ReneWaBLe eneRgy 40238 Considering Trade Policies for Liquid Biofuels Masami Kojima Donald Mitchell William Ward Energy Sector Management Assistance Program Copyright © 2007 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, NW Washington, DC, 20433 USA All rights reserved Produced in the United States First printing September 2007 ESMAP Reports are published to communicate the results of ESMAP's work to the development community with the least possible delay. The typescript of the paper therefore has not been prepared in accordance with the procedures appropriate to formal documents. Some sources cited in this paper may be informal documents that are not readily available. 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ESMAP encourages dissemination of its work and will normally give permission promptly and, when the reproduction is for noncommercial purposes, without asking a fee. Renewable eneRgy Special Report 004/07 Considering Trade Policies for liquid biofuels Masami Kojima Donald Mitchell william ward Energy Sector Management Assistance Program Contents Acknowledgments v Acronyms and Abbreviations vii Units of Measure ix Glossary of Terms xi Executive Summary xiii Report Summary 1 Link between Agriculture and Biofuels 3 Biofuel Policies 4 Impact of Higher Biofuel Production 6 Petroleum Price Impacts 7 Impact of Trade Liberalization 7 The Role of International Trade in Biofuels 8 1. Issues in Biofuels, Agriculture, and Trade 11 Biofuel Basics 13 Economics of Biofuels 18 Gasoline and Diesel Consumption 25 WTO Negotiations on Agriculture 26 2. Agriculture and Biofuels 29 Link between Biofuels and Agriculture 29 Agricultural Policies 32 Effects of Biofuel Production on Agricultural Commodities 36 Effects of Agricultural Trade Liberalization 40 3. Biofuel Policy and Trade Issues 45 Current Policies for Biofuels That Affect World Biofuel Markets 45 Potential Benefits of Biofuel Trade 57 Potential Impact of Biofuel Market Growth and Trade Liberalization 59 WTO Issues for Biofuels 62 iii Special Report Considering Trade Policies for liquid biofuels 4. Conclusions 67 Energy Security 67 Environmental Sustainability 68 Support for Domestic Agriculture 70 Synthesis of Analysis 70 Appendixes A. Issues in Agriculture and Environment under the WTO 75 B. EU and U.S. Agricultural Policies 79 C. Biofuel Policies in Different Countries 83 References 99 Tables 1.1: Change in Life-Cycle GHG Emissions per Kilometer Traveled by Replacing Gasoline with Ethanol in Conventional Spark-Ignition Vehicles 14 1.2: Change in Life-Cycle GHG Emissions per Kilometer Traveled by Replacing Diesel with Biodiesel in Conventional Compression-Ignition Vehicles 15 1.3: Economics of Ethanol Production for Domestic Sale in Landlocked Areas, Calendar Years 1990­2006 24 2.1: Correlation Coefficients for Prices of Crops Used to Produce Biofuels, 1960­2006 30 3.1: Worldwide Average Extraction Rates by Weight 60 3.2: Land Required for Biofuel Production 62 Figures 1.1: Comparison of Gasoline Prices and Opportunity Costs of Ethanol 20 1.2: Comparative Economics of Sugar versus Ethanol Sale 21 1.3: Viability of Ethanol for Highly Efficient Producers in Landlocked Areas 23 1.4: Viability of Ethanol in Landlocked Areas with Sugar Production Cost of US$250 per Tonne 24 1.5: Prices of Coconut, Soybean, Palm, and Rapeseed Oils, and Diesel 25 1.6: World Motor Gasoline Consumption and World Automotive Diesel Consumption in 2004 26 2.1 Index of Agricultural Prices 43 iv acknowledgments This study was performed under the guidance of the Energy and Mining, Agriculture and Rural Development, and Environment Sector Boards of the World Bank, with support from the Energy Sector Management Assistance Program (ESMAP), a joint program of the United Nations Development Programme and the World Bank. The financial assistance provided by the government of the Netherlands through ESMAP is gratefully acknowledged. This report was prepared by Masami Kojima of the Oil, Gas, and Mining Policy Division, World Bank; Donald Mitchell of the Development Prospects Group, Development Economics, World Bank; and William A. Ward, Professor and Director, Center for International Trade, Clemson University. At the World Bank, the authors thank Derek Byerlee of the World Development Report, Development Economics, and John Nash of the Sustainable Development Department, Latin America and the Caribbean Region, for providing comments as peer reviewers. Additional useful comments were provided by Boris Utria of the Sustainable Development Department, Africa Region; Carlos Braga and Krista Lucenti of the International Trade Department; Ariel Dinar, Gershon Feder, Daniel Lederman, and William Martin of the Development Research Group, Development Economics; Richard Henry of the Agribusiness Department, International Finance Corporation; and Dina Umali- Deininger and Kseniya Lvovsky of the Sustainable Development Department, South Asia Region. The authors are also grateful for comments provided by the following external reviewers: · Ronald Steenblik, Research Director, Global Subsidies Initiative · James Fry, Managing Director, LMC International · Dirk Aßmann, Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ) · Melinda Kimble, Senior Vice President, United Nations Foundation; and the three commentators from the Tepper School of Business, Carnegie Mellon University, who submitted comments through the foundation--Lester B. Lave, University Professor and Higgins Professor of Economics; Seth A. Blumsack, Postdoctoral Research Fellow, Carnegie Mellon Electricity Industry Center; and W. Michael Griffin, Executive Director, Green Design Institute · Astrid Agostini, Gustavo Best, Merritt Cluff, Jamie Morrison, and Jennifer Nyberg of the Food and Agriculture Organization The authors thank Jenepher Moseley and Nita Congress for editorial assistance, Nita Congress for desktop publishing, and ESMAP staff for overseeing the production and dissemination of the report. v acronyms and abbreviations APEC Asia-Pacific Economic Cooperation CAFTA Central American Free Trade Agreement CAP Common Agricultural Policy CBI Caribbean Basin Initiative CO2 carbon dioxide EBA Everything But Arms ESMAP Energy Sector Management Assistance Program ETBE ethyl tertiary-butyl ether EU European Union FAPRI Food and Agricultural Policy Research Institute FOB free on board FY fiscal year GATT General Agreement on Tariffs and Trade GHG Greenhouse gas GSP+ Generalized System of Preferences Plus HS Harmonized System MTBE methyl tertiary-butyl ether NAFTA North American Free Trade Agreement NExBTL next generation biomass to liquids OECD Organisation for Economic Co-operation and Development R&D research and development RON Research octane number USDA U.S. Department of Agriculture U.S. EPA U.S. Environmental Protection Agency WCO World Customs Organization WTO World Trade Organization vii Units of Measure $A Australian dollar B Thai bhat Can$ Canadian dollar ºC degrees Celsius euro R$ Brazilian real RM Malaysian ringgit Rp Indonesian rupiah Rs Indian rupees SKr Swedish kronor Y Chinese yuan ¥ Japanese yen Note: For current costs and prices, exchange rates prevailing in April 2007 are used. For past costs and prices, the exchange rate prevailing at the time is used. ix glossary of Terms Amber box Amber box policies in the Uruguay Round Agreement on Agriculture are subject to careful review and reduction over time. Amber box policies include market price support, direct payments, and input subsidies. Agreement on Part of the Uruguay Round Agreement covering issues related to agriculture. Agriculture Three pillars of this agreement are market access, export subsidies, and domestic subsidies. Anhydrous ethanol Ethanol with sufficient water removed to make it suitable for blending with gasoline. Biodiesel A diesel fuel, primarily alkyl (methyl or ethyl) esters (an organic compound with two oxygen atoms), that can be used in blends or in "neat" (pure) form in compression-ignition engines and produced from a range of biomass-derived feedstocks such as oilseeds, waste vegetable oils, cooking oil, animal fats, and trap grease. Biomass Organic matter available on a renewable basis. Biomass includes all plants and their residues: forest and mill residues, agricultural crops and wastes, wood and wood wastes, animal wastes, livestock operation residues, aquatic plants, and fast-growing trees and plants. Blue box Blue box policies in the Uruguay Round Agreement on Agriculture are exempt from reduction commitments. Examples include program payments received under production-limiting programs, if they are based on fixed area and yields, a fixed number of head of livestock, or 85 percent or less of base-level production. B5, B20 Diesel-biodiesel blends containing, respectively, 5 percent and 20 percent biodiesel. Cellulosic ethanol Ethanol produced from cellulose, which includes a great variety of biomass such as forestry materials, agricultural residues, energy crops such as switch grass, and urban wastes. Denatured ethanol Ethanol that has been rendered toxic or undrinkable, for example, by the addition of gasoline. E5, E10, E85 Ethanol-gasoline blends containing, respectively, 5 percent, 10 percent, and 85 percent anhydrous ethanol. xi Special Report Considering Trade Policies for liquid biofuels Green box Green box policies in the Uruguay Round Agreement on Agriculture are domestic support policies that are not subject to reduction commitments. These policies are assumed to have a minimal effect on trade and include such support as research, extension, food security stocks, disaster payments, and structural adjustment programs. HS Prefix for commodity numbering system used by the World Customs Organization in its Harmonized Commodity Description and Coding System. Hydrous ethanol Ethanol with about 95 percent purity, the balance being water. It is not suitable for blending with gasoline. Most favored An agreement between countries to extend the same trading privileges to nation status each other that they extend to any other country. Treatment is granted if two countries are members of the World Trade Organization, or if most favored nation status is specified in an agreement between them. Palm olein The liquid fraction obtained by fractionation of palm oil after crystallization at controlled temperatures. Tariff rate quota A two-tier tariff where the tariff rate charged depends on the volume of imports. An in-quota tariff is charged on imports within the quota volume. A higher (over-quota) tariff is charged on imports in excess of the quota volume. Undenatured Pure ethanol without foreign materials intentionally added. ethanol xii executive Summary This report--which addresses the issues associated with trade in liquid biofuels--is a second Energy Sector Management Assistance Program report on biofuels, and part of a broader assessment of bioenergy undertaken by the World Bank. The report asks how liberalizing trade in liquid biofuels might affect biofuel production and consumption. Bioenergy is playing an increasingly important role as an alternative and renewable source of energy. Bioenergy includes solid biomass, biogas, and liquid biofuels. Combustion of biomass residues for heat and power generation is commercially viable without government support in some applications. Liquid biofuels made from biomass are attracting growing interest worldwide, driven by concerns about energy security, climate change, and local environmental considerations and a desire to support domestic agriculture. The global liquid biofuel market today utilizes so-called first generation technologies and relies mainly on agricultural food or feed crops for feedstock. Second generation biofuels, still far from commercially viable, can open up many new opportunities because they can be sourced from a much wider variety of feedstocks, vastly expanding the potential for fuel production and for abating greenhouse gas emission. The timing of commercialization is uncertain, although some industry analysts indicate that the needed cost reductions may be achieved in the coming decade. The two most important liquid biofuels today are ethanol and biodiesel, and they are of primary interest for transportation. Support policies for these two biofuels fall into two general categories: (1) policies to replace consumption of petroleum fuels through such programs as mandating of biofuel use and comparative reductions in fuel taxes for biofuel; and (2) policies to stimulate biofuel production domestically through--for example--producer subsidies, import tariffs to protect local producers and direct government support for all biofuels to local production, and research to develop new or improved technologies. Some policies reduce trade directly and are obvious subjects of this report. Other policies do not reduce trade directly but may have indirect distorting effects on trade. Focusing primarily on ethanol and biodiesel, the report takes a time horizon of the next 5 to 10 years. It outlines the important link between agriculture and biofuels, reviews past and present government policies for agriculture and for biofuels, and considers how these policies might affect the world biofuel market. The report highlights the links between the markets for oil, biofuels, feedstocks, and the by-products of biofuel processing. It reviews existing studies, examining the likely consequences of much larger biofuel production and trade liberalization of biofuels and their feedstocks. It concludes with policy considerations. xiii Special Report Considering Trade Policies for liquid biofuels Current commercial feedstocks for biofuels are predominantly agricultural crops. Ethanol is made from sugarcane, sugar beets, maize, wheat, cassava, and other starches. Biodiesel is produced from rapeseed oil, soybean oil, waste oil, and, increasingly, palm oil. The physical properties of biodiesel depend on the feedstock and the extent of further downstream processing. Biodiesel manufactured using traditional methods (reacting an oil with an alcohol) can have cold climate and other performance problems. The world's leading ethanol producers are Brazil (from sugarcane) and the United States (from maize). The world's leading biodiesel producer is Germany (from rapeseed oil). Because biodiesel has historically been more costly than ethanol, the biodiesel market is much smaller. A number of industrial and developing countries have instituted programs to promote biofuel production and consumption, setting targets--some mandatory--for increasing the contribution of biofuels to their transport fuel supplies. In the future, second generation biofuels could use agricultural residues and other feedstocks that are not used as food or feed. Feedstock costs comprise more than half the costs of producing both ethanol and biodiesel. Despite remarkable reductions in production costs over the years in Brazil, the United States, and elsewhere, biofuels to date have been marginally economic under favorable conditions (high world oil prices and low feedstock prices) and only in a handful of circumstances, such as Brazil in 2004 and 2005. More generally, biofuels have not been commercially viable without significant government support, even though the two leading producers of biofuels--Brazil and the United States--are among the world's most efficient producers of biofuel feedstocks. As a result, all biofuel markets have been supported by government protection policies. Trade in biofuels is limited, although it is growing. Direct and indirect policy-induced price distortions greatly affect the financial attractiveness of ethanol and biodiesel production and trade. These price distortions are large, and the forward and backward links with other price-distorted markets (for example, sugar) are strong. Any effect on feedstock prices arising from agricultural or biofuel policies has an immediate effect upon the economics of biofuel production. Agricultural policies in industrial countries have tended to depress crop prices internationally--making, for example, ethanol from sugarcane more attractive in financial terms than in economic terms. Further complicating the analysis, the major feedstocks are primarily used as human foods and animal feed, and the by-produccts of biofuel manufacture play a significant role in biofuel economics. It has also been suggested that increasing diversion of a crop to the biofuel market is beginning to link that crop's price to the world petroleum market. These observations suggest that policy analysis should use economic values rather than rely only on financial or commercial prices, and that economic analysis needs to consider multiple markets in which many related prices are distorted by domestic and foreign government policies. Impediments to biofuel trade include high import tariffs, largely on ethanol, and technical barriers to trade. The latter may be legitimate and even welfare enhancing, but they reduce the volume of trade. Arguably the greatest technical barrier in the coming years could be certification of biofuels for environmental sustainability, prompted by concerns about burning and clearing of rain forests to plant palm and soybeans (both feedstocks for biodiesel) in Southeast Asia and Latin America. If policies that are potentially market distorting but not trade distorting--such as consumption mandates and fuel excise tax reductions for all biofuels--are maintained, liberalizing biofuel trade is likely to increase demand for biofuels by reducing prices in previously protected markets. However, xiv executive Summary massive growth of biofuel production based on current technologies would face several challenges, including limits on the amount of unutilized land that can be brought into production economically and potential water shortages that may contain expansion. Efficient producers of biofuels with scope for expansion (such as Brazil) will benefit, whereas those currently enjoying preferential treatment (such as the Caribbean countries) will lose their trading opportunities. An immediate effect of trade liberalization is estimated to be an increase in feedstock prices and a fall in by-product prices on the world market. More generally, biofuel and agricultural trade liberalization is expected to increase world prices of agricultural commodities. Higher feedstock prices in turn could slow the growth of the global biofuel market. Biofuel production growth has already begun to change the price relationships among various agricultural commodities. With a greater share of maize and other markets characterized by inelastic demand (through biofuel mandates, among others), increased price variability and market volatility are expected. Higher food prices will benefit producers and harm consumers. Net sellers of food, including many of the poor engaged in agriculture in developing countries, will benefit. The welfare of urban workers and net buyers of food generally will decline. Most evidence suggests that poor farming households in rural areas are net buyers of food, even though they also produce agricultural crops. Because maize is the staple food in a number of developing countries, rapidly rising maize prices are a particular concern. Prices are expected to rise more steeply for the food products developing countries import than for the commodities they export. The poorest countries--very few of which export products on which there are currently high tariffs--would generally be worse off. Lowering tariffs in developing countries could partially mitigate these adverse effects by lowering prices of imported food items and creating opportunities for regional trade. One possible exception to the above price trend is oilseeds and oilseed products, on which some major oilseed producers assess export taxes. Removal of the export taxes may prompt a large supply response and a fall in world prices, and greater exports of biodiesel feedstocks, rather than biodiesel, to industrial countries. Biofuel trade liberalization would increase competition, which should in turn help improve efficiency, bring down costs, and enable the world's most efficient producers to expand their market share. Removal of high tariffs would bring down prices in highly protected markets, although world biofuel prices may rise. That said, removing border restrictions for biofuels while continuing the agricultural and biofuel policies that distort biofuel markets could prolong those distortions, as additional markets for subsidized agricultural outputs and biofuels would be created. The greatest welfare gains might be realized with the full range of trade reforms carried out simultaneously. Failing that, trade in ethanol and biodiesel might be liberalized as a first step. Such a move could also force governments to address openly the question (and the costs) of what objectives their biofuel support policies are actually pursuing. xv Report Summary Bioenergy is playing an increasingly important · Concerns about energy security1 role as an alternative and renewable source · Environmental considerations that focus of energy. Bioenergy includes solid biomass, on GHG emissions, primarily in industrial biogas, and liquid biofuels. Combustion of countries, and on tailpipe emissions in biomass residues for heat and power generation developing countries that have relatively is commercially viable without government lenient vehicle emission and fuel quality support in some applications. Liquid biofuels standards made from biomass are attracting growing · A desire to support and protect domestic interest worldwide. The global liquid biofuel agriculture against the backdrop of market today utilizes so-called first generation negotiations for agricultural trade liberalization technologies and relies mainly on agricultural in international organizations and treaties crops for feedstock. Second generation biofuels, still far from commercially viable, can open up The two most important liquid biofuels today are many new opportunities because they can be ethanol and biodiesel, and they are of primary sourced from a much wider variety of feedstocks, interest for transportation. Support policies for vastly expanding the potential for fuel production these two biofuels fall into two general categories: and for abating greenhouse gas (GHG) (1) policies to replace consumption of petroleum emission. The timing of commercialization is fuels with such programs as mandated biofuel uncertain, although the needed cost reductions use and comparative reductions in fuel tax for may be achieved in the coming decade. biofuel; and (2) policies to stimulate biofuel production domestically through--for example-- This report--which focuses on the issues producer subsidies, import tariffs to protect local associated with trade in liquid biofuels--is a producers and direct government support for second Energy Sector Management Assistance all biofuels to local production, and research to Program (ESMAP) report on biofuels, and part of develop new or improved technologies. Some a broader assessment of bioenergy undertaken policies distort trade directly and are thus obvious by the World Bank. Three principal factors drive subjects of this report.2 Other policies do not the growing interest in liquid biofuels: distort trade directly but may affect it indirectly. 1 With energy, as with food, important policy distinctions are made between security and self-sufficiency. See chapter 2, footnote 4. 2 Any policy that subsidizes or mandates, and thereby increases, consumption of a product generates new trade (all else being equal); in that sense, all government support is trade distorting. Traditionally, a policy has been labeled trade distorting if it has an anti-trade bias or reduces trading opportunities for others in the global trading system (for example, domestic subsidies benefiting only domestic production, import tariffs and other import restrictions, export subsidies, and export taxes). This report uses the phrase "nontrade distorting" to describe policies that do not create an anti-trade bias or reduce global trading opportunities for some. Special Report Considering Trade Policies for liquid biofuels The previous ESMAP report on biofuels (ESMAP biofuels based on thermochemical processes can 2005) found the economics of biofuel production use virtually all forms of biomass to make diesel, and consumption to be site- and situation- gasoline, and ethanol. specific, suggesting scope for welfare gains from specialization and trade. This report examines Ethanol is a chemical compound, but biodiesel how liberalizing trade in liquid biofuels might is a mixture of many compounds and its affect biofuel production and consumption. The physical properties vary. Depending on the report focuses on ethanol and biodiesel over feedstock and the extent of further downstream a time horizon of the next 5 to 10 years. The processing, biodiesel manufactured using report does not attempt to assess the effect of traditional methods (reacting an oil with an policy changes on emerging technologies or alcohol) can have cold climate and other new (not yet commercially proven) feedstocks performance problems, making biodiesel more such as cellulosic ethanol, as they are unlikely suitable for use in low-percentage blends. to become sufficiently competitive commercially The world's leading producers of ethanol within a decade to have a significant impact and their primary feedstocks are Brazil (from on international trade in biofuels. The report sugarcane) and the United States (from maize). also does not cover direct use of plant oils in The two countries also dominate sugar and engines because of their limited application, or maize exports, respectively. The world's leading consider specific environmental effects of trade biodiesel producer is Germany (from rapeseed liberalization. oil). Because biodiesel has historically been more costly than ethanol, the biodiesel market The report begins by outlining the important is much smaller. A number of other countries link between agriculture and biofuels. It then have instituted programs to promote biofuel covers past and present government policies production and consumption. Argentina, for both agriculture and biofuels, and considers Australia, Canada, China, Colombia, European how these policies might affect the world biofuel Union (EU) member states, India, Indonesia, market. The report highlights the links between Malaysia, New Zealand, the Philippines, and the markets for oil, biofuels, feedstocks, and Thailand have all adopted targets--some the by-products of biofuel processing; then mandatory--for increasing the contribution of reviews previous studies examining the likely biofuels to their transport fuel supplies. consequences of increased biofuel production and of trade liberalization. It concludes with Feedstocks typically account for more than policy considerations for liberalizing trade in half of the production costs of liquid biofuels. biofuels. Despite remarkable reductions in production costs over the years in Brazil, the United States, Current commercial feedstocks for ethanol and elsewhere, biofuels to date have been only are sugarcane, sugar beets, maize, wheat, marginally economic under favorable conditions cassava, and other starches; in the future, (high world oil prices and low feedstock prices) cellulosic ethanol made from energy crops, and only in a handful of circumstances, as in forest and agricultural residues, and municipal Brazil in 2004 and 2005. More generally, biofuels solid waste could open up opportunities around have not been commercially viable without the world, including in countries not suited for significant government support, even though the ethanol production today. Biodiesel is produced two leading biofuel markets are also two of the from rapeseed oil, soybean oil, waste oil, and, most efficient producers of biofuel feedstocks increasingly, palm oil. Second generation (net of subsidies, Brazil is the world's lowest cost Report Summary producer of sugarcane, and the United States to agriculture. Although ethanol from sugarcane is one of the lowest cost producers of maize). in Brazil was the least-cost ethanol globally in Consequently, all biofuel markets have been much of the early 2000s, the economics became supported by government protection policies. considerably more unfavorable following a surge Only about one-tenth of the biofuels produced in world sugar prices to 25-year highs in early and sold are internationally traded, and Brazil 2006. Similarly, although ethanol from maize accounts for about half of the exports. There is in the United States is generally more costly to little trade of biodiesel, although it is growing. produce than ethanol from sugarcane in Brazil, it was markedly cheaper in June 2000 when Direct and indirect policy-induced price distortions sugar prices in Brazil reached their peak while greatly affect the financial attractiveness of U.S. maize prices fell. ethanol and biodiesel production and trade. The resulting price distortions are large, and the Agricultural policies affect the production, forward and backward links with other price- trade, and prices of agricultural commodities distorted markets are strong. This suggests and thus are important determinants of biofuel that policy analysis should use economic feedstock costs and biofuel prices. Policies values rather than relying only on financial that distort agricultural trade are much more or market prices, and that economic analysis pervasive and substantial than trade-distorting needs to approximate general equilibrium policies for other goods such as manufactures. considerations across multiple markets in which Historically, agricultural policies have tended many related prices are distorted by domestic to protect producers in industrial countries and foreign government policies. Financial price from imports from lower cost producers, while relationships for biofuels generally should be policies in developing countries have tended to viewed with some skepticism, and, for policy tax producers. Some major oilseed-producing purposes, attention should be paid to those countries continue to assess high export taxes economic values for which distortions have been on oilseeds and oilseed products; Argentina, accounted. ESMAP (2005) details a framework for example, levies a 27.5 percent export tax on for economic analysis. soybeans and a 24 percent tax on soybean oil; it assesses low or no export taxes on biofuels. There are other applications of bioenergy-- This export tax structure provides incentives notably combustion of solid biomass for heat to export biofuels rather than feedstocks. The and power generation--that are commercially highest protection is found in high-income Asia, viable without government subsidies. However, Europe, and the United States. The European there is a growing tendency to focus on liquid Union has used high tariffs to limit agricultural biofuels, and some have even come to use the imports for most of the past 40 years, but is now word "bioenergy" to mean bioethanol and shifting to direct payments that are decoupled biodiesel. Against this trend, it is important to from production decisions. The United States view the potential of liquid biofuels in a broader uses production subsidies and direct payments context that encompasses all forms of biomass to agricultural producers. Although its overall as energy sources. support to agriculture is much smaller than that in high-income countries, Brazil provides link between agriculture and biofuels low-interest loans to encourage expansion of agricultural exports and production. The value Because feedstocks dominate the production of total support to producers in the countries costs of liquid biofuels, biofuels are closely linked belonging to the Organisation for Economic Special Report Considering Trade Policies for liquid biofuels Co-operation and Development (OECD) was would find it difficult to launch commercially estimated at US$280 billion in 2005, compared viable biofuel markets because biofuels have to a total value for agricultural production (at historically required large tax reductions to farm gate) of US$837 billion in 2005 (OECD compete with petroleum fuels. Tax reductions for 2006b). ethanol in EU countries have been as high as US$0.84 per liter; such reductions are possible In countries where government provides only because fuel taxes are high to begin support to agriculture, biofuel feedstocks are with. The U.S. federal tax credit for ethanol is usually beneficiaries of the subsidies. Among relatively low at US$0.135 per liter of ethanol major biofuel producers, maize and soybeans blended, but a number of state governments in the United States and sugar beets and offer additional tax reductions. Biodiesel has rapeseed oil in the European Union are large enjoyed comparable tax reductions, up to recipients of government aid. The global sugar US$0.60 per liter of biodiesel blended in the market is among the most distorted, with high European Union, US$0.28 per liter in Australia, protection and price supports to EU, U.S., and and US$0.26 per liter in the United States. Japanese producers. These policies have been Among developing countries, Thailand provides estimated to depress world sugar prices by up significant fuel tax and fee reductions--as much to 40 percent from the levels that would have as US$0.65 per liter in April 2006. In assessing prevailed under a free market (Mitchell 2004). these fuel tax reductions, note that fuel economy Trade liberalization would increase world prices penalties associated with biofuel use amount for sugar more than those for all the biofuel to some 20 to 30 percent for ethanol and 5 to feedstocks currently being used commercially, 10 percent for biodiesel; this means that the tax which would have an adverse impact on ethanol reductions per liter of petroleum fuel equivalent economics. are even larger than the stated rates per liter of biofuel Policies biofuel. Some support policies for biofuels do not Some tax differentials may be justified to account in themselves distort trade, such as biofuel for externalities that are not properly reflected mandates (for example, mandatory blending) in end-user prices, such as environmental and fuel tax reductions that do not distinguish externalities. Carbon market payments can serve between domestic and imported biofuels. Other as an imperfect proxy for the benefits of reducing policies--such as import tariffs and producer GHG emissions. But even if 100 percent of subsidies--clearly protect or subsidize domestic the life-cycle GHG emissions of petroleum production at the expense of foreign-produced fuels are assumed to be offset by biofuels, a biofuels. carbon dioxide equivalent price range for the foreseeable future of between US$8 and US$20 Fuel tax reductions are the most widely used of per tonne would give a benefit of only US$0.01 all the support measures for biofuels, and are to US$0.07 per liter of biofuel (the upper end used even now in Brazil. This fiscal instrument of the range for biodiesel). For U.S. ethanol depends on the magnitude of excise taxes levied made from maize, only one-fifth to one-third of on petroleum fuels. Unlike industrial countries, petroleum GHG emissions have been estimated many developing countries levy low taxes or to be offset by biofuels use even under favorable even subsidize petroleum fuels. Countries circumstances, making the environmental with low or negative taxes on petroleum fuels benefits markedly smaller. For local air pollution Report Summary benefits, one set of rudimentary calculations lifted temporarily in February 2006 in the face for developing countries suggests that the of a looming ethanol shortage. Tariff rates on incremental value of ethanol compared with biodiesel in industrial countries are typically low gasoline may not be much higher than US$0.02 (Australia and Canada being two exceptions). per liter, and US$0.08 for biodiesel (ESMAP Ethanol is classified as an agricultural good and 2005). These externality estimates are much biodiesel as industrial. Ethanol's agricultural smaller than the tax reductions currently given classification affords countries that impose high to biofuels. Biofuel feedstock production and tariff rates on ethanol more time to liberalize biofuel processing may also carry environmental ethanol trade, protecting domestic producers costs: water and air pollution, soil depletion, longer. habitat loss, and potentially very large GHG emissions associated with the conversion of There are also technical barriers to trade. forests and grasslands to cropland. They may be legitimate and even welfare enhancing, but they reduce the volume of trade. Fuel tax reductions are typically granted to Arguably the greatest technical barrier in the domestic and imported biofuels alike, in order coming years could be certification of biofuels to comply with World Trade Organization (WTO) for environmental sustainability, prompted principles that prohibit adjusting internal taxes by concerns about burning and clearing of and other internal charges to afford protection rain forests to plant palm and soybeans (both to domestic products. In the case of ethanol, feedstocks for biodiesel) in Southeast Asia and however, these tax reductions are often offset Latin America. by nearly equivalent import tariffs to prevent foreign producers from sharing in the tax One form of government support given to reductions provided to domestic consumers. biofuels seems appropriate. A legitimate Border protection through high tariffs and role of government is to fund research and quota restrictions is a fiscally inexpensive way of development (R&D) for activities that, because protecting domestic producers and is liberally of their public good characteristics, are more used by governments. Ethanol enjoys much likely to be undertaken if centrally financed. higher tariff rates than biodiesel. The European Although the private sector can and should Union levies a specific import duty of 0.192 be encouraged to undertake such work, R&D (US$0.26) per liter on undenatured ethanol on biofuel technologies that can dramatically and 0.102 (US$0.14) per liter on denatured expand supply or reduce costs seems an ethanol; nevertheless, 101 developing countries appropriate area for governments to support. enjoy duty-free access to the EU ethanol market. In developing countries, R&D could focus on The United States levies a specific tariff of technologies--for primary feedstock production, US$0.1427 per liter of ethanol in addition to a processing of biofuels, or equipment small ad valorem tariff. Some countries in the modifications for alternative uses (such as region enjoy various forms of duty-free access direct use of plant oils in stationary sources in to the United States, and others take advantage remote areas with no electricity supply)--that of the "duty drawback" regulation. Australia are particularly suitable in their context. Studies has a specific import tariff of $A 0.38143 of government subsidies for biofuels in industrial (US$0.31) per liter for both ethanol and countries suggest that only a very small fraction biodiesel. Even Brazil levies a 20 percent ad of the aggregate subsidy is presently directed at valorem import tariff on ethanol, although it was R&D. Special Report Considering Trade Policies for liquid biofuels Impact of Higher biofuel Production used as high-protein animal feed, and glycerine, which is used in pharmaceutical and personal For biofuel trade to become significantly larger, care products--lower their prices and influence much greater global production of biofuels is the production of not only biofuel feedstocks needed. The net effect of increased production themselves but other crops that produce similar of biofuels on a large scale will be higher food by-products. prices, which will benefit producers and harm consumers. The effects will be different both Ramping up biofuel production will affect within and across countries. Within a given different farmers differently. A study of biodiesel country, the welfare of urban workers will found large differences in farmers' income decline, but that of rural households--including between biodiesel production from soybean farmers--will not necessarily rise uniformly. oil and from palm oil. Soybeans yield nearly Most evidence suggests that poor farming 80 percent by weight of soy meal, against households in rural areas are net buyers of food, 10 percent meal from palm. As a result, even though they produce agricultural crops. substantially higher soybean production for Because maize is the staple food in a number of biodiesel would lead to a large surplus of developing countries, rapidly rising maize prices meal and a large negative effect on soy meal are a particular concern. prices, thereby reducing income to soybean farmers relative to that of palm growers (LMC Higher feedstock prices in turn could slow the International 2003). growth of the global biofuel market. Growth in biofuel production has already begun to By the same token, ramped-up biofuel production change the price relationships among various would have a major impact on land use and agricultural commodities. With a greater share ecosystems. Another study modeled various of maize and other markets characterized by scenarios aiming to blend 5 percent biofuels in inelastic demand (through biofuel mandates, gasoline and diesel worldwide by 2015 using among others) which is also tied to the world agricultural crops. In terms of land requirements, oil market, and much smaller stocks of maize, the most efficient scheme was to derive the soybeans, and other biofuel feedstocks, incremental ethanol supply from sugarcane in increased agricultural crop price variability and the center-south region of Brazil and biodiesel market volatility are expected. from palm oil. The land requirement for ethanol tripled if the incremental supply was produced The price correlation occurs not only between from 50 percent cane and 50 percent maize oil, biofuels, and their feedstocks, but also from around the world. The land requirement with other crops that are substitutes and with for biodiesel quintupled if global use of other the by-products of those crops. Agricultural vegetable oils was made. In all cases, the amount commodity prices are highly correlated because of additional land required was substantial. If most cropland can be used to produce several the new biofuel feedstock production areas were different commodities, many commodities are shared proportionally among all carbohydrates substitutes in consumption, and agricultural and oilseeds, the world would need an increase commodities are internationally tradable. of more than 15 percent, or roughly 100 million Consumers also substitute among commodities hectares (LMC International 2006). Because in direct and indirect response to prices. And this study did not take water requirements into increased production of biofuel by-products-- account, the actual incremental land required such as oil meals and distillers grains, which are may be even greater. Report Summary Petroleum Price Impacts policies. The WTO defines trade liberalization to include reducing import tariffs, import quota Increasing biofuel production from a particular restrictions, export subsidies, and, significantly, crop could also link that crop's prices to domestic support (subsidies). Subsidies are petroleum fuel prices. For the foreseeable future, defined in the WTO Agreement on Subsidies biofuel production will remain small relative and Countervailing Measures to include not to petroleum fuel production, and biofuels only direct payments to producers, but also largely will continue to be price takers rather reductions in taxes and other charges that than drivers of transportation fuel prices. One reduce government revenues otherwise due. study suggests that diverting more than about 10 percent of a given crop to the biofuel market No modeling of global biofuel trade could link the price movement of that crop to liberalization has been conducted to date, but the world petroleum market (LMC International study findings on liberalizing world agricultural 2006). Thus, large-scale production of biofuel trade are informative. They have shown that the would not protect consumers against high largest gain from liberalizing trade will come petroleum prices for long, because feedstock from removing border distortions. An estimated prices would rise and reduce the price gap 75 percent of total agricultural support to OECD between petroleum and biofuel. As such, countries is provided by market access barriers biofuels are unlikely to become the answer to and only 19 percent by domestic farm subsidies high crude oil prices. (Anderson, Martin, and Valenzuela 2006). Meanwhile, in developing countries, nearly all However, if biofuels were to displace a mere price support is through border restrictions. 