Thursday, January 23, 2014

Alternative Transportation Fuel Standards: Economic Effects and Climate Benefits

This paper develops an integrated model of the fuel and agricultural sectors to analyze the welfare and greenhouse gas emission (GHG) effects of the existing Renewable Fuel Standard (RFS), a Low Carbon Fuel Standard (LCFS) and a carbon price policy. The conceptual framework shows that these policies differ in the incentives they create for the consumption and mix of different types of biofuels and in their effects on food and fuel prices and GHG emissions. We also simulate the welfare and GHG effects of these three policies which are normalized to achieve the same level of US GHG emissions. By promoting greater production of food-crop based biofuels, the RFS is found to lead to a larger reduction in fossil fuel use but also a larger increase in food prices and a smaller reduction in global GHG emissions compared to the LCFS and carbon tax. All three policies increase US social welfare compared to a no-biofuel baseline scenario due to improved terms-of-trade, even when environmental benefits are excluded; global social welfare increases with a carbon tax but decreases with the RFS and LCFS due to the efficiency costs imposed by these policies, even after including the benefits of mitigating GHG emissions.
The full paper is currently available via the Social Science Research Network (SSRN) www.SSRN.com free of charge at http://tinyurl.com/l3hxhuk

Fuel Prices
The reduction in consumption of gasoline and diesel due to the RFS-induced biofuel production reduces their prices in 2030 by 10.4% and 0.7%, respectively, relative to the business-as-usual (BAU) scenario. Since biofuels and fossil fuels are perfect substitutes, the consumer prices of ethanol and biodiesel would also fall by the same percentages as gasoline and diesel prices and remain at the energy equivalent level. The RFS provides an implicit subsidy to biofuel consumers (the difference between producer price and consumer price of biofuels). Since advanced biofuel production exceeds the minimum mandated level and reduces corn ethanol consumption to be below the upper limit on corn ethanol, this implicit subsidy is the same for all types of ethanol.... Specifically, this implicit subsidy is $0.15 per liter for ethanol and $0.21 per liter for oils-based biodiesel in 2030.
Unlike the RFS, the LCFS implicitly subsidizes biofuels and implicitly taxes fossil fuels depend on the stringency of the LCFS constraint and the carbon intensity of fuels. We estimate the subsidies to be $0.12 and $0.16 per liter for corn and sugarcane ethanol in 2030, while the subsidies for cellulosic ethanol and BTL are significantly larger with $0.22 and $0.38 per liter due to their lower carbon content. The LCFS also imposes a tax of $0.05 per liter on gasoline and on diesel of $0.07 per liter in 2030. Despite these taxes, the prices of gasoline and diesel are lower relative to the BAU. The LCFS lowers the consumer price of gasoline and gasoline blends by less than the RFS (4.1% as compared to 10.4% under the RFS) but it lowers the consumer price of diesel and diesel blends by more than the RFS (3.0% as compared to 0.7% under the RFS), because it leads to a larger displacement of diesel than the RFS.

The carbon tax of $60 per metric ton of CO2e implies a tax of $0.18 per liter on gasoline, $0.21 per liter on diesel, $0.06 per liter on corn ethanol, and $0.03 per liter on sugarcane ethanol. The corresponding taxes imposed on cellulosic biofuels are fairly small due to their low carbon intensities. Thus, the carbon tax raises gasoline and diesel consumer prices by 16.7% in 2030 as compared to the BAU scenario, which results in a 3.0% reduction in VKT.

Food Prices
As expected from the conceptual model, we find all three policies raise food crop prices because of the increase in biofuel production. However these effects differ because the three policies differ in the mix of biofuels they induce. Among the three policies, the RFS raises food prices the most since the production of first generation biofuels is largest in this case. Corn and soybean prices would be 26.4% and 22.6% higher in 2030 in comparison to the BAU scenario.  Unlike the RFS, more than 85.0% of the biofuels produced under the LCFS are from non-food based cellulosic feedstocks in the form of high-yielding energy crops and crop and forest residues. These energy crops do divert some land from food crop production but at the same time the reduction in demand for first generation biofuels under the LCFS reduces demand for land. Thus, corn and soybean prices under the LCFS would only be 10.8% and 12.1% greater as compared to the BAU scenario in 2030. These prices are 12.4% and 8.6%, respectively, lower than those under the RFS. The carbon tax generates modest impacts on food crop prices with corn and soybean prices increasing by 8.5% and 2.3%, respectively, relative to the BAU, in part due to some increase in corn ethanol consumption and in part due to higher costs of carbon inputs in crop production.

