Impact of Biofuel Production on Food Prices

1. Impact of Biofuel Production onFood Prices Miroslava Rajcaniova Faculty of Economics and Management, Slovak University of Agriculture, Nitra, Slovak Republic

2. Definition of Biofuels Biofuels are fuels derived from biomass that are provided by agriculture, forestry, or fishery as well as from wastes of agro-industry or food industry (FAO, 2008).

3. Background Production of biofuels tripled from 2000 to 2007 (OECD, 2008). Around 85 percent of the global production of liquid biofuels is in the form of ethanol. The production of ethanol tripled between 2000 and 2007 to reach over 60 billion liters, with Brazil and the United States accounting for most of this growth. Biodiesel output, mostly by the European Union, witnessed an even more pronounced expansion over the same period, having grown from less than one billion liters to almost 11 billion liters (FAO, 2009).

4. Developmentof Biofuel Production Source: Energy Information Administration (EIA)

5. Development of Bioethanol Production Source: Earth Policy Institute, F.O.Licht

6. Development of Biodiesel Production Source: Earth Policy Institute, F.O.Licht

7. World Ethanol Production by Country (Millions of U.S. liquid gallons per year) Source: RFA Industry Statistics

8. World Biodiesel Production by Country (in Thousand tonnes) Source: data from OECD.stat

9. Background Ethanol is an alcohol derived from sugar or starch crops (e.g. sugar beet, sugar cane or corn) by fermentation. Cellulosic materials (e.g. wood, grasses and some waste crop residues) can also be converted into bioethanol. Sugarcane is favorite raw material for ethanol production in Brazil, cereals and sugar beet in the USA, EU and other developed countries with temperate climate.

10. Feedstocks for Bioethanol in Europe Source: EU FAS posts

11. Background Biodieselis derived from vegetable oils (e.g. rapeseed oil, soy or palm oil). Waste residues (e.g. waste cooking fat) can also be converted into biodiesel. Biodiesel can either be burnt directly in diesel engines or blended with diesel derived from fossil fuels.

12. Feedstocks for Biodiesel in Europe Source: EU FAS posts

13. Background Blends of biofuels and gasoline or diesel are applied into cars. Low ethanol blends from 5 to 22% applied withoutmodificationsofengines and with the existing infrastructure. E10 used in USA, Brazil, E5 popular in Europe. High ethanol blends of 85 % require special engine modifications andused in flexible fuel vehicles (FFV). Biodiesel application ranges from pure biodiesel known as B100 to lowbiodiesel blends B20.

14. Reasons to Produce Biofuels The development of biofuel production is partly influenced by the government support programs and partly by the development of oil prices.

15. Government Support Programs Consumer excise-tax exemptions at the gasoline pump Mandatory blending or biofuel consumption requirements (from domestic and import supplies) Import tariffs on biofuels Production subsidies for biofuel feedstocks (e.g., maize) - Production subsidies for biofuels (grants, loan guarantees, tax incentives, etc.) Subsidies for R&D of new technologies Grants, loans...

16. Blending Mandates Brazil 1975 - ethanol blends 20–25 percent, all diesel must contain 2% biodiesel and this share will increase to 5 percentby 2013.

17. Blending Mandates European Union The 2003 biofuel directive (The Directive 2003/30/EC) sets that by 2010 EU should reach 5.75 percent share of biofuels in total transport fuel use (by year 2020 - 10 percent). At least 20% of the target in 2015 and 40% of the 2020 goal must be met from “non-food and feed-competing” second-generation biofuels or from cars running on green electricity and hydrogen.

18. Blending Mandates United States The US Renewable Fuel Standard (RFS) mandates the minimum use of 36 billion gallons of ethanol by 2022. About 11 billion gallons are used at present.

19. Blending Mandates Source: US EPA (2010)

20. Tax Exemption / Tax Credit Tax credit in the US amounts to 52 cents per gallon. The blender receives a subsidy per gallon of biofuel blended with a fossil fuel . In the European Union and Brazil - tax reductions or exemptions for renewable fuels. Tax exemption on biodiesel in Germany was reduced from 0.47 Euro per liter to 0.29 Euro per liter between 2005 and 2009. Tax on biofuels for transport may be not less than 50 percent of the normal excise tax.

