissions from road transport, increase security of energy supply and support development of rural communities. In this paper, we focus on one of these purported benefits, the reduction in greenhouse gas emissions. The costs of subsidising the price difference between European bioethanol and petrol, and biodiesel and diesel, per tonne of CO2 emissions saved are estimated. Without including the benefits from increased security of energy supply and employment generation in rural areas, the current costs of implementing European domestic biofuel targets are high compared with other available CO2 mitigation strategies. The policy instrument of foregoing some or all of the excise duty and other taxes now applicable to transport fuels in EU15 on domestically produced biofuels, as well as the potential to import low-cost alternatives, for example, from Brazil, are addressed in this context. r 2005 Elsevier Ltd. All rights reserved. Keywords: Biofuels; Greenhouse gas emissions; Transport policy

1. Introduction Currently1 transportation fuels pose two important challenges for the European Union (EU). First, under the provisions of the Kyoto Protocol to the Climate Change Convention, the EU has agreed to an absolute cap on greenhouse gas emissions; while, at the same time increased consumption of transportation fuels has resulted in a trend of increasing greenhouse gas emissions from this source.2 Second, the dependence upon oil imports from the politically volatile Middle East generates concern over price fluctuations and possible interruptions in supply. Corresponding author. Tel.: +353 1 716 2676; fax: +353 1 716 2776. E-mail address: [email protected] (L. Ryan). 1 The analysis in this study uses data from 1998 to 2004. The term ‘‘current’’ is used to refer to these data. More specific dates are provided in the relevant tables. 2 The European Commission’s White Paper ‘‘European transport policy for 2010: time to decide,’’ advanced the prospect of a rise of 50% in CO2 emissions from transport between 1990 and 2010 under ‘‘business as usual’’ policies.

0301-4215/$ - see front matter r 2005 Elsevier Ltd. All rights reserved. doi:10.1016/j.enpol.2005.06.010

Increasing the use of alternative fuels can address both these challenges, by providing an opportunity to reduce greenhouse gases and other polluting emissions, and by improving the security of energy supply. Additionally, the development of biofuels may create new employment opportunities, especially in declining rural areas. Given that legislative efforts in the EU to promote biofuels (discussed later) are recent, the policy implications of their use remain largely unexplored. Biofuels are currently commercially uncompetitive with fossil fuels (petrol and diesel) in Europe. However, can they become competitive once their external benefits to society, namely the CO2 emissions reduction, security of energy supply and rural development are accounted for? This paper addresses part of this question by focusing on the first external benefit, the reduction in greenhouse gas emissions. The commercial price of transport fuel in the European market before taxes and duties is assumed here for simplicity to be equivalent to its private marginal costs. This number is compared with the private marginal costs of supplying biofuels in order to

ARTICLE IN PRESS L. Ryan et al. / Energy Policy 34 (2006) 3184–3194

derive a threshold value per tonne of CO2 reduction that must be achieved if biofuels are to compete in price with petrol and diesel in Europe. The gap between the marginal costs of biofuels and traditional fuels motivates the analysis of different instruments that would be needed to encourage the uptake of biofuels: an excise duty reduction, a subsidy to the production of biofuels and/or relaxation of tariffs on imports from cheaper non-EU producers.3 In addition, this threshold value, or the cost of reducing a tonne of CO2 emissions using biofuels, can be contrasted with the marginal costs of achieving CO2 emission reductions elsewhere. It can be compared, for example, with the cost of technical measures in the transport sector to reduce greenhouse gas emissions or with the price of buying allowances in the CO2 emissions trading market. The remainder of this paper is structured as follows: Section 2 provides the policy and technical context surrounding the adoption of biofuels in Europe. Section 3 computes the threshold value per tonne of CO2 reduction that needs to be achieved for biofuels to be competitive with conventional transport fuels in Europe. Section 4 outlines the policy implications and Section 5 summarises our conclusions.

2. European policy and technical context In accordance with the ‘‘flexible mechanisms’’ of the Kyoto protocol, the EU has introduced a CO2 emissions trading scheme that commenced on a pilot basis in January 2005.4 Although not included in this pilot phase, reducing the transport sector’s emissions, and in particular emissions from road transportation, is a pressing issue as the latter currently represent 19% of total EU CO2eq. emissions and are expected to increase (European Environment Agency, 2004)5. The European Commission foresees that three alternative transport fuels, hydrogen, natural gas, and biofuels, will replace transport fossil fuels, each by 5% by 2020 (Commission of the European Communities, 2001). 3

