A Cost and Benefit, Case Study Analysis of Biofuels Systems

Within the past decade, biofuels have become key research initiatives and investments for many states with implications for agricultural and developmental economics. Recent innovations in both first generation (1G) and second generation (2G) biofuels herald a long-term emphasis on energy sustainability and efficiency. 1G energy crops include corn, grains, and sugar cane while lignocellulosic biofuels (2G) derive from corn stover, sugarcane bagasse, and various forest residues. This paper presents a methodology for the economic analysis of investment in different types of biofuel systems. Our paper aims to determine whether 1G and 2G biofuels would be a viable economic and financial investment for typical developed and developing nations, respectively. First, we will collate and analyze the empirical findings on the socioeconomic effects of biofuels to construct a cost-benefit analysis, focusing on US-based and international case studies. We will then analyze the energy and emissions potential of biofuels. Following the qualitative report, we will offer a preview of our Net Present Value (NPV) model and its final results.

 

Socioeconomic Cost-benefit Analysis (Biofuels)

The Socioeconomic Impact of First Generation Biofuels

Impact of Biofuels in Current Consumption and Production in U.S.

As of 2013, first generation biofuels have enjoyed regular and assured growth in the US. First generation biofuels must demonstrate a 20% reduction in lifecycle greenhouse gas (GHG) emissions compared to the baseline of the original fuel (U.S. D.O.E., 2013c).  As a result of this standard, biofuels, predominantly starch ethanol and biodiesel, have been increasingly introduced into fuels since 2005, when the standard was originally implemented as part of the 2005 Energy Policy Act. This trend has endured thanks to the Energy Independence and Security Act of 2007 (EISA) Renewable Fuel Standard (RFS), which requires the blending of renewable fuels with traditional petroleum-based fuels.

Today, biodiesel production is an estimated 135 million gallons in December 2013 with a capacity of 2.2 billion gallons per year (U.S. D.O.E., 2014a). Ethanol production is 1.2 billion gallons in December 2013 with a capacity of 13.852 billion gallons per year (U.S. D.O.E., 2014b).  This is a large increase from 2012, during which time the nation experienced a month-to-month decline in biofuel production due to the drought afflicting many of the nation’s agricultural regions. With the ebbing of the drought in 2013, biofuel production resumed. Ethanol production averaged 925,000 bbl/day in 2014, while biodiesel production averaged 87,000 bbl/d.

 

Anthony Uchicago2

Source: U.S. Department of Energy, 2014a

Projected Consumption and Production in U.S.

Over the following several decades, biofuels experienced some growth, but remained a small portion of the US liquid fuel supply. According to the U.S. Energy Information Administration, biofuels will grow by about 0.4 million barrels per day from 2011 to 2040, thanks to the RFS mandate (U.S. D.O.E., 2013a). This growth rate could increase if the RFS were increased, though for the moment that seems unlikely. However, despite the mandate, overall biofuel growth will remain limited as a result of decreased gasoline consumption, according to a prediction from the Energy Information Administration (EIA). This decline, down to 8.1 million barrels per day in 2022, will also cause biofuels to fall short of the EISA 2007 target. As a result, the mandate is not likely to cause any additional growth in biofuels in this half-century. After 2020, second generation biofuels will overtake 1G biofuels and provide most of the industry’s growth. Annual ethanol consumption is projected to decline to 14.9 billion gallons by 2040. Despite the decline, ethanol will continue to be the primary biofuel in the United States.

Anthony Uchicago1

Source: (U.S. Department of Energy, 2013c)

 

International Impact of Biofuels in Current Consumption & Production

Internationally, biofuel production and consumption is dominated by the United States and Brazil. In 2011, the two nations comprised 70% of global biofuel consumption and 74% of global production (U.S. D.O.E., 2011b). Biofuels in the United States are dominated by corn-based ethanol, while those of Brazil are primarily sugar cane-based. Both fuel types have been growing in use and consumption in the past decade. Other countries, such as France, Germany, and China, contribute to global biofuel production and consumption as well. France, Germany, and other countries favor biodiesel in keeping with the high proportion of diesel vehicles in those countries. Meanwhile, China prefers to use ethanol as a motor fuel. However, in no country other than the United States and Brazil do biofuels contribute a significant portion of the country’s motor fuel or energy supply.

