BIOFUELS AND IMPLICATIONS FOR WORLD FOOD MARKET

In today’s society, a new food economy is emerging, and it has very different characteristics from those at the end of the previous century. For a long time, it was been recognised that the agricultural sector was only part of the food economy and that it had to be seen within the context of the food supply chain, including activities from upstream to downstream. However, this supply chain concept is not sufficient today. The new food economy is characterised by its holistic nature, as it is at the centre of major global societal concerns.

Ethanol Plant in Brazil

This chapter evaluates the impact of the recent biofuels boom on world food markets. We begin with an analysis of the origins of the bio-fuel boom – from a US perspective. We conclude by predicting a slowing of the ethanol boom in the US, as production satiates the high-value demand for ethanol as an additive so that future growth hinges of its ability to substitute for petroleum products on an energy equivalent basis. This transition is reflected in the elimination of the price premium for ethanol, the price of which has dropped sharply recently. This, combined with higher corn prices, has served to curtail most plans for new ethanol capacity – at least for the present.
Our prospective analysis of the impacts of the biofuels boom on food markets focuses on the 2006-2010 time period, during which existing investments in the US, and new mandates in the EU are expected to substantially increase the share of agricultural products (e.g. corn in the US, oilseeds in the EU and sugar in Brazil) utilised by the biofuels sector. In the US, this share could double from 2006 levels, while the share of oilseeds going to biodiesel in the EU could triple. We expect such expansion to lead to a doubling of US cornand EU oilseed prices, from 2006 levels, thereby sharply reducing exports, while boosting imports. In the EU, the majority of the new demand for oilseeds due to biodiesel expansion is met by imports, with EU oilseed import volume rising by more than $4 billion. These increases in biofuels demand in the US and EU have a profound impact on the pattern of global agricultural production and land use.
Wheat and soybean acreage and production falls in the US, along with other crops, livestock and forestry land use. In the EU, acreage devoted to oilseeds rises by 21 precent. This reallocation of land use is rather similar in Canada and Brazil, where oilseeds production also responds strongly to higher world prices, as does coarse grains production in Canada, and sugarcane production in Brazil. This puts considerable pressure on agriculture and forest lands throughout the world. In Brazil, agriculture is expected to expand into forest lands – particularly in the most productive agro-ecological zones (AEZ).
In addition to altering the global agricultural landscape, these developments in US and EU biofuels use have a significant impact on energy markets. Solely as a result of these ‘mandates’, the US trade balance for petroleum products improves by about $6 billion. This is largely offset by deterioration in the US agricultural trade balance. In the EU, the deterioration in the agricultural trade balance is much larger, but this is compensated for by a strong increase in the net exports of manufactures and services. Overall, current developments in the US and EU biofuels markets, including the European Commission’s 5.75% biofuel mandate, are likely to have significant, and lasting impacts on the global pattern of agricultural production and trade.

Booming Biofuels

Interest in biofuels initially came about in the late 1970s as OPEC reduced crude oil supply on the world market and fuel prices increased substantially. Both the US and Brazil launched ethanol programmes during this period. The US, EU, and Brazil all have subsidies or regulations promoting biofuels. In Brazil and the US, ethanol is the predominant fuel, and in the EU, it is biodiesel. Until 2006, Brazil was the global leader in ethanol production, but with the developments in world oil markets plus US domestic policy described below, the US overtook Brazil in 2006. However, it is cheaper to produce ethanol from sugarcane, the resource used in Brazil, than to produce it from corn, the raw material currently used in the US. The energy balance also is much more positive for sugarcane based ethanol than for ethanol from corn. Therefore, in the absence of government intervention, we would expect Brazilian ethanol to be dominant.
The European Union Biofuels Directive requires that member states should realise 5.75% share of biofuels on the liquid fuels market by 2010 (Commission of the European Communities, 2003). Biodiesel production has been a more recent addition to the global biofuels scene, as shown in Figure 1 (note the difference in scales for the two types of biofuels). Germany is the largest producer (798 million gallons1 constituting about 54% of EU-27’s total biodiesel production in 2006) followed by France (15%), Italy (9%), United Kingdom (4%), Austria (2.5%), Poland (2.4%), Czech Republic (2.2%), Spain (2%), and others (9%) (European Biodiesel Board). The spectacular growth in the German market was the result of a very favourable legislation granting a total tax exemption for biofuels, which has recently been rescinded.