There are other schemes possible to promote biofuels, such as carbon-based fuel taxes, investment incentives, biofuels obligation, or tender schemes. We are grateful to an anonymous reviewer for pointing this out. In this paper we only deal with the three most common schemes currently in place. 4 Directive 2003/87/EC of the European Parliament and of the Council establishing a scheme for greenhouse gas emission allowances trading within the Community and amending Council Directive 96/61/ EC. This text will apply to the existing 15 Member States, those Accession States who joined in May 2004 and other countries (such as Iceland, Norway and Switzerland) who choose to participate. 5 In the first pilot phase (2005–2007) trading is confined to CO2 emissions from power stations in excess of 20 MW (except incinerators), oil refineries, smelters, manufacture of cement (4500 tonnes/ day), ceramics including brick, glass, and pulp, paper and board (420 tonnes/day). See footnote 2.

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Biofuels are an alternative motor vehicle fuel produced from biological material and are promoted as a transitional step until more advanced technologies have matured. Hydrogen and natural gas are seen as medium rather than short-term solutions, due to infrastructural, cost and technical challenges. Biofuels are viewed as an essential element in the development of alternative fuel markets, and some initiatives have already been introduced to promote biofuels in the EU. Under the European Directive on the promotion of the use of biofuels or other renewable fuels for transport (European Parliament and Council, 2003), Member States are instructed to ‘‘ensure that a minimum proportion of biofuels and other renewable fuels is placed on their markets,’’ and reference values for national targets are given as 2%, by 2005, and 5.75%, by 2010.6 Furthermore, Member States are permitted to reduce excise duties on biofuels7 (Council of the European Union, 2003). The Green Paper ‘‘Towards a European Strategy for Energy Supply’’ supports this initiative, and it also serves the reforms of the Common Agricultural Policy to support rural economies; by decoupling some subsidies from food production, land is released for potential energy crop production (Commission of the European Communities, 2003). The EU directive lists 10 products that should be considered as biofuels. Of these, there are two that have been most frequently employed to date: (i) Biodiesel, produced from plant oils, such as rape seed, soybean or palm, or from organic waste material; which can be used in a modified diesel engine or processed to be used in a conventional diesel engine; and (ii) bioalcohol, such as methanol and ethanol, which can be produced from cereal crops or sugar beets and can fuel modified petrol engines. These categories of biofuels have gained the most attention in the EU as they are produced from materials that are suitable for agricultural production in the EU, or are widely available waste products. Currently, other possibilities are either prohibitively expensive or energy intensive in their production,8 due mainly to the small scale of operation derived from the lack of market development for these fuels. Economies of scale may reduce these prices significantly in the future. For a general overview on biofuel choices and their characteristics see van Thuijl et al. (2003) or Fulton et al. (2004). There are many challenges facing alternative fuels before they can gain widespread acceptance in the transport 6 Directive 2003/30/EC. Although these targets are indicative rather than mandatory, failure to meet them requires Member States to explain the discrepancy in their annual biofuels progress reports. 7 Directive 2003/96/EC. 8 In the medium term, technological advances in the thermochemical processing of biomass could produce biodimethylether, synthetic fuels and hydrogen, to take a few examples.

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fuels market. The existing petroleum infrastructure is standardised and has extensive coverage, and the cost and therefore selling price of biofuels is significantly higher than that of mineral oil fuels.

Table 1 Costs of biofuels Biofuel

Cost at filling station (h2004/1000 L) Feedstock

3. Biofuels vs. conventional fuels: the value of reducing CO2 emissions Although the amount of biofuels produced in the EU is growing, the quantities remain small compared to the total volume of mineral-based transport fuels sold— approximately 0.3% of all EU petrol and diesel fuel in 2003 (Kavalov, 2004). Production costs of biofuels vary and are dependent on the prices of raw materials, the method of production, the extent of refining undertaken, and the supplementary utilisation of by-products and waste. The European biofuels cost estimates utilised in this paper, reported in Table 1a, come from Jungmeier et al. (2005)9 who reviewed 73 academic, public and industry studies to provide a comprehensive collection of cost and CO2-equivalent (CO2eq.)10 emissions estimates for biofuels. The costs are highly variable depending on the various combinations of feedstock and country of production. For this reason, Table 1a reports a range of cost estimates including the lowest, the most likely values (‘‘best estimates’’), and the highest values from the studies. Overall, the best estimates in Table 1a are at the upper end of values reported in other studies (see for example den Uil et al. (2003), Edwards et al. (2004) or Kavalov (2004)), while the full range of values falls within the range of the literature. Although the best estimates in Table 1a represent the most likely values, it is evident that some producers in Europe are producing with costs at the lower margin at this time. Jungmeier et al. estimate the future costs (post-2010) as significantly lower and these are represented in Table 1b. Note that because both biodiesel and bioethanol contain less energy per litre than the corresponding fossil fuel, the total cost per litre in Tables 1a and b is given as a cost per energy-equivalent litre.11 9 This project was undertaken as work package 2 of the VIEWLS project (Clear Views on Clean Fuels), which was funded as EC Project NNE5-2001-00619 from February 1, 2003–January 31, 2005. More details on the project and the consortium involved can be found at www.VIEWLS.org. 10 The emissions of CO2 and other greenhouse gases (N2O, CH4, HFC, PFC, SF6) are combined and represented as with ‘‘CO2eq’’. emissions units by multiplying the different emissions (in metric tons) by the global warming potentials of the individual greenhouse gases and summing together. 11 Bioethanol contains 67% as much energy per litre compared with petrol and biodiesel contains 87% as much energy per litre compared with diesel (Fulton et al., 2004). The energy-equivalent cost is the relevant variable since the targets contained in the EU biofuels directive are given on an energy basis. In addition, if consumers