21. Reasons to Support Biofuels biofuels reduce the dependency of many countries on imported oil countries are worried about the stability of oil prices increased production of biofuels is expected to improve the environment and to contribute to the reduction of global climate change biofuel support might reduce the cost of agricultural support programs

22. Greenhouse Gas Emissions In theory, the production of biofuels is carbon neutral. Most of the carbon emitted to atmosphere is CO2 which is greenhouse gas (GHG). Fossil fuels on the other hand release carbon that was stored for millions of years under the surface of the earth. At the same time production of food from maize or other feedstock used to produce biofuels is also carbon neutral (FAO, 2008).

23. Greenhouse Gas Emissions To assess the net effect of a biofuel on greenhouse gas emissions life cycle analysis is used. Life cycle analysis measures product’s environmental flows and potential impacts throughout the whole life time of the product. Greenhouse gas emissions of biofuels are strongly dependent on raw material and technology of production and consumption (Lee, Clark, Devereaux, 2008).

24. Estimated GHG savings of First Generation Biofuels Source: Scope, 2009

25. Estimated GHG Savings of Second Generation Biofuels Source: Scope, 2009

26. Energy Balance in Production of Biofuels The fossil energy balance expresses the ratio of energy contained in the biofuel relative to the fossil energy used in its production. A fossil energy balance of 1.0 means that it requires as much energy to produce a litre of biofuel as it contains; in other words, the biofuel provides no net energy gain or loss. Fossil fuel energy balance of 2.0 means that a litre of biofuel contains twice the amount of energy as that required in its production.

27. Energy Balance in Production of Biofuels Source: Worldwatch Institute 2006

28. Biofuels and Biodiversity Biofuel production can affect wild and agricultural biodiversity in some positive ways, such as through the restoration of degraded lands, but many of its impacts will be negative, for example when natural landscapes are converted into energy crop plantations or peat lands are drained, habitat loss following land conversions, agrochemical pollution and the dispersion of invasive species ... (CBD, 2008, FAO, 2008).

29. Biofuels and Land Use • supply of food is constrained by fixed land • to increase the production area for energy crops, land conversions of different native ecosystems are needed, these can have substantial impact on the GHG balances of biofuels

30. Biofuels and Land Use Conversion of grassland to cultivated land can release 300 tons of carbon per hectare. When forestland is converted, 600 – 1000 tons of carbon per ha are emitted (OFID/IIASA 2009). Conversion of native ecosystems, such as grassland, forests and peatland, to energy crop lands, or through returning abandoned croplands to production is called direct land use change (LUC) while indirect LUC occurs when existing food/feed cropland is diverted to energy crops.

31. Economics of Biofuels Biofuels are almost perfect substitutes to fossil fuels. The market price of biofuels should therefore be strongly dependent on the market price for gasoline. Perfect substitutes have the same prices, which means that price of gasoline (PG) = price of ethanol (PE), in energy terms PE = k.PG where in reality k is approximately 0.7 when adjusted to an E-100 basis. (DeGorter and Just, 2008)

32. Price relationships Excise tax imposed: PE + t= k(PG + t), t is an excise tax. Tax exemption of biofuels: PE + t - te = k (PG + t), te is tax exemption. PE = kPG – t(1-k) + te. To increase the price of ethanol and to stimulate its production the government can lower the excise tax on fuels, to increase the tax exemption.PE increases when PG goes up.

33. Ethanol is mainly used as an additive to gasoline and that the complementarity relationship is considered to be more dominant than the substitution relationship between ethanol and gasoline in the U.S. (Tokgoz and Elobeid, 2007). Coltrain (2001) found that ethanol price is typically 50 cents above the price of gasoline. Gallagher et al. (2003) support this finding, attributing the difference in ethanol and gasoline price to the U.S. federal excise tax.

34. Gasoline Ethanol Differential Source: Bloomberg - ethanol prices, EIA – gasoline prices, (Gasoline - ethanol differential without the taxes and tax credit)

35. The differentials below zero represent time periods when ethanol is more expensive than gasoline. Around September 2005, ethanol price dropped below the gasoline price. The same situation was observed in the US ethanol market as well. Hart (2005) attributes this fall in price to the expansion of ethanol production and to the expansion of ethanol products that directly compete with gasoline, such as E85 . There was an explosion in production in 2005 and 2006 with double-digit growth rates.

36. Different studies have shown similar results, showing that ethanol is not competitive with gasoline without government policies (Kruse 2007, de Gorter, Just 2008, Hermanson 2008). The costs of biofuel production are declining however. The second generation of biofuels produced from cellulosic material is expected to be more efficient than the first generation of biofuels produced from agricultural feedstock like sugarcane, maize, wheat, plant oils etc. (OECD/IEA 2008).