1 to 2 percent of global crude oil supply (2 to 7 percent of transport fuel demand), they might Several studies have estimated the percentage of moderate future petroleum price increases.3 the total costs of global distortions in agriculture Many factors influence whether such a level arising from import restrictions. The results of net displacement would occur. Because of range from about 80 percent to more than the large global potential to produce cellulose, 90 percent (OECD 2006c; Diao, Somwaru, and there is much interest in accelerating the Roe 2001; Anderson, Martin, and Valenzuela development of the required technologies. The 2006). The benefits of reducing distortions go U.S. government targets halving the production largely to industrial countries because they have cost of cellulosic ethanol by 2012, which would the greatest distortions and largest economies. require rapid advances in technology. However, when measured as a share of national income, the benefits to developing countries are Impact of Trade liberalization nearly double those of the industrial countries (van der Mensbrugghe and Beghin 2005). Production and trade policies for biofuels and for agriculture cannot be easily separated. WTO A study examining removal of U.S. import negotiations have taken a comprehensive view tariffs on ethanol--keeping all other U.S. of what constitutes trade restrictions and offer policy measures in place--estimates that tariff a useful framework in which to consider trade removal would increase world ethanol prices by 3In this regard, note that annual world oil consumption grew 1.7 percent in the last decade and is likely to maintain a comparable growth rate for the foreseeable future. Special Report Considering Trade Policies for liquid biofuels 24 percent and raw sugar prices by 1.8 percent, major oilseed producers assess export taxes. and decrease maize prices by 1.5 percent, as less Removal of the export taxes may prompt a large maize is channeled to the U.S. ethanol industry. supply response, a fall in world prices, and In the United States, ethanol prices would fall by greater exports of biodiesel feedstocks--rather 14 percent; overall imports would triple; imports than of biodiesel--to industrial countries. Some from the Caribbean, which currently enjoys duty- industry analysts posit that the most competitive free access under the Caribbean Basin Initiative, structure for the EU biodiesel market might would cease; and consumption would increase by consist of large multi-feedstock facilities in EU 4 percent. In Brazil, ethanol consumption would countries with good inbound logistics (preferably decline by 3 percent, and net ethanol exports located near a port) importing feedstocks. These would increase by 64 percent (Elobeid and facilities would combine scale, the ability to Tokgoz 2006). arbitrage among the various feedstocks and origins, and the ability to blend biodiesel fuels As the above study illustrates, liberalizing biofuel from different feedstocks to comply with EU fuel trade is likely to increase demand for biofuels by specifications and performance requirements. reducing prices in previously protected markets, especially if the subsidies for consumption, The Role of International Trade in biofuels mandates, or both are maintained. An immediate effect of trade liberalization would If biofuel production is economic, a producing be similar to that of higher biofuel production: country would presumably consume any an increase in feedstock prices and a drop additional biofuel production that the domestic in by-product prices on the world market. market could absorb before exporting, since Domestic biofuel prices in those markets that selling into the domestic market is almost heavily protect domestic producers would universally more profitable than exporting. If fall. More generally, biofuel and agricultural production takes place even if not economic, trade liberalization is expected to increase then the net subsidies provided for biofuel world prices of agricultural commodities. production should approximate the externalities Higher agricultural crop prices would benefit associated with environment and energy many of the poor engaged in agriculture in security from the point of view of maximizing developing countries. However, food security public welfare. Any net subsidies above that in those developing countries that are net food level or any additional distortions to trade can importers would be negatively affected. Prices reasonably be considered protectionism that are expected to rise more steeply for the food reduces societal welfare. products that developing countries import than for the commodities they export. The poorest It is important to distinguish between energy countries, very few of whom export products security and energy self-sufficiency in assessing on which there are currently high tariffs, would whether current support for biofuel production generally be worse off (FAO 2003). Lowering makes optimal use of public funding. It is also tariffs in developing countries could partially necessary to recognize the global nature of mitigate these adverse effects by lowering some of the environmental effects of substituting prices of imported food items and by creating biofuels for petroleum fuels in transportation. opportunities for regional trade. In many countries, a policy for energy security is equated with self-sufficiency. This in turn One possible exception to the above price trend conveniently leads to protection of domestic is oilseeds and oilseed products, on which some agriculture in industrial countries, since many Report Summary view development of biofuels as a substitute for additional GHG emissions and the loss of both agricultural reforms required under international existing biodiversity and GHG sinks. Another trade negotiations. But energy security objectives concern is that water is not valued as energy in might be met by trading with a broad range most countries. In those regions where water of countries. Similarly, global environmental is projected to become increasingly scarce-- benefits can be achieved from production and including parts of Africa--water shortages energy substitution anywhere on the globe. The may become a serious constraint on biofuel guiding principle should be to achieve reductions production, and this merits careful examination. in GHG emissions at least cost in any sector Unused land in sub-Saharan Africa faces a anywhere. By the same token, ecologically number of obstacles before it can be profitably harmful production pathways for biofuels brought into production. These obstacles include anywhere defeat the purpose of importing poor infrastructure, underdeveloped financial biofuels for global environmental gains. markets, and a hostile investment climate due to (often inappropriate) government policies and There are two questions to be answered in poor governance. assessing whether liberalizing trade in biofuels would improve economic welfare. First, is there If biofuels are not economic but some a combination of potential biofuel-deficit and governments are prepared to offer large biofuel-surplus countries that might beneficially subsidies or mandate biofuel use, trade engage in international trade? Second, how opportunities might arise for countries with do the existing subsidies in various countries duty-free access. Indeed, some transition measure up against current best estimates of economies are launching or planning to start potential environmental and other benefits? The biodiesel production with a view to exporting to report suggests that subsidies in a number of the European Union. The financial viability of countries in the past have probably exceeded the such trade obviously depends critically on the value of potential environmental gains from fuel political decisions in the countries providing the substitution. subsidies. The European Union, the United States, Biofuel trade liberalization would increase Japan, and perhaps a few other countries in competition, which should in turn help improve Asia might fall into the category of potential efficiency, bring down costs, and enable the biofuel or biofuel feedstock importers. Most world's most efficient producers to expand developing countries are densely populated and their market share. Removal of high tariffs do not have large tracts of underutilized lands would bring down prices in highly protected that could be used for crops or biofuels. The markets and increase consumption. While potential exporters include some parts of Latin efficient producers would gain, those developing America--notably Brazil and, to a lesser extent, countries with duty-free access to the EU and Argentina--and sub-Saharan Africa that have U.S. markets today might lose their trading considerable surplus land that has not been opportunities altogether. On the other hand, brought into production. Vast rain forests in removing border barriers to biofuel trade while Indonesia are also suitable for palm cultivation. continuing the agricultural and biofuel policies There is concern that additional production that distort biofuel markets could prolong and would occur via the clearing of rain forests and even worsen those distortions, as additional savannas in Latin America, Southeast Asia, markets for subsidized agricultural outputs and and Africa. Such new clearing would result in biofuels would be created. These considerations Special Report Considering Trade Policies for liquid biofuels underscore the importance of dealing liberalized as a first step, which could also force simultaneously with the full range of trade governments to address openly the question reforms defined broadly by the WTO. Failing (and the costs) of what objectives their biofuel that, trade in ethanol and biodiesel might be support policies are actually pursuing. 0 1. Issues in biofuels, agriculture, and Trade Bioenergy is playing an increasingly important have prompted industrial and developing role as an alternative and renewable source countries alike to pursue avenues for substituting of energy. Bioenergy includes solid biomass, biofuels for petroleum fuels. One sector in biogas, and liquid biofuels. Combustion of which diversification beyond oil is particularly biomass residues for heat and power generation difficult is transport. Unlike heat and power is commercially viable without government generation, where natural gas, solid biomass, support in some applications. Liquid biofuels and such alternative sources as hydroelectric made from biomass are attracting growing or geothermal power can be commercially interest worldwide. The global liquid biofuel viable, the shift from traditional liquid petroleum market today utilizes so-called first generation fuels for vehicles to either gaseous fuels or technologies and relies mainly on agricultural electricity may require costly modifications crops for feedstock. Second generation biofuels, to vehicles, fuel distribution, or refueling still far from commercially viable, can open up infrastructure. Liquid biofuels are among the few many new opportunities because they can be alternatives that can be readily used by vehicles sourced from a much wider variety of feedstocks, without significant modification in the existing vastly expanding the potential for fuel production infrastructure, and, for this reason, biofuels and for abating greenhouse gas (GHG) have been used primarily in the transport sector emission. The timing of commercialization is to date. Argentina, Australia, Brazil, Canada, uncertain, although some industry analysts China, Colombia, the European Union, predict that the needed cost reductions may be India, Indonesia, Malaysia, New Zealand, the achieved in the coming decade. Philippines, Thailand, and the United States have all adopted targets--some mandatory--for This report--which focuses on the issues increasing the contribution of biofuels to their associated with trade in liquid biofuels--is a transport fuel supplies. second ESMAP report on liquid biofuels and part of the World Bank's broader assessment of All liquid biofuel markets to date have been bioenergy in general. The previous ESMAP report supported by government protection policies on biofuels (ESMAP 2005) found the economics that include one or more of the following market of biofuel production and consumption to interventions: fuel tax reduction or exemption, be site- and situation-specific, suggesting mandatory blending, producer subsidies, high scope for welfare gains from specialization import tariffs, and financial incentive programs and trade. Recent surges in world oil prices, for users of biofuels such as lower taxes on concerns about energy security, and concerns vehicles designed for biofuels. International about climate change from GHG emissions biofuel trade is thus beset with both domestic Special Report Considering Trade Policies for liquid biofuels and border distortions. The most frequently cited to the energy crisis (Szmrecsányi and Moreira rationale for these support policies is energy 1992). In India, overcapacity in sugar production security. In the long run, hydrocarbons are and molasses were the initial motivation for the nonrenewable resources and will eventually be country's ethanol program. exhausted, requiring substitution with alternative sources. In the near term, governments fear Thus, issues in the liberalization of international scenarios that can lead to a marked or steady trade in liquid biofuels cannot be examined increase in world oil prices: disruptions to oil in isolation but must be studied in conjunction supply through weather conditions (such as with related issues in agricultural trade. Crop Hurricane Katrina in 2005), political events (such growers will sell biofuel feedstocks to the higher as the Iranian Revolution which began in 1978, priced of the two markets, agricultural crop or and more recently the events in Iraq and Nigeria), biofuel. Some agricultural products are close or unexpected infrastructure breakdown (Alaska substitutes (such as vegetable oils), and some in August 2006); higher than expected global by-products can be manufactured from several demand growth without supply expansion to different crops, only one of which may be used match; and policy decisions by the Organization for biofuel manufacture. An increase in the of the Petroleum Exporting Countries (OPEC) to production of a biofuel feedstock may depress limit supply (as illustrated by events in 1973­74). the price of a by-product from another crop These energy security concerns have led to a that competes on the same by-product market, desire for less dependence on petroleum, and, potentially reducing overall production of the nearly universally, to greater self-sufficiency in second crop. Traded and nontraded crops can fuel supply in the form of domestic production of be produced on the same land and use the biofuels. same basic inputs. Studies since the 1960s have shown that aggregate agricultural supply Nearly all liquid biofuels are commercially response with respect to price is fairly inelastic, manufactured from agricultural crops such as but individual supply responses are elastic and sugarcane, sugar beets, maize,1 cassava, wheat, respond seasonally to changing price ratios barley, rapeseeds, soybeans, and palm. As a among crops (Binswanger and others 1987). result, biofuel markets are inextricably linked to This means that policies for one commodity agriculture. Policies for biofuels affect agriculture are readily transmitted into effects on other and food production, and agricultural policies crops and into inputs--such as land, irrigation affect biofuel markets. This link to agriculture water, and fertilizers--that are used for several is one of the reasons why there has historically different crops. Because of crop substitutability, been strong government support for biofuels--a world biofuel trade will be affected not only by means of protecting domestic farmers. Some the biofuel feedstock market, but also by what biofuel support programs have been started in happens in other crop markets. response to low crop prices. The establishment of Proálcool in Brazil in 1975 has been described by This report examines policy issues associated some analysts as a way for the country to address with trade in liquid biofuels, posing the following sugar industry overcapacity more than a reaction questions: 1 Throughout this report, the internationally accepted term "maize" is used instead of "corn," the term used in the United States. "Corn syrup" is therefore written as "maize syrup," "corn gluten" as "maize gluten," and so on. Issues in biofuels, agriculture, and Trade · What border and domestic distortions protect and reviews trade reforms in agriculture and biofuel manufacturers, including feedstock associated welfare gains, past and future. growers, today? Chapter 3, supplemented by appendix C, · How would biofuel trade be affected by describes government policies that affect agricultural reform? important biofuel markets, discusses possible · How would removing restrictions on consequences of large expansion of biofuel international trade of biofuels affect the consumption, and reviews in greater detail global biofuel industry and other commodity policy issues in biofuel trade including WTO prices? negotiations. Chapter 4 concludes with policy · What are the policy lessons from the lessons and recommendations. analysis? biofuel basics The report focuses on ethanol and biodiesel, the two most important liquid biofuels, and The two most widely used liquid biofuels are on commercially demonstrated production ethanol and plant oil­based biodiesel. Ethanol technologies for these fuels. It does not address can wholly or partially substitute for gasoline, biomethanol or straight plant oil as a fuel, or and biodiesel can substitute for petroleum biogas. The report takes a time horizon of the diesel. So-called first generation biofuels are next 5 to 10 years, and does not attempt to made from agricultural crops by means of sugar assess the impact of policy changes on emerging fermentation (for ethanol) and the reaction of technologies or new (not yet commercially methanol (or a higher alcohol) with a plant oil viable) feedstocks such as cellulosic ethanol, or animal fat. The two most widely used crops because these are unlikely to be commercialized for ethanol production are sugarcane (Brazil, within the time horizon considered to have a Colombia, India, Pakistan, Thailand) and maize significant impact on international trade in (China, United States). Biodiesel is currently made biofuels. Similarly, no assessment is made of on a commercial scale mainly from rapeseed environmental externalities that are poorly (Europe) and soybeans (United States). Malaysia, accounted for or on specific environmental the world's second largest producer of palm oil, effects of trade liberalization. is emerging as a new biodiesel producer. There is limited production of biodiesel from animal fats This chapter begins with an overview of biofuel and recycled waste oil, and there is little scope for basics, the current economics of biofuels, and expanding supply from these sources on a large world consumption of gasoline and diesel (two scale. The United States is the largest producer primary petroleum fuels for which biofuels are of ethanol, producing slightly more than Brazil; substitutes). Following this is a discussion of Brazil is the world's largest ethanol exporter. The the global distribution of biofuel production leading manufacturer and consumer of biodiesel and consumption and the potential role of is the European Union. Biodiesel has historically international trade in achieving efficiency been more costly to produce than ethanol, and and related objectives. Chapter 1 ends with the global production of biodiesel is much smaller a discussion of the World Trade Organization than that of ethanol, but growing rapidly. (WTO) and ongoing negotiations on agricultural and biofuel trade; this information Biofuels are typically used in low-percentage is supplemented by appendix A. Chapter 2, blends--about 5 to 10 percent mixed into supplemented by appendix B, details the petroleum fuels--but can also be used "neat" interlinkages between biofuels and agriculture, (pure). Ethanol is dehydrated into a form called Special Report Considering Trade Policies for liquid biofuels anhydrous ethanol before it is blended into Biofuels have several potential environmental gasoline. Vehicles that are manufactured to run advantages. The most important perhaps is a on pure ethanol can use hydrous ethanol, which reduction in life-cycle GHG emissions relative contains about 4 to 5 percent water. Dehydration to petroleum fuels, since biofuels are derived of hydrous ethanol into anhydrous ethanol from plants which convert carbon dioxide (CO2) adds to the cost and energy used in making the into carbohydrates in their growth. The degree biofuel. Biofuel blends are designated by the of reduction varies markedly with feedstock and amount of biofuel contained in conventional the production technology used. Figures from petroleum products. The letters "E" and "B" different studies are shown in tables 1.1 and 1.2 are used to designate ethanol-containing and for ethanol and biodiesel, respectively. The tables biodiesel-containing fuels, respectively; thus, give an indication of the degree of divergence E10 designates a mixture of 10 percent ethanol of different study findings, with some studies and 90 percent gasoline. Gasohol is a gasoline even coming up with opposite signs for the blend containing at least 10 percent ethanol. same feedstock. There seems to be a consensus, Similarly, B100 represents pure biodiesel, B5 a however, that ethanol from maize in the United blend containing 5 percent pure biodiesel and States does not give a significant benefit, and 95 percent petroleum diesel, and so on. can even increase GHG emissions if coal is used Table 1.1: Change in Life-Cycle GHG Emissions per Kilometer Traveled by Replacing Gasoline with Ethanol in Conventional Spark-Ignition Vehicles Feedstock Location Change Source Wheat UK -47% Armstrong and others 2002 Sugar beet North France -35%a; -56%b Armstrong and others 2002 Maize, E90 USA, 2015 10% Delucchi 2003 Maize, E10 USA -1% Wang, Saricks, and Santini 1999 Maize, E85 USA -14% to -19%c Wang, Saricks, and Santini 1999 Cellulose, E85 USA, 2005 -68% to -102%c Wang, Saricks, and Santini 1999 Molasses, E85 Australia -51%; -24%d Beer and others 2001 Wood waste, E85 Australia -81% Beer and others 2001 Molasses, E10 Australia 1%; 3%d Beer and others 2001 Sugar, hydrous ethanol Brazil -87%; -95%e Macedo and others 2004 Sugar, anhydrous ethanol Brazil -91%; -96%e Macedo and others 2004 Note: Percentage changes are for neat ethanol unless otherwise indicated. To ensure a common basis, only those studies that give emissions in grams per kilometer traveled are considered. a. Average. b. Best case. c. A range given in the study report. d. Different assumptions about credits for by-product. e. The first uses average values of energy and material consumption; the second represents best practice. Issues in biofuels, agriculture, and Trade Table 1.2: Change in Life-Cycle GHG Emissions per Kilometer Traveled by Replacing Diesel with Biodiesel in Conventional Compression-Ignition Vehicles Feedstock Location Change Source Rapeseed Germany -21% Armstrong and others 2002 Rapeseeda Netherlands -38% Novem 2003 Soybeansa Netherlands -53% Novem 2003 Soybeansa USA -78% Sheehan and others 1998 Soybeans USA, 2015 -73% Delucchi 2003 Tallow Australia -55% Beer and others 2001 Waste cooking oil Australia -92% Beer and others 2001 Canola Australia -54% Beer and others 2001 Soybean Australia -65% Beer and others 2001 a. Biodiesel is imported. Only CO2 emissions are considered. to generate electricity consumed during ethanol monoxide and hydrocarbons, especially in cold production. On the other hand, ethanol from climates. Ethanol also has a very high blending sugarcane can yield significant GHG emission octane number (which is a measure of a fuel's savings. It is important to note that none of the resistance to self-ignition--or knocking--when studies considered changes in land use patterns. mixed with air in an engine cylinder).2 It can For example, if peat land is burned to clear a rain replace octane-enhancing gasoline additives forest to plant palm oil for biodiesel manufacture, such as lead, and can dilute other blending there could easily be a net increase, rather than components such as aromatics, both of which decrease, in life-cycle GHG emissions. Such produce pollutants that can be harmful to possibilities are heightening concerns in the human health. All biofuels are sulfur-free, an countries interested in importing biofuels or their advantage given the worldwide move to reduce feedstocks primarily to reduce GHG emissions, sulfur in petroleum fuels for environmental most notably in the European Union. and public health benefits. Biodiesel reduces emissions of carbon monoxide, hydrocarbons, Another benefit of biofuel use is a reduction and particulate matter, but can slightly increase in the emissions of local pollutants at the emissions of nitrogen oxides (ESMAP 2005). tailpipe. Ethanol has the greatest air quality benefits where vehicle fleets are old, as is Ethanol is a simple molecule and, aside from often the case in developing countries. It helps impurities, its properties are independent of the to reduce the exhaust emissions of carbon feedstock from which it is made. It does have 2 Because ethanol is typically used in low-percentage blends, its key properties are its blending octane number and blending vapor pressure-- that is, its effective octane number and vapor pressure when used in gasoline-ethanol blends. Special Report Considering Trade Policies for liquid biofuels some drawbacks, however. Blending ethanol Throughout this report, to approximate the into gasoline at low levels increases the blend's per liter financial equivalency of gasoline evaporative emissions. Higher evaporative and ethanol for consumers, the per liter price emissions of hydrocarbons constituting gasoline of ethanol is divided by 0.8 to arrive at the can be damaging to the environment, especially equivalent gasoline price--in this case, that if the gasoline contains light olefins (which are of the premium grade to account partially for powerful ozone precursors), in cities where ethanol's high octane. The divisor would be elevated ambient concentrations of ground-level smaller for high blends used in flex-fuel vehicles ozone are a public health concern. Gasoline capable of running on varying ratios of gasoline can be manufactured with low vapor pressure and ethanol (0.7 is typically used as a rule of to offset the high blending vapor pressure of thumb in Brazil against E20 to E25; the divisor ethanol, but doing so increases the cost of would be even smaller when comparing it with gasoline production. pure gasoline). As for biodiesel, one of the most comprehensive reviews found that the The impact of substituting gasoline with ethanol impact on fuel economy of using biodiesel was on vehicle fuel economy varies. As a broad a decrease of 0.9 to 2.1 percent for B20 and generalization, a reduction in fuel economy of 4.6 to 10.6 percent for pure biodiesel (U.S. EPA 20 to 30 percent can be taken as representative 2002). Thus, the price of biodiesel would need of study findings (ESMAP 2005). The energy to be about 5 to 10 percent lower than that content of ethanol is about a third lower than of petroleum diesel on a per liter basis to be that of gasoline on a volume basis, but ethanol's equivalent. high octane number enables a higher engine Any ethanol added to gasoline needs to be free compression ratio to be used in vehicles designed of water; otherwise, a phase separation can occur to run only on pure ethanol, which partially between gasoline and water-ethanol. For this compensates for ethanol's lower energy content. reason, anhydrous ethanol is used in a gasoline- Vehicles designed to run on gasoline-ethanol ethanol blend. Anhydrous ethanol is transported blends and flex-fuel vehicles--vehicles capable separately to terminals to minimize contact with of running on blends with varying ethanol water and typically blended into gasoline just content--do not have their engine compression before loading into trucks by splash blending, ratios optimized for each ethanol-gasoline blend; a process that requires no special equipment or consequently, their fuel efficiency is lower when temperature control. Because ethanol absorbs running on high ethanol blends than in vehicles water and impurities found in pipelines, it is best designed to run only on ethanol. In assessing transported via a dedicated pipeline. This makes prices of ethanol blended into gasoline, several long-distance transport of ethanol--such as from factors need to be considered: the maize-growing U.S. Midwest to California-- very expensive, since ordinary pipelines, which · A reduction in fuel economy of 20 to are the cheapest way to ship fuels long distances, 30 percent cannot be used. Ethanol is instead transported · Ethanol's higher blending octane numbers by tanker truck or rail tank car. There is no · The need, in some regions with tight gasoline pipeline transport of ethanol in the United States. quality specifications, to purchase more Converting ethanol to ethyl tertiary-butyl ether expensive base gasoline with low volatility to (ETBE)--as is done in France and Spain, and offset the higher blending vapor pressure of proposed in Japan--enables fuel blending at the ethanol refinery gate and avoids these handling problems. Issues in biofuels, agriculture, and Trade Ethanol is currently made from the fermentation of oil, palm oil, coconut oil, tallow, and waste six-carbon sugar molecules. The lowest processing cooking oil (sometimes called "yellow grease"). cost and most efficient pathway is to make ethanol The bulk of biodiesel is made from vegetable oils. from sugarcane, which yields not only six-carbon Historically, palm oil prices have been lower than sugars without any further chemical reactions, those of other vegetable oils. Excluding recycled but also bagasse as a residue during sugarcane waste oil, palm oil is the lowest cost feedstock crushing. Bagasse is burned for power generation, for producing biodiesel today, but these and enables sugar and ethanol plants to become price relationships may change in the future self-sufficient in electricity and even have some if demand for palm oil rises (see chapter 3). surplus for sale. Sugar beets do not produce the The Philippines is launching a biofuel industry equivalent of bagasse, and thus electricity has to based on coconut oil, and several countries be obtained externally. Molasses, a by-product of are experimenting with programs to produce sugar production, typically obtains prices lower biodiesel from Jatropha curcus and other plants than equivalent sugar prices. Converting molasses that can survive on marginal land. Biodiesel is to ethanol can be commercially attractive, not a simple molecule, and its physical properties enabling sugar processors to obtain higher depend on the feedstock. As such, variation in revenues from molasses. the physical properties of biodiesel fuels is much greater than for ethanol. Conversion of other feedstocks (such as maize, wheat, and cassava) to ethanol requires that One disadvantage of biodiesel is its greater starch contained in these feedstocks first be tendency to form wax at low temperature and converted to six-carbon sugars, which adds to the clog fuel filters, posing a technical challenge in processing cost. These feedstocks do not produce cold climate countries and in winter application residues that can be burned economically to in temperate climate countries. Not all vegetable generate power; and again, as with sugar oils perform similarly as a biodiesel feedstock. beets, electricity has to be separately purchased Under cold weather conditions, biodiesel made or produced. Ethanol from maize produces a from rapeseed oil outperforms that from palm, number of by-products depending on the type of soybean, and other oils. There are tests to milling plant used. So-called dry milling plants determine physical properties associated with use a grinding process and make distillers dried cold temperature operability. The cloud point is grains which are used as cattle feed. Wet milling plants use a chemical extraction process and one such measure of cold weather operability produce maize oil, maize gluten, and high limits. The cloud point is the temperature at which fructose maize syrup. Both types of processing a cloud of wax crystals first appears in a fuel produce CO2 which can be sold commercially. sample that is cooled under specified conditions. Sales of these by-products lower the overall Petroleum diesel may have a cloud point of cost of ethanol production. In the United States, -15 degrees Celsius (ºC) to as low as -48ºC, about 80 percent of the maize used for ethanol against a cloud point of -2ºC for rapeseed- production is processed by dry milling plants, based biodiesel, 0ºC for soy-based biodiesel, and and most new ethanol plants are dry mills. 15ºC for palm-based biodiesel. Work is under way to address these limitations of biodiesel fuel. Biodiesel is made by reacting methanol or The Malaysian Palm Oil Board is reported to have ethanol with an oil; methanol is typically used licensed its technology for making EU and U.S. because it is cheaper. Commercially used oils for winter specification­compliant biodiesel from biofuel production include rapeseed oil, soybean palm oil to 3 of the 52 biodiesel plant license Special Report Considering Trade Policies for liquid biofuels holders, and the technology is planned to come government targets halving the production cost on stream by mid-2007 (Reuters News 2006d). of cellulosic ethanol by 2012; this would require rapid advances in technology. The second An interesting development is commercialization pathway involves heating biomass to a high of next generation biomass to liquid (NExBTL) temperature under controlled conditions to either renewable diesel by Neste Oil of Finland. form a liquid directly or a gaseous mixture that in NExBTL employs an entirely different production turn is converted into liquids. The latter gasifies pathway to manufacture biodiesel from animal biomass into carbon monoxide and hydrogen, fats and plant oils. These feedstocks are not which is then converted into a wide array of reacted with methanol to make esters (organic chemicals, including gasoline and extremely compounds containing two oxygen atoms), and high-quality diesel. The latter, called synthetic NExBTL biodiesel does not contain any oxygen. diesel, is commercially available today but made Prized for its superior physical properties, NExBTL from natural gas and coal rather than biomass. is a mixture of normal paraffins and isoparaffins The advantage of these synthetic liquid fuels-- (the most desirable components of petroleum gasoline and diesel--is that they are completely diesel) with physical properties similar to those compatible with the current fuel infrastructure of synthetic diesel made from natural gas and and vehicle hardware. These second generation coal. NExBTL has a cetane number of around biofuels open up many new opportunities for 90--about double the minimum required in energy production because of the vastly expanded most countries--and its production process scope for feedstocks. At the same time, they can be adjusted to achieve a cloud point from involve more complex processing technologies -5ºC to -30ºC, thereby overcoming winter and are likely to require much larger economies performance problems of conventional ester of scale--and hence capital investment-- forms of biodiesel. Because the components of compared to first generation biofuels. NExBTL are no different from those of petroleum diesel, there are no material compatibility issues economics of biofuels (Rantanen and others 2005). Production will start in 2007, and a trial on public transport vehicles Biofuels have historically been more expensive in the greater Helsinki area involving about to produce than petroleum fuels, which is 700 buses and 75 refuse trucks is expected to why every biofuel program implemented to last from the autumn of 2007 to the end of 2010 date has required significant and ongoing (Nordic Business Report 2006). government subsidies, mandates, or both. These policies often are paired with tariff Second generation biofuels can use a much protection to ensure that the incentives go only greater variety of feedstocks, including to local producers. The cheapest source of agricultural and forest residues (including unused biofuel--based on explicit costs of production portions from such current feedstocks as maize that reflect opportunity cost--has been ethanol and sugarcane--for example, maize stover and produced from sugarcane in the center-south cane trash), energy crops (such as switch grass), region of Brazil. The opportunity cost of a and municipal wastes. Two primary pathways are feedstock--in this case, the choice of using the being pursued. The first breaks down biomass cane to produce sugar instead--is a critical components to make sugars for fermentation and often hidden factor in the economics of into (cellulosic) ethanol. Breakthroughs are biofuel production. This is as true for biodiesel needed to bring down the cost of transforming (for example, the cooking oil market versus the biomass components into sugars. The U.S. fuel market) as it is for ethanol. Thus, when the Issues in biofuels, agriculture, and Trade demand for maize in the alternative market production costs. A number of factors contribute (such as food and the animal feed market) is to low-cost and efficient manufacture of both low and, at the same time, the demand for sugar and ethanol in Brazil (ESMAP 2005): sugar is high, ethanol produced from maize can be less costly than ethanol from sugarcane · Cane cultivation is water intensive, but nearly (this is discussed further in chapter 2). One all cane fields in this region are rain-fed, recent example occurred in June 2000 when in contrast to irrigated sugar production in sugar prices in Brazil reached their peak. After countries such as Australia and India. adding freight charges, U.S. ethanol from maize · Sugarcane and other activities do not have to shipped to Brazil was cheaper by US$0.02 per compete for land because there is still plenty liter than ethanol made in Brazil (Gallagher and of land in this region suitable for growing others 2006). The following paragraphs take the sugarcane that is not currently used for economics of ethanol produced from sugarcane agriculture. as an illustration of the role that opportunity cost · Productivity in Brazil has been boosted plays in biofuel markets.3 by decades of research and commercial cultivation. For example, cane growers in Even in Brazil, at the time the world's lowest cost Brazil use more than 500 commercial cane biofuel producer, feedstock costs accounted for varieties that are resistant to many of the 40- 58 to 65 percent of the cost of ethanol production odd crop diseases found in the country. in mid-2005. In addition to feedstock costs, · Most distilleries in Brazil belong to sugar mill/ other explicit costs include the cost of the capital distillery complexes, capable of changing equipment required for production; the cost of the production ratio of sugar to ethanol. chemicals, labor, and energy used in production; This capability enables plant owners to take maintenance costs; and the (netted-out) value advantage of fluctuations in the relative prices of the by-products of the production process. of sugar and ethanol, as well as benefit from Because the majority of biofuel production costs the higher price that can be obtained by are in feedstocks, the commercial viability of any converting molasses into ethanol. biofuel is critically dependent on feedstock prices. · Flex-fuel vehicles--introduced in March 2003 In the case of ethanol in Brazil, the primary cost and capable of running on any mixture of determinant is the cost of cane production and hydrous ethanol and gasohol--have further the opportunity cost posed by the alternative of increased the attractiveness of building producing sugar from that cane. hybrid sugar-ethanol complexes and allayed consumer fears about the consequences of Brazil is the lowest cost producer of sugarcane potential ethanol shortages. in the world. Close to 100 countries around the world grow sugarcane, but none have been able The financial cost of ethanol production in Brazil to match Brazil's sugarcane cost structure. The was estimated to be in the range of US$0.23 to center-south region of Brazil, which accounts for US$0.29 per liter in mid-2005, corresponding 85 percent of the country's cane production, is to US$0.29 to US$0.41 per liter of gasoline virtually unmatched in its productivity and low equivalent (ESMAP 2005).4 The (net-of-tax) 3 A more detailed discussion of various opportunity costs--including water, land, and labor--can be found in ESMAP (2005). 4 For gasoline equivalent prices, ethanol prices were divided by 0.7­0.8 in this set of calculations. Special Report Considering Trade Policies for liquid biofuels price--as opposed to the cost of production--of European unleaded premium gasoline prices ethanol from sugarcane is determined by the (wholesale, net of tax). During the period opportunity cost of sugarcane, which is the higher covered--January 1990 to June 2007--world of that achieved from selling into the ethanol or sugar and gasoline prices (net of tax) spanned sugar market. World sugar prices reached 25- a wide range, from US$113 to US$398 per year highs in early 2006, causing the retail price tonne of sugar and US$0.08 to US$0.58 per of hydrous ethanol to exceed that of the gasoline liter of gasoline. The figure shows two prices for equivalent in Brazil despite a large tax reduction, ethanol: on a per liter basis, and converted to and prompted the government to reduce the gasoline equivalent assuming a fuel economy required anhydrous ethanol content in gasohol penalty of 20 percent. The scenario considered from 25 percent to 20 percent in March. As converts sugarcane, which can otherwise yield the world sugar supply expanded in response sugar and molasses, into ethanol, and assumes and prices began to fall later in the year, the that molasses obtains 25 percent of sugar mandatory blending percentage was increased to 23 percent in November 2006. prices on a weight basis. The intention here is not to perform precise calculations--which At a given world sugar price, the corresponding would, among others, require historical world ethanol price (or opportunity cost) can be prices of molasses, product yields as a function computed. The results are shown in figure 1.1, of technology and sugarcane characteristics, where they are compared with northwest and detailed information on opportunity costs Figure 1.1: Comparison of Gasoline Prices and Opportunity Costs of Ethanol US$ per liter 1.0 0.9 0.8 Ethanol, gasoline equivalent 0.7 0.6 0.5 0.4 Ethanol 0.3 0.2 0.1 Gasoline 0.0 January 1990 January 1995 January 2000 January 2005 Sources: World Bank calculations, premium unleaded gasoline in northwest Europe from Energy Intelligence 2007, raw cane sugar prices from the International Sugar Organization. Notes: Opportunity costs of ethanol are calculated based on the following parameters used to compute the equivalencies between sugar and ethanol in Brazil: 1.0495 kilograms of sucrose equivalent to 1 kilogram of sugar, and 1.8169 kilograms of sucrose equivalent to 1 liter of anhydrous ethanol. Sugarcane is assumed to yield 83 percent sugar and 17 percent molasses. Molasses prices are assumed to be equal to 25 percent of sugar prices on a weight basis, and the sucrose content of molasses is 55 percent that of sugar. Premium gasoline prices are northwest Europe monthly spot prices, barges, free on board (FOB) for premium unleaded. Sugar prices are raw, FOB, and stowed at greater Caribbean ports. 