Low

Best estimate

(a) Costs of biofuels produced using current technology Sugar crops 875 1265 Starch crops 809 1173 Lignocellulosic crops 1148 1448 Lignocellulosic residues 1052 1316 Brazilian sugarcane 117 294

High

1855 1572 2435 2232 351

Biodiesel Oil seeds Used oil/fat

755 354

945 454

(b) Costs of biofuels produced using future technology Sugar crops 671 954 Starch crops 653 963 Lignocellulosic crops 699 884 Lignocellulosic residues 638 802 Brazilian sugarcane Biodiesel Oil seeds Used oil/fat

753 317

888 395

1092 545

1432 1287 1469 1358

1068 504

Notes: 1. Source of data is Jungmeier et al. (2005), who reviewed 73 studies to provide a range of estimates for environmental performance and economic costs for biofuels within the VIEWLS project. Data are expressed in h2004. 2. Current technology refers to technology of production utilised until 2010. Future technology refers to technology after 2010. 3. Costs include production, transportation, conversion and distribution. 4. Biodiesel costs estimated per litre of energy-equivalent diesel. We assume the energy density of petrol to be 34.3 MJ/l (Nommensen, 2005). 5. Bioethanol costs estimated per energy-equivalent litre of petrol. We assume energy density of petroleum diesel to be 39.4 MJ/l (Nommensen, 2005).

Table 1a shows that using current production technology the cheapest bioethanol produced in Europe comes from starch crops. Overall, however, the cheapest bioethanol, comes from sugarcane in Brazil. Table 1a also shows that biodiesel is cheapest when produced from waste oils and fats. To be profitable, biofuel prices must cover production and distribution costs and be competitive in price with (footnote continued) substitute a biofuel for a fossil fuel, the difference in energy content will most likely translate into increased fuel consumption and therefore this real cost must be taken into account when comparing fossil fuel and biofuel prices. For this study, we consider it appropriate to convert the biofuel costs from an energy basis to energy-equivalent litres, since we would like to compare the prices of fuels at the filling station and the effect of excise duty rebate on prices (per litre).

ARTICLE IN PRESS L. Ryan et al. / Energy Policy 34 (2006) 3184–3194 Table 2 Cost comparison of biofuels with petroleum fossil fuels Biofuel

Cost at filling station (h2004/1000 l) Feedstock

Bioethanol Sugar crops Starch crops Lignocellulosic crops Lignocellulosic residues Brazilian sugarcane Biodiesel Oil seeds Used oil/fat

Biofuel

Fossil fuel

Difference

1265 1173 1448 1316 294

366 366 366 366 366

899 807 1082 950
72

945 454

386 386

559 68

Notes: 1. Best estimate value of current costs from Table 1a used for cost of biofuel. 2. Price of fossil fuel is petrol price for bioethanol and diesel price for biodiesel. The values are 6-month averages for EU15 for JulyDecember, 2004. Available from EU Oil Bulletin at http://europa.eu.int/comm/energy/oil/bulletin/2005_en.htm (accessed April 2005). 3. Costs of biofuels and fossil fuels are before excise duties and VAT.