International Projected Consumption and Production

Mirroring current levels, biofuel consumption is projected remain rather low on global scale, even when both 1G and 2G biofuels are included. The total increase in renewable energy consumption, which includes biofuels, is projected to be a meager 4% and to contribute between 11% and 15% of global energy consumption by 2040. More specifically, transportation fuels, the primary use for biofuels, are projected to grow 1.1% per year, or 38% overall, by 2040 (U.S. D.O.E., 2013b)  Among transportation fuels, non-petroleum liquid fuels, a category predominantly composed of biofuels, will experience 3.7% annual growth until 2040, with most of this growth occurring in the United States and Brazil. Overall, while it may seem impressive, this growth is small, if not negligible, in the face of global energy growth. Total global energy consumption will experience 56% growth between 2010 and 2040—from 524 quadrillion British thermal units (Btu) to 820 quadrillion Btu. This overall energy growth will primarily occur in developing countries, while the future of biofuels as a mainstream fuel will probably remain in the US and Brazil.

Environmental Impact and Emissions

Despite its occasional proclamation as a “green” fuel, first-generation biofuels, primarily ethanol, are not without their own GHG emissions. While ethanol does produce fewer overall GHG emissions than gasoline, its production is still an energy intensive process with secondary effects. Gasoline generally produces 8.91 kg CO2 per gallon, compared to 8.02 kg CO2 per gallon for E10 ethanol and 1.34 kg CO2 per gallon for E85 ethanol. Based on a study by Dias de Oliveira et al. (2005), corn-based ethanol requires 65.02 gigajoules (GJ) of energy per hectare (ha) and produces approximately 1236.72 kg per ha of carbon dioxide (CO2), while sugar cane-based ethanol requires 42.43 GJ/ha and produces 2268.26 kg/ha of CO2 under the assumption of non-carbon neutral energy production.  These emissions accrue from agricultural production, crop cultivation, and ethanol processing. Once the ethanol is blended with gasoline, it results in carbon-savings of approximately 0.89 kg of CO2 per gallon consumed (U.S. D.O.E., 2011a).

Secondary Effects

Beyond emissions, 1G biofuel production has many side effects. These effects include negative impacts on land and water, loss of biodiversity, and air pollution. Unlike fossil fuels, the production of biofuels requires large tracts of arable land for production in addition to land for the physical conversion plants. As a result, it suffers from many of the same issues as agriculture itself. These problems include water diversion and pollution, exhaustion of arable land, and destruction of natural habitats.  However, since biofuels can increase the demands on agricultural cultivation, these secondary effects can spread across a wider area as biofuel production grows.

 

Impact on Food Supplies

Price

Since 2000, global food prices have been increasing rapidly. These price increases have affected both developed and developing countries and have been seen globally. The spike in prices eased in 2009-2011 due to the Great Recession, however, food prices have maintained their upward trajectory nonetheless. Causes typically cited for food price increases include competition by biofuels, production issues, policy decisions, and droughts. Biofuel production contributes to the growth of food prices by reducing food production. Corn, as the primary crop used for biofuels, has seen the greatest price increases, and 70% of the growth in corn production was for biofuel production (Mitchell, 2008).  However, due to the nature of the international food market and the usage of other crops, such as sugarcane, for biofuels, prices for all major crops have increased. An estimate by the International Food Policy Research Institute indicates that biofuels may be responsible for 30% of weighted food price increases from 2001-2007 (Rosegrant, 2008).  Continued growth in biofuels can be expected to continue to add to the growth in food prices.

Supply

Based on its agricultural capacity, the United States will never be capable of producing enough first-generation biofuels to meet all of its fuel and energy needs without compromising its food supply and that of other nations that depend on the US for food. In 2005, it took 14.3% of the US corn production was used to replace a mere 1.72% of gasoline usage (Hill et al., 2006).  To achieve a significant long-term reduction in fossil fuel usage through first-generation biofuels alone would be impossible due to this prohibitive impact on the food supply.  As will later be discussed, second generation biofuels may have greater potential to reduce fossil fuel usage while maintaining food supply.

In international locales, we expect largely similar results, particularly in smaller, more densely populated nations. Currently, Brazil, the other major biofuel producer, has more of their fuel provided by biofuels. However, as their population grows and becomes wealthier, we can expect this percentage to decrease as they run into similar agricultural supply problems. If the United States and Brazil, two of the world’s largest agricultural producers, currently experience such difficulties, we can reasonably expect that most other nations will experience similar obstacles.