0 Issues in biofuels, agriculture, and Trade of production and transport costs for moving break-even line downward. Carbon market ethanol and gasoline to markets--but to payments can serve as an imperfect proxy for illustrate patterns for the economics of ethanol the benefits of reducing GHG emissions. But production from sugarcane. The results show a CO2-equivalent price range, expected for that, despite high world petroleum prices, the foreseeable future, of between US$8 and soaring world sugar prices made it difficult for US$20 per tonne would generally provide only ethanol to be economic in 2006. about US$0.01 to US$0.07 per liter of biofuel (the upper end of the range for biodiesel), even Figure 1.2 plots world sugar and premium if 100 percent of the life-cycle GHG emissions gasoline prices in real terms (that is, adjusted for of petroleum fuels are assumed to be offset by inflation) during the same time period against biofuels. For local air pollution benefits, one break-even gasoline prices (the ethanol, gasoline set of rudimentary calculations for developing equivalent, line in figure 1.1); if the price of countries suggests that the incremental value of gasoline is above the break-even line (solid line in ethanol compared to gasoline may not be much figure 1.2), domestic production and consumption higher than US$0.02 per liter, and US$0.08 of ethanol is economic. During the period for biodiesel (ESMAP 2005). Biofuel feedstock covered and again assuming a fuel economy production and biofuel processing may also penalty of 20 percent, ethanol broke even only carry environmental costs, including water and in a handful of months, half of them in 2005. air pollution, soil depletion, habitat loss, and Environmental benefits of ethanol that are potentially very large GHG emissions associated financially unaccounted for may shift the with the conversion of forests to cropland. Figure 1.2: Comparative Economics of Sugar versus Ethanol Sale International price of gasoline in US$ per liter (2007 US$) 0.8 0.7 0.6 Ethanol economic 0.5 0.4 0.3 0.2 0.1 0.0 0 100 200 300 400 500 600 International price of sugar in US$ per tonne Sources: World Bank calculations, premium unleaded gasoline in northwest Europe from Energy Intelligence 2007, raw cane sugar prices from the International Sugar Organization. Notes: For assumptions made in the calculations, see the notes to figure 1.1. Dollars are 2007 US$. Special Report Considering Trade Policies for liquid biofuels The foregoing discussion suggests that accounting Figure 1.2 suggests that the split between for environmental externalities might shift the sugar and ethanol in Brazil may not have been break-even line in figure 1.2 by a few cents optimal, and that, historically, too much cane per liter for ethanol, but would not alter the may have been diverted to ethanol. Had the overall conclusion. As such, figure 1.2 raises ethanol and sugar industries been left entirely questions about the economics of Brazil's long- to market forces, less ethanol might have been standing ethanol program. Brazil is a special produced and more sugar exported, until case because of its enormous market power in international sugar prices came down to a level sugar. Although about half of Brazil's cane has that would make ethanol production economic. been diverted to the ethanol sector in recent This argument would apply only to Brazil. All years, Brazil still accounts for about 30 percent other countries are effectively price followers in of world sugar exports. Thus, switching from the world sugar market, and the economics of ethanol to sugar and exporting the additional ethanol production would be determined by the sugar could lower world sugar prices, just as solid line in figure 1.2.5 Another consideration diverting more sugarcane production to ethanol for Brazil is that, as the world's largest exporter production could raise world sugar prices further. of both ethanol and sugar, the export-parity In fact, as chapter 2 shows, the collapse of the prices of these two commodities affect the hydrous ethanol market in Brazil before the country's ethanol economics. Since 2002, which launch of flex-fuel vehicles, and the subsequent includes a period of very high ethanol prices in increase in sugar exports, led to a decline in the United States (in 2006), ethanol has been world sugar prices in the late 1990s and early more profitable than sugar about half the time. 2000s (as evident in figure 1.1). Brazil is not Ethanol economics should be more favorable in a position to increase sugar production at in petroleum-importing, sugar-exporting, the expense of ethanol except on a limited landlocked areas, or in any other situation basis because of limited sugar milling capacity. where transportation costs for imports are high The ethanol industry has adopted hybrid mill- and there are indigenous sources of biofuel distillery configurations capable of adjusting feedstocks that can be grown at reasonable ethanol/sugar percentages within a 20 percent costs. Export-parity prices of sugar are lower band (40/60 to 60/40 ethanol/sugar), and views than world prices by the cost of transporting sugar and ethanol as joint products. This enables sugar to the nearest external market; the industry to diversify its product portfolio correspondingly, domestic gasoline prices are and mitigate some of the risks of the sugar and higher than world prices by the cost of importing ethanol markets. Also, making ethanol at a hybrid gasoline into the country. mill-distillery complex means that the proportion of molasses in the feedstock not converted to For illustrative purposes, consider the case of sugar and still fetching sugar-equivalent prices via a country for which the cost of taking sugar ethanol is higher, thereby improving economics to the nearest port is US$100 per tonne and (although surges in world prices of molasses in the cost of importing gasoline is US$150 per early 2006 affected these economics). tonne (US$0.1125 per liter).6 Under these 5In economic terms, analysts should use the "marginal export revenue" rather than the market price for sugar (that is, the "average" export revenue) in calculating both the trade-off between sugar and ethanol production in Brazil and the economic cost of producing ethanol in Brazil. 6US$100 per tonne is the approximate cost to transport sugar from Zambia to the nearest port. Issues in biofuels, agriculture, and Trade assumptions, the break-even line shifts to that Table 1.3 summarizes the economics of domestic in figure 1.3, and more than half of the data ethanol production for domestic sale at varying points lie above the break-even line. Of the costs of sugar production. Based on costs of 114 months when ethanol was economic, 99 production in 2004 to mid-2005, only Australia, were between September 1998 and June 2007. Brazil, and Thailand were able to produce sugar This would suggest that high world petroleum at US$200 per tonne or lower. Combined, prices would indeed be favorable for ethanol. they accounted for 27 percent of world However, even in this more favorable case, sugar production. Another 23 percent was ethanol was not economic in February and produced at between US$200 and US$300; March 2006 when world sugar prices soared. the remaining 50 percent was produced by high-cost producers, at mostly US$400 per The foregoing discussion does not consider tonne or higher (ESMAP 2005). The number the cost of sugar production, which, as stated of landlocked areas with very high transport earlier, represents more than half the financial costs that are also highly efficient producers of cost of producing ethanol. If the local cost of sugarcane is limited. sugar production is US$250 per tonne--which makes the producer relatively low cost in global The economics of biodiesel production terms--the break-even line becomes that shown and consumption are comparable to those in figure 1.4. Most of the data points that fall of ethanol in a number of respects. The above the break-even line are from April 2004 opportunity cost of feedstocks used to produce or later. biodiesel is the higher of biodiesel or vegetable Figure 1.3: Viability of Ethanol for Highly Efficient Producers in Landlocked Areas International price of gasoline in US$ per liter (2007 US$) 0.6 0.5 Ethanol economic 0.4 0.3 0.2 0.1 0.0 0 100 200 300 400 500 600 International price of sugar in US$ per tonne Sources: World Bank calculations, premium unleaded gasoline in northwest Europe from Energy Intelligence 2007, raw cane sugar prices from the International Sugar Organization. Notes: For assumptions made in the calculations, see the notes to figure 1.1. Dollars are 2007 US$. Special Report Considering Trade Policies for liquid biofuels Figure 1.4: Viability of Ethanol in Landlocked Areas with Sugar Production Cost of US$250 per Tonne International price of gasoline in US$ per liter (2007 US$) 0.6 0.5 Ethanol economic 0.4 0.3 0.2 0.1 0.0 0 100 200 300 400 500 600 International price of sugar in US$ per tonne Sources: World Bank calculations, premium unleaded gasoline in northwest Europe from Energy Intelligence 2007, raw cane sugar prices from the International Sugar Organization. Notes: For assumptions made in the calculations, see the notes to figure 1.1. Dollars are 2007 US$. oil prices in the international market. A liter glycerine being the most important by-product) of vegetable oil produces approximately a are subtracted from costs, and a normal profit liter of biodiesel. In figure 1.5, world prices margin is added to arrive at the plant-gate for the last dozen years of several vegetable cost of biodiesel. This calculated biodiesel oils that are feedstocks for biodiesel are break-even price should be compared to that compared with diesel prices in northwest of petroleum diesel, taking into account the Europe. In addition to the feedstock cost, the fuel economy penalty associated with using plant-gate price needs to reflect the capital cost biodiesel and the environmental benefits from recovery for biodiesel plant construction and reducing environmental externalities, regardless operating costs, including the purchase cost of whether the actual fuel prices capture these of methanol. By-product sale revenues (with or not. Figure 1.5 shows that, even in the face Table 1.3: Economics of Ethanol Production for Domestic Sale in Landlocked Areas, Calendar Years 1990­2006 Domestic sugar production cost per tonne US$200 US$250 US$300 US$350 Percentage of months in 1990­2006 when ethanol production would have been economic 17 8 3 0 Percentage of months in 2004­06 when ethanol production would have been economic 83 42 19 0 Source: Authors' calculations. Note: For assumptions made in the calculations, see the notes to figure 1.1. Issues in biofuels, agriculture, and Trade Figure 1.5: Prices of Coconut, Soybean, Palm, and Rapeseed Oils, and Diesel US$ per liter 0.9 Rapeseed 0.8 Coconut 0.7 Soybean 0.6 0.5 0.4 Palm 0.3 0.2 Diesel 0.1 0.0 Jan. 1993 Jan. 1995 Jan. 1997 Jan. 1999 Jan. 2001 Jan. 2003 Jan. 2005 Jan. 2007 Sources: U.S. Department of Agriculture oilseed data for coconut oil, soybean oil, and palm oil; World Bank Development Economics Prospects Group for rapeseed oil; and Energy Intelligence 2007 for diesel. Notes: Coconut oil prices are average monthly export values, Philippines; soybean oil prices are for crude oil, tank cars, free on board (FOB), Decatur; palm oil prices are crude, delivered, Malaysia, and converted from Malay ringitts using the average exchange rate for each month; rapeseed oil prices are Dutch, FOB, ex-mill; diesel prices are northwest Europe monthly spot prices, barges, FOB for diesel with 0.2 percent sulfur. of rising diesel prices, biodiesel has remained diesel consumption in the transport sector in relatively expensive: biodiesel feedstock costs 2004 (the most recent year for which global have generally been higher than petroleum data are available) was 1.2 trillion liters and diesel prices. One notable exception is palm oil 0.76 trillion liters, respectively. The United States since early 2005, although the cost advantage of constituted 43 percent of total world demand palm oil has disappeared in 2007. for gasoline, the European Union 13 percent, Japan 5.2 percent, and China 5.2 percent. Biofuel by-product prices can have a large The European Union consumed 27 percent of impact on biofuel economics. If biofuel by- automotive diesel, followed by the United States products cannot be absorbed easily by the at 20 percent, China at 6.5 percent, Japan at market, their prices may collapse and adversely 4.4 percent, and Brazil at 4.1 percent (IEA 2006). affect producers of biofuels and of products that compete with biofuel by-products. The impact The percentage figures for consumption of motor of biofuel production on by-product prices is gasoline and automotive diesel in 2004 in major discussed in more detail in chapters 2 and 3. regions of the world are plotted in figure 1.6. gasoline and Diesel Consumption These consumption statistics, together with the potential for economic expansion of domestic The potential size of the world biofuel market biofuel production, indicate that the largest and trade is derived from the market for potential importers of biofuels are the United gasoline and diesel. Worldwide gasoline and States and the European Union, followed by Special Report Considering Trade Policies for liquid biofuels Figure 1.6: World Motor Gasoline Consumption and World Automotive Diesel Consumption in 2004 Motor gasoline Automotive diesel OECD Europe OECD North America Asia Latin America Middle East Africa Former Soviet Union region Rest of the world Source: IEA 2006. Note: OECD North America includes Mexico. Japan. Substituting 5 percent of world gasoline distorting if it has an anti-trade bias or reduces and diesel consumption in 2004 would have trading opportunities for others in the global required about 73 billion liters of ethanol trading system (such as domestic subsidies (assuming an overall fuel economy penalty of benefiting only domestic production, import 20 percent) and 40 billion liters of biodiesel tariffs and other import restrictions, export (assuming a fuel economy penalty of 5 percent). subsidies, and export taxes). This report uses the Global production of biofuels was estimated phrase "nontrade distorting" to describe policies in early 2006 to be more than 35 billion liters that do not create an anti-trade bias or reduce (European Commission 2006a), or less than global trading opportunities for some. Policies one-third of what would have been needed to that distort agricultural trade remain much displace 5 percent of world gasoline and diesel more pervasive and substantial than trade- fuel consumption in the transport sector.7 distorting policies in other goods and services. wTO negotiations on agriculture The Agreement on Agriculture is directly relevant to biofuel trade because ethanol is classified This chapter concludes with a brief overview of as an agricultural good by the World Customs WTO negotiations, and particularly the Uruguay Organization (WCO), and the Agreement on Round Agreement on Agriculture (hereafter Agriculture bases its product coverage on WCO "the Agreement on Agriculture"). Anything classifications. Further, virtually all commercial that subsidizes or mandates--and thereby feedstocks for biofuel production are agricultural increases--consumption of a product generates crops at present. Tariffs on agricultural goods new trade, everything else being equal; in that remain substantially higher than those on sense, all government support is trade distorting. manufactured goods almost everywhere in the Traditionally, a policy has been labeled trade world. The global trade-weighted average tariff 7These comparisons do not take into account additional energy needed to grow and harvest crops, manufacture biofuels, and transport them to markets. The effective displacement rate would be lower than 5 percent as a result. Issues in biofuels, agriculture, and Trade for agricultural products in 2001 was more than and credits), purchases goods or provides three times the average for all merchandise goods and services other than for general trade, with almost every country having higher infrastructure, or entrusts a nongovernmental tariffs for agricultural goods than for other goods body to conduct any one of the above (CBO 2005). The Agreement on Agriculture activities and in doing so confers a benefit; under the WTO concerns not only border · any form of income or price support other distortions but also trade-distorting forms of than that provided through tariffs. domestic support; as such, it provides a useful framework for considering policy questions for Although WTO negotiations use these definitions biofuel trade. in the context of determining whether a subsidy discriminates between domestic and imported The WTO has 150 members, the majority of goods in favor of the former and thereby distorts which are developing countries, including 32 trade, they are useful for considering subsidies in least-developed countries. The Agreement on general. Agriculture was negotiated during the Uruguay Round of the General Agreement on Tariffs and The first pillar of the Agreement on Agriculture Trade (GATT), the predecessor to the WTO; it aims to reduce these subsidies. The subsidies are entered into force with the establishment of the divided into three categories or "boxes": WTO on January 1, 1995. The Agreement on Agriculture has a provision for its own review · Amber box--subsidies that are considered and renewal, and renegotiation has been under trade distorting and that governments have way for some years. The long-term objective of agreed to reduce but not eliminate the Agreement on Agriculture is "to establish a · Blue box--subsidies that can be increased fair and market-oriented agricultural trading without limit, provided payments are linked system." It recognizes that reform agreements to production-limiting programs must look beyond import access restrictions · Green box--subsidies that are considered and touch upon all measures affecting trade minimally or nontrade distorting and not in agriculture, including domestic agricultural subject to annual limits. policies and the subsidization of agricultural These are described in greater detail in exports. Negotiations are taking place in three appendix A. areas: reducing domestic support, increasing market access, and reducing export subsidies (WTO 2007). Market Access Market access refers to the reduction of tariff Domestic Support and nontariff barriers to trade. Ethanol generally In its Agreement on Subsidies and encounters much greater tariff barriers than Countervailing Measures, the WTO defines a biodiesel. Commodity classifications affect subsidy as maximum tariff rates that can be imposed in world trade agreements, as well as the pace at · a financial contribution by the government which trade liberalization occurs. Classification whereby it transfers funds or liabilities (such of ethanol as an agricultural good gives as grants and loans) or there is a potential more flexibility to governments to protect their to do so (as in loan guarantees), forgoes domestic producers through high tariffs and revenue otherwise due (as with tax reduction other border restrictions. Special Report Considering Trade Policies for liquid biofuels Export Subsidies by at least 35 percent by value or 21 percent by volume over five years to 2000. At present, The Agreement on Agriculture required export subsidies are not a trade policy concern developed8 countries to reduce export subsidies for biofuels. 8There are no WTO definitions of developed and developing countries. Members identify themselves as developed or developing, although the decision of a member to make use of provisions for developing countries can be challenged. The WTO uses the same classification as the United Nations for least-developed countries, characterized by low income, weak human assets, and economic vulnerability. In this report, "developed countries" is used in the context of GATT and WTO negotiations; in all other contexts, "high-income countries" is used in referring to industrial countries. 2. agriculture and biofuels As stated in chapter 1, ethanol and biodiesel tonnes (with world consumption of about are generally produced from agricultural crops, 146 million tonnes), sugar prices are falling and and feedstock typically accounts for more than are expected to remain low for the foreseeable half of the production costs. Ethanol, which has future. Energy prices, which affect the cost of the largest market share among biofuels, is ethanol production in the United States, have produced from starch (cereals) or sugar crops also risen, and the Brazilian real has appreciated (cane and beets); biodiesel is produced mainly substantially since 2003. All these events-- from plant oils (such as rapeseed, soybean oil, particularly the crop price increases--have and, more recently, palm oil), some animal fats led to a sizable increase in production costs in (tallow), and recycled waste cooking oil. U.S. dollars. These illustrative figures highlight the close association between feedstocks and Brazil is the lowest cost producer of ethanol biofuels and their effects on biofuel economics. from sugarcane and is estimated to have produced ethanol at US$0.23 to US$0.29 per link between biofuels and agriculture liter in mid-2005 and much lower in 2003­04. During the same period, the United States In examining the linkage between feedstocks produced ethanol from maize at US$0.27 to and biofuels, it quickly becomes evident that US$0.29 per liter.1 However, feedstock prices associations between biofuel feedstocks and have increased--substantially in the case of other crops must also be taken into account. maize--since these estimates were made. Maize An increase in biofuel production will lead to prices rose sharply in 2006, gaining 57 percent increased demand for feedstock crops, and in one year and another 6 percent in the first is likely to increase all food and feed prices quarter of 2007. Raw cane sugar prices rose (but lower by-product prices), at least in the from an annual average of US$185 per tonne short run. Agricultural commodity prices are in 2004 to US$218 in 2005, US$326 in 2006, highly correlated because cropland can be and US$235 during the first quarter of 2007. used to produce different commodities, many Thanks to bumper crops in 2006­07 leading to commodities are substitutes in consumption, a projected world surplus of more than 7 million and agricultural commodities are internationally 1 OECD (2006b) estimated the cost of ethanol production from sugarcane in Brazil at US$0.22 per liter and of ethanol production from maize in the United States at US$0.29 per liter in 2004. ESMAP (2005) reported the financial cost of ethanol production in Brazil in mid-2005 (at the exchange rate of R$2.40 = US$1.00) to be US$0.23 to US$0.29 per liter, with the range largely reflecting the difference in sugar production costs in different regions. OECD (2006b) estimated biodiesel production costs to be US$0.61 per liter in the EU-15 and US$0.55 per liter in the United States in 2004. Special Report Considering Trade Policies for liquid biofuels traded and have a single price after allowing a 2006 U.S. Department of Agriculture (USDA) for transportation and quality differences. For report stated that soybean meal could benefit example, wheat, maize, and soybeans can from the anticipated limited global wheat supply all be grown in the same areas in the United in the 2006­07 harvest season; on the other States, and land is commonly shifted from hand, tapioca, normally used in combination one crop to another from one year to the next with soybean meal, was in tight supply, partially in response to market signals, especially in offsetting what could otherwise be higher transition areas where both crops are grown. demand for soybean meal from reduced wheat In Brazil, sugarcane and soybeans can also be supplies (USDA 2006h). grown on the same lands. As a result, prices and production of all of these crops are linked via Processed food products provide yet another international markets. link between commodities when alternative sweeteners such as sugar or maize syrup are Consumers also substitute among commodities used to make soft drinks or processed foods. in response to prices either directly--between Thus, higher sugar prices arising from diversion food grains such as wheat and rice, for of sugarcane to ethanol in Brazil will lead to example--or indirectly when livestock and increased use of high fructose maize syrup in poultry are fed different rations of maize, several countries and, eventually, to higher soybean meal, and wheat in response to maize prices in the United States. market prices. The degree of direct substitution varies among countries and regions, and there These relationships are reflected in the are still some consumers who are reluctant correlation coefficients of annual prices shown in to switch, but this is slowly changing as more table 2.1 for agricultural commodities commonly consumers enjoy a more diversified diet. The used for biofuel feedstocks. The table shows that, complexity of interactions among different on average, if sugar prices rise by 1 percent, crops can be illustrated with an example linking maize prices will rise by 0.61 percent. The rapeseed-based biodiesel, wheat, soybeans, correlation coefficients are predictably highest and tapioca. In Western Europe, rapeseed meal for annual crops such as maize, wheat, and will increasingly compete with soybean meal soybeans, which can be easily substituted; and because of rising production of rapeseed for lowest for sugar or palm oil, which are produced biodiesel manufacture. Countering this effect, from perennial crops and are more difficult Table 2.1: Correlation Coefficients for Prices of Crops Used to Produce Biofuels, 1960­2006 Crop Sugar Maize Soybeans Palm oil Wheat Sugar 1.00 Maize 0.60 1.00 Soybeans 0.55 0.92 1.00 Palm oil 0.56 0.90 0.87 1.00 Wheat 0.69 0.94 0.91 0.85 1.00 Source: World Bank staff estimates. 0 agriculture and biofuels to switch than annual crops. All correlation The by-products of biodiesel production are coefficients shown in table 2.1 are statistically meal from the crushing of oilseeds to make significant at the 1 percent level. Because of the oil, and glycerine from the transesterification high correlation among agricultural commodity process to convert the oil to biodiesel. The prices, an increase in the use of any agricultural meal yield varies from a world average of commodity for biofuel production will affect 78 percent for soybeans to 10 percent for palm all commodities after adjustments in demand (LMC International 2003). Glycerine is used in and supply, leading to competition between pharmaceuticals, food and beverages, personal agricultural commodities for biofuels and those care products, plastics, and foams. for food and feed. The United States and Brazil are the world's Biofuel manufacture produces by-products that largest exporters of maize and sugar, have economic value as animal feeds, foods, respectively. The United States accounts for about and fertilizers. For example, to produce ethanol two-thirds of world maize exports (68 percent from maize, only the starch in maize is used; the in 2005­06), and Brazil accounts for about remaining 30 percent of the maize kernel is used one-third of world sugar exports (38 percent in to produce other products such as vitamins, food 2005). The rapid increase in ethanol production and feed additives, and CO2. When produced in these countries has contributed to the recent in large quantities, these by-products can affect rise in maize and sugar prices by increasing total the prices of other agricultural commodities and demand for these crops and diverting production alter the price relationship among commodities. from traditional food and feed uses. World sugar prices more than doubled from an average of There are two processes used to produce ethanol US$155 per tonne during 2002­04 to US$326 from maize--wet milling and dry milling--each per tonne in 2006, in part because of three of which produces different by-products. Dry years of poor crop performance in Brazil, India, milling accounts for about 80 percent of U.S. ethanol production and produces a high-protein and Thailand. The steep rise in world market animal feed by-product called distillers grains. prices at the end of 2005 and the first half of Distillers grains are fed to beef and dairy cattle 2006 has encouraged a strong production and compete with other high-protein feeds such response, which--combined with ideal weather as soybean meal. Wet milling produces maize conditions around the globe--has led to an oil, high-protein animal and poultry feeds, estimated increase of 13 million tonnes in world vitamins, and CO2 as by-products. sugar output in 2006­07 to reach 161 million tonnes (Dow Jones Commodities Service 2007d) The by-products of ethanol production from and falling sugar prices. The impact of the U.S. sugarcane or molasses are similar to those of ethanol program on the world maize market producing sugar from sugarcane. The most since 2006 has been considerable. Despite three important by-product is cane fiber residue successive years of good maize harvests, maize (bagasse), which is burned to produce power prices rose 64 percent between January 2006 and steam to operate the sugar factory and and March 2007. More than half of the increase power the ethanol plant. This gives ethanol in global demand is due to use of maize for produced from sugarcane a significant cost ethanol production in the United States. The advantage compared with biofuels from other increased consumption will cause world ending- feedstocks, whose manufacture typically entails year stocks to decline by mid-2007 to the lowest purchasing external energy. levels since 1973 when measured relative to Special Report Considering Trade Policies for liquid biofuels consumption, exerting further upward pressure of government support tend to be capitalized on maize prices. into land values, benefiting landowners. Somewhat offsetting the increase in demand Policies in Brazil and the United States affect for maize and sugar for ethanol production domestic prices of sugar and maize and thereby are government policies that encourage influence ethanol's profitability; EU policies for overproduction of these commodities. The oilseeds are similarly important. In addition, EU United States has a range of support policies policies on sugar have an effect on world market for maize, and the European Union and the prices and Brazil's export opportunity costs for United States have policies that encourage sugar. sugar overproduction and depress international prices. The global sugar market is one of the This section briefly examines the agricultural most distorted of agricultural markets, and world policies of Brazil, the United States, and prices are estimated to have been depressed by the European Union--three leading biofuel up to 40 percent from the levels that would have producers--and their effect on biofuel feedstock prevailed under a free market (Mitchell 2004).2 prices in order to better understand the links Producers in the European Union currently receive between agricultural commodities and biofuels. triple the historical average world sugar market More details on EU and U.S. agricultural policies price--although reforms are under way that will are given in appendix B. reduce this to "only" twice the historical world market average--while producers in the United Brazil States receive about double the historical average world market price. These various policies have Brazil is the world's largest and lowest cost slowed the growth of world market imports and sugarcane producer, with 428 million tonnes encouraged Brazil to divert its sugarcane to of production in the 2006­07 harvest and a ethanol production and away from sugar exports. forecasted 480 million tonnes in 2007­08 (USDA 2007k). About half of this sugarcane agricultural Policies is used to produce fuel ethanol; the other half is used to produce sugar. Ethanol prices Agricultural policies affect the production, trade, in the country tend to increase and become and prices of agricultural commodities and thus more volatile during the December­April inter- are important determinants of biofuel feedstock harvest period. Sugarcane production has been costs. Historically, agricultural policies have increasing at an annual rate of 3.4 percent tended to protect producers in industrial countries since 1990, compared with an annual increase from imports from lower cost producers, while of 20 percent in sugar exports. The more rapid policies in developing countries have tended growth of sugar exports has been due to shifts of to tax exports to fund government budgets. As cane from ethanol to sugar as Brazil liberalized incomes increase, the pressures for agricultural controls and reduced subsidies on ethanol protection also seem to increase; the highest production. Further increases in exports will protection is now found in high-income Asia, the depend on sugar and ethanol prices as well as European Union, and the United States. Benefits government policy. 2 This estimate is based on a partial equilibrium analysis whereby only the sugar sector is liberalized. If the entire agricultural sector is liberalized globally, the impact on sugar prices would be much smaller. One study found a price increase of about 3 percent (Anderson, Martin, and van der Mensbrugghe 2006). agriculture and biofuels The ability to shift production between these a surge in sugar exports and a further shift alternative uses allows Brazil to satisfy domestic away from ethanol production. At its peak in demand for sugar and ethanol, and still the 1970s, more than 80 percent of Brazil's supply one-third of the world's sugar imports sugarcane was used for ethanol production; this and one-half of the world's ethanol imports. proportion fell to just 30 percent in 1990. This Seemingly unlimited land to expand sugarcane massive shift led to an increase in sugar exports production--at least tripling current production, from 1.5 million tonnes in 1990 to 19.1 million according to some estimates (Valdes 2006)--all tonnes in 2004 (35 percent of world exports) but guarantees that Brazil will be a dominant and to a decline in world sugar prices.3 player in both of these markets for decades to come. Prior to the 1990s, Brazil produced sugar Agriculture underwent liberalization in the and ethanol under strict government controls 1990s, but these policies have been partially that limited exports to surpluses not needed in reversed in recent years. Underlying factors the subsidized domestic market. for policy reversal include lower international grain prices, the continuing appreciation of the Brazil embarked on a national fuel ethanol Brazilian real relative to the U.S. dollar, and program in response to the oil price shock of higher production costs. The Brazilian soybean the early 1970s. Supply controls and price- sector--targeted for biodiesel production--has setting mechanisms were set up to guarantee faced adverse effects from a drought in nearly the supply of ethanol and sugar to the domestic half the soybean-producing states and from market and keep the price of ethanol at levels soybean rust (a serious disease that can destroy acceptable to motorists. Credit guarantees and up to 80 percent of a crop if left untreated). low-interest loans were provided to construct The net result has been rising production costs, distilleries to produce the alcohol. The domestic poor credit availability to farmers, and declining prices of sugar and gasoline were set in line with soybean area (USDA 2007c). In response, the the ethanol price. Exports were restricted until government has dramatically increased support domestic requirements were met, and prices to agriculture. This support has come mostly were controlled so that consumers were insulated in the form of subsidized credit for production, from world prices of sugar and fuels. Domestic marketing, and investment at long-term sugar prices in particular were kept well below interest rates that are about half of commercial world market levels. Under this controlled rates. These programs vary by crop, region, environment, dedicated cars fueled by hydrous and producer size. Soybean producers have ethanol accounted for more than 90 percent of benefited from a line of credit at preferential total car sales in the mid-1980s. rates. Exporters benefit from a program that entitles them to cash advances from the Bank of Controlled low domestic prices for sugar Brazil (USDA 2005a). contributed to the pressures for policy reform that began in 1990 with the liberalizing of The sugar industry receives sugarcane input the sugar export market and the ending of loans (AE Brazil 2006) and state-specific sugar price controls. The government-decreed assistance. For example, Rio Cana in Rio Janeiro producer prices for sugarcane were eliminated has been in place since 2001 to help revitalize in February 1999. Policy liberalization led to the state's sugarcane output. In the 2005­06 3World Bank staff estimates based on the Food and Agriculture Organization Statistical Database (www.faostat.fao.org). Special Report Considering Trade Policies for liquid biofuels harvest season, interest rates on Bank of Brazil (USDA 2006c). Domestic price supports have loans for the state's independent sugarcane been the traditional backbone of CAP farm producers averaged about 4 percent for rural support, with prices for major commodities families and 8.75 percent for other small such as grains, oilseeds, dairy products, beef producers; these rates were reduced to 2 percent and veal, and sugar depending on the EU price starting in March 2006, against Brazil's base support system. (overnight) Selic interest rate of 17.25 percent. The state also cut the interstate and intercity Major reform packages have significantly tax imposed on sugar and ethanol by a large modified the CAP over the last 15 years. The margin, to 2 percent (Dow Jones Commodities first reform, adopted in 1992, began the Service 2006). process of shifting farm support from prices to direct payments by reducing support prices, European Union creating direct payments based on historical yields, and introducing new supply control The European Union introduced the Common measures. In addition, per hectare payments Agricultural Policy (CAP) in 1958 to provide fixed are made to certain crop producers based on agricultural prices above world market levels to average historical yields. Producers of grains, protect farmers in the then six member countries, oilseeds, and protein crops are eligible for direct which generally had higher production costs payments if they remove a specified percentage than other world market producers. Despite of their area from production. Producers also substantial reform in the 1990s, these policies receive a separate set-aside payment for the still exist and provide very high domestic support areas removed. The area of subsidized oilseed to EU producers. According to the OECD production is limited by the terms of the 1992 (2006b), the European Union's producer support U.S.-EU Blair House Agreement, and oilseed estimate was 34 percent during 2003­05, of producers (except for small producers) are which 50 percent was market price support. required to set aside a minimum of 10 percent of their land to qualify for payments. The Blair The CAP is a supranational and domestically House Agreement limits output from oilseeds oriented farm policy for EU member countries planted on set-aside land for nonfood purposes and has had a historically heavy influence on EU (such as industrial and energy, including crop production patterns. The CAP is based on biodiesel) to 1 million tonnes of soybean meal three principles: equivalent a year, if the use of the biomass is guaranteed either by a contract or by the farmer. · A unified market in which there is a free Because nonfood crops are permitted on set- flow of agricultural commodities within the aside land, this policy has encouraged oilseed European Union production for biodiesel manufacture on set- · Product preference in the internal market over aside land. foreign imports through common customs tariffs The 2003 CAP reform decoupled income · Financial solidarity through common support from production. In particular, crops financing of agricultural programs that were eligible for direct payments only under the nonfood regime on set-aside areas The CAP's main policy instruments include may now be cultivated on any area without agricultural price supports, direct payments to loss of income support. In addition, the reform farmers, supply controls, and border measures introduced special assistance for energy crops. agriculture and biofuels A premium of 45 (US$61) per hectare is paid, subsidized exports to the levels agreed in the for a maximum guaranteed area of 1.5 million WTO Agreement on Agriculture and will entail hectares (expanded to 2 million hectares a reduction of exports of 4 to 5 million tonnes beginning in 2007). If applications exceed the a year from recent levels. These reforms are budgetary ceiling, the premium will be reduced expected to increase world sugar prices as the proportionally. In 2005, rapeseed intended European Union reduces sugar production and for use as biodiesel feedstock was grown on exports and increases imports. 1.8 million hectares, including 0.9 million hectares of set aside. An estimated 0.5 million United States hectares received the energy crop payment of 45 a hectare (CRS 2006b). The United States introduced commodity policies during World War I and price supports in the Sugar is made from sugar beets in the European 1930s. These policies have had a range of Union, a much more costly production process objectives over the years including price and than that from sugarcane. The EU sugar income support, production control, food aid, industry is supported through a mixture of price export promotion, and environmental protection. supports, import quotas, and supply controls. According to recent OECD estimates, 17 percent CAP support of sugar is restricted to production of the value of commodity production at the farm within a quota, which raises sugar prices for gate was provided by domestic support policies. consumers. Intervention buying of raw or white This includes 20 percent of maize production, sugar supports the price of the raw commodity. 