conventional transport fuels. The European Oil Bulletin contains data on the final price paid by consumers in the EU for petrol and diesel and on the excise duties and value added tax (VAT) charged in all EU countries. In Table 2 we compare the average pre-tax fossil fuel price12 (i.e. the price before excise duty and VAT), that would be the value assigned to biofuels on the market, for the period July–December 2004 with the actual costs of biodiesel (produced from EU15 oilseeds and waste oil) and bioethanol (produced from EU15 wheat and sugar beet, and the cheapest Brazilian sugarcane) from Table 1a. Table 2 provides thus a rough comparison of the costs of biofuels with those of mineral fuels. A couple of considerations must be taken into account when using the pre-tax price of fossil fuels as proxy for their costs: the pre-tax fossil fuel prices do not subtract profit margins, and they are derived from erratic and very high fossil fuel prices. Both factors tend to drive up the fossil fuel cost estimates and thus could bias the cost difference with biofuels in the last column of Table 2 downwards. Nevertheless, it appears that the prices are not decreasing. Fig. 1 presents the historical pre-tax petrol and diesel nominal prices, which have increased in EU15 since 1999. Additionally, a projected increasing fossil fuel demand in emerging economies such as India and China is likely to translate into pressure for even higher fossil fuel prices than those used to compute the numbers in Table 2. 12 EU Oil Bulletin provides weekly and monthly average prices for transport fuels in EU15 and EU25. The data used is the 6-month average for petrol and diesel prices in EU15 from June–December 2004. It is available at http://europa.eu.int/comm/energy/oil/bulletin/ 2004_en.htm.

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Table 2 applies to current conditions, and thus it also ignores the evolution of the costs of biofuels and fossil fuels in the medium and long term. Some studies predict that the costs of cellulosic ethanol will drop considerably to equal the pre-tax price of petrol after 2010 (Department of Transport (UK), 2003; Fulton et al., 2004). These findings are consistent with the numbers in Table 1b. According to Table 2, however, current biofuels are not cost competitive with conventional fossil fuels in Europe unless the biofuels are imported from Brazil. The natural question is whether they become competitive once the external benefits to society are accounted for, namely the reduction of CO2 emissions, security of energy supply and rural development. For example, recent estimates have put the number of jobs in rural areas that could be generated by achievement of the EU biofuel targets at 212,000 and 354,000 in 2010 and 2020, respectively, under current policies (Whitely et al., 2004), corresponding to approximately 1.5–2.5% of the EU15 unemployment in 2005, 14.7 million (Eurostat, 2005). It is not clear, however, how rural employment generation can be translated to rural development and how many of these jobs would not be removed from food-producing activities. The focus of this paper, is on the benefit to society related to climate change, namely the reduction of greenhouse gas emissions from transport. The estimation of greenhouse gas and energy balances of biofuels is complex. The full fuel cycle and not just the direct emissions during combustion must be considered for comparison with fossil fuels. While the combustion of biofuels is considered to be CO2-neutral (IPCC, 1996), their production requires inputs that may distort the positive energy and greenhouse gas balance.13 The final accounting is country-specific and is a function of the raw material cultivated, the associated agricultural yield, and the utilisation of by- and co-products, for example as fuel in the production process, and as animal feedstuffs (Henke et al., 2003; Shapouri et al., 2002). If by-products have an economic value they bear a part of the energy and emission burden. Table 3 presents a range of estimates of the CO2eq. emissions savings (or total greenhouse gas emissions weighted in terms of their global warming potentials), as a result of utilising biofuels over the corresponding fossil fuel. The CO2eq. emissions include cultivation, production, distribution and vehicle emissions for biofuels. For consistency with the cost data in Tables 1a and 2, the CO2eq. emissions data are also from the Jungmeier et al. (2005) review.14 Since there were not enough CO2 emissions data available for biodiesel produced from 13

For example nitrate fertilisers, which cause the emission of N2O

gas. 14 As mentioned above, the VIEWLS study reviewed 73 studies and provided a range of emission values, which include all stages of the life cycle of both biofuels and fossil fuels (Jungmeier et al., 2005).

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3188 500

450

400

350

/1000litres

300

250

200

Petrol Diesel

150

100

50

0 1998s02

1999s01

2000s01

2001s01

2002s01

2003s01

2004s01

18/03/2005

Fig. 1. Historical nominal petrol and diesel prices. Notes: (1) Prices are EU15 6-month averages. (2) To provide an indication of the continuing trend, the spot prices for 14/3/05 and 18/4/05 are given. Source: EUROSTAT, 2005 and EU Oil Bulletin. Table 3 Overview of CO2eq. emissions savings from biofuels, compared with reference fossil fuel vehicle CO2 eq. emissions savings

Biofuel Feedstock

t/1000 L

g/km Low

Best estimate

High

Low

Best estimate

High

50
50 181 190 169

90 30 183 191 212

169 70 184 192 254

0.7 0.0 2.6 2.7 2.4

1.2 0.4 2.5 2.6 2.9

2.2 0.9 2.4 2.5 3.3

30

82

115

0.5

1.3

1.8

Bioethanol Sugar crops Starch crops Lignocellulosic crops Lignocellulosic residues Brazilian sugarcane Biodiesel Oil seeds