Growth in Ethanol Production

In the US, subsidisation of ethanol began with the Energy Policy Act of 1978. At the time, the main arguments that were used to justify the subsidy were enhanced farm income and, to a lesser extent, energy security. In 1990, the Clean Air Act was passed, which required vendors of gasoline to have a minimum oxygen percentage in their product. Adding oxygen enables the fuel to burn cleaner, so a cleaner environment became an important justification for ethanol subsidies. Since ethanol has a larger percentage of oxygen than standard gasoline, or methyl tertiary butyl ether (MTBE), its main competitor in the additive market, the demand for ethanol as an additive offered good prospects. However, MTBE is produced from petroleum products by oil companies and was generally cheaper than ethanol, so it continued to be the favored way of meeting the oxygen requirements throughout the 1990s.
This growth in MTBE use was, however, short-lived, as it began to crop up in water supplies in several regions in the country. Since MTBE is highly toxic, it was subsequently banned by about 20 states. That left ethanol as the major source of added oxygen in those states by the early 2000s. Two years ago, Congress debated and ultimately passed the Energy Policy Act of 2005. During the debate, oil companies lobbied to be given exemption from legal liability from MTBE issues. Congress did not grant the legal liability exemption but did agree to remove the oxygen requirements leaving oil companies free to meet the clean air rules in any way they saw fit (ethanol, reformulated gasoline, etc.).
The US Environmental Protection Agency issued rules eliminating the oxygen requirement as of May 2006. Oil companies generally believed they had legal cover for MTBE so long as the government was requiring them to meet a minimum oxygen requirement. But with the removal of the oxygen requirement, companies no longer had that legal cover and made a big push to use ethanol in its place. This resulted in a sharp price spike in the ethanol market in summer 2006. Since that time, the price of ethanol has been falling, as the demand for ethanol as an additive has become satiated, and ethanol is increasingly priced for its energy content. During the 20 years between 1983 and 2003 the US ethanol subsidy varied between 50 and 60 cents per gallon. Over that time period, crude oil ranged between $10 and $30 per barrel with a couple of short exceptions. Figure 2 shows the growth of US ethanol production and coincident decline in MTBE production during the 1992-2006 period. The subsidy was sufficient to ensure a profit except for a few months in 1996 when corn prices reached record high levels. However, the subsidy was not enough to create rapid growth in the industry. That subsidy, together with oil in the $10 to $30 range was sufficient to permit steady growth in ethanol production from about 430 million gallons in 1984 to about 3.4 billion gallons in 2004. In other words, production grew by about 149 million gallons per year over this period.
In 2004, the crude oil price began its steep climb to around $70/bbl, and it has been hovering between $60 and $80/bbl in recent months. This rapid increase in the crude price, together with an exogenously fixed ethanol subsidy, led to a tremendous boom in the construction of ethanol plants. Ethanol production in 2005 was about 4 billion gallons, and it will likely surpass 11 billion gallons in 2008. At this point, we expect it to make use of over 30% of the US corn crop. Production will have grown by about 1.9 billion gallons per year over that four year period compared with 149 million gallons in the preceding years. It has been, then, the combination of high oil prices, a shift in the demand for ethanol as a fuel additive, and a subsidy that was keyed to $20 oil that has led to this boom in US ethanol production.
Combinations of crude oil and corn prices revenues equal costs under three different assumptions. (1) The top line in the graph assumes there is no ethanol subsidy and that ethanol is priced on an energy equivalent basis with gasoline. (2) The second line assumes no subsidy again but that there is a 35 cent per gallon additive value for ethanol. (3) And the third line adds the 51 cent per gallon federal ethanol subsidy (the assumptions and econometric estimations used in producing this graph are contained in Tyner and Taheripour, 2007).
For $60/bbl oil, the energy, additive, and additive plus subsidy breakeven corn prices are $2.01, $3.12, and $4.72 per bushel (bu.) respectively. If there is no additive value, the energy plus subsidy breakeven is $3.62/bu. at $60/bbl oil. Clearly, so long as ethanol has a considerable additive value, ethanol production will continue to grow until corn reaches about $5/bu. But if ethanol is priced on an energy equivalent basis (as it would be for E-85 blends for example) and the current policy regime remains in place, then investment would cease at corn prices not much higher than they are today. We expect that the additive market will be saturated in the near future, so energy equivalent pricing is much more likely for the future. This suggests that the biofuel boom in the US may soon be coming to an end.