30 percent of wheat production, 18 percent of Imports to the European Union are effectively oilseed production, and 57 percent of sugar blocked by high tariffs. However, there is duty- production at the U.S. farm gate during 2002­ free access within a quota for raw sugar from 04 (OECD 2005). former African, Caribbean, and Pacific colonies, and duty-free imports of raw sugar are phased U.S. government support to commodity in for least-developed countries until 2009 under producers is provided under farm legislation that the Everything-But-Arms (EBA) trade agreement. typically extends for five years. The most recent After 2009, the least-developed countries will of these farm bills was signed in 2002 and have quota-free and duty-free access. expires in 2007. It provides direct government income support to eligible commodity producers, EU sugar policy reform was agreed in November mainly through three programs: direct payments, 2005 and began to be implemented in 2006. counter-cyclical payments, and the marketing The reform reduces the guaranteed price for loan program. In addition, subsidized crop and white sugar by 36 percent over four years revenue insurance is provided to assist farmers beginning in mid-2006. EU farmers have been with risk management. Commodity producers compensated for 64.2 percent of the price cut, also receive benefits from government programs on average, through a decoupled payment. promoting trade liberalization and food aid. Intervention prices will be replaced by reference Specific programs apply to individual crops. prices. Thus prices, instead of being supported directly, are supported through a private storage Direct payments are fixed payments made system that will act as a safety net, allowing annually to farmers who participate in the sugar supplies to be withheld when market government program. Decoupled from prices fall below the reference price (European production, these payments are made regardless Commission 2005b). The reforms also limit of the level of production or which of the eligible Special Report Considering Trade Policies for liquid biofuels crops (maize, soybeans, other oilseeds, sorghum, same effect. Mandates on renewable fuel use, barley, oats, wheat, upland cotton, rice, peanuts) tax incentives to blenders, and tariffs on imports are grown. Counter-cyclical payments are increase the demand for ethanol and biodiesel available to farmers whenever the effective price and increase prices of feedstocks such as maize of the eligible crop is less than the target price. and soybean oil. The marketing assistance loan program provides nonrecourse loans to eligible producers, with the effects of biofuel Production on agricultural farm's program crop used as collateral. Commodities The United States has a variety of government The impact of increased production of biofuels policies that support domestic producers of on agricultural commodity prices has been maize and prevent world market price signals examined by the USDA, Food and Agricultural from being transmitted to farmers (OECD Policy Research Institute (FAPRI), and OECD 2006a), even though the United States is (USDA 2007a, FAPRI 2007, OECD 2006a). among the lowest cost producers of maize net The estimated effects vary due to the different of subsidies. These policies encourage maize assumptions used and scenarios analyzed, farmers to produce even when world market but the general conclusions are that prices of prices are depressed and keep global maize the agricultural commodities used to produce stocks high and prices low. Removing all import biofuels would rise sharply, while prices of tariffs and farm support programs would result commodities and products that compete with in an estimated increase in average world by-products of biofuel production would decline. maize prices of 5.7 percent and an increase The former include maize, sugar, and vegetable in maize trade of 4.5 percent (Fabiosa and oils; the latter, soybean meal and substitutes. In others 2003). This relatively small impact on addition, prices of meat from animals relying prices and trade is due to the fact that much on maize for feed and for which there is limited of the land devoted to maize production would scope for substitution--hogs and poultry--will likely remain dedicated to maize even without rise more than in the absence of biofuel market government policies, thereby maintaining expansion. Most other agricultural commodities supply levels. The main impact would be a drop would see moderate price increases as the in farm land prices. production of biofuels increases and, in the process, draws land and other inputs away from In the United States, incorporated family farms these commodities. These results clearly depend receive the bulk of government farm payments. on the assumed or projected level of biofuel Program payments tend to be capitalized into production. the value of farm land, and most of the benefits accrue ultimately to the largest farm landowners, Impact of U.S. Biofuel Program with little of the benefits going to small farmers (IPC 2005). Government subsidies distort market The USDA carried out its study in October­ incentives; this was illustrated in 1999 and 2000 December 2006, by which time the impact when a shift in land use from maize to soybeans of the U.S. ethanol program on world maize occurred in response to government policies, prices was evident. The study showed that while opposite signals were being given by earlier projections might have underestimated comparative market prices (CRS 2000). The U.S. the impact of global biofuel programs (see, for policies on renewable fuels are not designated example, USDA 2006a). The study's agricultural as agricultural policies, but they have much the baseline projection focused especially on the agriculture and biofuels U.S. biofuel market and assumed that the soybeans) in the United States in 2004 and tax credits available to ethanol and biodiesel 2005. Higher maize prices provide incentives blenders and the ethanol import tariff would to increase maize acreage at the expense of remain in effect through 2016. In the study's soybean plantings. Other sources of land for scenario, crude oil prices (more precisely, refiner increased maize plantings include cropland used acquisition cost) first fall from US$59 a barrel as pasture, reduced fallow, acreage returning in 2006 to US$57.5 in 2008, after which they to production from the expiring Conservation rise gradually to US$73 a barrel by 2016. U.S. Reserve Program contracts, and shifts from other ethanol production quickly surpasses the target crops such as cotton. set by the Energy Policy Act of 2005 of 7.5 billion gallons (28 billion liters) of ethanol use by Higher maize prices also support wheat prices 2012 and reaches 12 billion gallons (45 billion by encouraging increased feed wheat use. liters) by 2016, with the sharpest increase in Farm-gate wheat prices rise from US$3.42 per production occurring by 2009­10. The leveling bushel in 2005­06 to US$4.35 in 2010­11 off of production in the last several years of (nearly double the rate of inflation) and to the projection period reflects the saturation of US$4.55 in 2014­15 before leveling off. Except the ethanol additive market: above a certain for the last year of the forecast period, wheat prices increase at a higher rate than inflation. percentage, there is bound to be a sizable price The soybean stock-to-use ratio declines steadily discount for ethanol relative to gasoline due to from 15.6 percent in 2005­06 to 7.4 percent ethanol's lower energy content. Twelve billion in 2016­17, while farm-gate soybean prices gallons (45 billion liters) represent less than increase 29 percent in nominal terms between 8 percent of annual gasoline demand by volume 2005 and 2009--more than double the rate by 2016, and even less in gasoline equivalent of inflation--after which they fall gradually. amounts. U.S. biodiesel production is projected In real terms, soybean prices rise until 2012, to rise to 700 million gallons (2.7 billion liters) after which they fall. Increased coproduction by 2011­12. Production levels off after 2011 as of distillers grains replaces some direct maize higher soybean oil prices reduce profitability. At use in livestock feed as well as soybean meal 700 million gallons, biodiesel will comprise less in some animal rations. Soybean meal prices than 2 percent of U.S. highway diesel fuel use. in real terms rise until 2009­10 and then fall significantly. Distillers grains are less suitable In the United States, the ending stocks for maize in rations for hogs and poultry; the latter will fall sharply, and the stock-to-use ratio falls continue to require (now more expensive) maize, from 17.5 percent in 2005­06 to 4.5 percent pushing up pork and poultry prices. Crop in 2009­10, after which it rises gradually to price increases are not sufficient to lead to a 5.7 percent in 2016­17. Increased demand for significant overall increase in cropland planted maize to produce ethanol raises the price paid to major crops: the planted acreage for eight to maize farmers to US$3.75 a bushel by 2009­ major crops increases by less than 2 percent 10--about twice the price paid in late 2004-- between 2005 and 2016. When all food items after which the farm-gate price is forecast to fall are considered, U.S. food prices rise more slowly gradually to US$3.30 by the end of the forecast than the consumer price index (as they have period. The maize price increase between done historically). 2005 and 2016 is still nearly double the rate of inflation, although this is in part because of The above results for the U.S. domestic market back-to-back large crops of maize (and also are important for international trade and Special Report Considering Trade Policies for liquid biofuels food prices because the United States remains domestic food use of soybean oil, and domestic the world's largest exporter of maize and feed use of maize all rise at the expense of wheat throughout the projection period, and biofuel use of maize and soybean oil. of soybeans in 2006­08. Rapid expansion in global production of biofuels changes the FAPRI Assessment of Global Biofuel price relationships among various agricultural Production commodities in the next three to four years. The U.S. share of world maize trade falls from 60­ FAPRI considered only one scenario and 70 percent to 55­60 percent. Ethanol demand incorporated the most likely assumptions into is expected to be inelastic in the range of prices its baseline projection. Although there are no projected in the study. With a greater share of counterfactuals to show the effect of increased the maize market captured by inelastic demand biofuel production, the FAPRI modeling results that is also tied to the world oil market and are included here to show the expected growth much smaller stock levels in the United States, of biofuels and the overall projected path for the study forecasts increased price volatility, agricultural prices to 2016. This study also especially in response to weather variability. shows that FAPRI's earlier studies underestimated Global expansion of biodiesel will result in the impact of the development of the global prices of vegetable oils rising more than those of biofuel market (see FAPRI 2006). An important oilseeds and protein meals. difference between the FAPRI and USDA analyses is the future crude oil price trend: Rising prices of maize--and potentially of the USDA assumed an initial fall followed by cassava, which is also an ethanol feedstock-- a rise to US$73 a barrel by 2016, whereas would be a concern for the world's poor, most FAPRI assumed a gradual decline to US$51 a of whom are net food purchasers. Maize is the barrel by the same terminal year. As with the preferred staple food of more than 1.2 billion USDA study, the FAPRI analysis projects that people in Latin America and Africa (Global Crop U.S. ethanol production will expand much more Diversity Trust 2006). Cassava provides one-third rapidly than mandated by the Energy Policy of the caloric needs in sub-Saharan Africa and is Act of 2005, surpassing 7.5 billion gallons the primary staple for more than 200 million poor (28 billion liters) before 2008 and 12 billion people. It is also a reserve when other crops fail. gallons (45 billion liters) by 2010, after which A study at the University of Minnesota estimated production plateaus. There is no appreciable that, for every percentage increase in the real increase in the production of ethanol in India prices of staple foods, the number of food- and China. China becomes a net importer of insecure people in the world would rise by more ethanol in 2009. Between 2006 and 2016, than 16 million (Runge and Senauer 2007). India's ethanol imports increase by 65 percent, Japanese imports increase by 76 percent, The USDA study also examined the impact of U.S. imports halve, and EU imports more than ending fuel blenders' credits and the ethanol triple. Brazilian ethanol production increases by import tariff. In this alternative scenario, prices 58 percent, consumption by 63 percent (because of maize, soybeans, soybean oil, and soybean of the increased number of flex-fuel cars), and meal fall by 6 to 9 percent by the end of the exports by 35 percent. EU biodiesel production forecast period relative to the baseline case. grows slowly because of increasing vegetable oil Maize planting acreage declines, soybean prices, stagnant crude oil prices, and the gradual planting acreage increases, and maize ending phase-down of fuel tax exemption for biofuels stocks, U.S. maize and soybean exports, in Germany. The use of renewable fuels in the agriculture and biofuels European Union is not expected to achieve the USDA study). U.S. soybean exports fall. Soybean goal of a 5.75 percent share of renewable fuels prices increase in real terms until 2009­10, after by 2010 (see chapter 3 for more detail on these which they fall in both nominal and real terms. biofuel policies). World ethanol prices (taken as By the terminal year, real soybean prices are Brazilian anhydrous ethanol prices) in nominal 17 percent lower than in the initial year. Soybean terms gradually fall from US$0.48 a liter in meal prices fall substantially--14 percent in 2006 to US$0.36 a liter in 2016. In the United nominal terms and 31 percent in real terms. States, ethanol prices fall from US$0.68 a liter in Driven by biofuel demand, world edible oil 2006 to US$0.42 a liter in 2016. prices remain strong in the first three years of the projection period. Soybean oil prices in In agricultural trade, the United States exports particular soar, more than doubling the price much more maize--19 percent more in gap between soybean oil and palm oil in 2008­ 2016­17--than in the USDA projection, despite 10 compared to that in the initial year. Argentina having the same harvested acreage and ethanol and Brazil, despite their own domestic biodiesel production between the two studies. U.S. maize programs, continue to dominate world soybean ending stocks are also higher in the FAPRI study. oil trade, accounting for 89 percent of total net Nominal world maize prices (represented as exports in the terminal year. Palm oil remains free on board [FOB] in the U.S. Gulf Coast) rise the lowest cost edible oil. Canada dominates slightly from US$159 per tonne in 2006­07 to rapeseed oil trade, accounting for 92 percent US$163 per tonne in 2007­08. They remain at of world trade by the terminal year. Rapeseed that level until 2010­11 when they begin to fall oil prices rise in real terms during the first three gradually, reaching US$152 per tonne in 2016­ years, after which they fall. Nominal rapeseed oil 17. Although not exactly comparable, the USDA prices rise only 3 percent during the projection projection sees nominal farm-gate maize prices period. rising by 10 percent during the same period. World sugar prices fall by 13 percent between OECD's Two Biofuel Scenarios 2006­07 and 2007­08, after which they rise back to the 2006­07 level by 2009­10 and rise The OECD study explored two biofuel scenarios another 12 percent by the terminal year; in real relative to the base case projection that assumed terms, world sugar prices fall. FOB wheat prices biofuel production would remain constant at in the U.S. Gulf Coast fall from 2006­07 to 2004 levels. The first scenario assumed the 2008­09, after which they rise gradually but do growth of biofuel quantities in line with officially not recover to the level in the initial year; in real stated national goals on biofuel use in countries terms, they fall by more than 20 percent. with biofuel targets or goals. Nominal crude oil prices were assumed to peak at US$46 per World soybean production falls in 2007­08 barrel in 2005 and then to decline to US$34 as U.S. soybean acreage shifts to maize for per barrel in 2014 in this scenario and the ethanol, and then continues on an upward trend base case. The second scenario allowed biofuel thereafter. Brazil surpasses the United States as profitability to determine biofuel production the world's largest soybean producer in 2014­ under the assumption of constant crude oil 15. Consumption in Argentina (the world's prices of US$60 per barrel from 2005 to 2014. third largest producer and exporter) and Brazil The baseline projection for these scenarios is rises, but more slowly than production, resulting relatively constant nominal prices for agricultural in growing exports and in fact a doubling of commodities through 2014. Wheat prices, Brazilian soybean exports (but less than in the for example, are projected to decline slightly Special Report Considering Trade Policies for liquid biofuels from 2005­06 to 2014­15, while rice prices As a result, there is increasing demand for are projected to rise about 8 percent over the sunflower oil, which is considered a higher forecast period. quality oil, and imports into the European Union are growing (USDA 2006h). In the first scenario, the prices and trade of most commodities are affected. Relative to the One casualty of rapid growth in biodiesel baseline projection, vegetable oil prices rise demand is the glycerine manufacturing sector. by 15 percent, while oilseed meal prices fall Every kilogram of biodiesel produces about by 6 percent. Sugar prices rise by 60 percent 0.1 kilogram of glycerine. Glycerine prices have because of reduced exports from Brazil and dropped by two-thirds in the last five years, increased ethanol production from sugar and market analysts anticipate downward beets in the European Union. The effects are pressure on glycerine prices to last for the mostly confined to the commodities that are next few years (EnergyResource 2006). Falling used as feedstock for biofuel production. For glycerine prices would adversely affect the example, wheat prices are projected to rise economics of biodiesel production. Given these only 4 percent compared with the baseline market conditions, glycerine manufacturers are projection. Sustained higher crude oil prices searching for new applications for glycerine. in the second scenario affect both the cost of agricultural production and the profitability effects of agricultural Trade liberalization of biofuel production. High crude oil prices encourage biofuel production but increase the Studies examining the impact of agricultural cost of agricultural production, which raises trade liberalization offer useful insights for feedstock prices and lessens the profitability of the biofuel sector for a number of reasons. biofuel production. The impact on agricultural First, biofuel feedstocks today are agricultural commodity prices relative to the baseline is commodities, and trade liberalization in substantial, with nearly all commodity prices agriculture would affect their production and affected. Wheat prices are projected to rise prices. Second, because biofuel trade is limited about 15 percent, while maize and oilseed today, there are few studies of the impact of prices are projected to rise about 20 percent biofuel trade liberalization, but some of the in nominal terms. Sugar prices have the conclusions from studies on global agricultural largest increase of about 85 percent as more trade liberalization may be applicable to sugarcane in Brazil and more sugar beets biofuel. The welfare effect of higher agricultural in the European Union are used for ethanol commodity prices resulting from trade production. liberalization would be one such example, as higher biofuel production (which could be Recent Developments one outcome of biofuel trade liberalization) is expected to raise agricultural crop prices. Rapidly growing demand for rapeseed oil in Europe has already shifted the price relationship There are similarities as well as important between rapeseed and sunflower oil. Sunflower differences between agricultural and biofuel oil was once the most expensive vegetable oil in trade liberalization. In a number of OECD Europe, and rapeseed oil one of the cheapest. countries, government support for sugar and Rising biodiesel demand has altered this biofuels is alike in that they benefit from both relationship, and currently rapeseed oil is trading border protection and producer subsidies. This about US$150 per tonne above sunflower oil. package of support measures is unlike that for 0 agriculture and biofuels cotton, which enjoys producer support but no rules and disciplines of the multilateral trading border protection. Biofuels are also afforded system. The agreement did not achieve the consumption subsidies, mainly through tax reforms hoped for because of the wide flexibility reductions, and, increasingly, consumption afforded in its implementation and the high level mandates. Consumption mandates as a of support during the base period of 1986­88 means of government support have no parallel from which future reforms were measured among agricultural crops. Upon liberalization, (Ingco and Nash 2004). The Doha Round, production and trade patterns of agricultural launched in November 2001, has encountered crops would shift, and overall consumption the same opposition to reforms in agriculture might even rise. In the case of biofuels, however, as in the Uruguay Round, and the Doha WTO absent further cost reductions, both production negotiations were suspended in July 2006. and consumption might decline sharply if all forms of government support, and especially Potential gains from a successful conclusion of consumption mandates, were eliminated. In the Uruguay Round were estimated to reach this sense, the welfare gains from liberalization US$270 billion annually, with most of the gains of biofuel trade depend on border protection, projected to come from agriculture through subsidies, and consumption mandates. This savings from lower government price supports section of the report assumes that the current and lower consumer food prices (World Bank protectionist policies for biofuels will continue, 1994). The largest gains were expected to go and attempts to draw inferences for the impact to the countries with the highest agricultural of reducing trade-distorting policies (narrowly protection (EU member states, Japan, the defined as those that create an anti-trade bias or Republic of Korea, Norway, and Switzerland). reduce global trading opportunities for some). Developing countries were expected to benefit primarily from lower tariffs on manufactured According to studies of the impact of agricultural items and expanded exports of textiles and trade liberalization, reduced support to agricultural goods. agriculture and liberalized trade would provide large welfare gains to both industrial and The gains from the Uruguay Round reforms developing countries. The value of total support have been less than expected, especially in to producers in OECD countries was estimated at agriculture, because the actual reforms were not US$280 billion in 2005 compared to total global as extensive as expected. Developing countries trade of agricultural products of US$837 billion have not been able to significantly increase (OECD 2006b). The level of producer support exports of agricultural commodities to industrial fell from 37 percent of farm receipts in 1986­88 countries because tariffs have remained to 29 percent in 2003­05 (OECD 2006b); high and quotas on imports have limited that reduced level of support was first reached market access. However, tariffs in developing in 1995­97, just after the Uruguay Round countries have declined for both manufactures Agreement on Agriculture was signed, and and agriculture, which has increased export has changed little since then. The Agreement opportunities among developing countries. on Agriculture was signed in 1994 amid high According to one study (Aksoy and Beghin hopes for reforms in agriculture. It required 2005), the average tariff in developing most member countries to make specific countries declined from 22.9 to 18.4 percent policy changes in domestic price supports, for agricultural products and from 16.1 to market access, and export subsidies. Its main 11.4 percent for manufactured products from achievement was to include agriculture within the 1995 to 2000. Special Report Considering Trade Policies for liquid biofuels Until the 1990s, industrial countries generally potential impact of these differentiated export protected agriculture, while developing taxes is on the location of investments in countries generally taxed it either directly or biodiesel. Some industry analysts examining the indirectly (Krueger, Schiff, and Valdes 1992). biodiesel market in Europe suggest that, in the Taxes on agricultural commodities focused absence of export tax differentiation, the most primarily on exports as a convenient source competitive market structure might consist of of revenue, which also helped keep domestic large multi-feedstock facilities in EU countries prices low. This pattern began to change with with good inbound logistics (preferably located reforms in developing countries. Governments near a port) importing feedstocks. These moved away from taxing agriculture while facilities would combine scale, the ability to liberalizing trade in manufactured goods arbitrage among the various feedstocks and more rapidly than in agriculture, thereby origins, and the ability to blend biodiesel fuels affording greater relative protection to the from different feedstocks to comply with EU fuel latter. These changes have come about through specifications and performance requirements. eliminating import restrictions and lowering However, export tax differentials in favor of tariffs on manufactured products, devaluing biodiesel in surplus countries might result in exchange rates, abandoning multiple exchange biodiesel plants being built for export in these rate systems that penalized agriculture, countries rather than in Europe. and eliminating export taxes. Meanwhile, reforms in most industrial countries have been About two-thirds of agricultural support to modest despite the Agreement on Agriculture. OECD countries is provided through higher Increasing incentives for agricultural production prices associated with border barriers, while in many developing countries without lowering one-third is provided by direct subsidies (OECD incentives in industrial countries has led to 2006b). In developing countries, nearly all overproduction and price declines for many support is through border barriers. Most of agricultural commodities. the costs of global agricultural distortions are accounted for by a small number of An important exception to the above commodities. Rice and beef alone are development in export tax policy is the oilseed responsible for the bulk of costs, with sugar sector. Some major oilseed exporters impose (an ethanol feedstock), oilseeds (biodiesel high export taxes to this day--oilseeds, meals, and oils in Argentina (see appendix C for more feedstocks), and other livestock products (oil on export taxes in Argentina), crude palm oil meals and distillers grains being by-products in Malaysia, and sunflower seeds in Russia of biofuel manufacture) accounting for another and Ukraine. If trade were liberalized and quarter (Anderson, de Gorter, and Martin these export taxes eliminated, it is possible that 2005). Because the bulk of support provided there would be a strong supply response, and by non-OECD countries is through border increased trade and lower prices. distortions, border protection comprises an even greater proportion of the overall costs Argentina, the world's second largest exporter of trade distortions when global statistics are of grains after the United States, also imposes compiled. Modeling by one group estimates high export taxes on grains including maize. that 93 percent of the total costs of global Argentina and Malaysia levy low or no export distortions arose from import tariffs, while taxes on biofuels, giving incentives to export domestic support and export subsidies biofuels rather than biofuel feedstocks. One accounted for an estimated 5 and 2 percent, agriculture and biofuels respectively (Anderson, Martin, and Valenzuela remove distortions (border and domestic) in 2006; Hertel and Keeney 2006). agriculture, the global gains in 2015 would amount to US$265 billion--nearly 70 percent The impact of the Agreement on Agriculture of the gains from full reform of trade of goods. on agricultural prices appears to have been The benefits of reducing distortions go largely minimal, and most agricultural prices continued to industrial countries because they have the to decline from the highs of 1994­95 until greatest distortions and largest economies. 2001 when the global economy emerged from However, when measured as a share of gross recession. The Asian financial crisis of 1997 domestic product, the benefits to developing contributed to the price declines by reducing countries are nearly double those of the incomes and commodity demand in the most industrial countries (Anderson, Martin, and van affected countries and leading to currency der Mensbrugghe 2006). devaluations in major commodity-exporting countries such as Brazil. Prices finally began to The welfare gains from agricultural trade recover in 2002 and have since increased in the liberalization depend on the baseline used in the wake of normal cyclical trends, lower supplies of computation, among other factors. For example, agricultural products due to higher crude oil and higher energy prices and recent biofuels policies fertilizer prices, and strong import demand from that encourage or mandate consumption rapidly growing developing countries such as have raised the level of agricultural prices China (see figure 2.1). Changes in stockholding in international markets and some domestic patterns by major commodity exporters and markets. Adjusting the baseline accordingly will importers are expected to lead to increased change the projection of the world economy. How price volatility in the future as smaller supplies this will affect the estimated welfare gains from of stocks are available to buffer a production agricultural reforms depends on what is assumed shortfall (Mitchell and Le Vallée 2005). about policy responses to fuel and fuel-related price hikes. If there are no changes in ad valorem Despite disappointing gains from reforms tariffs on agricultural products, and they are the undertaken as part of the Agreement on only means of farm support, then protection Agriculture, the potential benefits of agricultural levels and their welfare costs will change little. But trade liberalization are estimated to be large. if farm support is only in the form of deficiency Recent work has shown that if all countries payments, the rise in market prices will lead to a decline in payments from the treasury and hence Figure 2.1: Index of Agricultural Prices a fall in the welfare cost of such programs. Index of nominal prices (1990 = 100) The above qualifications notwithstanding, the 140 studies of the benefits of agricultural trade 120 liberalization suggest that reforms in biofuel 100 trade would likely reduce ethanol and biodiesel 80 prices in countries with high protection such as 60 the United States and EU member states, and 40 increase incomes of countries that export these 20 0 biofuels such as Brazil. The magnitude of these 1990 1995 2000 2005 gains cannot be inferred from the studies on agricultural trade liberalization; these estimates Source: World Bank Development Prospects Group. will need to come from additional studies. Special Report Considering Trade Policies for liquid biofuels The effect on welfare distribution is another prices of most agricultural commodities are important outcome of agricultural trade likely to increase. As mentioned earlier in liberalization, and there are several useful the chapter, liberalization of trade in sugar studies on the subject. A study of sub-Saharan is expected to increase world sugar prices African countries estimated that reducing by as much as 40 percent. Those countries average tariffs from 40 percent to 10 percent that are already integrated into international would entail a real income loss of 35 percent for markets and possess good infrastructure urban employers; urban workers who receive are likely to benefit, but rising agricultural trade rents (typically those in protected industries) commodity prices could have a negative effect would lose 41 percent, but rural farmers on food security in developing countries that would receive an income gain of 20 percent. are net food importers.4 Prices are expected Because rural farmers significantly outnumber to rise more steeply for the food products affected urban workers and employers, trade that developing countries import than for liberalization would have an overall positive the commodities they export. The least- effect on welfare (Bannister and Thugge 2001). developed countries, very few of whom export Krivonos and Olarreaga (2006) found that a temperate-zone or competing products on 10 percent increase in world sugar prices would which there are currently high tariffs, would lead to a total income gain of US$5 billion generally be worse off (FAO 2003). In all (in 2002 dollars) for Brazilian workers, or cases, there are intra-country variations in 1.04 percent of gross domestic product, and addition to differences across countries. Net a decline in the poverty rate of 1.5 percentage buyers of food, including farmworkers, will points. In the sugar growing and processing be adversely affected by rising food prices; sectors as well as other sectors, wages would the negative effects are not confined to urban increase in percentage terms with increasing areas only. education. Among those already employed in these sectors, households at the top of the income Developing countries would benefit from distribution would experience larger income lowering their own tariffs on agricultural goods. gains than other income categories due to higher These tariffs tend to be especially high on wages. Significantly, households at the bottom essential food items. To varying degrees, lower of the income distribution would experience tariffs would offset increases in world food proportionally larger income gains because many prices following agricultural trade liberalization would move out of unemployment. and would let developing countries increase their trade with each other. Reciprocal tariff The poor can be adversely affected by reductions are needed for this to happen, and agricultural trade liberalization because would create local trade opportunities. 4 Food security exists when all people at all times have physical, social, and economic access to sufficient, safe, and nutritious food to meet their dietary needs and food preferences for an active and healthy life. Food security is usually discussed with reference to the three foundational pillars of availability, access and utilization. The self-sufficiency dimension concerns ensuring food availability through domestic production, rather than through domestic production and trade. 3. biofuel Policy and Trade Issues Chapter 2 explored interlinkages between promotion policies to domestic producers biofuels and agriculture, and discussed past and and favored countries ongoing trade barriers in agriculture and the · Price supports targeted at increasing biofuel benefits of removing them. This chapter explores production conditions that would increase the potential · Production-linked producer payments and tax benefits from trade in biofuels. It begins by credits reviewing the current status of biofuel policies · Investment incentives such as grants, loans in the large industrial economies and in the and loan guarantees, and tax-related developing economies with current or potential incentives (tax holidays, accelerated major production of biofuels. The chapter then depreciation, tax reductions) considers how these policies might affect biofuel · Funding for research and development (R&D) trade. It summarizes studies that have examined targeted at increasing biofuel supplies likely consequences of increasing trade and · Downstream subsidies for vehicles designed biofuel consumption, and concludes with policy to run on high-blend biofuels and for biofuel questions that may be negotiated in the coming storage facilities targeted at the infrastructure years under the auspices of the WTO. of fuel production and consumption Current Policies for biofuels That affect Some support policies for biofuels stimulate world biofuel Markets consumption and do not in themselves distort trade (except to the extent that they may All countries with sizable biofuel markets have artificially stimulate it); two examples are biofuel adopted policies to promote both domestic mandates and fuel tax reductions that do not biofuel production and substitution of biofuels distinguish between domestic and imported for petroleum fuels in consumption. Among such biofuels. Other policies--such as import tariffs policies are the following: and producer subsidies--clearly protect or subsidize domestic production at the expense of · Fuel tax reductions for biofuels relative to foreign-produced biofuels. taxes on petroleum products · Mandatory blending or biofuel consumption Fuel tax reductions are the most widely used requirements support measure. This instrument critically · Import tariffs or quotas on biofuels, paired depends on the presence and magnitude of with preferential waivers of tariffs and excise taxes levied on petroleum fuels. There is quotas for certain countries, largely intended an important difference between industrial and to restrict access to benefits from biofuel developing countries. All industrial countries tax Special Report Considering Trade Policies for liquid biofuels the consumption of petroleum fuels, and many under market access and domestic support-- levy taxes at rates higher than those commonly concepts discussed in chapter 2 in the context of found in developing countries. Some developing agricultural policies. countries, on the other hand, tax little or even subsidize petroleum fuel consumption. In 2005, In the following sections of this chapter, biofuel total fuel price subsidies amounted to nearly policies are reviewed within the above general US$10 billion in India and Indonesia, both net framework for the major biofuel markets. The importers of oil (ESMAP 2006). Such differences European Union, the United States, and Brazil in policy traditions influence the kinds of biofuel are covered at some length because these promotion policies that individual countries are the largest biofuel markets. The materials can and do pursue, as the following discussion on EU and U.S. policies are supplemented explicates. by additional information in appendix C. The biofuel policies of India and Malaysia are also Countries providing price subsidies to discussed in this chapter. India is pursuing both petroleum fuels are not in a position to use fuel ethanol and biodiesel; its ethanol mandate tax reduction as a primary policy device for policy, which was reversed in 2004 in the face promoting biofuel substitution in consumption. of an ethanol shortage on the domestic market, Further, the tax rate levied on diesel--which offers interesting observations. Malaysia, a is used economy-wide in goods and public major producer of both petroleum crude oil passenger transport, and the price of which and palm oil, is aggressively pursuing biodiesel many governments want to keep low--is often production for both exports and domestic low compared with the tax rate on gasoline. consumption and has recently introduced a That said, some developing countries levy high blending mandate. fuel taxes, primarily for revenue generation. One analysis shows that taxes on petroleum Argentina, Australia, Canada, China, Colombia, products are a critical source of government Indonesia, Japan, and Thailand are reviewed revenue for low-income countries (Bacon 2001). in appendix C. Argentina and Colombia have In fact, taxing fuel is one of the easiest ways to both mandated biofuel consumption. Australia obtain revenue: collecting fuel taxes is relatively and Canada have no mandates, but have straightforward, and the consumption of fuels as set national targets for ethanol consumption; a group is relatively price inelastic and income Canada is also considering introducing a elastic, ensuring buoyant revenue as income blending mandate. China is the world's third rises and tax rates are increased. Tax rates on largest ethanol producer and is expected to gasoline, generally viewed as a fuel of the rich, become a major player in the global biofuel tend to be the highest; reducing tax rates on market. Indonesia, like Malaysia, is a major ethanol, a gasoline substitute, could raise fiscal producer of palm oil, and the government has as well as equity concerns. set ambitious targets for biodiesel production and domestic consumption. Japan has no Important trade issues that are being negotiated prospect of becoming a significant biofuel under the WTO include reducing border tariffs, producer in the near to medium term and has import quota restrictions, producer subsidies, shown considerable interest in biofuel imports. and any incentives offered only to local Thailand, like Brazil, is a low-cost sugar producers that continue to promote domestic producer and is pursuing ethanol and biodiesel; production at the expense of international the difficulties Thailand has encountered in trade. In WTO parlance, these policies fall launching an ethanol industry are worth noting. biofuel Policy and Trade Issues Trade data and details for fuel ethanol are biofuel producers (European Commission incomplete or nonexistent because no distinction 2006b). The latter principle is intended to avoid is usually made between fuel ethanol and the possibility of large windfalls accruing to other end uses of alcohols used in liquors biofuel manufacturers in times of high world or chemicals. Data are available for ethanol petroleum prices and low feedstock prices. In production and trade for all uses, but fuel accordance with this principle, Germany raised ethanol can be a small fraction of a country's the excise tax on biodiesel from zero to 0.09 total consumption, as in India. For these (US$0.12) per liter beginning in August 2006. reasons, this report does not attempt to provide quantitative information on fuel ethanol trade The European Union issued a Biofuels Directive (the volume of internationally traded biodiesel is in 2003, requiring member states to set national negligible at this time). indicative targets to ensure that a minimum proportion of biofuels and other renewable European Union fuels is placed on their markets. A reference target value, calculated on the basis of energy The European Union produces biodiesel from content, for end 2005 was set at 2 percent rapeseed, sunflower, and soybean oil; and of all gasoline and diesel for transportation ethanol from sugar beets, wheat, and barley. It is purposes, and 5.75 percent by end 2010 (EU the world's largest biodiesel producer; its annual 2003a). The 2005 target was not met, and production surged from 1.9 million tonnes in recent assessments suggest that the 2010 2004 to 3.2 million tonnes (about 3.6 billion indicative target is also unlikely to be achieved. liters) in 2005 (EBB 2007a). EU ethanol Nevertheless, EU energy ministers agreed in production is smaller, although increasing-- February 2007 to increase the share of biofuels 0.5 billion liters in 2004, 0.9 billion liters in used in transport to 10 percent by 2020. 