Notes: 1. All biofuels and reference vehicle CO2eq. emissions values from VIEWLS project (Jungmeier et al. 2005). 2. Assume reference petrol vehicle consumes 2.5MJ/km and produces 230g/km CO2eq. emissions. 3. Assume reference diesel vehicle consumes 2.1MJ/km and produces 180g/km CO2eq. emissions. 4. Brazil estimates exclude transport to Europe and import tariffs. 5. All CO2eq. emissions represent full life-cycle emissions, i.e. ‘well-to-wheel’.

waste oils and fats, this feedstock is not included in Table 3 and subsequent tables. The wide range of values presented in Table 3 is a result of differences in calculation methods, production yields and the use of co- and by-products in the

production chain in the studies collected by Jungmeier et al. (2005). The first three values in Column 2 represent the range of CO2 g/km savings for bioethanol produced from sugar, starch crops, lignocellulosic crops and residues, and Brazilian sugarcane, and biodiesel

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produced from oilseed compared with a ‘‘standard’’ petrol or diesel vehicle.15 As before, due to the wide range of estimates published, the low, high and best estimates of values from the literature are presented. The best estimates do not represent average values, but rather values that have a realistic use of co- and byproduct credits. The values in the last three columns of Table 3 convert the estimates of the reductions in CO2eq. emissions from g/km to the quantity of CO2eq. emissions that would be saved by substituting 1000 litres of diesel and petrol with the energy equivalent biofuel litres. For example: 1.2 tonnes of CO2eq. emissions saved per 1000 litres of petrol substituted with energyequivalent bioethanol from sugar crops ¼ (90 g/km)/ (0.073 L/km)  1000. According to Table 3, both biodiesel and bioethanol have a positive energy balance. Use of European bioethanol yields a CO2 emissions savings of 13–83% compared with operation of a standard petrol vehicle, given above. Table 3 also shows that bioethanol produced from Brazilian sugarcane has a better wellto-wheels energy balance than bioethanol produced from starch and sugar crops in the EU. This is due to the high productivity of sugarcane crops in Brazil and the use of by-products (the remains of the crushed cane after the sugar is extracted) to provide energy to nearly all processing plants. In fact, many biofuel processing plants in Brazil are net exporters of electricity resulting in fossil fuel requirements near zero (Fulton et al., 2004). For biodiesel, the CO2eq. emissions savings range between 36–83% compared with conventional diesel. With data on the commercial price (p) net of excise duties and taxes, private marginal costs of supplying biofuels (MCPriv) from Table 2, and on the tonnes of CO2 emissions saved by the introduction of biofuels from Table 3, we can derive a threshold value per tonne of CO2eq. emissions reduction that needs to be achieved if biofuels are to compete with conventional transport fuels in Europe. This threshold value represents the cost to society of reducing a tonne of CO2eq. emissions using biofuels and is therefore denoted MCSoc. MC Soc ¼

½MC Priv
p tCO2 reduced

(1)

The results of this calculation are presented in Fig. 2. The columns in the figure represent the low, best estimate and high values16 for the threshold value calculations. The results are sensitive to the value of the denominator. For example, the high value or worst 15 Based on a vehicle with the following energy/fuel usage: Petrol: 2.5 MJ/km or 0.073 L/km; Diesel: 2.1 MJ/km or 0.053 L/km. 16 Low CO2 mitigation costs are estimated from (low biofuel cost
fossil fuel price)/high CO2 emissions savings; high CO2 mitigation costs are estimated from (high biofuel cost
fossil fuel price)/low CO2 emissions savings; best estimate costs utilise best estimate values for the biofuel costs and CO2 emissions savings.

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case CO2eq. emissions mitigation cost using bioethanol produced from starch is extremely high, since its production chain emits rather than saves CO2eq. emissions (see column one, Table 3). If the value of the CO2eq. emissions savings (denominator) is set to near zero (rather than left as a negative value), MCsoc rises to a high value, which is not fully shown in Fig. 2. These threshold values, or the costs per tonne of CO2 emissions mitigated for European biofuels, are estimated between h229–2085 (excluding the estimate for bioethanol with positive CO2eq. emissions). However, it is less than zero for bioethanol produced in Brazil from sugarcane. These values also represent the cost of the direct subsidy required to equalise the price difference between fossil fuels and biofuels at the filling station.