37. Hypotheses From literature review the following hypotheses follow: Food prices are positively related to fuel prices. Biofuel prices are positively related to fuel prices. Food prices are positively related to biofuel prices. The main goal is to check whether the relationships among fossil fuel, biofuel and food prices are statistically significant as suggested in the literature.

39. Data • weekly data (April, 2005 to August, 2010) for oil, ethanol, corn, wheat and sugar prices • prices are expressed in USD per gallon of fuel and USD per ton of agricultural commodity. • Two periods: • 2005 - 2008 increasing ethanol production , peak of oil prices • 2008 - 2010 increasing ethanol production, mature biofuel market • German ethanol prices come from Bloomberg database. Europe Brent oil prices are from Energy Information Administration. Commodity prices come from FAO and Detsche Boerse database.

40. Development of Fuel and FoodPrices Source: Bloomberg - ethanol prices, EIA – gasoline prices, oil prices, Deutsche Börse – corn, wheat and sugar prices

41. Methods • The study evaluates the relationship among the following variables: fuel prices (oil, ethanol and gasoline) and selected food prices (corn, wheat and sugar). • We conduct a series of statistical tests, starting with • tests for unit roots and stationarity, • estimation of cointegrating relationships between price pairs, • evaluating the inter-relationship among the variables in a Vector Autoregression (VAR) and • Impulse Response Function (IRF). The direction of causation in the variables runs from oil to gasoline to ethanol investigated by means of • Granger causality tests.

42. Correlation Matrix (2005 – 2010) Source: Own calculation

43. Correlation Results Abbot et al., (2009), found the crude/corn price correlation to be high and positive at 0.80 for the period 2006-08 Campiche et al. (2007), examined the correlation coefficients computed for corn price series and crude oil prices for the 2003-2007 time period. Corn prices have a positive, but low correlation with crude oil prices in 2003-2005. However, in 2007, the correlation between corn prices and crude oil prices was negative which causes the cointegrating relationship to be questionable. Sugar prices have an extremely positive and significant correlation with crude oil prices in 2003-2006 and a high negative correlation in 2007.

44. Unit RootTests Source: own calculation, Notes: * significance at the 10% level, ** significance at the 5% level, *** significance at the 1% level

45. Unit Root Tests We use two tests to check for stationarity of time series: augmented Dickey Fuller (ADF) test and Phillips Perron (PP) test. The lags of the dependent variable were determined by Akaike Information Criterion (AIC). Both tests show that all the time series (oil, ethanol, corn, wheat and sugar prices) are integrated of order 1, i.e. non-stationary. To make them stationary we therefore take the first differences.

46. Johansen cointegration test results Source: own calculation, Notes: * significance at the 10% level, ** significance at the 5% level, *** significance at the 1% level

47. Cointegration • Absence of relationship between oil and commodity prices – strange if we believe that oil prices affect commodity prices through inputs • Prices are related when biofuel markets get matured, price transmission from oil to biofuels to commodities works slowly

48. Cointegration Ciaian and Kancs (2009) tested the relationship between crude oil and nine major traded agricultural commodity prices including corn, wheat, rice, sugar, soybeans, cotton, banana, sorghum and tea. There were no cointegration relationships in the period 1994-1998, the prices of crude oil and corn and crude oil and soybean were cointegrated in the period 1999-2003 and all nine agricultural commodity prices and crude oil prices contained a cointegrating vector in the period 2004-2008.

49. Cointegration Higgins et al.(2006) found a cointegrating relationship interconnecting ethanol price and corn price during the period of June of 1989 and August of 2005. The results indicate a nearly one to-one relationship between corn and ethanol prices. Campiche et al. (2007) tested the cointegration of corn, soybean oil, palm oil, sugar and crude oil in two different time periods. No cointegrating relationship was observed in the time period 2003-2005. Corn and soybeans, but not soybean oil were found to be cointegrated with crude oil from 2006 through the first half of 2007.

50. Cointegration Results Cointegration tests in Serra (2008) support the existence of a (single) long-run relationship between US ethanol, US corn and US oil prices. Results from Zhang (2009) yield cointegration relationship between ethanol and corn prices for the 1989-1999 period. In contrast, results indicate no long-run relation between ethanol and corn prices in the 2000-2007 period. In contrast to popular belief, between 2000 and 2007 ethanol and corn do not appear to have any long-run price relationships.