2005, and 1.6 billion liters in 2006 (Ebio 2007). Increased use of soybeans, including imported The European Commission issued "An EU soybeans, in biodiesel manufacture is expected Strategy for Biofuels" in February 2006 in Germany, Portugal, and Spain in the coming (European Commission 2006a). The strategy years (USDA 2006h). specifically addressed enhancing trade opportunities and supporting biofuel industries According to the European Commission (2006a), in developing countries. Trade enhancement domestically manufactured biodiesel becomes measures include assessing the benefits and economic at crude oil prices of about 60 a costs of putting forward a proposal for separate barrel; domestic ethanol becomes economic nomenclature codes for biofuels, not worsening at crude oil prices of 90 a barrel. These access conditions for imported bioethanol, economics have historically prompted large pursuing a balanced approach in trade tax incentives in countries with active biofuel negotiations with ethanol-producing countries programs. Under article 16 of the European and regions, and proposing amendments to Union's Energy Tax Directive, EU member states the biodiesel standards to facilitate the use of may exempt or reduce excise taxes on biofuels a wider range of vegetable oils for biodiesel (EU 2003b). Member states have notified production. tax reductions on the order of 0.3 to 0.6 (US$0.41 to US$0.81) per liter of biofuel. These The strategy also stresses the importance of tax incentives must take into account changing optimizing GHG benefits for the expenditure raw material prices to avoid overcompensating made, avoiding environmental damage linked to Special Report Considering Trade Policies for liquid biofuels the production of biofuels and their feedstocks, biodiesel will be taxed at 0.45 (US$0.61) a and ensuring that the use of biofuels does not liter, which is 0.02 a liter lower than the tax give rise to environmental or technical problems. on petroleum diesel. This tax policy change The annex to the strategy points out that is reported to have led to a sharp decline in additional production using, for example, virgin the sales of biodiesel and a 30 to 40 percent savanna in Brazil could cancel out GHG benefits reduction in output by the biodiesel industry for decades. It also highlights increased pressure (Financial Times 2007). on rain forests as the main general negative effect of biofuel feedstock expansion. The The top three biodiesel producers in the decision of the government of the Netherlands to European Union in 2006 were Germany, cut the subsidy for "green electricity" produced France, and Italy; the top three EU ethanol from palm oil (all of which is imported) has been producers were Germany, Spain, and France. reported to be driven in part by the negative Germany is by far the largest manufacturer publicity on the sustainability of palm production of biofuel; its biodiesel production in 2006 is in Indonesia and Malaysia (USDA 2006h). The estimated to be quadruple that of France, the Committee on Industry, Research, and Energy second largest biodiesel manufacturer. The of the European Parliament in October 2006 biofuel policies of the three leading producers called for an EU-wide ban on the use of biofuels of biodiesel and ethanol are reviewed in derived from palm oil. The Dutch government is appendix C. developing environmental sustainability criteria for the use of biomass, which will also be used Biodiesel imports into the European Union are as criteria for granting government subsidies. subject to a (relatively low) ad valorem duty of Additionally, the European Union is working on 6.5 percent. In practice, major vegetable oil possible certification. In response to pressure producers (including Argentina, Indonesia, and from the European food industry, major soybean Malaysia) are covered under the Generalized traders in July 2006 declared a two-year System of Preference and have duty-free access moratorium on purchasing soybeans from areas to the European Union. A recent development cleared after July 24 in the Amazon forest zone, is imports of rapeseeds from Russia and including soybeans grown on legally cleared Ukraine for biodiesel manufacture. As for land. The moratorium agreement includes an ethanol, a specific import duty of 0.192 element to ensure traceability of soybeans and (US$0.26 as of April 2007) per liter is levied on to avoid sourcing from farms that are involved in undenatured ethanol and 0.102 (US$0.14) deforestation (USDA 2006k). per liter on denatured ethanol. In Germany, fuel ethanol imports are eligible to receive the Austria, Lithuania, and Slovenia have mandatory tax concession on fuel ethanol (100 percent biofuel blending requirements; the mandate is of gasoline excise tax) only if the ethanol is for new fuel marketers only in Austria. Germany imported undenatured. Between 2002 and and the Netherlands have introduced mandatory 2004, 93 percent of ethanol imported into the blending in 2007. The Renewable Transport European Union (for all uses) was undenatured. Fuel Obligation in the United Kingdom requires As explained in appendix C, 101 developing oil companies to blend 2.5 percent biofuel in countries enjoy unlimited duty-free access motor fuel by 2008 and 5 percent in 2010­11. for ethanol exports to the European Union; In Germany, B100 lost its tax-exempt status in significantly, Brazil is not among them. In 2004, August 2006. The tax will increase annually by 55 percent of ethanol imported was free of 0.06 (US$0.08) a liter until 2011. In 2012, import duties (European Commission 2006a). biofuel Policy and Trade Issues For the reasons described in chapter 1, only 0.28 billion liters in 2005 and an estimated biodiesel made largely from rapeseed oil meets 0.95 billion liters in 2006. the biodiesel standard EN 14214. Rapeseed biodiesel complies with the standard even if Much of the growth in the production of ethanol blended with a small amount--for example, from maize is due to government incentive 25 percent--of biodiesel made from other oils programs, first begun in 1978. By 1980, such as soybean or palm (European Commission 25 states had exempted ethanol from all or 2005a). In the 2006 "EU Strategy for Biofuels," part of their gasoline excise taxes (U.S. National the European Commission proposed an Alcohol Fuels Commission 1981). Legislation amendment to EN 14214 to facilitate the use has also been passed to give income tax credits of a wider range of vegetable oils, to the extent and loan guarantees to small ethanol producers. feasible without significant ill effects on fuel Additional information is provided in appendix C, performance and respecting the sustainability and a detailed description of past and present standards. The commission will also examine the incentives can be found in a report by Koplow limits placed on biofuels in petroleum fuels set (2006). out in the Fuel Quality Directive--for example, the current maximum limit of 5 percent on In January 2005, the federal ethanol tax incentive biodiesel blended into petroleum diesel fuel-- was extended through December 31, 2010, at a with a view to enabling greater use of biofuels. rate of US$0.51 per gallon (US$0.135 per liter) of ethanol blended; a federal excise tax credit United States was also granted to biodiesel blenders. The credit amounted to US$1.00 per gallon (US$0.26 per About 90 percent of U.S. ethanol is made from liter) of biodiesel made from agricultural products maize. The remaining 10 percent is produced and US$0.50 per gallon (US$0.13 per liter) of largely from grain sorghum (CRS 2006a). biodiesel made from other feedstocks such as In crop year (September­August) 2005­06, recycled oils. This tax credit is largely responsible 14 percent of maize was converted to fuel for the surge in production of biodiesel and ethanol (USDA 2007a). Biodiesel is made growth of production capacity. The federal excise predominantly from soybeans. As with Brazil, taxes on motor gasoline and diesel are US$0.184 there has been steady progress in improving and US$0.244 per gallon (US$0.049 and efficiency: thanks to improved hybrid maize US$0.064 per liter), respectively. varieties and more efficient ethanol plants, one bushel of maize now yields 2.8 gallons The Energy Policy Act of 2005 contained a (10.6 liters) of ethanol, up from 2.5 gallons Renewable Fuels Standard requiring a minimum (9.5 liters) several years ago (Automotive World of 7.5 billion gallons (28 billion liters) of 2006). Approximately 30 percent of gasoline renewable fuels to be used annually in gasoline sold in the United States contains ethanol, and by 2012. The act also gave additional incentives ethanol constituted nearly 4 percent of total U.S. for cellulosic ethanol, extended the biodiesel fuel gasoline supplies by volume (less than 3 percent excise tax credit through 2008, and authorized by energy content) in 2006. Fuel ethanol a US$0.10 per gallon (US$0.026 per liter) demand rose from 15.3 billion liters in 2005 income tax credit to small biodiesel producers to 20.4 billion liters in 2006, against domestic (U.S. Congress 2005). In April 2007, the U.S. production of 14.8 billion and 18.4 billion Environmental Protection Agency (U.S. EPA) liters, respectively (RFA 2007). U.S. biodiesel announced the implementation details, whereby production tripled in two successive years to a specified percentage of the total volume of Special Report Considering Trade Policies for liquid biofuels gasoline a company produces or imports must Koplow (2006) estimated the aggregate be produced from renewable sources. The subsidy (federal and state combined) to percentage is 4.02 in 2007 and increases every amount to US$5.1 billion for ethanol and year (U.S. EPA 2007). Looking to the future, the US$0.38 billion for biodiesel in 2006. Nearly Twenty in Ten initiative promoted by President all of the aggregate subsidy for biodiesel and Bush aims to reduce gasoline use by 20 percent about half that for ethanol is in the form of within 10 years by increasing the use of the excise tax credit. When expressed in terms renewable and alternative transportation fuels to of outlay equivalent to take this into account, the equivalent of 35 billion gallons (132 billion the aggregate subsidies are US$8.7 billion liters) of ethanol a year by 2017. for ethanol and US$0.48 billion for biodiesel. Averaged over 2006­12, annualized aggregate At the state level, 38 states have introduced subsidies total US$6.3 billion ($8.7 billion in incentive schemes, including either producer outlay equivalent) for ethanol and US$1.7 billion payments or excise tax reductions. These include ($2.3 billion in outlay equivalent) for biodiesel. mandating government agencies to use biofuels; Per gallon of biofuel, the aggregate subsidies mandating biofuel use statewide; and providing in 2006 are US$1.05 (US$0.28 per liter) for grants, production tax credits, and other forms ethanol and US$1.54 (US$0.41 per liter) for of subsidies to the state's biofuel industry. biodiesel, rising to US$1.38 (US$0.36 per Most renewable fuel standard laws mandating liter) and US$1.96 (US$0.52 per liter) in outlay biofuel consumption were approved in 2006. equivalent, respectively. The volumetric excise The states that have passed legislation include tax credits given by the federal government (in chronological order) Minnesota, Hawaii, constitute about half of the aggregate subsidy. A Washington, Montana, Iowa, Louisiana, and side-by-side comparison of federal tax incentives Missouri. Some states require minimal state given to ethanol versus petroleum in the United production of biofuels before the mandate States was undertaken by the U.S. General becomes effective. Minnesota (ethanol and Accounting Office (now the U.S. Government biodiesel) and Hawaii (ethanol) are the only states Accountability Office) at the request of Congress at present where biofuel standards are already in and reported on in 2000. The comparison found effect (see appendix C for more detail). that, on a per liter basis, tax incentives given to ethanol were significantly larger (ESMAP 2005). There are other incentives given to biofuel plants. They include accelerated depreciation Ethanol imports, including ethanol imported for the plants, capital grants, loan guarantees, directly from Brazil, are taxed at a specific subsidized loans, credit-grant hybrids, regulatory rate of US$0.1427 per liter and also carry exemptions (environmental impact assessment an ad valorem import tariff of 2.5 percent for waiver in Minnesota for ethanol plants less undenatured and 1.9 percent for denatured than a certain size, use of eminent domain ethanol (20 percent for countries that do not in Nebraska), and support for land used (for have a most favored nation status, now called example, reduced property tax rate on ethanol normal trade relations, with the United States). facilities in the state of Washington). There are The specific tariff was instituted in the 1980s to also incentives given downstream of biofuel prevent foreign producers from benefiting from production, that is, vehicles and refueling the fuel excise tax incentive for ethanol. It was stations. They include tax reductions, tax credits, intended to be a temporary tariff, but it has been immediate expensing rather than depreciation revised and extended several times. The current over years, and grants (Koplow 2006). tax credit, which was scheduled to expire in 0 biofuel Policy and Trade Issues September 2007, has been extended to January Against a backdrop of sharply rising ethanol 2009. According to the U.S. International Trade prices in summer 2006, there were growing but Commission, the total volume of undenatured unsuccessful calls to eliminate the US$0.1427 and denatured ethanol imported into the United per liter import tariff on ethanol. A loophole States surged from 0.8 billion liters in 2005 to referred to as a manufacturer's drawback allows 2.7 billion liters in 2006 (USITC 2007). In 2006, duty-free imports of ethanol even from countries the United States bought 1.77 billion liters of outside the CBI, NAFTA, and CAFTA regions. ethanol directly from Brazil, or 52 percent of the Specifically, an oil marketer can import ethanol record 3.4 billion liters of ethanol Brazil shipped as a blending component to manufacture out, according to the Brazilian agricultural gasoline and "draw back" on the duty paid ministry. The United States also bought when exporting a like commodity within two 475 million liters of Brazilian ethanol via the years. Jet fuel is considered a like commodity Caribbean, accounting for another 14 percent and is considered exported when it is used to of Brazilian exports (Dow Jones Commodities fill the fuel tanks of an aircraft in the United Service 2007c). States destined for an international route. This has allowed oil marketers to add ethanol to Under the Caribbean Basin Initiative (CBI), jet fuel and recover the import duty paid on countries in Central America and the Caribbean ethanol. Some reports estimate that the amount have had duty-free access to the United States of tariff that is ultimately not paid could exceed since 1989 for ethanol produced from at two-thirds of the total amount due (Energy least 50 percent local feedstocks. If the local Washington Week 2006a). feedstock content is lower, limitations apply, but duty-free ethanol is permitted up to 7 percent Biodiesel carries a much lower import tariff rate of total U.S. ethanol consumption for ethanol with only an ad valorem charge of 1.9 percent. containing no local feedstock. The upper limit There is growing concern that some traders would have amounted to 1.4 billion liters in are abusing the US$1 per gallon tax credit by 2006. This duty-free access has historically importing biodiesel, blending it with a trace of prompted hydrous ethanol produced in Brazil petroleum diesel fuel, collecting the blender's and Europe to be shipped to dehydration plants tax credit, and then exporting the resulting in CBI countries for re-export to the United blend (Energy Washington Week 2006b). The States. Costa Rica, El Salvador, Jamaica, and, European Biodiesel Board lodged a complaint more recently, Trinidad and Tobago have built with the European Commission in March and operate dehydration plants for this purpose. 2007, stating that biodiesel imported into the The U.S.-Central America Free Trade Agreement United States is being spiked with as little as (CAFTA) does not increase overall access to 0.1 percent petroleum diesel, benefiting from the the U.S. ethanol market (see appendix C for blending tax credit, and exported to Europe at a more detail). The CBI countries accounted for significant price discount; the amount entering nearly 50 percent of all ethanol imported into Europe was estimated to be 30,000 tonnes in the United States in 2005, but their contribution January 2007 (EBB 2007b). The U.S. National fell to 22 percent in 2006. Brazil accounted for Biodiesel Board issued a statement in April 46 percent in 2004, 34 percent in 2005, and 2007, announcing its intention to pursue a record 63 percent in 2006 (USITC 2007). legislation, regulatory rulemaking, or both that Mexico and Canada can also export biofuels would make clear that biodiesel involved in re- to the United States duty free under the North exporting transactions would not be eligible for American Free Trade Agreement (NAFTA). the tax credit (NBB 2007). Special Report Considering Trade Policies for liquid biofuels Brazil launched in March 2003 and reached the 2-million mark in mid-2006. They give car With an ethanol industry dating from the 1930s, owners the option of buying the cheaper (on an Brazil vies with the United States for global energy-equivalent basis) of the two fuels. There leadership in ethanol production and is the is a small tax reduction for the purchase of flex- world's largest ethanol exporter. Brazil produced fuel cars and cars dedicated to run on hydrous 17.5 billion liters of ethanol and exported ethanol. In 2006, flex-fuel vehicles accounted for 20 percent in the 2006­07 harvest season (Dow 78 percent of all new car sales (ANFAVEA 2007). Jones International News 2007a). Blending Nearly all of Brazil's 32,000 filling stations sell of 5 percent anhydrous ethanol in gasoline hydrous ethanol (USDA 2006b). was first authorized in 1931 and mandated in 1938. The National Alcohol Program, Proálcool, Brazil achieved self-sufficiency in petroleum oil was launched in 1975. Under Proálcool, the supply in 2006, to which its ethanol program government provided price guarantees, price contributed. Petrobras, Brazil's national oil subsidies, public loans, and state-guaranteed company, plans to increase its ethanol exports private bank loans to processors and growers. from 320 million liters in 2006 to 850 million Ethanol and gasoline prices in Brazil were liters in 2007. The investment plan includes liberalized between 1997 and 1999 (ESMAP building pipeline infrastructure to transport 2005). There are no direct production subsidies ethanol from producing regions to ports. for ethanol today, but the industry benefits from Petrobras's 2007­11 investment program both an ethanol mandate and tax reduction, includes exporting 3.5 billion liters of fuel as well as financing provided for stockholding ethanol annually (BNAmericas Oil & Gas News during the inter-harvest periods. As described 2006). in chapter 2, the government has been reviving support to agriculture in recent years, and some The biodiesel industry in Brazil began production assistance--but not price support--is being in 2005. The coordinator for the National provided to the sugar industry at both the federal Biodiesel Program reported in early 2007 that a and state levels. Brazil's ethanol production total of 24 biodiesel plants would be operational decisions affect the country's sugar exports which, by the end of the year with a combined annual at one-third of global sugar trade, influence production capacity of 1.3 billion liters (Global international sugar prices. Insight Daily Analysis 2007). The program requires 2 percent biodiesel in diesel by 2008 Pure gasoline is not available for sale in Brazil. and 5 percent by 2013. This would require Fuel purchasers can buy either hydrous ethanol 800 million liters of biodiesel by 2008 and or gasoline containing 20 to 25 percent approximately 2.4 billion liters by 2013 (Dow anhydrous ethanol. The blending mandate Jones International News 2007c). was 25 percent until March 2006, lowered to 20 percent on account of rising world sugar The government is looking to the country's prices, and increased in November 2006 to soybean production as an important feedstock 23 percent in response to falling sugar prices. In for its biodiesel program in the near term. light of the global sugar surplus, the government Soybeans account for much of Brazil's oilseed is expected to raise the mandated level to production; soybean production doubled 25 percent in June 2007. Flex-fuel vehicles, between 1993 and 2002. As discussed in capable of running on any mixture of hydrous chapter 2, the soybean industry has suffered ethanol and the gasoline-ethanol blend, were from three years of adverse conditions, but in biofuel Policy and Trade Issues the coming decade, production is expected to and prospects of an ethanol shortage loomed, rise by more than 60 percent. In the long term, the Brazilian government lowered the tariff rate there are other crop possibilities for biodiesel, to 0 percent temporarily. including palm oil and oil from castor beans (USDA 2006e). India There are concerns among biodiesel producers India's government has been pursuing biofuel that Brazilian biodiesel will not be able to programs for some time in an effort to reduce compete with biodiesel from Argentina. dependence on imported petroleum oil, which Petrobras has developed an alternative makes up two-thirds of demand. Because food biomass-based diesel substitute called H-Bio. security is a national priority, the government H-Bio is produced through a process called does not promote biofuel production from grain hydrogenation at petroleum refineries and sources or edible oils. By regulation, ethanol differs from methyl-ester-based biodiesel: H-Bio cannot be produced directly from sugarcane, is obtained by hydrogenating a mixture of although India is a major sugar producer. In vegetable oil with a petroleum diesel fraction. March 2007, the state government of Bihar amended its Sugarcane Act to produce ethanol The primary incentive given to promote ethanol from sugarcane juice. Ethanol is produced from in recent years has been a tax reduction for molasses, which helps minimize the impact of ethanol consumption. Since pure gasoline is not the ethanol program on sugar prices, but cross- sold, a meaningful distinction in the tax rates subsidization between sugar and molasses is between gasoline and anhydrous ethanol cannot an issue. The government encourages biodiesel be made. Hydrous ethanol enjoys a significant production from nonedible oils grown on tax reduction compared with gasohol. Several marginal land so as to avoid competition with states, including São Paulo--which accounts for food production. 85 percent of ethanol production and more than half of hydrous ethanol consumption--have lower Blending 5 percent ethanol into gasoline was state sales tax rates for hydrous ethanol. A couple mandated in nine sugar-growing states and four of other taxes are lower for hydrous ethanol, union territories in January 2003. To promote resulting in an effective tax difference of R$0.81 the use of ethanol-blended fuel, an excise (US$0.30 at the time) per liter in June 2005 duty concession of Rs 0.75 per liter for E5 was (ESMAP 2005). A separate assessment estimated announced in the Union Budget 2002­03, the tax reduction in São Paulo in October 2005 corresponding to Rs 15 (US$0.31 at the time) to be R$0.80 per liter (US$0.36 at the then- per liter of ethanol. Supply shortages forced prevailing exchange rate) (USDA 2006b). India to become the largest importer of ethanol from Brazil in 2004­05. In response to higher The import tariff on ethanol from countries than anticipated ethanol prices, the government outside of Mercosur--a duty-free trade bloc issued a gazette notification in October 2004 consisting of Argentina, Brazil, Paraguay, making ethanol blending optional, contingent on and Uruguay--was lowered in steps from the delivery price of ethanol at a given location 22.5 percent in 2001 to 20 percent in 2004. being comparable to the import-parity price of Brazil levies an import tariff of 20 percent on gasoline. Three states stopped selling ethanol in ethanol, which is occasionally lifted in response December 2004. The government announced to fears of a domestic shortage. For example, that 5 percent blending would be mandatory in February 2006, as world sugar prices surged from October 2006 in 20 of India's 28 states, Special Report Considering Trade Policies for liquid biofuels requiring about 600 million liters of ethanol and petroleum ministries (Business Standard in total, but the implementation deadline has 2006). In November 2006, a price of Rs 21.50 been postponed several times. Production of fuel (US$0.48) per liter of ethanol was offered to, ethanol fell from 180 million liters in 2002­03 and accepted by, the Indian Oil Corporation, to 90 million liters in 2003­04 and to 20 million corresponding to US$0.60 per liter of gasoline liters in 2004­05, before rising to 200 million equivalent. This price was considerably above liters in 2005­06. Subsidized loans of up to a premium gasoline prices in the Arab Gulf maximum of 40 percent of the project cost are (US$0.38) in October 2006. available for establishing ethanol production facilities from the Sugar Development Fund Due to high sugar prices and good weather held by the government, but there is no direct conditions at the time of planting, sugarcane financial assistance for the production or production rose by 12 percent to a record marketing of ethanol (USDA 2006i). 315 million tonnes in 2006­07. Domestic prices fell below production costs in response, creating After being a net importer for the last two years, a crisis for the sugar industry. One way to reduce India became a net sugar exporter in 2005­06, the surplus would be to divert cane to ethanol but concerns about domestic supply shortages production, but the agreed price of Rs 21.50 prompted the government to ban sugar exports (US$0.21) a liter was considered too low by many from June 22, 2006, to January 22, 2007. cane growers. One industry estimate suggested The sugar sector is one of the most controlled in April 2007 that the ethanol blending program agribusiness sectors in the country. The was running at only 30 to 40 percent of the target government establishes a minimum support price (Reuters News 2007). for sugarcane every year--Rs 802.5 (US$19) per tonne in 2006­07--and some sugarcane- The International Crops Research Institute for growing states mandate a higher minimum price the Semi-Arid Tropics in Andhra Pradesh has for cane ("state-advised prices"), as high as been engaged for some years in R&D to develop Rs 1,320 (US$31) per tonne in 2006­07 (USDA high-sugar sweet sorghum varieties particularly 2007l). Agriculture in India, including the sugar suited for ethanol production, and technology industry, benefits from subsidies given to power, for converting sweet sorghum into ethanol. The water, and fertilizers. On the whole, India does institute has formed a public-private partnership not possess comparative advantage in sugarcane with Rusni Distillery to set up an ethanol plant production: the country faces agricultural water with a daily capacity of 40,000 liters using shortages, and sugarcane cultivation is water sorghum varieties it has developed. Sweet intensive. Without government export incentives, sorghum can be grown with much less water Indian sugar is said to be uncompetitive in the than sugarcane. The institute is sharing its international market (USDA 2007l). technical know-how with the Philippines, and Rusni Distillery is participating in an ethanol The purchase price of ethanol has been an project based on sweet sorghum in Uganda issue. The price of ethanol sold to oil marketing (Manila Bulletin 2006). The first commercial companies was fixed in May 2005 at Rs 18.75 production of ethanol from sweet sorghum (US$0.43 at the time) per liter. Negotiations on started in June 2007 (Business Standard 2007). increasing the ethanol price became gridlocked in August 2006, with ethanol manufacturers India is also actively promoting fuel switching asking a new price of Rs 27.83 (US$0.60) per from petroleum diesel to biodiesel. A national liter; the matter was referred to the agriculture mission on biodiesel has been proposed. biofuel Policy and Trade Issues The Ministry of Petroleum and Natural Gas biofuel development board to set a minimum announced a biodiesel purchase policy support price for nonedible plant oilseeds used in October 2005, under which petroleum as biodiesel feedstocks (Press Trust of India marketing companies are required to purchase Limited 2006). biodiesel at Rs 25 per liter (US$0.56 a liter at the time) through 20 select purchase India's first commercial launch of biodiesel centers, beginning January 2006. Biodiesel occurred in December 2005 in Maharashtra, manufacturers protest that the purchase price is derived from karanja seeds. In February 2006, not commercially viable, given that the cost of UK petroleum company BP announced that biodiesel production from Jatropha curcus seeds it was launching a US$9.4 million, 10-year is Rs 30­40 (US$0.67­0.89 at the time) per liter project on biodiesel from Jatropha curcus in the (Financial Times Asia Africa Intelligence Wire state of Andhra Pradesh. Cleancities Biodiesel India is expected to start operating what will 2006). The purchase price is reviewed every six be India's largest export-oriented biodiesel months and is currently Rs 26.5 (US$0.65) per manufacturing plant by July 2007, using liter (USDA 2007p). Industry sources recently mostly imported feedstock. The plant's initial estimated that the biodiesel production cost output capacity will be 250,000 tonnes, to be ranged between Rs 35 and Rs 45 (US$0.86­ doubled to 500,000 tonnes in 2008 (Dow Jones US$1.10) per liter (USDA 2007p). Rs 35 to Commodities Service 2007b). Rs 45 is significantly higher than international prices of diesel. One attraction of Jatropha India imposes high import tariffs on agricultural curcus is that it can grow on marginal land with commodities, including vegetable oils, and little rainfall, but experience to date seems to biofuels. In fiscal year (FY) 2006­07, the suggest that the plant does not grow well under Central Board of Excise and Customs lists the marginal conditions in any commercial sense. customs tariff rate on undenatured ethanol The advantages of relying on Jatropha curcus-- (2207.10)1 as 182 percent, that on denatured and similar plants that are said to be drought ethanol (2207.20) as 30 percent, and that on resistant--are not yet clear. biodiesel (3824.90) as 12.5 percent (CBEC 2006). A June 2007 USDA report lists total The Ministry of New and Renewable Energy existing import duties on denatured ethanol, suggested a range of fiscal incentives on the undenatured ethanol, and biodiesel as 198.96, October 2006 draft National Policy on Biofuels. 59.08, and 36.82 percent of the landed value The proposed incentives reportedly include excise (USDA 2007p). These percentages are very high duty exemption to biofuels in pure and blended and appear to include other taxes. A recent form up to a certain percentage, customs and government report states that ethanol imports excise duty exemption for manufacturing plants for potable purposes are levied a customs and machinery used for processing oilseeds for duty of 150 percent, but the customs duty for biodiesel production, excise duty exemption for ethanol imports for use by the chemical and biodiesel blended with petroleum diesel (similar petroleum industries is 10 percent (Planning to the concessions given to ethanol blended Commission 2006). The import tariff on raw into gasoline), and establishment of a national sugar consists of a 60 percent ad valorem duty 1 These code designations are explained later in this chapter, under the heading "WTO Issues for Biofuels." Special Report Considering Trade Policies for liquid biofuels and a "countervailing" duty of Rs 850 (US$20) the government suspended new licenses in per tonne in lieu of local taxes and fees imposed July 2006, by which time 52 manufacturing on domestic sugar (USDA 2006d). Concerned licenses had been granted by the government. about rising domestic sugar prices at the time, The government estimated in 2006 that annual the government lifted import duties on sugar biodiesel production capacity would increase from June 23 to September 30, 2006 (USDA to 1.2 million tonnes in 2007; most of the 2007l). The government also lowered the produced biodiesel would be exported (AFX tariff rate on crude palm oil from 80 percent Asia 2006b). As of April 2007, six plants with a to 70 percent in August 2006 (Business Times combined annual capacity of 300,000 tonnes 2006), to 60 percent in January 2007, and were operational, and another plant with to 50 percent in April 2007 (Dow Jones an annual capacity of 100,000 tonnes was Commodities Service 2007e). scheduled to come on stream by June (USDA 2007m). As figure 1.5 shows, palm oil prices Malaysia have been rising sharply in recent months, slowing the growth of the biodiesel industry. Historically, Malaysia has been the world's largest palm oil producer, although it is now In April 2007, the parliament passed a biofuels being overtaken by Indonesia. Malaysia is a net industry bill, requiring blending of palm olein exporter of petroleum crude oil, with petroleum (the liquid fraction obtained by fractionation consumption about 60 percent of production in of palm oil after crystallization at controlled 2005. Malaysia subsidizes the domestic price temperatures) in petroleum diesel. Referred of certain petroleum products. In 2005, despite to as Envo Diesel, B5 in this act is a mixture several price increases, the total subsidy borne containing not a fatty acid methyl ester formed by the government increased to RM 6.6 billion by reacting methanol with a plant oil, but palm (US$1.7 billion). Domestic petroleum fuel prices olein (USDA 2007m) and petroleum diesel. were last raised in February 2006, but remain While blending palm oil directly reduces the below parity with international prices (ESMAP fuel cost by avoiding transesterification, vehicle 2006). manufacturers have expressed fears that the fuel may have lower oxidation stability; consequently, Prime Minister and Minister of Finance Badawi the life of fuel injectors and injection pumps may in his 2006 budget speech announced a range be shortened. In September 2006, the Malaysian of biofuel initiatives, including the introduction of Automotive Association, which represents almost B5 on a pilot basis; the development of biodiesel all local auto distributors, reportedly expressed fuel specifications; construction of three palm unease about blending unesterified palm oil into oil biodiesel plants with a total annual capacity petroleum diesel. The association cited concerns of 180,000 tonnes, principally for export; and about potentially more frequent breakdowns tabling of a biofuel act in the parliament in and repairs, which in turn would affect vehicle 2006. The first commercial-scale biodiesel plant warranties (AFX Asia 2006a). went into production in June 2006. By mid- 2007, 20 new biodiesel plants were expected The government's fuel pricing policy poses a to be in production in Malaysia (Platts Oilgram challenge to the domestic biodiesel market News 2006), but these construction plans in the near term. Nevertheless, Malaysia, have fallen considerably behind schedule. like Indonesia, is in a position to become an Concerned about the availability of crude palm important exporter of biodiesel. The Indonesian oil for the food and oleochemicals sectors, and Malaysian governments jointly announced biofuel Policy and Trade Issues in July 2006 that each would commit 6 million production from maize feedstock increases, tonnes annually of crude palm oil for biodiesel the supply of maize in international markets manufacture. The commitment, which stopped eventually declines and raises the price of short of an official mandate, represents about maize. Meanwhile, ethanol production from 40 percent of each country's respective annual maize increases the supply of by-products in production of crude palm oil. Some industry the market, causing their prices to decline and analysts have expressed concerned that this and hurting the overall margin received from ethanol similar moves for increasing biodiesel production production. These factors provide natural brakes could make palm oil too expensive for both food on the economics of ethanol. Indeed, Ethanol and fuel (Reuters News 2006b). Africa, which is planning South Africa's first commercial ethanol plant based on maize, In response to growing concerns about adverse stated in February 2007 that high grain prices environmental effects of expanding palm oil were making it difficult to raise funding for its plantation into rain forests, some 185 private plant (Financial Times 2007). sector companies and industry groups-- including Malaysian and Indonesian palm oil So far, the margin of competitiveness for biofuels associations--have formed the Roundtable on has been narrow. The small competitive margin Sustainable Palm Oil, which is now formulating has important implications for the tradability of sustainability criteria and certification ethanol and explains why only a tenth of global procedures. biofuels produced and sold in the world are internationally traded, half of which is Brazilian Potential benefits of biofuel Trade ethanol (USDA 2006n). It is easy to show a large number of countries where local costs of biofuel For the consumption of biofuels to be economic, production would be higher than import-parity marginal costs of production should be prices for biofuels and for equivalent petroleum comparable to, or lower than, those of their fuels. But it is difficult to find countries that are substitutes--petroleum fuels--after accounting potential large exporters of ethanol or other for differences in their respective externalities. biofuels (Brazil being a recent exception). Until recently, this condition was seldom satisfied for ethanol and practically never satisfied for Some countries suffer from exceptionally biodiesel. In 2005, ethanol from sugar in Brazil high insurance and freight costs for all goods was competitive at the economic margin with including liquid fuels. Landlocked countries in petroleum fuel; but in 2007, higher sugar Africa, Asia, and Latin America, for example, prices eroded Brazilian ethanol's margin of cannot have large sea-going tankers arriving at competitiveness with petroleum products. their borders. Besides the higher per kilometer Biofuel economics has its own built-in, self- costs of shipping fuels by rail or road, they also limiting brakes. For example, as Brazil's ethanol face political problems and uncertainty posed production from sugarcane increases, the supply by traversing other national jurisdictions. Even of sugar on international markets declines and the countries on the coast of Africa face high thereby raises the price of sugar. The rising insurance and freight charges because of low price of sugar will induce sugarcane to be shipping volumes and irregular shipments, poor redirected back into sugar production and away on-loading and off-loading infrastructure, and from ethanol. The supply response to soaring poor inland capacity for handling shipments. world sugar prices in late 2005­early 2006 is Brazil has long suffered from poor port and a good illustration. Similarly, as U.S. ethanol inland transport infrastructure, further raising Special Report Considering Trade Policies for liquid biofuels import-parity and lowering export-parity prices Biofuels may be price takers, but they may still at inland markets (Espadas 1994). Emerging be able to influence world petroleum prices soybean producer and potential biodiesel if they can contribute to sufficient additional competitor Argentina suffers similarly high "pre- marginal supply. For example, if--after adjusting FOB" costs (Nardi 2006). for fuel efficiency differences and incremental energy used in biofuel production--biofuels Countries with high insurance and freight could meet 3 percent of global gasoline and costs have in place one natural advantage for diesel fuel demand, or 1.5 percent by volume import substitution of biofuels (as was discussed of total oil consumption, this would amount to regarding figures 1.3 and 1.4). The same factors about 1 million barrels per day of petroleum oil. suggest they are unlikely to be able to compete in While such substitution would not reduce world biofuel exports--except with respect to adjacent petroleum consumption in absolute terms, which landlocked countries. The unresolved issue is the has been growing at 1.6 percent annually during extent to which these same high transport costs the last decade, it would moderate petroleum feed back into costs for domestically produced demand growth and petroleum price increases, biofuels--so high, in fact, as to overwhelm everything else being equal. the seemingly large natural import protection afforded biofuels in that country. An important remaining issue is that of security of supply of biofuels. Trade in biofuels will not In analyzing the impact of biofuel production develop as an alternative to trade in petroleum and trade, it helps to distinguish between the fuels if biofuel supply poses comparable issues of quantitative versus pricing effects. insecurity issues to that of petroleum supply. Some governments express the hope that Importing countries are concerned about biofuels could develop into cheaper alternatives such things as geographical distribution to petroleum fuels on a large scale. This is not of exporting countries. If regions with low likely for a long time. For the foreseeable future, production costs are concentrated primarily biofuel production will remain a small fraction of in one or two countries, it may be difficult for total petroleum fuel production, and, as a result, biofuel trade to take off, even if the potential biofuels largely will continue to be price takers in exporting countries have plentiful land suitable the market rather than drivers of transportation for biofuel production. For example, Japan, fuel prices. This means that average biofuel which is ill suited for biofuel production and is prices on a petroleum-equivalent basis will not interested in biofuels for their GHG emission be significantly lower than those of petroleum reduction benefits, worries that Brazil is now over the long run on the international market-- the only obvious large exporter and views particularly as countries try to force biofuel reliance on one exporting country as potentially production to higher levels. As the production of compromising security of supply. biofuel feedstocks increases, the marginal cost of supply increases as well because of limitations The effects of biofuel trade liberalization are of suitable lands and available water, among closely linked to the economics of biofuel other causes. Given the existing stocks of land production relative to petroleum prices and to and the expected feedstock yields per hectare far the related overall size of the biofuel market in into the future, the economic scale of production the future. In the short run, trade liberalization of biofuels will remain a small percentage of would enable a few low-cost producers to global transport fuel consumption for some time expand their market share, while high-cost to come. producers that currently are given preferential biofuel Policy and Trade Issues trade agreements (for example, CBI countries) States, ethanol production declines by 7 percent, could lose their market share entirely. This but consumption increases by 4 percent. Net could help reduce overall subsidies provided to imports triple, and domestic ethanol prices fall by biofuels, increasing welfare globally. 14 percent. In Brazil, ethanol production increases by 9 percent but domestic consumption falls by Potential Impact of biofuel Market growth 3 percent, and net exports rise by 64 percent. and Trade liberalization In the second scenario, the study assumed that There are few studies examining the effects the federal tax credit of US$0.51 per gallon of biofuel trade liberalization. Two recently would be eliminated in addition to the removal published papers investigate the impact of of import tariffs. In that case, U.S. consumption liberalizing ethanol trade between Brazil and of both ethanol and gasoline would fall relative the United States. The findings of the two to the base case (which has both the import studies show some differences, but both point tariffs and tax credit for ethanol blenders in to increasing trade between the two countries place). U.S. ethanol prices; world ethanol, sugar, following liberalization. and maize prices; Brazilian ethanol production; and net Brazilian exports of ethanol would all be The first study found that removal of the U.S. lower than in the first scenario. import tariffs on ethanol from Brazil would reduce ethanol production in the United The second study focused on a comparison States, reduce ethanol consumption in Brazil of sugar-ethanol processing in Brazil with the and increase its consumption in the United U.S. maize-ethanol industry. A time-series States, increase ethanol exports from Brazil to analysis of data for the last 30 years, including the United States, lower ethanol prices in the historical market prices and exchange rates, United States, and raise world ethanol prices. was carried out to compare dry mills, wet mills, Predictably, it would also eliminate ethanol trade and distilleries. The study also examined the between the Caribbean and the United States possibility of dry mills using high-starch maize-- through the CBI (Elobeid and Tokgoz 2006). In which was found to reduce ethanol production the first scenario, the study assumed that the costs by nearly US$0.03 per liter--and the U.S. government's domestic biofuel policy would benefits and costs of cogeneration of biomass remain in place, including the federal tax credit power--which would reduce ethanol production of US$0.51 per gallon, but that the specific costs by a further US$0.02 per liter. The import tariff of US$0.54 per gallon would be study compared the processing cost effects of eliminated (with all other support measures changing commodity prices and exchange rates remaining in place). Between 2006 and 2015, with today's technology2 with a view to assessing elimination of the tariff results, on average, in the direction of trade in the absence of tariffs on an increase of 24 percent in world ethanol prices, ethanol. The study found that there was no trend an increase of 1.8 percent in world sugar prices, in cost advantage between ethanol from maize and a decline of 1.5 percent in world maize in the United States and ethanol from sugar in prices (because less maize in the United States Brazil, but that there would be seasonal patterns is diverted to the ethanol market). In the United of advantage. These periods of advantage would 2 The study assumed an ethanol yield of 2.8 gallons of ethanol per bushel of maize, which is current; but 76.1 liters per tonne of sugarcane, against the yield of 79.4 liters of anhydrous ethanol per tonne of sugarcane in the 2004­05 crop season in Brazil. Special Report Considering Trade Policies for liquid biofuels last several years. Ethanol from sugarcane was Table 3.1: Worldwide Average Extraction Rates by favored half the time. The study also computed Weight (Percent) the break-even price of petroleum oil above which E85 used in vehicles optimized for E85 Oilseed Meal Oil with a fuel economy penalty of 15 percent would Soybeans 78 18 be competitive. It found that the break-even price was US$35 per barrel of oil in 2000, rising to Rapeseed 60 39 US$55 per barrel when maize prices increased Sunflower 47 41 to US$3.40 per bushel in spring 2004, and returning to US$40 per barrel after maize prices Palm 10 90 fell later in 2004 (Gallagher and others 2006). Source: LMC International (2003). Another study examined the impact in 2010 in the price of vegetable oil, palm growers on the world sugar and ethanol markets posed receive 5.0 percent more, but soybean growers by Brazil's requiring blending of 8 percent receive only 0.8 percent more. The study ethanol in diesel fuel beginning in 2006. World assumed that the net income of an oilseed ethanol prices rise by 0.9 percent, and sugar grower was the volume-weighted average of prices rise by 3.5 percent. In Brazil, ethanol the increase in the price of vegetable oil and consumption increases by 16 percent, ethanol the decrease in the price of meal. Because exports fall by 3 percent, sugar exports fall by soybean growers produce much more meal 2.9 percent, ethanol prices rise by 4.7 percent, relative to oil than other oilseed growers, their and sugar prices rise by 5.5 percent (Koizumi earnings increase the least. This finding would and Yanagishima 2005). suggest that, for the purpose of aiding farmers, mounting a biofuel program based on soybeans To gain an understanding of how the world would be much less efficient than that for other oilseeds market might be affected by growth oilseed growers with higher oil extraction rates. in demand for biofuel, a 2003 study examined one effect of an initial increase in demand for The Energy Information Administration of the vegetable oils (LMC International 2003). The U.S. Department of Energy carried out a study study considered soy, rapeseed, sunflower, and analyzing the near- and mid-term potential palm oils, and assumed that they were, for price and supply effects of the Fuels Security the purpose of the study, entirely substitutable. Act of 2005, which was similar in content to the The study used historical supply and demand 2005 Energy Bill. The average price increase elasticities with respect to price for oils as well for gasoline between 2006 and 2025 resulting as by-products to arrive at the equilibrium from adopting the Fuels Security Act of 2005 was response. The oilseed's world average extraction calculated to be US$0.8 per gallon (US$0.2 per rates for meal and oil differ considerably (see liter). The ethanol content in gasoline would rise table 3.1). These differences have a large impact and peak at 5 percent in 2012, after which it on oilseed producers. would fall because of increasing use of cellulosic bioethanol, which receives extra credit (U.S. EIA The study found that vegetable oil prices 2005) (see appendix C for how cellulosic ethanol increased, but meal prices declined, because is treated in the 2005 Energy Bill). of surplus production. An interesting finding, consistent with the extraction rates shown in A study by LMC International conducted in 2006 table 3.1, is that, for an increase of 5.8 percent examined the impact of substituting biofuels for 0 biofuel Policy and Trade Issues 5 percent of gasoline and diesel fuel demand 5. Palm oil produced in Indonesia alone will worldwide by 2015. The study, which took fuel supply the required additional biodiesel. economy differences into account, first examined 6. Palm oil worldwide will supply the required whether biofuel production has had effects on additional biodiesel. crop prices. An analysis of correlations between 7. Oilseeds (rapeseed, soybean, palm, and monthly world prices of feedstocks for biofuels sunflower oil) worldwide will supply the and Brent crude oil between 1994 and 2006 required additional biodiesel. found that prices of sugar and molasses were highly correlated with those of Brent, with a The study showed that if the entire world supply correlation coefficient of 80 percent and more of carbohydrates were converted to ethanol than 90 percent, respectively. The study suggests today, the maximum potential share of ethanol that a share of 10 percent of global demand in gasoline would be only 40 percent. For derived from biofuel might be the threshold oilseeds, even a 10 percent blend of biodiesel above which a positive association between fuel with petroleum diesel would not be achievable. and commodity prices starts to emerge--ethanol The study found that to achieve a 5 percent in 2005 accounted for about 15 percent of world blend, by far the most efficient pathways were sugarcane demand and about 45 percent of sugarcane to ethanol in the center-south region world molasses demand. This would suggest that of Brazil and palm oil to biodiesel, in terms of the decision by Indonesia and Malaysia to set additional hectares required (see table 3.2). aside 40 percent of their total palm oil production Using carbohydrates and oilseeds worldwide for biodiesel would be expected to lead to a to make the two biofuels would require an strong link between palm oil and crude oil prices. additional 100 million hectares of land, or an Conversely, palm oil analysts in January 2007 increase of more than 15 percent. The amount speculated that falling petroleum crude oil prices of land required to make biodiesel from palm might exert downward pressure on palm oil oil around the world is only marginally greater prices, in part by casting doubts on the feasibility than that required for biodiesel from palm oil in of biodiesel, after the "psychological level" of Indonesia. The figures for biodiesel illustrate the US$60 a barrel was broken in futures trading high biodiesel yield per hectare of land when (Dow Jones Commodities Service 2007a). using palm oil compared with other oilseeds. In practice, relying only on Brazil and Indonesia In examining the prospects of blending 5 percent would result in major inroads into grazing biofuels, the LMC study analyzed several areas in Brazil, pushing ranches further into the scenarios for additional supply to meet this goal: cerrado--the country's vast tropical savanna ecoregion--and to large-scale encroachment 1. Sugarcane produced in the center-south on tropical rain forest areas of Kalimantan in region of Brazil alone will supply the required Indonesia, with potentially significant effects additional amount for ethanol. on biodiversity as well as net changes in GHG 2. Sugarcane worldwide will supply the required emissions. additional ethanol. 