4. Policy implications Society has a number of choices to reduce the amount of greenhouse gasses released in the atmosphere including switching to less carbon intensive fuels, reducing energy consumption, or carbon sequestration. According to Fig. 2, for EU biofuels to be economically efficient as a measure to reduce CO2eq. Emissions— based on current costs and prices—the marginal benefit of reduction of CO2eq. emissions would need to be at least h229/tonne. This would stimulate the use of bioethanol from wheat and would encourage the development of better performing biofuels. To evaluate the magnitude of the numbers in Fig. 2, an estimate of the marginal benefit of CO2eq. emissions abatement is needed. The European CO2 emissions trading scheme provides some direction, as the price per tonne of CO2 emerging from this market will inform participants to what extent they should abate or purchase allowances if necessary.17 When comparing the cost of CO2 reductions by utilising biofuels with the prices from the European CO2 emissions market, it must be noted that current prices represent a conservative estimate of the value of the benefits to society of CO2 abatement. Member States have given the participant sectors very generous allocations, and the participant sectors are likely to have lower abatement costs than the non-participants. Both these factors tend to reduce the price of the allowances traded in the market (Convery and Redmond, 2004). Since the basis for these calculations is a wide range of studies (Jungmeier et al., 2005), the CO2eq. emissions mitigation costs for biofuels estimated in this paper are within 17 Trading started in January 2005, and since November 2003 a futures market for CO2 emissions was in operation. Although the EU emissions trading scheme includes only CO2 emissions rather than CO2eq. emissions, the price is not likely to change greatly for CO2eq. emissions, since CO2 emissions make up the largest share of greenhouse gas emissions.

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3190 2200

High Best estimate Low

2000 1800 1600

/tCO2eq. mitigated

1400 1200 1000 800 600 400 200 0

Sugar crops

Starch crops

Lignocellulosic crops Lignocellulosic Brazilian sugar cane Biodiesel/oil seeds residues

-200

Fig. 2. Range of estimates for threshold values (biofuel mitigation costs), h/tCO2eq. emissions Notes: (1) Data from Jungmeier et al. (2005). (2) Threshold value calculation ¼ price difference between biofuel and fossil fuel on energy-equivalent basis divided by tonnes of CO2eq./1000 l saved through use of biofuel.

the range in the literature. Nevertheless, the estimated threshold cost of biofuels is significantly higher than the traded price of CO2 emissions of around h17/tonne CO2. (See Fig. 3).18 Moreover, the threshold cost is at the higher end compared with the costs of CO2 emissions mitigation overall in the transport sector. Blok et al. (2001) estimated that the cost of technical measures to reduce greenhouse gas emissions in the transport sector would range between h73–350/tCO2. 4.1. Costs of excise duty rebate Given the cost differential with fossil fuels, government intervention is needed in order to promote the market introduction of biofuels. There are several possible ways to do this. Currently the most widely used method of subsidy in Europe is the rebate of excise duties. The recent EU Directive on the taxation of energy products and electricity, permits partial or total exemptions in the taxation of biofuels (Council of the 18 The European Union Allowance (EUA) price development graph is based on daily price information obtained from Point Carbon’s daily allowance market newsletter Carbon Market Daily—www.PointCarbon.com. We are grateful to Luke Redmond for compiling it for us.

European Union, 2003). Many countries have already introduced an excise duty rebate on biofuels and others are considering doing so. Table 4 compares the cost difference between a fossil fuel and the corresponding biofuel, from Section 3, with the excise duty applied to mineral fuels in each EU15 country. This table shows that at these fossil fuel prices (July–December 2004), the cost difference between European bioethanol and petrol is higher than the excise duty applied to petrol in all EU15 countries, and a remission of excise duty would be insufficient to equalise the prices between fossil and biofuels. For diesel fuels, the cost difference between biodiesel and diesel utilised for private consumption is also greater than the excise duties applied to diesel in all EU15 countries. This demonstrates that further intervention would be needed in all countries to promote biofuels in the EU transport fuels market. However, this is obviously subject to the level of oil prices. As fossil fuel prices rise, the level of subsidy required to compensate the cost difference between biofuels and fossil fuels is reduced. The rebate of excise duty of transport fuels constitutes an exemption to Community State Aid Rules19 and is permitted under certain conditions when the tax reduction given 19

Article 87(3)(c) of the EC Treaty.

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Fig. 3. Carbon prices December 2004–July 2005. Source: Point Carbon 11/7/2005 (www.pointcarbon.com).