Consequences for Corn

The ethanol boom has, in turn, led to a rapid run-up in corn and other commodity prices in 2006-2007, as land has been diverted from these crops to corn – soybeans, in particular. The run-up in commodity prices has fueled debate over the food-fuel issue and raised questions on the extent to which renewable fuels can be supplied from corn alone. In a year’s time the price of corn went from $2.20/bu. to $3.50/bu. or higher – an increase of 60%. Soybean prices went up even more as there were massive shifts in soybean acreage to corn. This is not to say, however, that food prices will increase in like proportion. Corn is used primarily as an animal feed, with the proportion varying by animal species. Poultry meat and eggs are facing the largest shock as corn constitutes about two-thirds of the poultry ration. As a consequence, the total cost of producing poultry meat and eggs has increased by about 15% over this period. It is unlikely, however, that all this cost increase can be passed on to consumers.
For other commodities, the cost increase is smaller, and it is substantially smaller for the total consumer food bill. Recent estimates put the consumer food bill increase to date, due to corn ethanol, between 1.1 and 1.8% (Tokgoz et al., 2007). But in terms of the annual food bill, it is estimated that US consumers will pay $22 billion more for food due to biofuels (Alexander and Hurt, 2007). As indicated above, corn ethanol production is likely to reach 11-12 billion gallons in 2008. In a remarkable response to this increased demand and favourable prices, US corn acreage went from 78 million in 2006 to 92 million acres in 2007. Most of that acreage increase came at the expense of soybeans, thereby driving soybean prices substantially higher. How much higher will ethanol production go and what will be the determining factors? Most industry and agriculture experts (Tokgoz et al., 2007) figure corn ethanol production will top out around 15 billion gallons by 2012.
This would constitute 10% of projected US gasoline consumption (US Energy Information Administration) by volume and about 7% on an energy equivalent basis. The volumetric and energy equivalent shares are different because ethanol contains about 68% of the energy of gasoline per unit volume. Miles per gallon, at least in the short run, will be determined by energy content, so consumers are unlikely to be willing to pay more for ethanol than its energy equivalence to gasoline once it is widely known that ethanol blends yield lower fuel economy than gasoline alone. This suggests that there is limited scope for increasing the price of ethanol unless petroleum prices rise substantially. Unless current high oil prices are sustained, the US biofuel boom based on corn will gradually come to a halt, with total capacity settling in at about 15 billion gallons – nearly double current levels – and conveniently at the level dictated for 2015 by the 2007 US Energy Policy and Security Act.
Although factoring in the capacity already nearing completion, ethanol demand in the US represents a very substantial claim on corn production. When coupled with mandates in the EU, and potential subsidies for biofuels elsewhere around the world, this could have a very substantial impact on the long run patterns of global food and agricultural production and trade. The remainder of this chapter seeks to investigate this link between increased biofuel production and food trade. Mandates in the EU and US As noted earlier, both the EU and the US have announced biofuel targets. The share of biofuels in liquids for transport on energy basis constituted only 1.91% and 1.53%, respectively for the US and EU during 2006. In the EU, the goal is to reach 5.75% of energy used in transportation by 2010. Compared to reported biofuel use in 2006, this entails a 281% increase in biofuels’ share of liquid fuel consumption. In the US, the Energy Policy and Security Act of 2007 targets 15 billion gallons of ethanol by 2015.
However, capacity is already in place or under construction to nearly reach this target. Indeed, we estimate that ethanol capacity will reach 13.4 billion gallons by 2010 which constitutes 4.62% of liquid fuels for
transportation on energy basis. This amounts to a 176% boost in ethanol production for 2010. We adopt this as our target in this ‘mandates’ simulation. Importantly, we do not include bio-diesel in this US mandate as it is produced from soybeans in the US, which is regarded as an expensive source of feedstock  biodiesel. Due to its non-viability, biodiesel production is not likely to grow much and hence we assume no contribution from biodiesel to meet the mandate.
Biofuel growth and US food market: a 2010 scenario The strong expansion in ethanol production envisioned under our 2010 scenario more than doubles the share of US corn going to ethanol production – from 16% of total sales in our 2006 data base, to 38% of total sales in the projected 2010 data base. This increased share comes primarily at the expense of corn going to feed use and exports, which decline by 6% and 48%, respectively. The share of US coarse grains production exported falls from 23% in our 2006 baseline to 10% under the mandates scenario, as the price of US corn nearly doubles under this scenario. The change in output following the implementation of the mandate, is given in terms of domestic and exports components.
In US, only production of coarse grains goes up by 14% which mainly comes from 25% increase in demand for domestic use, coupled with decline in exports by 11%. The production of all other agricultural commodities goes down substantially. Meanwhile, the share of production going to feedstuffs falls from 43% to 37%. This contraction of other uses, coupled with a 14% increase in corn output, permits ethanol production to rise by 174%, as mandated in our 2006-2010 simulation scenario.
Next to a modest increase in yields as a result of more intensive cultivation practices, the increase in corn output is met largely by increases in land used for coarse grains. Figure 4 shows a map of the world, with the percentage change in coarse grains acreage, by agro-ecological zone (AEZ) and region. The percentage increase in acreage varies by AEZ, with the rise in the US Corn Belt being about 10%. The largest percentage changes in corn acreage (up to 25%) are in the less-productive AEZs which contribute little to national coarse grains output. Thus the productivity-weighted rise in coarse grains acreage is close to the Corn Belt figure and is just 11%. Meanwhile, oilseeds acreage in the US falls, as land is shifted from soybeans to corn.