3. Sugarcane worldwide will supply 50 percent, The above study did not give consideration to the and maize worldwide will supply 50 percent, water implications of area expansion. If Brazilian of the required additional ethanol. sugarcane and Southeast Asian oil palm are 4. Carbohydrates (maize, wheat, barley, cassava, chosen to meet global biofuel needs, there will sugarcane, and sugar beets) worldwide will be little or no additional demand for irrigation supply the required additional ethanol. water. If feedstocks are grown around the world, Special Report Considering Trade Policies for liquid biofuels Table 3.2: Land Required for Biofuel Production (Million Hectares) Biofuel Feedstock Location Baseline 5% blend Difference Ethanol Sugarcane Brazil (center-south) 8 17 10 Ethanol Sugarcane World 22 38 16 Ethanol Cane/maize World 178 207 29 Ethanol Carbohydrates World 448 498 50 Biodiesel Palm oil Indonesia 9 20 10.5 Biodiesel Palm oil World 20 32 11.3 Biodiesel Oilseeds World 208 258 50 Source: LMC International (2006). a greater area of land than that indicated in border value when converted to an ad valorem table 3.2 may be required. tariff equivalent, as the discussion of Australia in appendix C shows. wTO Issues for biofuels Agricultural goods tend to enjoy greater Chapter 2 and the description of biofuel policies protection than industrial goods. Importantly, in this chapter show that industrial countries are in once a good is afforded protection, it is easier a position to provide greater subsidies to domestic to prevent reform if the good is classified as an biofuel producers--both for the production of the agricultural commodity and trade negotiations feedstocks and for the manufacture of biofuels fall under the Agreement on Agriculture. Ethanol, themselves--than developing countries. This but not biodiesel, falls under this agreement. has created a large domestic biofuel industry Ethanol is included in the WCO's HS chapter 22, that may not be able to compete with imports of and annex 1 to the Agreement on Agriculture petroleum fuels and biofuels, necessitating high states that HS chapters 1 through 24 are covered tariffs on the latter while providing tax reductions by the agreement. Biodiesel, on the other on the domestic market. If the current policies hand, falls under chapter 38, which is excluded continue, this may adversely affect developing countries that have comparative advantage in from consideration under the agreement. The biofuel production and export. rationale for classifying ethanol under agriculture is that, undenatured, it can be imbibed. As explained in chapter 2, removing border Support given to biodiesel manufacture may restrictions yields considerable welfare gains. For fall under governments' commitments under biofuels, maximum applied ad valorem tariffs for the Agreement on Agriculture if the subsidies harmonized system (HS) 2207.10 (undenatured can be shown to reach the farmer directly. One ethanol) and HS 2207.20 (denatured ethanol) example is if the biodiesel manufacturer is have been reported as 300 and 125 percent, required to offer a minimum guaranteed price respectively, against 30 percent for HS 3824.90 to the farmer. Indirect benefits to agriculture as a (biodiesel) (Steenblik 2005c). Specific tariffs for result of increased demand for biodiesel--from biodiesel can be higher than 30 percent of the such government interventions as biodiesel biofuel Policy and Trade Issues mandates or fuel excise tax exemptions--are good does enable governments to protect not considered agricultural subsidies. Although domestic producers longer, and, in the extreme, ethanol is classified as an agricultural good, declare ethanol a sensitive or special product it remains to be seen how subsidies provided (see appendix A) to shield it further from external for ethanol production will be reported to the pressure for liberalization. WTO (that is, as agricultural subsidies or non- agricultural subsidies). One policy question falling under the rubric of environmental goods is whether distinctions To increase market access more rapidly, some should be made on the basis of process have proposed that ethanol be reclassified as and production methods. Such distinctions an industrial good or an environmental good. would make administration more complex, The latter is a relatively new concept that is but there is already growing pressure and still being formulated, and is unlikely to affect interest in examining the environmental impact market access for ethanol in the near to medium of individual crop and crop-based energy term. But because this proposal has received production pathways. Although not related to some attention, it is covered in some detail in WTO negotiations, the Dutch government's appendix A. The Doha Ministerial Declaration of statement that palm oil will likely be excluded 2001 specifically refers to environmental goods from future subsidies for renewable projects and services as an area that could be targeted and the soybean traders' moratorium on the for faster liberalization. The declaration also has purchase of soybeans grown on newly cleared a paragraph on the desirability of increasing rain forests in Brazil (mentioned earlier in this market access for non-agricultural products, chapter) are indicative of this growing trend. highlighting products of export interest to developing countries--which biofuels could very Article III, National Treatment on Internal Taxation well be. and Regulation, in GATT 1947, states that In practice, reclassification is unlikely to have internal taxes and other internal charges, and near-term policy consequences. The WCO laws, regulations and requirements affecting Council considers amendments in four-year the internal sale, offering for sale, purchase, cycles. The most recently completed review transportation, distribution or use of products, and internal quantitative regulations requiring occurred in June 2004, with the amendments the mixture, processing or use of products in implemented on January 1, 2007. Amendments specified amounts or proportions, should not be under the next review cycle are not scheduled applied to imported or domestic products so as for implementation until 2012 (Steenblik to afford protection to domestic production. 2005b). Waiting for reclassification with a view to quickening the pace of liberalization thus Article 3 of the Agreement on Subsidies and does not seem practical in the near term. More Countervailing Measures prohibits "subsidies importantly, reclassification is not a requirement contingent, whether solely or as one of several for liberalizing market access. Being classified other conditions, upon the use of domestic over as an agricultural product does not bind the imported goods," including production subsidies good to high tariff rates, nor is reclassification contingent on use of domestically grown necessary to take a good out of annex 1 of the feedstocks (WTO 2007). These principles ensure Agreement on Agriculture (which spells out which equal treatment of biofuels and their feedstocks products are included under the agreement). from around the world on any given domestic However, classifying ethanol as an agricultural market. Special Report Considering Trade Policies for liquid biofuels Although they have not been challenged other forms of support, they do not require a under WTO commitments, some subsidies budgetary allocation. Fuel tax reduction and and mandates are reserved explicitly for in- exemption may have to be debated by the state production. For example, the provincial parliament because they will entail a loss of government of Manitoba in Canada provides a government revenue. By contrast, imposing reduction in the gasoline tax of Can$0.025 per high import tariffs may not entail any budgetary liter for gasohol containing a 10 percent blend loss. Because they are not subject to budgetary of ethanol produced and sold in Manitoba, and debate and scrutiny, high tariffs, which distort exempts biodiesel produced in the province from trade significantly, tend to be readily imposed for both the retail sales tax and the automotive fuel goods that governments wish to protect. tax (Manitoba Government 2003 and 2006). In June 2006, the Louisiana State Legislature One question in the context of the Agreement in the United States passed a bill that requires on Agriculture is whether the current agricultural 2 percent by volume of the total gasoline sold support for biofuels or their feedstocks belongs in the state to be ethanol from domestically to the amber box or the green box. To be eligible grown feedstock or other biomass once a certain for green box payments, certain criteria must domestic ethanol production target is reached be met. Under all circumstances, subsidies must (Louisiana State Legislature 2006). Interestingly, be publicly funded, not involve transfers from the U.S. Supreme Court ruled in 1988 that consumers, and not have the effect of providing tax credits given only to in-state manufactured price support to producers. In addition, the ethanol violated the commerce clause of the government support must meet specific policy federal constitution. More specifically, the case criteria, the relevant one of which for biofuels heard by the Supreme Court involved a challenge is described in annex 2, paragraph 12, to the mounted by an Indiana firm against an Ohio Agreement on Agriculture. That paragraph statute. The statute gave a tax credit against the covers payments under environmental programs. Ohio motor vehicle fuel sales tax for each gallon Payments must be part of a clearly defined of ethanol sold (as a component of gasohol) government environmental or conservation by fuel dealers, but only if the ethanol was program and must fulfill specific conditions, produced in Ohio or, if produced in another state, including those related to production methods to the extent that the state granted similar tax or inputs. Payments must be limited to the extra advantages to ethanol produced in Ohio. At the costs or loss of income arising from compliance time, Indiana had no ethanol tax exemption, and with the program (WTO 2007). hence the ethanol produced in Indiana was not eligible for the Ohio tax credit (FindLaw undated). It seems difficult to regard subsidies given to promote biofuel production as offsetting Aside from possibly a handful of exceptions such the extra cost or loss of income involved in as those discussed above, fuel tax reduction complying with an environmental program. For and exemption--an instrument of nearly all example, as described in appendix C, the U.S. governments implementing biofuel programs-- government does not consider that the Bioenergy are not trade distorting because they do not Program of the Commodity Credit Corporation discriminate on the basis of origin. The fiscal met any of the policy-specific criteria in the instruments that can be used within the bounds green box. Citing annex 3, paragraph 7, of of WTO rules to protect domestic producers the Agreement on Agriculture, which states that are import tariffs. Import tariffs are the easiest "measures directed at agricultural processors policy instrument to employ because, unlike shall be included [in the Aggregate Measure of biofuel Policy and Trade Issues Support] to the extent that such measures benefit EN 14214 is not applicable if the carbon number the producers of the basic agricultural products," is 14 or lower. This means that the test cannot the USDA suggested that the Bioenergy Program be used for biodiesel derived from coconut oil or could be viewed as an amber box subsidy (USDA palm oil (JPEC 2005). 2006l). This statement also suggests that the USDA regards subsidies for ethanol production The European fuel specifications currently as agricultural subsidies. allow blending of up to 5 percent ethanol and 15 percent ethers (oxygen-containing organic Trade in biodiesel is extremely small at present. compounds for which ethanol is one possible There are no large tariff barriers in major feedstock) in gasoline, and up to 5 percent current and future biodiesel consumers and biodiesel in petroleum diesel. As mentioned potential importers, including the United States earlier, raising these limits is currently under and the European Union which levy high tariffs consideration to expand the use of biofuels. In on ethanol. Arguably the greatest impediment the United States, blending 10 percent ethanol in to biodiesel trade in the coming years could gasoline is common. The U.S. EPA has said that be technical barriers to trade in the form of it would consider E20 to be a new fuel, and the certification for environmental sustainability. state of Minnesota would need to obtain an EPA waiver before implementing its E20 mandate Another policy area involves technical in 2013 (see appendix C) (NMMA 2006). As in barriers to trade. Fuel specifications can Europe, blending biodiesel up to 5 percent is constitute such barriers. In December 2001, considered permissible. the American Society of Testing and Materials issued a specification (D 6751) for biodiesel Technical barriers to trade are likely to be more fuel, to be used in a blend with petroleum important for biodiesel than ethanol. Unlike diesel. Biodiesel defined by this specification is ethanol, biodiesel is a mixture of different size registered with the U.S. EPA as a fuel and a fuel molecules with varying levels of unsaturation. additive. Major engine companies operating The composition of a given biodiesel fuel, and in the United States have adopted D 6751 for the molecular structure of each ester comprising warranty purposes. German authorities issued a the fuel, depends on the feedstock (and the provisional specification for fatty acid methyl ester process conditions to a lesser extent); the under DIN 51606. In 2003, DIN 51606 was amounts of contaminants left in the biodiesel replaced by EN 14214 of Europe's Committee fuel depend on the production process. It for Standardization upon its publication, for is relatively easy to make biodiesel, but it is biodiesel to be used pure as well as in a blend. difficult to make on-spec biodiesel. Ensuring The European specifications have more stringent fuel quality consistency presents a much greater limits for sulfur and water. The iodine number challenge for biodiesel than ethanol, especially in EN 14214 effectively excludes pure biodiesel for biodiesel made at small-scale, simple- derived from soybean oil or sunflower oil, but technology facilities. The European Union has Spain has raised the limit for the iodine number historically channeled efforts to establishing to permit greater use of soy-derived as well as standards based on data obtained from domestic sunflower-derived biodiesel. Additional biodiesel made from rapeseed oil, whereas the work is needed for wider application of the United States has concentrated on biodiesel from EN 14214 specifications and associated test soybean oil. Biodiesel from rapeseed is more methods. For example, test method EN 14103 suited to the European climate from the point for determining the ester content required by of view of wax formation at low temperature, Special Report Considering Trade Policies for liquid biofuels although biodiesel from other vegetable oils Wide Fuel Charter in August 2005, continue such as soybeans and palm can be mixed with to recommend against permitting biodiesel in rapeseed diesel at low percentages without the most advanced fuel specification category causing vehicle performance problems. The (Methanol Institute and International Fuel existing specifications and test methods are Quality Center 2006). More work is needed considered insufficient for protecting advanced for developing test methods and specifications engines used to meet the most stringent emission that are applicable to a larger pool of biodiesel standards in industrial countries. For this reason, fuels made from a variety of feedstocks and the world's major auto manufacturers, in their for ensuring compatibility with modern diesel most recent proposed revision for the World engines. 4. Conclusions For much of the world, interest in biofuel trade nearly all countries, the objective of increasing liberalization is driven by a more general energy security has been more narrowly focused interest in the potential for biofuels to substitute and is synonymous with independence from for petroleum products in transportation imported energy and with self-sufficiency; this applications. As pointed out in chapter 1, this excludes trade as an alternative for meeting more general interest targets three primary the above broader objective. Previous chapters objectives: showed that biofuels are likely to play only a small role in volumetric terms in replacing · Concerns about energy security arising from petroleum fuels in transportation on a global increasing world petroleum prices and the basis in the foreseeable future. Present and prospect of eventual depletion of petroleum projected input-output relationships among · Environmental considerations that motivate the land, water, and other resources available governments to seek ways of curbing rising globally suggest substitution for petroleum GHG emissions overall and especially from transportation fuels on the order of a few the transport sector, and, to a lesser extent, percentage points. Given projected growth in reducing tailpipe emissions of harmful demand for transportation fuels, this level of pollutants substitution will not reduce overall petroleum · A desire to support domestic agriculture fuel consumption below current levels but, rather, in the face of international negotiations to will moderate the growth in demand for those liberalize agricultural trade fuels. Although these objectives are not shared equally It helps to differentiate between volumetric by all countries, together they explain much of effects on self-sufficiency versus those on future the motivation for the biofuel policies overviewed petroleum price increases. In this latter sense, in chapter 3 and interact with the agricultural biofuel production provides some potential production and policy issues discussed in for helping ameliorate future price increases chapter 2. This chapter begins by addressing for petroleum and its products. Given the tight the three objectives before turning to the supply situation that has led to large price implications for biofuel trade policy. increases since 2004 on the world petroleum energy Security market, an even marginal increase in supply would be expected to lower fuel prices. While The first objective may call for diversity of supply, this potential for relative impact on price and, in particular, identifying energy suppliers increases is worth mentioning, it does not mean other than major petroleum oil exporters. In that petroleum prices will not continue to remain Special Report Considering Trade Policies for liquid biofuels high or even increase into the future as overall the objective of self-sufficiency. There are also global demand continues to grow. serious environmental concerns about expansion of palm plantation in Indonesia. As for countries Some countries see biofuels as a way to secure with limited or no petroleum production cheaper fuels. Indonesia, for example, aims to potential, chances of achieving self-sufficiency substitute biodiesel for 10 percent of petroleum in transportation fuels from investing in biofuel diesel with the aim of reducing or eliminating the production are highly unlikely. Most petroleum- diesel price subsidy. The basis for this approach importing countries will be left with the option of seems questionable. First, biofuels have importing biofuels from what is expected, in the required--and will, for the foreseeable future, near term, to be a small number of exporters of continue to require--significant subsidies. As relatively small volumes of biofuel (with Brazil's such, it is difficult to see how biofuels can help current ethanol export prospects being a possible reduce fuel price subsidies. Second, biofuels are exception). A combination of policies to reduce nearly perfect substitutes for petroleum fuels and petroleum consumption should be implemented require essentially no additional infrastructure together with policies for biofuels to achieve the or infrastructure modification for transport objective of reducing dependence on imported and distribution (with the exception of pipeline energy. Policies to reduce energy consumption transport and blending of ethanol). Under these should include sending correct market signals to circumstances, it would be difficult to maintain consumers by reflecting international fuel prices, a sizable price difference between biofuels and incentives for energy efficiency improvement, petroleum fuels for long, except in landlocked and demand management. or isolated areas or very small economies. In an open market, prices of biofuels and petroleum environmental Sustainability fuels would equilibrate, after allowing for transportation and differences in quality and fuel The environmental objective that provides economy differences. Third, growing demand part of the interest in biofuel production and for biofuels exerts upward pressure on feedstock consumption also confronts issues related to prices--as recent world price movements of agricultural policy, to choice of feedstock crops maize and palm oil have shown--again making by different countries, and to limitations in it difficult to maintain sizable price differences feedstock production capacities within existing with petroleum products in favor of biofuels. agricultural operations. Theoretically, biofuels are renewable, but their potential for reducing In terms of national prospects for meeting the life-cycle GHG emissions varies markedly, as more narrowly defined self-sufficiency objective, shown in tables 1.1 and 1.2. There are also biofuel production is likely to make only a small local environmental effects associated with contribution in most countries. Brazil recently biofuel production and use that can be, but are passed the self-sufficiency margin by combining not always, positive. As such, the environmental domestic petroleum production with ethanol benefits of biofuels should not be assumed but production. But Brazil is exceptionally well need to be examined on an individual basis. endowed for the purpose of ethanol production, and few countries can match these natural Studies indicate that some feedstock and ethanol endowments. Indonesia has substantial potential production pathways provide net environmental to be a major supplier of biodiesel from palm benefits. An example of such benefits is ethanol oil, but its domestic policies underprice transport produced from sugarcane in Brazil, especially fuels in the domestic market and work against when net GHG impacts are accounted for Conclusions and assuming no change in land use. But from newly cleared rain forests in Brazil may other cases--such as ethanol produced from foreshadow the impact of environmental sugarcane under irrigated conditions in water- concerns on world agricultural and biofuel scarce India--would have lower environmental markets. Global environmental benefits such as benefits. net GHG reductions need to be verified for each feedstock, production pathway, and location; Water is going to be an increasingly scarce and the negative environmental effects occurring resource due to competition from urban areas at regional, national, and local levels from the and, in many places, due to climate variability. feedstock production process also should not be In most countries, water is not valued as energy. ignored. These considerations raise questions Where water is projected to become increasingly about classifying all bioethanol and biodiesel as scarce, including in parts of Africa, water environmental goods. shortages may become a serious constraint on biofuel production and should be carefully A careful consideration of environmental effects examined. Similarly, greater maize production in is particularly important to level the playing field. the United States for ethanol could increase the High petroleum oil prices are spurring not only size and intensity of the "dead zone" in the Gulf efforts at making biofuels commercially viable-- of Mexico that is attributed to agricultural runoff the most significant and potentially promising (fertilizer and pesticides) from maize farms. And being pursuing technical breakthroughs to any ethanol production in the United States from dramatically reduce costs of second generation maize is acknowledged to have much smaller biofuel production. The same high oil prices benefits in the reduction of life-cycle GHG are also driving investments and R&D efforts emission compared with ethanol from sugarcane toward the production of other liquid fuels, such in Brazil, and could even result in a net increase as coal to liquids, gas to liquids, oil from tar in GHG emissions if electricity from coal is used. sands, and shale oil. Most of these alternative On the other hand, the European Commission liquid fuels are economic and commercially questions if there will be benefits in the reduction viable at US$60 per barrel of crude oil, but of GHG emissions from additional ethanol uncertainties about future oil prices have kept production in Brazil if cane areas are expanded commercial development in check. Production by clearing virgin savanna. of liquid fuels from tar sands and shale oil has large and adverse ecological consequences, Similarly, biodiesel produced from tropical both local and global. For example, if tar sands plant oils that come from expanding palm are included, Canada may be home to the oil plantations into rain forests--notably in world's largest petroleum reserves, but tar sands Indonesia--raises serious questions about lie under Canada's boreal forests. Tar sand the loss of biodiversity and potential benefits production entails strip mining, and extracting regarding life-cycle GHG emissions. Indonesia oil is extremely energy and water intensive, becomes the world's third largest emitter of requiring 2 to 5 liters of water for every liter of CO2 after the United States and China when oil and leaving vast quantities of contaminated emissions from burning peat land (in part to tailings. If tar sand output reaches more than expand palm oil plantation) and other forest 3 million barrels a day by 2015, Canada's fires are considered; it is 21st when these GHG emissions could double between 2004 emissions are not included (WSJ 2006, Energy and 2015, according to figures released by the Economist 2007). The two-year moratorium by Canadian government (Petroleum Economist soybean traders on the purchase of soybeans 2006). But in the absence of properly accounting Special Report Considering Trade Policies for liquid biofuels for these environmental externalities, tar sands farmers. National biofuel agendas indeed may look attractive, and production costs could provide appreciable scope for increasing the be lower than those for biofuels. demand for various agricultural commodities (maize and sugar in particular) that receive The foregoing discussions highlight interactions large subsidies in a number of countries. With among different economic forces, and also feedstocks constituting more than half the between the energy security and environmental production costs for biofuels, the link between objectives outlined above. High oil prices offer biofuels policy and agricultural policy (and, the potential to commercialize a range of increasingly, the links between petroleum prices alternative energy sources, not just biofuels. The and agricultural prices) cannot be ignored in benchmark price may shift over the medium to discussing biofuel policy. long term as these alternative energy sources are developed on a large scale. For example, These same links bring into further question the Canada plans to triple oil production from tar arguments from some quarters that subsidies for sands in the next 10 to 15 years, adding another biofuel production should be considered green 2 million barrels of oil a day to the supply chain. box environmental payments within the WTO. Environmental concerns are having increasing If government expenditures were being made effects on commercial production, driving to compensate farmers and ethanol producers R&D efforts at environmental sustainability of for costs borne directly in support of otherwise- production methods for all energy sources. The uncompensated environmental improvements pace of technological breakthroughs in terms (such as soil erosion prevention), then the green of both cost of production and environmental box argument could hold some sway. However, sustainability of production methods--and hence this is not the case with any of the feedstocks the relative commercial viability of different receiving current government support, as was substitutes for conventional petroleum oil--is discussed in chapter 3. The preceding discussion difficult to forecast. As a general observation, on the environmental impact of biofuels also diversifying supply can help hedge against cautions that environmental benefits of biofuels escalating oil prices. Experience suggests that an cannot always be assumed. Lastly, large efficient way to promote supply diversification producer subsidies for biofuels are likely to be is to establish and enforce a clear, stable, and provided predominantly in industrial countries. transparent regulatory framework including Permitting their continuation would discriminate environmental regulations; establish hard against developing countries which are not in a sunset clauses for financial assistance and budgetary position to offer them, while slowing other protection measures (such as import trade reform negotiations and entrenching tariffs) provided by government so that an protection. infant industry does not remain in its infancy for decades to come; and properly account for Synthesis of analysis environmental externalities through fiscal and other means. There are circumstances in which energy security and environmental concerns can be Support for Domestic agriculture better addressed by other forms of bioenergy. Some forms of bioenergy, such as biomass With regard to the third objective, some have for heat and electricity generation, have been argued that biofuel production objectives largely demonstrated to be commercially viable amount to disguised support for domestic without subsidies. Although biofuels appear to 0 Conclusions be attracting more attention at the moment, Only a handful of developing countries would perhaps in response to U.S. and EU biofuel be in a position to provide the magnitude of tax policy developments, they need to be viewed in a exemptions granted in the European Union, not context that encompasses all forms of bioenergy. least because many developing countries levy Thus, it might be more productive in many low fuel taxes, especially on diesel. In granting developing countries to channel efforts toward tax exemptions, the European Union has publicly developing other forms of bioenergy rather than stated a principle of not overcompensating liquid biofuels. biofuel producers and applying it during the latter half of 2006. Other countries grant What answers then does the present study tax exemptions even in times of favorable provide for the questions posed in chapter 1: biofuel economics (as in the United States in summer 2006). Certain tax differences may · What border and domestic distortions protect be justified to capture poorly accounted for biofuel manufacturers, including feedstock environmental externalities, but even where such growers, today? externalities exist, they are much smaller than · How would biofuel trade be affected by the tax reductions typically offered. At the least, agricultural reform? consideration should be given to moving away · How would removing restrictions on from a fixed subsidy to a sliding scale subsidy international trade of biofuels affect the that changes with a measure of profitability. global biofuel industry and other commodity prices? Many factors need to be considered in setting tax · What are the policy lessons from the rates on fuels. Taxes on transport fuels typically analysis? seek to satisfy multiple objectives, including the following: Supporting Domestic Biofuel Industry · Raising government revenue for general This report outlines a broad array of measures (nontransport) expenditure purposes supporting biofeedstock and biofuel production, · Allocating resources efficiently to and within including fuel tax reduction or exemption, the transport sector mandatory blending, high import tariffs, · Financing road provision and maintenance government purchase policy for biofuels, · Reducing congestion production subsidies, investment subsidies, and · Reducing the environmental externalities of financial user incentive programs such as lower road transport taxes on vehicles designed for biofuels. Industrial · Redistributing income countries have a greater capacity to apply policies that constitute either budget expenditures Correcting for environmental externalities is or public revenue reductions than do developing one of the several objectives of fuel taxation. As countries. Consequently, industrial countries tend such, there is no reason to waive fuel taxation to be better positioned to use policy interventions altogether. The challenge of meeting the various to affect biofuel supply and demand. The objectives is especially difficult in low-income economics of biofuel production underscore countries, where fewer policy instruments are this distinction: no biofuel pathway and product available. Tax rates on goods that have external combination provides a low-risk and profitable costs should be adjusted upward to reduce their investment without some kind of government consumption to a social optimum. Environmental fiscal support at this point in time. externalities should be corrected for by taxing Special Report Considering Trade Policies for liquid biofuels polluting goods, not by subsidizing nonpolluting which can be used to generate heat and power. alternatives (see Gwilliam and others 2001). However, studies have shown that policy reforms affecting sugar will increase world sugar prices. One type of government support given to Similarly, the limited studies of biofuel trade biofuels seems appropriate. A legitimate role reform that have been carried out point to of government is to fund R&D for activities that, increasing world prices of both biofuels and because of their public good characteristics, crops used in their production following tariff are more likely to be undertaken if centrally removal, provided mandates, consumption financed.1 Although the private sector can and subsidies, or both remain. These increases should be encouraged to undertake such work, would reduce the economic attractiveness of research on emerging biofuel technologies that biofuel use. For example, there have been many can dramatically expand supply or reduce costs announcements targeting palm oil in Asia. In seems an appropriate area for governments to particular, a joint announcement by Malaysia support. R&D in developing countries could focus and Indonesia committing what amounts to on technologies that are particularly suitable 40 percent of palm oil production to biodiesel in their context, such as for primary feedstock has made analysts fear that palm oil prices production, processing of biofuels, or equipment could rise above soybean oil prices and in modifications for alternative uses (for example, fact make palm oil too expensive for both fuel direct use of plant oils in stationary sources in remote areas with no electricity supply). and food. A similar reversal of vegetable oil An analysis of U.S. government subsidies for price relationships has already occurred in biofuels found that only a small fraction was for Europe, making rapeseed oil considerably more funding R&D (Koplow 2006); similar findings expensive than sunflower oil in recent years. No are reported for the European Union (Kutas and detailed modeling has yet been done on second- Lindberg forthcoming). order effects (examining the impact of increased demand for a particular feedstock on the Interactions among Different Markets prices of by-products and other crops that are substitutes), the combined effect of agricultural Financial returns to biofuel manufacture are and biofuel trade reform, and links to the world very much affected by feedstock and by-product petroleum market. Doing so would give a better prices, which themselves are largely determined understanding of the likely consequences of by agricultural policy regimes. For example, greater biofuel production and greater trade. when the amount of a given feedstock used for biofuel manufacture exceeds a certain threshold, The fuel ethanol market is much larger than its market price becomes increasingly affected that for biodiesel and has been the subject of by world oil prices; this is a new and emerging more research on the impact of policy change. trend discussed in chapter 3. Excluding feedstock Biodiesel has been less economical to produce. costs, conversion of sugarcane to ethanol is the Much of the biodiesel production in Europe has least-cost route because sugarcane immediately arisen from EU policy that allowed set-aside yields six-carbon sugars that can be fermented land to be used for nonfood crop production, into ethanol, and cane crushing leaves bagasse, resulting in increased planting of rapeseed. At 1Publications that address issues related to public and private R&D policies in agriculture include those by Byerlee and Echeverria (2002), Evenson (2001), and Roseboom (2003). Conclusions the same time, biodiesel has not been subject to (for which these specifications are intended). the level of trade protection facing ethanol and, As suggested in chapter 3, some test methods thus, would be unlikely to be as heavily affected cannot be used for biodiesel fuels made from by trade liberalization. certain feedstocks. Technical Barriers to Trade Enhancing Biofuel Trade There are technical barriers to trade. Some For both ethanol and biodiesel, the core policy may be legitimate and even welfare enhancing, issues affecting the potential for beneficial trade but they impede trade. The topic receiving the are greatest attention at the moment is ensuring environmental sustainability of biofuel 1. import barriers, production, as witnessed by a call for an EU- 2. the agricultural policy regimes (including wide ban on palm oil from Southeast Asia. domestic support and market access) Work is under way in the European Union as affecting feedstocks, well as by associations such as the Roundtable 3. tax reduction and production subsidies on Sustainable Palm Oil to draft sustainability affecting biofuels themselves. criteria and certification procedures. However, only effectively enforced worldwide certification If biofuels are economic, nearly all countries may have a reasonable chance of making a would presumably consume biofuels on the difference in terms of global environmental domestic market first--at least to the point that sustainability. Selective certification that leaves can be fully utilized by the existing vehicle fleet-- some biofuels uncertified could give the before exporting, since selling into the domestic appearance of sustainable production to some, market is almost always more profitable than while allowing the practice of unsustainable exporting. An exception would be countries with production for other consumers. In the worst surplus supply. Brazil is one such example and case, even if a majority of biofuels is certified, would thus benefit from trade liberalization, considerable environmental damage may still as one study described in chapter 3 showed. be incurred depending on the manner in which Worldwide, total cropland has been relatively uncertified biofuels are produced. This would stable. Some parts of Latin America--notably argue for rapidly building a consensus on what Brazil and, to a lesser extent, Argentina--and would be a realistic way forward to ensure sub-Saharan Africa have surplus land that has global environmental sustainability. not been brought into production. Vast rain forests in Indonesia are also suitable for palm In addition, unlike ethanol, biodiesel properties cultivation, but environmental concerns would and performance vary depending on the need to be addressed for massive expansion feedstock, and some feedstocks (such as in biofuel production to be sustainable. Most rapeseed) make biodiesel that is inherently developing countries are densely populated more suitable for cold climate applications and do not have large tracts of underutilized than others (such as palm). The United States lands that could be used for crops or biofuels. and the European Union have issued biodiesel Before unutilized land in sub-Saharan Africa can specifications and associated test methods, but be profitably brought into production, several more work is needed. The existing specifications obstacles must be overcome, including poor and test methods are inadequate even for infrastructure, underdeveloped financial markets, biodiesel fuels made from domestic feedstocks and a hostile investment climate deriving from Special Report Considering Trade Policies for liquid biofuels (often inappropriate) government policies and There is one caveat concerning the benefits poor governance. of reducing and eventually eliminating border barriers. If biofuels continue to require very If biofuels are not economic but some large subsidies, lowering their import tariffs governments are prepared to offer considerable may merely serve to enlarge an industry that price subsidies, trade opportunities might arise cannot stand on its own, and make future for countries with duty-free access. Indeed, some adjustments even more painful should subsidies countries in Eastern Europe and former Soviet be substantially curtailed or withdrawn. Biofuel Union republics are launching or planning to start trade liberalization coupled with continued biodiesel production with a view to exporting to agricultural and biofuel policies that distort the European Union. The financial viability of such markets for biofuels could prolong and even trade obviously depends on political decisions worsen those distortions, as additional markets in the countries providing large subsidies. The for subsidized agricultural outputs and biofuels sustainability of such trade is uncertain. would be created. The three sets of policies listed In general, lowering trade barriers increases on the previous page are closely interwoven, and global welfare in the long run. Biofuel trade is the theory of second best (Lipsey and Lancaster no exception. Reducing border barriers to biofuel 1956­57) suggests that it would not necessarily trade would increase competition, which should improve overall welfare to address biofuel in turn help improve efficiency, bring down costs, trade separately from other distortions affecting and enable the world's most efficient producers biofuels and biofuel feedstocks. to expand their market share. As the study on The general conclusion that emerges from U.S.