Table 4 Comparison of price difference between biofuel and fossil fuel with excise duty applied in EU15 Member States Member states

Belgium Denmark Germany Greece Spain France Ireland Italy Luxembourg Netherlands Austria Portugal Finland Sweden United Kingdom EU15 average

Bioethanol and petrol cost difference h/1000 l

Biodiesel and diesel

Sugar

Starch crops

Lignocellulosic crops

Lignocellulosic residues

Brazilian sugarcane

Petrol excise duty

Oil seeds

Diesel excise duty

911 907 928 872 891 953 885 862 888 865 879 888 910 908 931 896

819 815 836 781 800 862 793 770 797 773 788 796 818 816 839 805

1094 1090 1111 1055 1074 1136 1068 1045 1071 1048 1062 1071 1093 1091 1113 1079

962 958 979 923 942 1004 936 913 939 916 930 939 961 959 982 947


60
64
43
98
79
17
86
109
82
106
91
83
61
63
40
74

574 541 654 296 396 589 443 564 442 665 425 523 597 547 675 529

551 573 575 537 554 587 546 533 554 542 548 566 578 554 588 557

340 367 470 245 402 417 368 413 265 265 310 308 347 402 675 373

Notes: 1. Fossil fuel prices are 6-month averages for EU15 for July-December, 2004. Available from EU Oil Bulletin at: http://europa.eu.int/comm/energy/oil/index_en.htm. 2. Biofuel prices from best estimates in Table 1a. 3. Excise duty from EU Oil Bulletin, 31 March 2005.

by a Member State is not higher than the cost difference between the biofuel and fossil fuels. In this case the price difference between fossil fuels and biofuels before excise duty and VAT is substantially higher than the excise duty in all countries. Table 5 presents the revenue foregone in EU15 as a result of eliminating excise duties per tonne of CO2eq.

emissions saved. It is calculated as the value of excise duty foregone per 1000 l of energy-equivalent biofuel sold (EU15 average), divided by the best estimate of tonnes of CO2 emissions saved per energy-equivalent litre of biofuel from Table 3. The values in Table 5 are lower than the best estimates of the costs of the financial support required to the prod

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Table 5 Cost or revenue foregone as a result of an excise duty rebate (h/ tCO2eq.) Biofuel

Feedstock

h/tCO2eq.

Sugar crops Starch crops Lignocellulosic crops Lignocellulosic residues Brazilian sugarcane

429 1286 211 202 182

Bioethanol

Biodiesel Oil seeds

279

Notes: 1. Average excise duty for petrol and diesel in EU15, 31/03/2005. Available at http://europa.eu.int/comm/energy/oil/bulletin/2005_en.htm. CO2eq. emissions savings from best estimates in Table 3.

uction and distribution cost difference between European biofuels and fossil fuels, illustrated in Fig. 2. This is clear since the difference between biofuel and fossil fuel costs on average is currently higher than the excise duty. Even if the costs of either an excise duty rebate or subsidising the cost difference were comparable, the rebate of excise duty may be preferred due to the ease of implementation. The transaction costs can be low, since the rate of subsidy is fixed at the excise duty rebate and hence once a fuel meets the criteria of the definition of a biofuel, the supplier is automatically awarded an exemption from excise duty. With a scheme comprising compensation of the cost difference of fossil fuels and biofuels, in order to ensure that the price of the biofuel matches that of the corresponding fossil fuel, the amount awarded must continuously change and may be subject to renegotiation. However, direct subsidy ensures that the price of a biofuel matches that of the corresponding fossil fuel. An excise duty rebate is not tied to prevailing oil or biofuels costs; therefore the implicit subsidy given is not a function of the current price differential. Reducing excise duty on fuels would affect an important source of government revenue. Revenue from transport fuel excise duty in 2002 for the 15 Member States in the EU reached h178 billion (ACEA, 2004). Energy and transport taxes in 2002 made up 2.6% of total GDP and 6.3% of total taxation in EU15 (Commission of the European Communities, 2004). In addition, although on average the costs of remitting excise duties are comparable with the cost difference between biofuels and fossil fuels, for many countries, the rebate of excise duty may not be sufficient to make all biofuels competitive with mineral fuels. 4.2. Tariffs and world prices So far we have focused primarily on biofuels produced in EU15. Do the results change if the