Impacts of Biofuel Growth: EU and International Trade

Next we turn to the projected impacts in the EU. Here, the mandate represents a much larger change in percentage terms. The 281% increase in biofuel production is largely biodiesel, and this generates a strong demand for oilseeds, the production of which rises by 26% in response to a doubling of oilseed prices in the EU. This increase in production is far less than the required rise in use by the biodiesel sector, which is about triple this amount (nearly 80% of current production), and the difference is made up by increased imports of oilseeds as well as the virtual elimination of exports by the EU oilseeds sector. Thus the EU biofuel mandate has a very strong impact on international agricultural trade.
In order to meet the increased domestic production of oilseeds, oilseeds acreage rises across the board, with the increases ranging from 7% to more than 30%, depending on the AEZ, with the overall productivity-weighted average for land used in oilseeds rising by 12%. This land comes out of other grains, livestock and forestry, as the coarse grains and sugar acreage expands slightly, the price rises following the ethanol boom. Apart from the domestic impacts in the US and EU, it is clear that these effects will be felt around the world. These oilseeds are sourced from around the world, with the largest increase coming from Brazil. Imports of ethanol from Brazil also rise, as do imports of grains and livestock products.
Of course in the aggregate, global trade must balance, and each region’s current account must be equated to its capital account. Since the latter changes little as a result of the biofuel mandates, any increase in regional import values must be largely offset by an increase in export values. Thus the US farm and food sector shows a negative change in trade balance ($3.6 billion). This is offset by a positive change in the trade balance for oil and oil products ($6.3 billion), as biofuels substitute for petroleum products.
In addition, there is an increase in biofuel imports and a (net) positive change in the trade balance for other manufactures and services. In the aggregate, the US trade balance improves slightly as a result of these mandates, and the terms of trade improve, as the price of oil imports falls and the prices of agricultural exports rise.

The story in the EU is quite similar to the US in sign, but the magnitude of the agri-food trade balance deterioration is much larger in the EU (-$15.3 billion). The improvement in oil products trade balance is half that in the US (+$3.0 billion). The difference is made up by a much stronger improvement in the trade balance of other sectors such as manufactures and services ($12.1 billion). Here, the terms of trade deteriorate slightly.

By Dileep K. Birur, Thomas W. Hertel and Wallace E. Tyner in the book 'The Food Economy'- Global Issues and Challenges, (as 'The Biofuels Boom: Implications for World Food Markets') edited by: Frank Bunte & Hans Dagevos, Wageningen Academic Publishers, The Netherlands, 2009, p.61-75. Adapted and illustrated to be posted by Leopoldo Costa.