-Brazil ethanol trade cited in chapter 3 the body of literature currently in existence on shows, removal of high tariffs would bring down agricultural and biofuels policies is that trade prices in highly protected markets and increase liberalization for biofuels should ideally be consumption. considered part of the broader set of issues in There is an important difference between the Doha Round of trade negotiations. To do ethanol and biodiesel trade. Quality and quality otherwise would benefit consumers in highly consistency are far more likely to be an issue protected countries and some interests (for with biodiesel than with ethanol. It may make example, ethanol and feedstock producers in more sense for Europe, for example, to import Brazil and Pakistan, and those countries where biodiesel feedstocks than biodiesel. Removal by certain commodity prices switch from being major oilseed producers of differentiated export export parity to import parity as a result), but taxes that are currently in favor of biodiesel may would not necessarily move the world closer increase feedstock trade, provided that there are to resolution of broader issues affecting the no barriers in importing countries. Ethanol, on biofuel market. On the other hand, reform the other hand, is more likely to be exported as must start somewhere--even if in piecemeal a finished product, but it encounters high border fashion--if a program of reform is ultimately tariffs in major potential importers. Sugarcane to be achieved. Beginning the overall trade degrades rapidly and is clearly unsuited for liberalization process with ethanol and biodiesel export. In some circumstances, it might make presents the advantage of forcing governments more economic sense to import grains and to address openly the question (and the costs) of process them into ethanol near consumption what objectives their biofuel support policies are centers. actually pursuing. appendix a. Issues in agriculture and environment under the wTO The Agreement on Agriculture was negotiated access restrictions and touch upon all measures during the Uruguay Round of the General affecting trade in agriculture, including domestic Agreement on Tariffs and Trade and entered agricultural policies and the subsidization into force with the establishment of the World of agricultural exports. The Agreement on Trade Organization on January 1, 1995. Agriculture is especially relevant for ethanol, Its implementation period was six years for which is currently classified as an agricultural developed countries.1 Developing countries good under the WCO's Harmonized Commodity were given the flexibility to implement their Description and Coding System. reductions in trade restrictions and other specific commitments over a period of up to 10 years. Three Pillars in the agreement on Least-developed countries were effectively agriculture exempted from subsidy and tariff reductions. The agreement did not achieve the reforms hoped for, The Agreement on Agriculture has three main and the launch of the Doha Round in November areas for negotiation: reducing domestic 2001 was seen as an opportunity to strengthen support, increasing market access, and reducing the disciplines of the Agreement on Agriculture export subsidies. and focus on issues of importance to developing countries under the Doha Development Agenda. Domestic Support Unfortunately, the Doha Round has encountered the same opposition to reforms in agriculture The first pillar aims to reduce domestic subsidies. as the Uruguay Round. WTO Director General The subsidies are divided into three categories or Pascal Lamy suspended the Doha WTO "boxes." negotiations in July 2006 when they failed to reach agreement on the issues of domestic · The amber box contains domestic subsidies support and market access for agriculture. that are deemed to distort trade and that governments have agreed to reduce but The agreement's long-term objective is "to not eliminate. The reductions are based on establish a fair and market-oriented agricultural a formula called the Aggregate Measure trading system." The agreement recognizes that of Support, accompanied by a minimum reform agreements must look beyond import threshold below which spending on domestic 1There are no WTO definitions of developed and developing countries. Members identify themselves as developed or developing, although the decision of a member to make use of provisions for developing countries can be challenged. The WTO uses the same classification as the United Nations for least-developed countries, characterized by low income, weak human assets, and economic vulnerability. Special Report Considering Trade Policies for liquid biofuels subsidies does not need to be included in the Export Subsidies support calculations. With more than half the world total, the European Union provides The Agreement on Agriculture required the largest amount of amber box support as developed countries to reduce export subsidies measured by dollar value, with the United by at least 35 percent by value or 21 percent by States a distant second and Japan a distant volume over five years to 2000. The European third (CBO 2005). Union is by far the dominant provider of export · The blue box contains subsidies that can be subsidies, providing 85 to 90 percent of the increased without limit, provided payments world's total (CBO 2005). are linked to production-limiting programs. The level of payment is based on fixed areas Other Provisions and yields, or per head of livestock. Very few Several provisions permit greater protection developing countries have programs that can of certain commodities or by certain countries be classified under the blue box category. under the agreement. They include special · Green box policies are those that are and differential treatment, special products, expected to have a minimal or no impact and sensitive products. No products have been on trade and are not subject to annual explicitly classified as sensitive or special to date, limits. Green box payments include those for but these classifications are due to be made environmental programs, pest and disease once decisions on modalities are finalized. control, infrastructure development, domestic Negotiations have included how many tariff lines food aid (purchased at market prices), and developed countries will be allowed to categorize income insurance and emergency programs; as sensitive and their treatment, including tariff along with direct payments to producers, reductions and tariff quota expansions. provided they are decoupled from current production levels. The bulk of domestic Special and differential treatment allows exports support provided by the United States and from developing countries to receive preferential Japan falls into the green box (CBO 2005). access to developed markets without having to accord the same treatment in their domestic It is not clear whether subsidies for biofuel markets. It recognizes that developing countries feedstock production (or biofuel production itself face greater difficulties in world trade, and thus if farmers can be shown to benefit directly from should be granted greater flexibility in moving the subsidies, and for ethanol if WTO members toward a market-based system. Numerous notify subsidies for ethanol as agricultural developing countries enjoy preferential access to subsidies) can be classified as green box policies. the European Union for ethanol and sugar. Market Access Special products can be claimed by developing countries only. This mechanism was created to Market access refers to the reduction of tariff protect and promote food production, livelihood and nontariff barriers to trade. Least-developed security, and rural development. Developing countries were exempted from tariff reductions, countries can designate a certain number but either had to convert nontariff barriers to of products that would be exempt from tariff tariffs ("tarification") or create a ceiling for their reduction requirements and other disciplines. tariffs that could not be increased. Ethanol tends to encounter much greater tariff barriers than Sensitive products can be claimed by developed biodiesel. countries to continue protection of particular appendix a. Issues in agriculture and environment under wTO agricultural products for political, social, or industrial goods (such as pollution-reduction cultural reasons. Sensitive products receive equipment) could. Those wishing to protect less rigorous disciplines in relation to tariff and domestic ethanol producers against cheaper domestic support reductions. In exchange, tariff imports would argue against classifying ethanol rate quotas on the products are expanded. as an environmental good, while those who The European Union is currently asking for stand to benefit from liberalized trade would 8 percent of product lines to be deemed sensitive argue the reverse. and given special levels of protection, against 1 percent proposed by the United States. Although the WTO has not formulated a Declaring ethanol a sensitive product would definition, other international organizations enable a country to protect its domestic ethanol have proposed definitions for the environmental industry longer. industry. The United Nations Conference on Trade and Development defined environmentally environmental goods and Services preferable products as those that The Doha Ministerial Declaration of 2001 cause significantly less environmental harm specifically referred to environmental goods at some stage of their life cycle (production/ processing, consumption, waste disposal) and services as an area that could be targeted than alternative products that serve the same for faster liberalization. WTO members agreed purposes, or products the production and to negotiate "the reduction or, as appropriate, sale of which contribute significantly to the elimination of tariff and non-tariff barriers to preservation of the environment (UNCTAD environmental goods and services" with a view 1995). to enhancing the mutual supportiveness of trade and environment (WTO 2006, paragraph 31 An informal working group meeting under the [iii]). The declaration did not attempt to define auspices of the OECD and the Statistical Office what constitutes environmental goods and of the European Communities defined the services; there is, as yet, no agreed definition for environmental goods and services industry as these nor agreed criteria for their classification. consisting of activities that "include those that Negotiations on environmental goods have measure, prevent, limit, minimize or correct been assigned to the Non-Agricultural Market environmental damage to water, air and soil, Access Negotiating Group, which could be as well as problems related to waste, noise interpreted to mean that environmental goods and ecosystems" (OECD/Eurostat 1999). These are non-agricultural products. Negotiations definitions have been referred to in the WTO on environmental services have been assigned negotiations. to the Committee on Trade and Environment meeting in special sessions. This committee is the There is less common understanding of main body where debate relevant to the present environmental goods than environmental discussion occurs. services. OECD and the Asia-Pacific Economic Cooperation (APEC) independently developed It is not clear whether agricultural goods could lists of environmental goods.2 Their objectives qualify as environmental goods, or whether only and procedures for generating the lists were 2 APEC members are Australia, Canada, Chile, China, Indonesia, Japan, the Republic of Korea, Malaysia, Mexico, New Zealand, Peru, the Philippines, Russia, Thailand, the United States, and Vietnam. Special Report Considering Trade Policies for liquid biofuels different. OECD's list was intended to be an environmentally sustainable manner seems illustrative; APEC's aim was to obtain more consistent with the spirit of the Doha Ministerial favorable tariff treatment for environmental Declaration, whereby increased trade resulting goods. Consequently, the APEC list was from liberalization is expected to promote confined primarily to goods that could be both environmental protection and economic readily distinguished by customs agents and development (paragraph 31). It is also consistent treated differently for tariff purposes. APEC's list with the definition of environmentally preferable focuses more on end-of-pipe pollution control products. However, such a distinction would and monitoring equipment. These differences make administration more complex. notwithstanding, the two lists have helped frame WTO negotiations. On the basis of three broad A related question is whether ethanol for fuel categories used by OECD for its list--pollution use should be classified as a non-agricultural management, resources management, and product. Under the Doha Ministerial Declaration, cleaner technologies and products--the lists WTO members agree to the following regarding contain a large number of goods under pollution market access for non-agricultural products: management, and some under resources management including renewable energy. The negotiations which shall aim, by modalities items on OECD's list under cleaner technologies to be agreed, to reduce or as appropriate and products do not appear on APEC's list. eliminate tariffs, including the reduction or elimination of tariff peaks, high tariffs, and Under renewable energy, OECD's list, but not tariff escalation, as well as non-tariff barriers, APEC's, includes ethanol. Neither list contains in particular on products of export interest to biodiesel (Steenblick 2005a). developing countries. Product coverage shall be comprehensive and without a priori exclusions. Discussions on definition and classification The negotiations shall take fully into account the of environmental goods stalled long before special needs and interests of developing and the suspension of WTO negotiations in July least-developed country participants, including 2006. Developing countries are concerned that through less than full reciprocity in reduction negotiations have focused on high-technology commitments (WTO 2006, paragraph 16). products of little export interest to them. At a special negotiating session of the WTO Biofuels are likely to be products of export Committee on Trade and Environment in July interest to developing countries. 2005, Brazil proposed classifying ethanol and biodiesel--as well as flex-fuel engines and There are no large tariff barriers in major vehicles--as environmental goods. Previously, current and future biodiesel consumers and both Canada and New Zealand had submitted potential importers. As an industrial good, the lists of proposed environmental goods that tariffs that do apply to biodiesel may be tackled included biodiesel. under paragraph 16 of the Doha Ministerial Declaration. Some countries are also proposing Another issue is whether distinctions should be to classify biodiesel as an environmental good made on the basis of process and production with a (long-term) objective of accelerating tariff methods. Requiring that a good be produced in reduction and elimination further. appendix b. eU and U.S. agricultural Policies Some of the first policies to protect agricultural 30 members spent on domestic agriculture in producers were introduced in Europe in the 2005 was essentially unchanged from 2004 1800s, when, for example, sugar beet producers at US$280 billion. Subsidies accounted for in Europe could not compete with lower cost close to one-third of farm incomes. EU aid to sugar produced from cane outside of Europe. its farmers fell marginally from US$136 billion This led to high import duties on cane sugar to US$134 billion, while Japanese farmers from the Caribbean. Opposition to high remained among the most protected. The protection dates back several centuries, and the producer support estimate--which measures English economist David Ricardo was one of the the cost to taxpayers of subsidies and that to first to argue against Britain's early 19th century consumers of tariff barriers--was 32 percent in agricultural protection, the so-called Corn Laws, the European Union and 56 percent in Japan. which imposed high duties on wheat imports The US$43 billion support given by the U.S. (Ricardo 1817). Since then, many countries have government represented 16 percent of receipts. bowed to political pressure from farm groups or concerns over food security and provided direct The two most important economies that have or indirect support to domestic producers and historically restricted biofuel trade to protect protection from lower cost foreign producers. domestic farmers are the European Union and Often this support was intended as a temporary the United States. Their agricultural policies are measure, but became permanent when prices described in this appendix. remained low for a sustained period of time. There are many different ways policies can be european Union used to protect agricultural producers, as evident from the policies overviewed in this section. The European Union's Common Agricultural Policy dates to 1958.1 The stated objectives of OECD countries provide significant protection the CAP are to increase agricultural productivity, to domestic farmers in the form of high import ensure a fair standard of living for farmers, tariffs and subsidies. The most recent figures stabilize markets, guarantee regular food from the OECD show that the amount its supplies, and ensure reasonable prices to 1 The CAP was agreed to at the Stresa conference in July 1958 for the then six members of the European Economic Community. The CAP established a common pricing system for all farmers in the European Economic Community, and it fixed agricultural prices above world market levels to protect farmers in member countries, which generally had higher production costs than other world market producers. Commodities covered by the CAP included cereals, beef, butter and skimmed milk powder, fruits and vegetables, and olive oil. Sugar was included in 1968, and the EU sugar policy remained largely unchanged until major reforms were agreed to in November 2005. Special Report Considering Trade Policies for liquid biofuels consumers. Domestic price supports are the new support price cuts. Agenda 2000 set the base historical backbone of CAP farm support, rate for the required set-aside for arable crops at although price support has become less 10 percent. Producers with an area planted with important for maintaining grain and beef these crops sufficient to produce no more than 92 farmers' incomes under the CAP reforms. tonnes of grain are classified as small producers High domestic prices were maintained by price and are exempt from the set-aside requirement. intervention and high external tariffs, whereby Supply control quotas have been in effect for the authorities buy surplus supplies of products dairy and sugar sectors for nearly two decades. when market prices threaten to fall below agreed intervention (minimum) prices. High The most recent reforms began as a mid-term tariffs limit imports of most price-supported review of Agenda 2000 and resulted in a third commodities and allow the high internal market major set of reforms in June 2003 and April price set by EU authorities to be maintained. 2004. These latest reforms represent a degree of Farmers are guaranteed intervention prices for renationalization of farm policy, as each member eligible agricultural products. This means that state will have discretion over the timing and EU authorities will purchase, at the intervention method of implementation. The 2003 reforms price, unlimited excess products that meet allow for decoupled payments--payments that minimum quality requirements and that cannot do not affect production decisions--that vary be sold on the market. The surplus commodities by commodity. Called single farm payments, are then put into EU storage facilities or exported these decoupled payments are based on with subsidy. While less important from a budget 2000­02 historical payments and replace the perspective, exports of processed products that compensation payments begun by the 1992 contain a portion of a CAP-supported commodity reform. When member states implement the also receive an export subsidy, based on the reforms, compliance with EU regulations proportion of the commodity in the product and regarding environment, animal welfare, the difference between the intervention price and food quality and safety will be required and the world price. Other mechanisms, such as to receive single farm payments. Moreover, consumer subsidies paid to encourage domestic land not farmed must be maintained in good consumption of such products as butter and agricultural condition. Coupled payments, which skimmed milk powder, also support domestic can differ by commodity and require planting prices. a crop, are allowed to continue to reinforce environmental and economic goals in marginal Reforms of the CAP began in 1992, when supply areas. The CAP budget ceiling has been fixed controls were instituted through a mandatory, from 2006 to 2013, and--if market support paid, set-aside program to limit production. and direct payments combine to come within These supply controls have been maintained 300 million (US$405 million) of the budget through subsequent reforms. To be eligible for ceiling--single farm payments will be reduced to direct payments, producers of grains, oilseeds, stay within budget limits. or protein crops must remove a specified percentage of their area from production. The 2003 reforms cut storage subsidies by 50 percent. Reforms have lowered the cost of the The second reform, Agenda 2000, began CAP to consumers, as intervention prices have preparation for EU enlargement, and, like been reduced. However, taxpayers now bear a the first CAP reform, used direct payments to larger share of the cost because more support is compensate farmers for half of the loss from provided through direct payments. 0 appendix b. eU and U.S. agricultural Policies Price supports remain a principal means of from production in order to receive direct maintaining farm income. Compensation (coupled) payments in compensation for reduced payments for price cuts generated by the 1992 price supports. The 2003 reforms required a reform began in 1994 and were increased decoupled payment of at least 75 percent for for the price cuts of the Agenda 2000 reform. arable crops. Since receipt of a decoupled These compensation payments were established payment does not require a crop to be planted on a historical-yield basis for arable crops by or produced, farmers are free to plant whatever farm, and farmers had to plant to receive the crop they want or to not plant at all. Durum payment. In contrast, the payments specified in wheat was allowed a 40 percent coupled the 2003 reform will be made to farmers based payment in traditional areas, while support for on the average level of payments made during durum in nontraditional areas was abolished. 2000­02 and no production is required. Direct In addition, storage payments for grains were payments currently account for about 35 percent cut by 50 percent. Nevertheless, most EU grain of EU producer receipts and for an even higher prices will likely remain above world prices most percentage of net farmer income once input of the time, requiring export subsidies to remain costs are subtracted from receipts. competitive on the world market (USDA 2006c). In preferential trade agreements, such as those United States with former colonies and neighboring countries, the European Union satisfies consumer demand U.S. government support to commodity while protecting high domestic prices through producers is provided under farm legislation, import quotas and minimum import price which typically extends for five years. The most requirements. The CAP also applies tariffs at recent of these farm bills was the Farm Security EU borders so that imports cannot be sold and Rural Investment Act of 2002, which is domestically below the internal market prices scheduled to expire in 2007. The act provides set by the CAP. Although the Uruguay Round direct government income support to eligible Agreement on Agriculture called for more commodity producers, mainly through three access to the EU market, market access to the programs: direct payments, counter-cyclical European Union's agricultural sector remains payments, and the marketing loan program. highly restricted. In addition, the European In addition, subsidized crop and revenue Union subsidizes agricultural exports to make insurance is provided to assist farmers with domestic agricultural products competitive in risk management. Commodity producers also world markets. receive benefits from government programs promoting trade liberalization and food aid. The CAP regime covers most grain produced Specific programs apply to individual crops. by and imported into EU countries (bread wheat, barley, and maize). However, high Direct payments are fixed payments made prices for some grains indirectly raise the annually to farmers who participate in the prices of unsupported grains, principally program. Decoupled from production, these feed wheat. As with other commodities, grain payments are made regardless of the level of support mechanisms include a mixture of price production or which of the eligible crops (maize, supports and supply controls, as described soybeans, other oilseeds, sorghum, barley, oats, above. CAP reforms have affected the grain wheat, upland cotton, rice, peanuts) are grown. regime mainly by requiring grain farmers to The direct payment is calculated by multiplying remove a percentage of their arable cropland the commodity payment rate by the farm's Special Report Considering Trade Policies for liquid biofuels payment yield and 85 percent of the farm's base Commodity producers can also purchase acres. The maize payment rate is US$0.28 per subsidized crop or revenue insurance to manage bushel (US$11 per tonne). Payment yields are these risks, and USDA's Risk Management based on historical farm maize yields, and base Agency pays a portion of contract premiums acres depend on historical farm plantings. for producers' insurance policies and some of the delivery and administrative costs of private Counter-cyclical payments are available to insurance companies that sell these policies. In farmers whenever the effective price of maize 2001, 74 percent of maize-planted areas were is lower than the target price of US$2.60 per covered by crop or revenue insurance. bushel (US$102 per tonne). The effective price is the sum of the direct payment rate and the The USDA's Foreign Agricultural Service larger of the national average farm price or promotes exports of U.S. feed grains under the national average loan rate. The difference the Export Credit Guarantee Program and the between the effective and target price is the Intermediate Export Credit Guarantee Program. counter-cyclical payment rate paid on a farm's These programs are used to underwrite credit base acres and payment yields. Counter- extended by U.S. banks to approved foreign cyclical payments are made to eligible farmers banks to pay for food and agricultural products regardless of the level of production or which sold to foreign buyers. The credit programs crops are grown on the farm. A farm's payments provide assurance to U.S. exporters that they will are equal to the product of the counter-cyclical be paid. In addition, as part of U.S. food-aid payment rate, the payment yield, and 85 percent programs, the USDA provides low-interest loans of the farmer's base acres. to qualified developing countries purchasing U.S. commodities. The marketing assistance loan program provides nonrecourse loans (loans that limit the lender's Finally, under the 2002 Farm Act, producers rights to the asset financed) to eligible producers, can choose from a wide range of voluntary with the farm's program crop used as collateral. conservation and environmental programs The marketing loan for maize is US$1.98 per designed to protect multiple resources. bushel (US$77 per tonne), and producers may Land retirement programs--including the settle the loan either by forfeiting the collateral Conservation Reserve Program, Conservation to the Commodity Credit Corporation at Reserve Enhancement Program, Wetland Pilot maturity with no penalty or by repaying the loan. Program, and Wetlands Reserve Program-- Producers may forgo taking out a loan and remove land from production. Working lands instead receive a loan deficiency payment equal programs, such as the Environmental Quality to the difference between the posted county price Incentives Program and the new Conservation and local loan rate on the quantity eligible for Security Program, provide assistance on lands in loan. production (USDA 2002). appendix C. biofuel Policies in Different Countries Biofuels are protected by a complex web of received state aid approval for ethanol; France subsidies. This appendix gives more details and Hungary have received state aid approval on biofuel policies in the European Union and for ethyl tertiary-butyl ether; Austria, Belgium, the the United States. A significant portion of the Czech Republic, Denmark, Estonia, Germany, materials on the European Union is drawn from Hungary, Ireland, Italy, Lithuania, and the United Kutas and Lindberg (forthcoming). The appendix Kingdom have received state aid approval for also provides information on biofuel policies in biodiesel; Austria, Belgium, Estonia, Germany, Argentina, Australia, Canada, China, Colombia, Ireland, and Lithuania have received state aid Indonesia, Japan, and Thailand. approval for vegetable oils; and Sweden has received state aid approval for all so-called european Union CO2-neutral fuels. The European Union produced 3.2 million Set-aside land accounts for about 10 percent of tonnes of biodiesel in 2005 (EBB 2007a), total EU farmland. In 2005, of the 7.0 million mostly from rapeseed oil. The European Union hectares of set-aside land, 836,000 were produced approximately 1.6 billion liters of planted with feedstocks for biofuels. Farmers are bioethanol in 2006, representing an increase of compensated for setting aside land. Set-aside 71 percent from the previous year (Ebio 2007). land planted with energy crops is not eligible for Countries producing 500,000 tonnes or more of the 45 (US$61) per hectare payment under biodiesel in 2006 were Germany, France, and the Energy Crop Scheme introduced in 2003. Italy;1 those producing 200 million liters or more However, sugar beets grown as a nonfood crop of bioethanol in 2006 were Germany, Spain, qualify for set-aside payments and energy crop and France. aid, and are exempted from production quotas. As described in chapter 3, article 16 of the Several countries have mandatory blending Energy Tax Directive permits member states requirements. In Austria, beginning in October to exempt or reduce excise taxes on biofuels. 2005, those who enter the gasoline and Austria, Belgium, Denmark, Estonia, Germany, diesel fuel market for the first time must have Ireland, Italy, Lithuania, and the United Kingdom 2.5 percent biofuel, calculated on the basis have notified the European Commission and of energy content. This percentage will rise to 1Aggregate EU biodiesel production in 2006 is not given here because different sources give different estimates, and the production figures from the European Biodiesel Board, which is the primary source of EU data for this report, were not available at the time of publication. Special Report Considering Trade Policies for liquid biofuels 4.3 percent in October 2007 and 5.75 percent made from wheat and sugar beets, has in October 2008. A description of biofuel historically been converted to ETBE before being policies in the top three biodiesel and bioethanol blended into gasoline. The country's biofuel producers (Germany, France, Spain, and Italy) industry was aided by the Biofuel Production as well as Sweden--which in 2004 exceeded the Program, which has in the past provided capital biofuel consumption target set by the EU Biofuels grants. Fuel excise taxes are reduced by 0.33 Directive for 2005--is given next. (US$0.45) per liter for ethanol in ETBE or blended into gasoline and by 0.25 (US$0.34) Germany has historically provided generous per liter for biodiesel (USDA 2006j). These tax fuel excise tax concessions with no quantitative reductions are not automatically granted. Each restrictions. Full excise tax exemption has been year, the government establishes a quota for the granted to biofuels and heating oils produced maximum volume of biofuels that are given the from biomass, whether sold pure or blended. tax relief. This annual adjustment is intended Historical tax exemptions have amounted to to take into account varying production costs 0.4704 (US$0.64) per liter of biodiesel and and petroleum fuel prices, and to avoid possible vegetable oil, and 0.6545 (US$0.88) per liter overcompensation. A public tender system is used of ethanol and ETBE. The exemption must be to allocate eligible biofuel production quantities adjusted if overcompensation is established. In to production units approved by the government. August 2006, in response to falling world crude Production quotas will rise sharply in the coming oil prices, the government introduced a fuel excise years, doubling for biodiesel between 2006 and tax of 0.09 (US$0.12) per liter of biodiesel 2007 and doubling again between 2007 and and straight vegetable oil for automotive use. 2009, and tripling for ethanol between 2006 and Capital grants are also given for bioenergy. The 2008. The government also imposes a tax on government also funds R&D projects. Germany fuel distributors failing to meet a biofuel blending has maintained an end-user price advantage for rate, set at 1.75 percent in 2006, 3.5 percent biodiesel over petroleum diesel through combined in 2007, 3.5 percent in 2008, 6.25 percent in exemption of fuel excise tax and ecological tax, 2009, and 7 percent in 2010 (USDA 2007n). No which is 0.10 (US$0.14) per liter. capital grant programs appear to be in place at In October 2006, Germany issued new present. The government funds R&D for biofuels. legislation requiring mandatory blending of France has just set a target of 15 percent for the biodiesel and bioethanol and gradually phasing percentage of state-purchased flex-fuel vehicles out fuel tax reductions beginning in 2007. There in 2007, doubling to 30 percent in 2008. The are penalties for failing to meet the blending country also plans to install 500 E85 pumps targets, which are set at 4.4 percent for biodiesel by September (Dow Jones International News and 1.2 percent for ethanol in 2007 and rise 2007b). over the coming years. By 2011, both biodiesel Italy was the third largest biodiesel producer and straight vegetable oil will be taxed at in the European Union in 2006, but it 0.323 (US$0.44) per liter; in 2012, the tax manufactures biodiesel mainly from imported rate will rise to 0.449 (US$0.61). Biogas and vegetable oils. Italy grants tax exemption to liquid biofuels produced using biomass-to-liquid biodiesel but limits the quantity of biodiesel technologies will continue to enjoy 100 percent that enjoys the exemption. The annual tax exemption until 2015. quota was increased from 125,000 tonnes France is a major producer within the European to 300,000 tonnes in 2002, but reduced to Union of both biodiesel and ethanol. Ethanol, 200,000 tonnes in 2005. The exemption appendix C. biofuel Policies in Different Countries amounts to 0.413 (US$0.56) per liter, subject available only for ethanol imported under the to adjustment for overcompensation. Italy was higher EU duty of 0.192 (US$0.26) a liter also the fifth largest producer of ethanol in (USDA 2006g). This policy change was largely the European Union in 2006. According to responsible for Brazilian ethanol imports into the the government, the reduction in the quota of European Union falling from about 300 million biodiesel eligible for fuel tax exemption was liters in 2005 to 233 million liters in 2006 (Dow to permit tax relief for ethanol which, unlike Jones International News 2007b). biodiesel, might use domestic feedstocks. In 2005, ethanol and ETBE were given a fuel Swedish excise duties consist of an energy tax excise tax reduction of 0.26 (US$0.35) and and a CO2 tax. Once a fuel is deemed by the 0.25427 (US$0.34) per liter, respectively. authorities to be CO2-neutral, the CO2 tax is waived. Biofuels have been classified as Spain was the European Union's second largest CO2-neutral, and all biofuels, domestic and producer of ethanol in 2006; this was made imported, are eligible for exemption from the from wheat and barley. As in France, most of CO2 tax. The exemption applies until the end of its ethanol is converted to ETBE. Full excise tax 2007, subject to adjustment if overcompensation exemption is granted for biofuels until the end is established. The CO2 tax is set at SKr 1.46 of 2012, amounting to 0.42 (US$0.57) per (US$0.21) per liter for gasoline and SKr 1.80 liter for ethanol and 0.29 (US$0.39) per liter (US$0.26) per liter for diesel. In 2004, the for biodiesel. The government has provided government introduced a five-year program other forms of assistance, although apparently whereby CO2-neutral fuels are exempt from both in limited amounts: capital grants, a reduction CO2 and energy taxes. This tax measure, which of 0.5 percent in the interest rate for eligible was approved by the European Commission in projects, and a tax deduction for investments in March 2006, will increase the tax exemption tangible fixed assets that would use renewable to SKr 4.62 (US$0.68) per liter of ethanol sources. and SKr 3.12 (US$0.46) per liter of biodiesel. Full tax exemption has historically been given Sweden is a large importer of ethanol in addition to biofuels produced in pilot plants. Because to being the fourth largest EU ethanol producer ethanol technologies are considered sufficiently in 2006. It has limited biodiesel production. In commercially proven, any ethanol pilot projects 2004, biofuel use averaged 2.3 percent of all must first be approved by the European transportation fuel consumption, thus exceeding Commission to be eligible for the tax exemption. the 2 percent target set in the Biofuels Directive There appear to be no capital grants provided for end 2005. In 2005, Sweden was the only for biofuel manufacturing plants. Some funding country in which direct gasoline-ethanol blends has been provided for R&D. were produced and where ethanol consumption exceeded domestic ethanol production. Ethanol The EU Strategy for Biofuels imported from Brazil accounted for 70 percent of total consumption in 2005, imported blended "An EU Strategy for Biofuels," issued in February with 20 percent gasoline under an "other 2006, sets out a strategic approach to support chemicals" tariff line and subject to a markedly market growth of both first and second lower tariff rate. Ethanol imported under the generation biofuels. The latter include lingo- "other chemicals" tariff code could also benefit cellulosic processing and conversion of biomass from Swedish tax relief for biofuels, as described to liquid dimethyl ether and Fischer-Tropsch below. In January 2006, tax relief was made biodiesel. The strategy acknowledges both the Special Report Considering Trade Policies for liquid biofuels comparative advantage of developing countries programs that are environmentally and in the production of biofuels and environmental economically sustainable and social concerns in the event of large-scale · Supporting R&D expansion of feedstock production. The latter include pressures on eco-sensitive areas such as Biofuel Import Tariffs rain forests (for palm plantation, for example); effects on soil fertility, water availability and Biodiesel imports into the European Union are quality, and pesticide use; potential dislocation subject to an ad valorem duty of 6.5 percent. of communities; and competition between An import duty of 0.192 (US$0.26) per biofuel and food production. The strategy liter is levied on undenatured ethanol, and presents seven policy axes, as follows: 0.102 (US$0.14) per liter on denatured ethanol. Between 2002 and 2004, 93 percent of · Stimulating demand for biofuels through ethanol imported into the European Union was national targets, favorable treatment to undenatured. In 2004, 55 percent of the ethanol second generation biofuels, and promotion imported was free of import duties. Until recently, of public procurement of vehicles using high Pakistan was the largest duty-free exporter. blends of biofuels Pakistan lost its duty-free status in 2005, however, · Capturing environmental benefits including and is now subject to full import duties. Brazil GHG emission reduction and ensuring exported even greater amounts to the European sustainable cultivation of biofuel feedstocks Union as a most favored nation exporter with no · Developing the production and distribution of duty exemptions or reductions. Three categories biofuels by considering biofuels in national of countries and Egypt and Norway enjoy an plans for rural development and ensuring no unlimited duty-free status with respect to ethanol. discrimination against biofuels · Expanding feedstock supplies through · The Generalized System of Preferences Plus incentive schemes, information campaigns (GSP+) incentive scheme covers Bolivia, for farmers and forest holders, studying Colombia, Costa Rica, Ecuador, El Salvador, legislation revision to facilitate authorization Georgia, Guatemala, Honduras, Moldova, and approval processes for biofuel Mongolia, Panama, Peru, Sri Lanka, and production, and monitoring the impact of Venezuela, and grants them unlimited biofuel demand on commodity and by- and duty-free access for denatured and product prices undenatured ethanol. The scheme is in effect · Enhancing trade opportunities through from January 1, 2006, to December 31, assessing advantages, disadvantages, and 2008. legal implications of proposing separate · The Everything-But-Arms initiative covers nomenclature codes for biofuels; not 50 developing countries and grants worsening market access conditions for unlimited duty-free access to denatured and imported bioethanol; and pursuing a undenatured ethanol. balanced approach · Under the Cotonou Agreement, all 79 · Supporting developing countries by ensuring African, Caribbean, and Pacific countries that support for the countries affected by the qualify for unlimited duty-free access for EU sugar reform can help develop bioethanol denatured and undenatured ethanol with production, developing a coherent biofuels the sole exception of South Africa. These assistance package, and examining how countries include all the EBA countries in best to assist in the development of biofuel Africa, the Caribbean, and the Pacific. appendix C. biofuel Policies in Different Countries · Egypt has unlimited duty-free