Welfare Effects of Biofuel and Climate Policies
As a result of the reduction in fuel prices, fuel consumers gain by 1.9% ($408 billion) and 0.6% ($131 billion) under the RFS and the LCFS, respectively, relative to the BAU scenario. In contrast to this, the carbon tax reduces fuel consumers’ surplus by -7.5% ($1619 billion). Fuel producers will suffer a significant loss in surplus from the reduction in fuel production and producer prices of fuels across all scenarios considered here, with the largest surplus loss being 13.8% ($388 billion) under the RFS as compared to the BAU scenario. The LCFS and carbon tax reduce the surplus of fuel producers by 2.6% ($74 billion) and 6.2% ($176 billion), respectively.

The increase in demand for biofuels raises the opportunity costs of cropland and thereby raises producer surplus for crop producers. We find that the gain in surplus for agricultural producers is largest under the RFS, by 19.1% ($285 billion) relative to the BAU while the loss for agricultural consumers is by 5.0% ($110 billion). The welfare effects of the LCFS and carbon price policies on the agricultural sector are much more modest. Specifically, agricultural producers’ surplus increases by 6.2% ($92 billion) and 1.2% ($17 billion) under the LCFS and the carbon tax, respectively. Both policies have negligible impacts on agricultural consumers.

All of the policies considered here increase overall social welfare relative to the BAU, by improving the terms of trade for the US. Welfare gains are the highest under the RFS (by 0.8% of $238 billion) relative to the BAU. The LCFS and the carbon tax increase domestic social welfare by 0.6% ($173 billion) and 0.4% ($125 billion), respectively, relative to the BAU. While the LCFS and carbon tax policies lead to additional reduction in carbon emissions than the RFS, they also lead to lower levels of domestic social welfare than the RFS.

Sensitivity Analysis
The welfare and GHG impacts of these policies depend on a number of technological and behavioral assumptions in the model. Here we focus on examining the sensitivity of our results to wide variations in the parameter assumptions that were analyzed in the conceptual framework. In scenario (1), we double the demand elasticity of VKT from -0.2 to -0.4 while in scenario (2) we significantly increase the ROW supply elasticity of gasoline from 0.2 to 30. In scenario (3), we consider a case with 30 times higher demand elasticities for food in the ROW relative to the parameters in the benchmark case. We present the mix of cumulative biofuels consumption over 2007-2030 under the three policy scenarios (the RFS, the LCFS and a carbon tax) with the changes in each of these parameters in Fig. 1. We also compute the percentage changes in cumulative liquid fossil fuel consumption, GHG emissions, and social welfare under these policies relative to the corresponding BAU with each of the parameters (Figs. 2 and 3).

We find that despite the large differences in parameters considered here there is a remarkable similarity in the level and mix of biofuels consumed over 2007-2030 under a particular policy. An exception is the reduced consumption of biofuels, particularly cellulosic ethanol and larger consumption of BTL under the LCFS with a high supply elasticity of gasoline; the reduction in GHG intensity in this case is met largely by reducing fossil fuel consumption.

Across the parameter assumptions considered here, the reduction in fossil fuel consumption ranges between 3.8 - 6.5% under the carbon tax, between 3.4-3.8% under the LCFS and between 4.8-6.2% under the RFS relative to the corresponding BAU levels with each of those parameters....

In general, we find that changes in parameters in the agricultural and fuel sectors affect fuel consumption but do not have significant impacts on GHG emissions and social welfare relative to those with the benchmark parameters. Across the scenarios considered here we find the carbon tax always leads to the largest reduction in GHG emissions, ranging from -4.8% in the benchmark to -7.3% in scenario (1), while the RFS generates the smallest reduction in GHG emissions fluctuating between -3.1% in scenario (1) to -4.5% in scenario (2). The reduction in GHG emissions under the LCFS is about 4.5% to 4.8% despite the large changes in parametric assumptions. The larger reduction in GHG emissions under the LCFS occurs when the elasticity of supply of gasoline is relatively larger.
by Xiaoguang Chena, Haixiao Huangb, Madhu KhannacCorresponding author contact information and Hayri Önald
a Research Institute of Economics and Management, Southwestern University of Finance and Economics, China
b Energy Biosciences Institute, University of Illinois at Urbana Champaign, 1206 West Gregory Dr, Urbana, IL 61801
c Department of Agricultural and Consumer Economics, University of Illinois at Urbana Champaign, 326 Mumford Hall, 1301W. Gregory Dr, Urbana, IL 61801
d Department of Agricultural and Consumer Economics, University of Illinois at Urbana Champaign, 326 Mumford Hall, 1301W. Gregory Dr, Urbana, IL 61801
Corresponding author contact informationCorresponding author. Fax: +1 217 333 5358.
Journal of Environmental Economics and Management via Elsevier Science Direct www.ScienceDirect.com
Available online 20 January 2014
In Press, Accepted Manuscript
Keywords: Biofuel mandateLow carbon fuel standardGreenhouse gas emissionsSocial welfareCornEthanolCellulosic biofuelsDynamic optimization; Sectoral model

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