accession of 10 new Member States20 to the EU in 2004 is considered? Kavalov et al. (2003) estimate the potential contribution of the new Member States at 1% of the enlarged EU fuels market. With optimal technology, the potential rate of substitution could be 2% of diesel consumption and 3% of petrol consumption. This production is sufficient to meet the new Member States requirements under the EU biofuels Directive, but it can only be a small supplement to EU15 biofuel production. In addition, the biofuels production costs in accession countries appear to be similar to those in EU15, as lower factor costs are offset by lower yields. Potential sources of cheaper biofuels are found in non-EU countries from South America and Asia. The bioethanol market in Brazil has been established since the launch of a biomass programme in the 1970s (the Proalcool programme). The Brazilian government has supported this programme with vehicle technology subsidies and fuel tax reductions. Currently it is mandatory to blend petrol up to 20–25% with anhydrous bioethanol. This rule has provided a stable market for bioethanol producers in Brazil over the last 30 years and created a low risk environment for investors. As a result, Brazil has a significant cost advantage in the production of bioethanol compared with the EU, mainly due to large-scale commercial production (reaching 13.7 billion litres in 1997 (Fulton et al., 2004)) and favourable conditions for the cultivation of sugarcane. This has led to cheap bioethanol and high capacities available for export. From Table 2 it can be seen that if bioethanol imports from Brazil are used, the net costs per tonne of CO2 emissions reduction in the EU fall dramatically, to the point where it is competitive in private cost terms with petrol and diesel. Note however, that this conclusion holds at current prices, i.e. it relies on a sufficient Brazilian export capacity and assumes no import tariffs. Tariffs of approximately h0.1–0.2/l 21 exist on imported bioethanol to the EU. The EU Council Regulation22 on laying down specific measures concerning the market in ethyl alcohol of agricultural origin, introduced a monitoring system from January 2004 affecting bioethanol imports. An export and import license scheme was introduced and the Commission has the power to administer tariff quotas ‘‘resulting from international agreements concluded in accordance with the Treaty from other legislative acts of the Council.’’ The International Energy Agency has called for the lowering 20 Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovenia, Slovakia. 21 The tariff on bioethanol depends on whether it is denatured (h0.102/l) or undenatured (h0.192/l). Germany requires bioethanol to be undenatured but other Member States do not. Information on tariffs is available on http://europa.ey.int/comm/taxation_customs/ dds/en/tarhome.htm. 22 Council Regulation no. 670/2003.

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of tariffs on biofuels (Fulton et al., 2004), and it appears that the EU is negotiating with Latin American countries to reduce tariffs for the import of bioethanol into the EU.23

5. Conclusions The substitution of fossil fuels with biofuels has been proposed in the EU as part of a strategy to mitigate greenhouse gas emissions from road transport, increase security of energy supply and support development of rural communities. This paper focused on one of these purported benefits, the reduction in greenhouse gas emissions, and examined whether implementing this measure is economically efficient. The current cost of subsidising the price difference between European biofuels and fossil fuels per tonne of CO2 emissions saved is calculated to be h229–2000. This is the threshold value that must be assigned to one tonne of CO2 emissions, in order for the biofuels policy measure to be economically efficient; it is high compared with other available CO2 mitigation strategies, both within the transport sector and (especially) outside. CO2 allowances in the EU are being traded at around h17/ tonne. The marginal abatement costs of CO2 emissions for the road transport sector are in the range of h73–350/tCO2 (Blok et al., 2001). The cost of subsidising biofuels falls within the upper end of this range. It seems then that supporting biofuels is currently not efficient without including the economic benefits from additional employment generated or the resulting incremental security of energy supply. Even in this case, it is likely that these strategic and social objectives could be met by alternative means that are less expensive. The use of biofuels is currently cost efficient only when the bioethanol is imported from Brazil, assuming that the Brazilian supply is perfectly elastic and import tariffs are sufficiently low. If the production of European biofuels for transport is to be encouraged, exemption from excise duties is the instrument that incurs the least transactions costs, as no separate administrative or collection system needs to be established. However, for most European countries, total exemption from the prevailing excise duties would not suffice to make production viable. Moreover, given the pressure that most EU countries are under to reduce budget deficits and taxes simultaneously, it seems unlikely that the stimulation of biofuels will be seen as a priority. These conclusions are valid at current costs and prices (oil prices at approximately $50 bbl). However, anecdotal evidence shows that a number of entrepreneurs are producing biofuels at the lower margin of the costs specified here profitably, once an 23

Personal communication DG TREN 11/2004.

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excise duty rebate is given. For example, the production of biodiesel in Germany reached 1.04 million tonnes in 2004 and 170,000 tonnes of bioethanol were produced in Spain in 2003. It is likely that growth in the volume of the business will engender both economies of scale and innovation that will reduce costs substantially (Jungmeier et al., 2005). However, under current conditions, it seems that it will take time, large scale, innovation and higher fossil fuel prices before European biofuels will be able to compete on a cost-effectiveness basis with imports from Brazil or alternative abatement options.

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