access under with a combined annual capacity of 3.3 billion the Euro-Mediterranean Agreement, and liters. Seventy-seven companies reported plants Norway has been granted duty-free access under construction that were scheduled to come under the system of tariff rate quotas. on stream within 18 months with a combined additional annual capacity of 6.4 billion liters In 2004, 45 percent of ethanol imported into (NBB 2007). the European Union was from GSP+ countries. Full import duties were levied on 36 percent Much of the growth in the production of ethanol of the total imports. Despite import duty from maize is due to government incentive concessions, African, Caribbean, and Pacific programs, beginning with the Energy Tax Act and EBA countries combined accounted for a of 1978. This act defined gasohol as a blend mere 5.6 percent. If successfully completed, the of gasoline with at least 10 percent alcohol ongoing negotiations on a free trade agreement by volume, excluding alcohol made from between the European Union and Mercosur petroleum, natural gas, or coal. A federal (Argentina, Brazil, Paraguay, and Uruguay) could excise tax exemption on gasohol equivalent have a significant impact on ethanol imports to US$0.40 per gallon (US$0.11 per liter) of from Brazil to Europe. ethanol blended was granted. This reduced the United States cost of ethanol to about the wholesale price of gasoline. The tax exemption was a credit Total production of fuel ethanol in the United that fuel blenders received for using ethanol States in 2006 was 18.4 billion liters. In the in gasoline. Federal excise tax exemption was absence of mandates (until recently), U.S. supplemented by state tax incentives to ethanol ethanol production has historically been producers. The tax exemption rose as high as responsive to feedstock prices, such as when US$0.60 per gallon (US$0.159 per liter) in the ethanol production plummeted in mid-1996 in Tax Reform Act of 1984 before gradually falling response to peak maize prices. As of May 2007, to US$0.51 per gallon (US$0.135 per liter) by there were 118 ethanol plants in the United 2005. States, with a combined total annual capacity of 23 billion liters, up from 16.4 billion liters in Beginning in January 2005, the volumetric January 2006. Another 24 billion liters worth ethanol excise tax credit in the American Jobs of annual capacity was being added through Creation Act of 2004 has extended the ethanol plant construction and expansion. Of the existing tax incentive through December 31, 2010, at a plant capacity, 34 percent is farm owned; of the rate of US$0.51 per gallon (US$0.135 per liter) new planned capacity, only 12 percent will be of ethanol blended. This tax credit is allowed farm owned (RFA 2007). This reversion to the on all bioethanol (and biomethanol) in ETBE ownership patterns of the 1980s for processing or any other ether, or blended with gasoline or capacity has the potential to transfer some of diesel, thus removing earlier restrictions on the the benefits of biofuel promotion policies from percentages of ethanol that could be blended farmers to monopsonistic industrial interests, into gasoline (U.S. Congress 2004). The tax and to add new political dimensions to biofuel incentive does not recognize point of origin. policy making in the United States. U.S. To address concerns over Highway Trust Fund biodiesel production tripled to 75 million gallons revenue losses, the American Jobs Creation Act (284 million liters) in 2005. As of January 2007, of 2004 replaced the excise tax exemption with there were 105 biodiesel production plants an income tax credit. Special Report Considering Trade Policies for liquid biofuels The act also provided a federal excise tax credit provided a boost to the maize-ethanol industry. to biodiesel blenders: US$1.00 per gallon The two principal oxygenated fuels used to (US$0.26 per liter) of biodiesel made from meet the oxygenate mandate were ethanol agricultural products and US$0.50 per gallon and methyl tertiary-butyl ether (MTBE), with (US$0.13 per liter) of biodiesel made from ethanol used primarily in the maize-growing other feedstocks such as recycled oils. The tax Midwest and MTBE elsewhere. Concerns incentive was in effect between January 2005 about groundwater contamination with MTBE and December 2006 (U.S. Congress 2004). This have led a growing number of states to ban tax credit is largely responsible for the surge in its future use. Elimination of the oxygenate the production of biodiesel and in the growth of mandate means that MTBE does not have to production capacity. be replaced by ethanol. In summer 2006, most oil companies decided to phase out The Energy Policy Act of 2005 contained a MTBE altogether, creating a severe shortage of Renewable Fuels Standard requiring that a ethanol; industry analysts regard this as a one- minimum of 7.5 billion gallons (28 billion time adjustment. liters) of renewable fuels be used annually in gasoline by 2012. The act created programs In 2000, the USDA initiated the Bioenergy and incentives to encourage the production Program, administered by the Commodity of cellulosic biofuels and fund research on Credit Corporation, to address crop surpluses conversion technology. To meet the Renewable and stimulate biofuel production. The program Fuels Standard, the act counts every gallon of paid U.S. producers of ethanol and biodiesel to ethanol derived from nongrain sources (such increase their production from eligible feedstocks as cellulose or waste) as 2.5 gallons (9.5 liters) in one fiscal year compared with the same time of grain-based ethanol. Beginning in 2013, the period in the previous year. The program's goals act requires a minimum of 250 million gallons are aimed at encouraging increased purchases of (about 1 billion liters) of cellulosic biofuels to be eligible feedstocks for the purpose of expanding consumed, and aims to deliver the first 1 billion production of, and to support new production gallons (3.8 billion liters) in annual production capacity for, such bioenergy. Between FY 2003 of cellulosic biofuels by 2015 (U.S. Congress and FY 2006, the program was funded at up 2005). to US$150 million a year. Eligible feedstocks were listed and had to be domestically produced The act eliminated the oxygenate mandate (USDA 2004). The program was discontinued in for reformulated gasoline. This mandate, June 2006. which was provided in the 1990 Clean Air Act Amendments, required wintertime use At the state level, several states have adopted of oxygenated fuels in 39 non-attainment legislation mandating biofuel use, in addition areas for carbon monoxide and year-round to tax incentives. Most of the mandates were use of oxygenates in nine severe ozone non- approved in 2006, some dependent on minimal attainment areas in 1995.2 These measures state production of biofuels. 2The addition of oxygen to gasoline could reduce carbon monoxide and hydrocarbon emissions in old technology vehicles if the engine was tuned with a low air-to-fuel ratio. Gasoline vehicles manufactured in the United States since the early 1990s are equipped with oxygen sensors, which automatically adjust the fuel injection rate to achieve an optimal air-to-fuel ratio, and the environmental benefit of adding oxygenates to gasoline for these vehicles is very small. appendix C. biofuel Policies in Different Countries · Minnesota was the first state to implement · Louisiana approved a bill in June 2006 that an ethanol standard. Since 1997, state law requires gasoline sold in the state to contain has required all gasoline sold within the at least 2 percent ethanol manufactured state to include 10 percent ethanol. Over the from domestically grown feedstock or other 17 years prior to the mandate, the state had biomass materials within six months of forgone US$155 million in revenue because annualized domestic production reaching there was a blender's credit of US$0.40 50 million gallons (189 million liters), and per gallon (US$0.106 per liter) of ethanol similarly requires diesel sold in the state blended. In 2005, new legislation requiring to contain at least 2 percent biodiesel a 20 percent ethanol standard by 2013 was manufactured from domestically grown signed. Through FY 2006, Minnesota has feedstock within six months of annualized reportedly paid US$284 million to ethanol domestic production reaching 10 million production plants in production subsidies. gallons (38 million liters) (Louisiana State Although Minnesota is not the leading Legislature 2006). There are currently no ethanol-producing state, it perhaps leads the ethanol or biodiesel manufacturing plants in nation in subsidies to ethanol (Koplow 2006). Louisiana. In September 2005, it became the first state · Missouri's Renewable Fuel Standard, signed to implement a biodiesel standard, requiring in July 2006, requires gasoline sold in all diesel sold within the state to include the state to contain 10 percent ethanol by 2 percent biodiesel. January 2008 (Missouri General Assembly · In Hawaii, regulations call for at least 2006). 85 percent of gasoline sold in the state to contain 10 percent ethanol beginning in April Several states have also launched initiatives 2006. to increase biofuel production. Pennsylvania · Washington approved legislation in March in May 2006 announced a new initiative to 2006 requiring 2 percent ethanol in gasoline inject 900 million gallons (3.4 billion liters) of and 2 percent biodiesel in diesel, with locally produced biofuel or synthetic fuels into graduated increases in these requirements the state's gasoline and diesel supplies over over future years, provided that certain the next decade. In April 2006, Indiana passed supply and environmental conditions are met the Biofuels Use and Production Credits Bill, (Washington State Legislature 2006). extending tax credits for ethanol and biodiesel · In May 2006, Montana approved a production and offering greater incentives to 10 percent requirement that takes effect companies for production of renewable fuels in when ethanol production in the state reaches the state. In March 2006, Wisconsin issued an 40 million gallons (151 million liters) executive order under which all state agencies (Montana State Legislature 2005). would have to use E10, E85, or biodiesel in their · Iowa in May 2006 approved legislation vehicle fleets as much as possible to cut down requiring that 10 percent of the motor on petroleum-based gasoline by 20 percent fuel sold in the state contain biofuel by by 2010 and by 50 percent by 2015. The 2009, increasing to 25 percent by 2019. order also mandates a reduction in the use Small retailers are given a longer time of petroleum-based diesel fuel by 10 percent period, beginning at 6 percent in 2009 by 2010 and 25 percent by 2015. Earlier, in and reaching 25 percent by 2021 (Iowa October 2005, California passed a law enabling Legislature 2006). public agencies to use vehicles that run on Special Report Considering Trade Policies for liquid biofuels biodiesel and biodiesel blends, and Indiana Costa Rica within the existing CBI quota without in April 2005 approved a bill that required increasing the overall quota size. Other CAFTA renewable fuels, such as gasohol and ethanol, countries retain existing CBI benefits on ethanol. to be used in state-owned vehicles as much as The country-specific shares for Costa Rica and possible. El Salvador have the effect of limiting the overall CBI quota available to other Caribbean and A detailed estimate of aggregate subsidies Central American countries. for biofuels can be found in Koplow (2006). Estimates are given for 2006 and as an argentina annualized value for 2006­12. Support for feedstock producers is prorated based on the In April 2006, the Argentine government passed share of crops used in the biofuels industry. a bill requiring that gasoline and diesel contain Low and high estimates are computed, where 5 percent biofuel by 2010. It also provides fiscal the main difference is primarily the result of the incentives via tax exemption for biofuels and incremental outlay equivalent value of a number other tax incentives. A number of firms--Repsol of important tax breaks. The findings, given YFP, Mitsui Argentina, Terminal Puerto Rosario, in table C.1, show that, in outlay equivalent, Vicentín, Oil Fox, and Cargill--have announced aggregate subsidies are the same order of plans to invest in biofuel plants. magnitude as net-of-tax market prices of gasoline and diesel. Expressed in terms of tonnes Argentina is a leading low-cost producer of of CO2 equivalent saved, the high 2006 estimate soybeans. The country's soybean production for ethanol gave US$520 one to two orders of as well as exports nearly tripled in the 10-year magnitude higher than market carbon prices. period between 1993 and 2002. Its maize production has also been rising sharply (USDA Under the Caribbean Basin Initiative, countries 2001). More than 95 percent of soybean in Central America and the Caribbean have production is exported. Oilseeds and oilseed had duty-free access to the United States since products, as well as many other agricultural 1989. The U.S.-Central America Free Trade products, are assessed export taxes. Soybeans Agreement does not increase overall access to are assessed a 27.5 percent export tax the U.S. ethanol market but simply establishes (increased from 23.5 percent in January country-specific shares for El Salvador and 2007), and producer prices are automatically Table C.1: Total Annual U.S. Support to Ethanol and Biodiesel Ethanol Biodiesel Year Unit Low High Low High 2006 US$ per liter 0.28 0.36 0.41 0.52 2006­12 US$ per liter 0.28 0.38 0.30 0.41 2006 US$ per liter of petroleum fuel equivalent 0.38 0.49 0.45 0.57 2006­12 US$ per liter of petroleum fuel equivalent 0.38 0.52 0.33 0.45 Source: Koplow 2006. 0 appendix C. biofuel Policies in Different Countries discounted by the same percentage, lowering oil, 45 percent when international oil prices rise the domestic soybean price. Meals and oils are above US$45 a barrel. Domestic gasoline and assessed a 24 percent export tax (raised from diesel prices essentially remained unchanged 20 percent in January 2007), again lowering between January 2004 and February 2006, domestic prices by the same percentage. when international gasoline prices (as measured Biodiesel, in contrast, carries an export tax of in the U.S. Gulf Coast) rose by 55 percent and 5 percent, giving incentives to export biodiesel diesel prices by 85 percent (ESMAP 2006). rather than oilseeds or oilseed products. The A pricing policy aimed at keeping domestic export tax is eliminated if a biodiesel blend petroleum fuel prices low poses a challenge for is exported. In March 2007, the European launching a sustainable and viable domestic Biodiesel Board complained to the European biofuel market. Commission that these differential export taxes create a 19 to 24 percent incentive given to the australia Argentine biodiesel industry to process vegetable oils into biodiesel and export it (EBB 2007b). In Australia has set a target of increasing annual December 2006, the government announced biofuel production to 350 million liters by 2010. that Argentina would have the capacity to Although the target was originally announced produce 2.5 million tonnes of biodiesel and as part of the government's 2001 election ethanol by January 2010, of which nearly commitment, the country's fuel ethanol program 1.7 million tonnes would be available for export has encountered a number of obstacles, notably (Dow Jones International News 2006b). low consumer confidence (ESMAP 2005). Ethanol-blended gasoline has reportedly been As of April 2007, 17 ethanol producers had sold mostly at independent outlets and less at the produced 204 million liters of ethanol from outlets of the four major oil companies (Courier sugarcane in the marketing year 2007, about Mail 2007). In May 2007, New South Wales half of which was for export and the remaining became the first state to mandate 2 percent half for domestic consumption (USDA 2007i). ethanol in gasoline effective from September Argentina is arguably the world's lowest cost 2007. Domestic fuel ethanol production rose producer of maize. The government levies a by more than 50 percent from about 23 million 20 percent export tax on maize, but no tax on liters in 2004­05 to 36 million liters by the ethanol exports. As with biodiesel, this export tax end of June 2006. The government's support structure provides an incentive to convert surplus for biofuel production has included more than maize to ethanol for export. Recent increases in $A 37 million (US$28 million) in capital grants, world maize prices, however, have led to a sharp $A 52 million (US$39 million) in ethanol rise in maize exports, prompting the government production grants, the introduction of an E10 to close the maize export registry in mid- label of assurance on all locally built vehicles, November 2006 to ensure adequate supplies on and, most importantly, fuel tax exemption (Platts the domestic market (USDA 2007f). Commodity News 2006). Ethanol produced is from wheat, waste starch, and molasses. The government exercises tight control over Ethanol production based on sugarcane uses domestic gasoline and diesel prices and has only the poorest grade molasses not suitable not permitted recent increases in international for crystal sugar production (USDA 2007j); this petroleum prices to be passed through to does not represent a large share of ethanol the domestic market. This is achieved largely production. Most of the growth in ethanol through levying a high export tax on petroleum production is expected from using sorghum Special Report Considering Trade Policies for liquid biofuels and winter cereals. Of concern is the possibility and $A 0.191 (US$0.16) per liter for biodiesel-- of a significant domestic grain shortage in the a 50 percent discount (Biofuels Taskforce 2005). coming decade; prolonged periods of drought The tax advantage on a per liter basis would are not uncommon in Australia. Biodiesel be $A 0.25643 (US$0.21) for ethanol relative became available in commercial quantities in to gasoline and $A 0.19043 (US$0.16) for 2006. One plant with an annual production biodiesel relative to diesel. capacity of 140 million liters uses palm oil imported from Indonesia and Malaysia. Canada In September 2002, the government announced Canada's biofuel industry was established in that both gasoline and ethanol blended with the 1980s. Ethanol production in 2005 was gasoline would attract an excise tax rate of 240 million liters. There is little production of $A 0.38143 (US$0.21 at the time, US$0.31 biodiesel at present. Government support has as of April 2007) per liter. Imported ethanol been in the form of tax reductions and project would attract customs duty at the same rate. financing (see Littman forthcoming for more A subsidy of $A 0.38143 per liter would be detail). provided to domestic ethanol producers, offsetting the excise tax and giving them a In 1992, the federal government granted an cost advantage equivalent to the import tariff excise tax exemption of Can$0.085 (US$0.07 on ethanol. The producer grant would be in using the 1992 exchange rate) per liter of effect until June 2011. In September 2003, ethanol made from biomass and used in the government similarly announced that both gasoline. This was increased to Can$0.10 diesel and biodiesel locally manufactured for (US$0.09) per liter of ethanol blended in automotive use would attract an excise rate of 1995. By the mid-1990s, several provincial $A 0.38143 per liter. Imported biodiesel would governments had granted exemptions from their attract customs duty at the same rate. Unlike excise taxes for ethanol. Out of 13 provinces, 6 ethanol, however, a subsidy of $A 0.38143 per provide biofuel subsidies. Manitoba, Ontario, liter would be given until June 2011 for both and Saskatchewan have mandatory blending the production and import of eligible biodiesel. requirements for ethanol in gasoline. Manitoba Domestically produced biodiesel thus does not and Saskatchewan offer a provincial fuel tax enjoy a tax advantage over imports. The grant reduction for ethanol produced in their own will be progressively phased out from July 2011 provinces. Quebec bases its tax credit on the to June 2015 (Australian Taxation Office 2006a price of West Texas Intermediate crude, reducing and 2006b). the tax credit to zero when the crude oil price reaches US$65 per barrel. In December 2003, the government announced a new schedule for automotive fuel tax, based Between 1999 and 2005, the National Biomass on energy content and comprising four fuel tax Ethanol Program created a guaranteed bands. Gasoline, diesel, and biodiesel belong repayable line of credit of Can$70 million to the high energy content band and would be (US$62 million). The program was extended in taxed at $A 0.38143 per liter; ethanol belongs 2003 to end of March 2006, increasing the total to a mid-energy content band and would be credit limit to Can$135 million (US$120 million). taxed at $A 0.25 (US$0.21) per liter. The final The government announced an Ethanol fuel tax rates in 2015 (net of grants) would be Expansion Program in August 2003, in which it $A 0.125 (US$0.10) per liter for fuel ethanol offered up to Can$100 million (US$89 million) appendix C. biofuel Policies in Different Countries in repayable contributions toward the Canada imposes an import tariff of Can$0.0492 construction of fuel ethanol production facilities (US$0.043) per liter of ethanol from countries in Canada. In the two rounds under the Ethanol with most favored nation status (Can$0.1228 Expansion Program, a total of Can$124 million per liter otherwise). The corresponding tariff on (US$110 million) was allocated. biodiesel is Can$0.11 (US$0.10) per liter. There is no tariff on imports from countries with which The federal government's Climate Change Canada has a free trade agreement (such as Action Plan 2000 included a target to enable NAFTA) or a special tariff treatment agreement 25 percent of Canada's total gasoline supply (Commonwealth Caribbean Countries tariff to contain up to 10 percent ethanol. The plan treatment, Least Developed Country tariff increased the percentage of total gasoline supply treatment, General Preferential tariff treatment, containing 10 percent ethanol to a minimum of Chile tariff, and Costa Rica tariff). 35 percent. More recently, the government has expressed a desire for 5 percent of Canada's China transport fuel to be renewable. Gasoline and diesel consumption in 2005 was 38 billion and China is the second largest petroleum oil 16 billion liters, respectively. A 5 percent target consumer in the world after the United States. would have required more than 1.9 billion liters It is a large crude oil producer but needs to of ethanol (taking into account ethanol's lower import about 40 percent of the petroleum it energy content) and 0.8 billion liters of biodiesel, consumes. The country's net import status and requiring an order of magnitude increase in concerns about rapidly growing demand for biofuel production. energy are driving the government to seek alternative indigenous sources of energy. China In December 2006, Environment Minister Rona is the world's third largest producer of fuel Ambrose announced the government's plan ethanol after the United States and Brazil, and, to pursue regulations under the Canadian according to the government, 20 percent of all Environmental Protection Act that would require gasoline sold now contains ethanol. Biodiesel blending of 5 percent ethanol in gasoline by is still in the very early phases of testing and 2010 and 2 percent biodiesel in diesel fuel development. and heating oil by 2012, subject to verification through testing that the blended biodiesel fuel To date, fuel ethanol has been made mostly is safe and effective for Canadian climate and from maize; other feedstocks include cassava, conditions. She added that the regulations sugarcane, and, on a trial basis, sorghum. Fuel would take at least two years to develop ethanol production in 2005 was 920,000 tonnes and that the government would consult with (about 1.2 billion liters); maize was used as provinces, territories, affected sectors, and a feedstock for 80 percent of fuel ethanol other stakeholders on the regulations' design production (USDA 2006n). In 2007, three and implementation. In the same month, the new ethanol plants were scheduled to come government also announced an investment on stream, using mostly feedstocks other than of Can$345 million (US$300 million) to maize. Nine provinces participate in the fuel help producers capture new opportunities in ethanol program based on E10; five of these biofuels. In addition, the budget for FY 2007 provinces are close to selling only E10 (USDA has allocated Can$2 billion (US$1.8 billion) 2007o). Concerns for food security have led over seven years to support the production of China to import Thai tapioca for ethanol renewable fuels. production (Reuters News 2006a) and the Special Report Considering Trade Policies for liquid biofuels government to restrict production of ethanol foreseeable future, the biofuel program in China from maize at the end of 2006. A draft 11th five- will be determined by government policy rather year plan, originally scheduled for introduction than economics. China levies an import tariff of in December 2006 and prepared under the 30 percent on ethanol (USDA 2006n). central planning agency National Development and Reform Commission, envisaged a variety of Colombia programs to expand fuel ethanol use. However, concerns over rising grain prices led the State Colombia is a net petroleum oil exporter, but its Council not to approve the five-year plan for oil production has been declining steadily since biofuel development (USDA 2007o). Ethanol 1999. The country exports about half of its crude exports surged from 138,000 tonnes in 2005 to oil production. Colombia is also an exporter 865,000 tonnes in 2006. Fearing domestic grain of sugar. In September 2001, the government shortages, the government eliminated the rebate approved a law requiring cities with populations on the 13 percent value added tax in January exceeding 500,000 to add 10 percent ethanol 2007 (USDA 2007d). to gasoline beginning in 2006. Fuel ethanol is exempt from the value added tax and several Subsidies of Y 1,373 (US$172) per tonne of other levies. Current ethanol production capacity ethanol (US$0.14 per liter) are given to ethanol is 1.1 million liters per day; five ethanol plants producers (USDA 2006n). Gasoline and diesel owned by major sugar producers supply an prices are controlled by the government and estimated 60 percent of the total needs to are set below world prices. Concerns about comply with the requirement to blend 10 percent rising fuel prices have repeatedly delayed ethanol into gasoline. Investments for the implementation of the government's plan to remaining 40 percent have not yet started (USDA introduce fuel excise taxes, precluding fuel excise 2007g). tax reduction as a biofuel support measure. Incentives for ethanol are granted by exempting The new requirements for use of ethanol are the 5 percent consumption tax on ethanol, having a major impact on domestic sugar guaranteeing a profit of Y 100 per tonne of production and exports. Sugarcane needed for ethanol (US$0.01 per liter) and setting the price this purpose could reach the equivalent of half of E10 at 91.11 percent of the shipping price what is currently used for exports. Colombia's of gasoline with a research octane number sugar production fell by approximately (RON) of 90 (USDA 2006n). In November 2006, 0.3 million tonnes to 2.4 million tonnes in the government announced further subsidies marketing year 2005­06 due to diversion and tax breaks for both biofuel producers of sugarcane for ethanol production, and is and farmers who grow feedstocks other than expected to rise only slightly in 2006­07. Sugar grains. The additional incentives for biofuel exports correspondingly declined 20 percent producers will be provided when world oil to 988,000 tonnes, while imports reached prices fall below a threshold level (Reuters News 116,000 tonnes in 2005­06 (USDA 2007g). 2006e). In December 2006, the government announced that biodiesel made from animal fat The sugar industry enjoys protection from the or vegetable oil is not subject to consumption government. A government decree issued in tax (Xinhua Business Weekly 2006). However, October 2003 exempts areas newly planted there are no national standards for automotive with sugarcane from taxes for the next 14 years. biofuel use, and the government's focus is likely Sugarcane production receives credit from a to remain on fuel ethanol (USDA 2007o). For the government institution, which subsidizes the credit appendix C. biofuel Policies in Different Countries by forgiving up to 40 percent of the principal. One of the government's strategies for reducing The government also provides support to sugar consumption of subsidized petroleum fuels is exports (USDA 2007g). to switch to biofuels. Indonesia and Malaysia produce about 15 million tonnes of palm oil Colombia is the largest palm oil producer each and account for 85 percent of global in Latin America, although its output is only production (USDA 2006m). Compared to 4 percent that of Malaysia. Biodiesel production Malaysia, Indonesia has considerable unutilized is anticipated shortly. A plan announced in mid- land left that is suited for growing palm. As such, 2006 to construct a biodiesel plant indicated it is in a position to become a leading biodiesel that the bulk of the biodiesel would be exported producer. In April 2006, the government issued to Spain (Latin American News Digest 2006). In regulations allowing blending of 10 percent April 2007, Colombian state-owned petroleum ethanol in gasoline and 10 percent biodiesel in company Ecopetrol, jointly with local palm diesel fuel, effective from the previous month. In oil producers, is reported to have announced July 2006, the minister of energy and mineral that it would invest US$23 million in a new resources announced that the country required biodiesel plant. The plant, scheduled to come an investment of Rp 200 trillion (US$22 billion) on stream in mid-2008, will have an annual for biofuel production aimed at reducing production capacity of 100,000 tonnes of subsidized petroleum product consumption biodiesel, which will be blended into petroleum by 10 percent by 2010. The minister also diesel at 2 percent (Latin American News Digest announced that Indonesia planned to build 2007). Colombia appears to impose an ad 11 biodiesel plants and that a special fund for valorem tariff rate of 15 percent on ethanol and the development of alternative energy would be 10 percent on biodiesel (TIC 2006). used to pay for the plants (Agence France Presse 2006). In 2006, the government announced a Indonesia plan to develop up to 1.8 million hectares of land for new palm oil plantations and to use the Although Indonesia is a major petroleum new production for biodiesel while maintaining producer, it became a net petroleum oil the existing production for cooking oil. This plan importer for the first time in 2004. Domestic has encountered difficulties in its implementation petroleum product prices have historically been (USDA 2007e). considerably lower than international market prices, leading to widespread smuggling In January 2007, 67 agreements were of subsidized fuels out of the country and signed by 52 foreign, local, and state-owned increasing apparent consumption. The fuel enterprises under the Joint Initiative for Biofuel subsidy bill in 2005 was close to US$10 billion. Development. The contract values are estimated Although domestic fuel prices in 2005 more to be US$12.4 billion; the financing will be than doubled--and, for kerosene, tripled--they supported by the government's bank interest remain below international levels, posing subsidy program. However, many companies a budgetary burden. Based on an assumed that signed agreements had no experience in world crude oil price of US$57 per barrel, the biofuel production (USDA 2007r). Two firms government allocated Rp 54 trillion (US$6 billion) were producing biodiesel from palm oil at to fuel subsidies in 2006. The government is that time and selling it to the state-owned focusing on reducing demand and fuel switching oil company, Pertamina, for blending into to cope with the large fuel subsidy bill (ESMAP petroleum diesel for local consumption. A few 2006). other firms were producing biodiesel on a small Special Report Considering Trade Policies for liquid biofuels scale for their own consumption. One facility country's Quality Assurance Act was amended in under construction will have an annual capacity March 2007 to permit blending up to 5 percent of 350,000 tonnes (USDA 2007e). Two firms biodiesel in petroleum diesel. were producing ethanol. The Ministry of Environment has set a long-term Indonesia's subsidized domestic diesel price goal of achieving 10 percent biofuel in total is likely to pose a challenge to establishing a automotive fuel consumption by 2030. To help commercially viable domestic biodiesel industry. meet this target, the ministry requires that all new Pertamina has recently announced that it will gasoline-engined cars registered in Japan from decrease the amount of biodiesel blended in 2010 be capable of running on E10, by which petroleum diesel (sold at more than 200 filling date 40 percent of all such vehicles on Japanese stations) from 5 percent to 2.5 percent, and roads are to be E10 compatible. of ethanol in gasoline (sold at only two filling stations) from 5 percent to 3 percent (USDA Instead of blending ethanol, the Petroleum 2007r). Indonesia could become a world Association of Japan plans to blend ETBE, leader in biodiesel exports, depending on the and set a target of using 360 million liters of movement of world palm oil prices and how ethanol (against total gasoline consumption of questions about the environmental sustainability about 60 billion liters) to blend 7 percent ETBE of palm cultivation are addressed. According in 20 percent of all gasoline by 2010. One to announced plans for plant expansion and advantage of this strategy is that ETBE can be new construction, the annual capacity for blended at the refinery. The association will biodiesel production could increase to nearly import ethanol and ETBE to this end. Japan 2.5 million tonnes at the end of 2007, up from levies high import duties on fuel ethanol. The approximately 300,000 tonnes at the beginning import duty was 23.8 percent in FY 2006­07, of the year (USDA 2007b). and will decline each year until it is lowered to 10 percent in 2010. The import duty on crude Japan oil is ¥0.16 a liter (US$0.23 a barrel) (USDA 2006f). The duty on biodiesel appears to be There is little production of biofuel in Japan. 4.6 percent (TIC 2006). This may change if technologies for cellulosic ethanol and other alternative feedstocks become Thailand commercially viable. Japan's interest in biofuels stems primarily from the government's desire to Thailand produces enough crude oil and reduce life-cycle GHG emissions in the transport condensates to satisfy just one-quarter of its sector to help meet Kyoto Protocol targets. In petroleum consumption. Rising petroleum prices April 2005, the Japanese cabinet committed to have strengthened the government's resolve consuming 500 million liters of crude equivalent to reduce dependence on imported petroleum of biofuel in FY 2010. In 2003, the government oil. Ethanol in Thailand is made from molasses began allowing ethanol blending in gasoline and cassava. Seven out of 45 approved ethanol at 3 percent, but biofuel consumption has plants are in operation, making ethanol mostly remained negligibly small, in part because of from molasses. Plant utilization is only about a lack of fiscal incentives. It was reported in 50 to 60 percent, due to a surplus of ethanol. 2006 that the government would introduce Ten ethanol plants are under construction and a new tax incentive for blending ethanol into are expected to come on stream in 2008. They gasoline in FY 2007­08 (USDA 2006f). The will add another 1.6 million liters of ethanol appendix C. biofuel Policies in Different Countries per day, of which 1.1 million liters will be from in recent years, making ethanol economics cassava (USDA 2007q). unfavorable. In 2006, domestic prices of molasses rose to B 4,000 (US$104) per tonne. The government actively promotes ethanol Prices fell to B 2,500 (US$70) per tonne in by maintaining a consistent price differential 2007, and are expected to remain at that between E10 and gasoline of the same level in 2008 (USDA 2007h). One ethanol octane grade. The price difference more than producer stopped plant operation in January compensates for the slightly lower fuel economy 2006 on the grounds that the negotiated price of E10, prompting E10 consumption to increase in effect at the time was too low and that the 23-fold in 2004 and 11-fold in 2005 (EPPO company could no longer sustain financial 2006). Consumption has been relatively flat losses (Dow Jones International News 2006a). since early 2006, with supply far exceeding In April 2006, a new price (exclusive of fuel demand by 2007 (Platts Oilgram Price Report taxes and fees) of B 23 (US$0.60) per liter was 2007). Until February 2007, the price difference negotiated. This corresponded to US$0.75 per was B 1.5 (US$0.043) per liter for E10 and liter of gasoline equivalent, far in excess of premium gasoline, both 95 RON. The price the benchmark premium gasoline price in the difference is achieved by lowering taxes and region (Singapore) of US$0.51 per liter at the levies on E10, amounting to a difference of time. The price was subsequently renegotiated B 2.47 per liter of E10 in late April 2006-- and raised to B 25.30 (US$0.66) per liter, or corresponding to B 24.7 (US$0.65) per liter US$0.83 per liter of gasoline equivalent-- of ethanol--a very large fiscal concession by double premium gasoline prices in Singapore any measure. In February and March 2007, of US$0.39 in October 2006. In February faced with an ethanol surplus, the government 2007, Thailand adopted a new ethanol pricing increased the price difference three times in formula, pegging domestic prices to those on the an attempt to make E10 more attractive, to Brazilian Commodity Exchange and including B 2.5 (US$0.071) by mid-March. Earlier, the other components such as insurance and government had planned to phase out 95 RON transportation costs. The new pricing policy was gasoline in January 2007 and replace it entirely reported to have the effect of bringing down the with 95 RON gasohol. However, concerns price of ethanol from B 25.30 (US$0.71 at the about compatibility of E10 with older vehicles exchange rate prevailing in February 2007) to prompted postponement of the phaseout date. B 19.33 (US$0.54) per liter (Platts Commodity The government has also announced that, as News 2007). soon as the phaseout of 95 RON gasoline is complete, the price of gasohol will be raised by In April 2007, the Energy Policy Management B 2.5 per liter (Thai News Service 2006). Committee agreed to mandate B2 beginning in April 2008. The government had earlier Until February 2007, ethanol prices were promoted a plan to expand palm oil plantation negotiated among ethanol producers and significantly to make biodiesel. The government petroleum companies and set for a few months withdrew this plan in October 2006, however, at a time. Unlike in Brazil, ethanol producers stating that against falling world crude oil purchase molasses, forfeiting the benefit prices, palm oil cost more than diesel on a of using bagasse for energy generation or volume basis, and it would not make economic adjusting the sugar-ethanol production split sense to subsidize a palm-based biodiesel on the basis of relative market prices. Local project started two years earlier and not taken molasses and cassava prices have risen sharply up by farmers (Reuters News 2006c). The Special Report Considering Trade Policies for liquid biofuels committee will provide a refund--at a rate to B 800 (US$20) per tonne. There are two ethanol be determined--to B2 manufacturers and offer plants, based on sugarcane and molasses. additional incentives for B5. 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Center September 2006." www.eia.doe.gov/pub/oil_gas/ for Transportation Research, Argonne National petroleum/data_publications/petroleum_marketing_ Laboratory. www.transportation.anl.gov/pdfs/TA/58. monthly/current/pdf/pmmall.pdf. pdf. U.S. Environmental Protection Agency (U.S. EPA). Washington State Legislature. 2006. "Engrossed 2002. "A Comprehensive Analysis of Biodiesel Substitute Senate Bill 6508." www.leg.wa.gov/pub/ Impacts on Exhaust Emissions, Draft Technical Report." billinfo/2005-06/Pdf/Bills/Senate%20Bills/6508- EPA420-P02-001, October. www.epa.gov/otaq/ S.E.pdf. models/analysis/biodsl/p02001.pdf. World Trade Organization (WTO). 2007. www.wto. ­----. 2007. "Regulation of Fuels and Fuel Additives: org/english/thewto_e/thewto_e.htm. Renewable Fuel Standard Program." www.epa.gov/ otaq/renewablefuels/#regulations. World Bank. 1994. "Commodity Markets and the Developing Countries." World Bank Quarterly, March. U.S. International Trade Commission (USITC). 2007. "U.S. Import/Export Data." www.usitc.gov/. Xinhua Business Weekly. 2006. "No Consumption Tax on Biodiesel." December 5. U.S. National Alcohol Fuels Commission. 1981. Fuel Alcohol: an Energy Alternative for the 1980s. Washington, DC. 0 Special Report Series Renewable eneRgy THeMaTIC aRea Latin America and the Caribbean Region (LCR) Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua (003/07) Global (GLB) Risk Assessment Methods for Power Utility Planning (001/07) Considering Trade Policies for Liquid Biofuels (004/07) eneRgy POVeRTy THeMaTIC aRea East Asia and Pacific (EAP) Household Energy, Indoor Air Pollution and Health: A Multisectoral Intervention Program in Rural China (002/07) Energy Sector Management Assistance Program (ESMAP) Purpose The Energy Sector Management Assistance Program (ESMAP) is a global technical assistance partnership administered by the World Bank since 1983 and sponsored by bilateral donors. ESMAP's mission is to promote the role of energy in poverty reduction and economic growth in an environmentally responsible manner. Its work applies to low-income, emerging, and transition economies and contributes to the achievement of internationally agreed development goals through knowledge products such as free technical assistance; specific studies; advisory services; pilot projects; knowledge generation and dissemination; training, workshops, and seminars; conferences and round-tables; and publications. The Program focuses on four key thematic areas: energy security, renewable energy, energy poverty, and market efficiency and governance. governance and Operations ESMAP is governed by a Consultative Group (CG) composed of representatives of the World Bank, other donors, and development experts from regions that benefit from ESMAP assistance. The ESMAP CG is chaired by a World Bank Vice President and advised by a Technical Advisory Group of independent energy experts that reviews the Program's strategic agenda, work plan, and achievements. ESMAP relies on a cadre of engineers, energy planners, and economists from the World Bank, and from the energy and development community at large, to conduct its activities. Funding ESMAP is a knowledge partnership supported by the World Bank and official donors from Belgium, Canada, Denmark, Finland, France, Germany, Iceland, the Netherlands, Norway, Sweden, Switzerland, the United Kingdom, the United Nations Foundation, and the U.S. Department of State. It has also enjoyed the support of private donors as well as in-kind support from a number of partners in the energy and development community. Further Information Please visit www.esmap.org or contact ESMAP via email (esmap@worldbank.org) or mail at: ESMAP c/o Energy, Transport and Water Department The World Bank Group 1818 H Street, NW Washington, DC 20433, USA Tel.: 202-458-2321 Fax: 202-522-3018 REnEwAblE EnERgy Moving into a world with less carbon emissions, better energy security through a more diversified energy supply, and increased availability of energy in unserved areas, in particular where the poorest people live. ESMAP supports renewable energy with advice on policy formulation and development incentives adapted to local conditions. The program assists in design of renewable energy projects suitable for financing by bilateral assistance, international institutions, or the private sector. Energy Sector Management Assistance Program The analytical work of ESMAP includes 1818 H Street, NW legal and regulatory frameworks for Washington, DC 20433 USA renewables, efficient integration of Tel: 202-458-2321 distributed generation in electrical power Fax: 202-522-3018 Internet: www.esmap.org systems, and better energy access for Email: esmap@worldbank.org remote and poor communities. ESMAP is a knowledge clearing house for good practice and opportunities for renewable energy ranging from large- scale electricity generation to biomass serving household heating and cooking needs.