1G versus 2G

In recent years, the socioeconomic and environmental sustainability of first generation biofuels (1G) has been called into question. The viability of 1G energy crops such as corn, grains, and sugar cane is uncertain, primarily because they compete with food crops, and may not even offer significant GHG emissions reduction. Although there is a tendency to consider sustainability issues regarding 2G energy crops, there are important lessons to be learned from the sustainability challenges posed by 1G crops (Carriquiry et al. 2011). The major sources of lignocellulosic biofuel feedstocks (2G) are as follows: agricultural residues (corn stover, sugarcane bagasse), forest residues, and herbaceous and woody energy crops, including perennial forage grasses like miscanthus (Miscanthus giganteus) and switchgrass (Panicum virgatum).

Issues commonly classified as either environmental, economic or social are often related to each other in complex ways (Mohr & Raman, 2013). For example, food security issues arising from diversion to 1G biofuels might be resolved by production of 2G biofuels because they are not produced from feedstocks commonly used for food production. However, food security quickly becomes a relevant issue when non-food energy crops are grown on land that could potentially be valued in food production or if biofuel production using agricultural residues can be linked to 1G feedstocks. While 2G biofuels can be grown on otherwise marginal land, this land could possibly be utilized by the poor for subsistence (Mohr & Raman, 2013).

Nonetheless, cellulosic energy crops are promising because of their environmental benefits. Madhu Khanna (2008) listed the following potential incentives for transitioning to 2G biofuels: reduced soil erosion, improved sequestration of carbon in the soil and lower inputs of energy, water and agrochemicals. Khanna (2008) notes that environmental benefits vary, among other factors, with the ability of different crops to sequester carbon into soil and with energy input requirements .

Costs of Production

Khanna’s report (2008) includes useful quantitative metrics for assessing the economic viability of cellulosic biofuel energy crops. From a production standpoint, miscanthus can produce 742 gallons of ethanol per acre of land, which is nearly twice as much as corn (399 gal/acre, assuming average yield of 145 bushels per acre under normal corn-soybean rotation) and nearly three times as much as corn stover (165 gal/acre) and switchgrass (214 gal/acre). Production costs are a big impediment to large-scale implementation of 2G biofuels, and their market demand will depend primarily on their price competitiveness relative to corn ethanol and gasoline. At this time, costs of conversion of cellulosic fuels, at $1.46 per gallon, were roughly twice that of corn-based ethanol, at $0.78 per gallon. Cellulosic biofuels from corn stover and miscanthus were 24% and 29% more expensive than corn ethanol, respectively, and switchgrass biofuel is more than twice as expensive as corn ethanol.

Social Impact

Availability of land is undoubtedly one of the key considerations in the discussion of future potential for biofuels. According to a 2010 report published by the World Bank, a major advantage of using agricultural residue crops to produce biofuels is that they do not require additional land. Barring secondary environmental effects, such as their potential usefulness as ground cover, residue crops should have almost no direct impact on food prices. Biofuels produced from crop and forest residues have significantly less land requirements than do dedicated energy crops, such as switchgrass and miscanthus (Carriquiry et al., 2011). Job creation and regional income growth are also important factors to consider in assessing the viability of 2G-biofuel productions. According to a 2010 report published by the International Energy Agency, there is potential for job creation in the cultivation of feedstocks based from dedicated energy crops. If production is based on residue use, then existing farm labor can be utilized, thus prolonging employment past the harvest season (Eisentraut, 2010). Feedstock cultivation and transportation do not require skilled labor and thus there will be a sufficient workforce even in developing economies. The use of residues can also bring added revenue to the agriculture and forestry industries, with beneficial impact on local economies and rural development.

Greenhouse Gas Emissions

Life-cycle analysis is often used to estimate the potential for various biofuel feedstocks to reduce GHG emissions in comparison with gasoline. Khanna’s findings (2008)show that corn and corn stover can reduce greenhouse gas emissions by 37% and 94%, respectively, in comparison to energy equivalent gasoline. Switchgrass and miscanthus, however, are carbon sinks, meaning that they accumulate and store carbon-containing compounds for indefinite periods of time. A more comprehensive table compiled by the World Bank (Carriquiry et al., 2011) shows the relative GHG emission mitigation properties of various biofuels (see below) .

Biofuel Type Emission Reduction (%)
Sugarcane ethanol 65 – 105
Wheat ethanol -5 – 90
Corn ethanol -20 – 55
Sugarbeet ethanol 30 – 60
Lignocellulose ethanol 45 – 112
Rapeseed biodiesel 20 – 80
Palm oil biodiesel 30 – 75
Jatropha biodiesel 50 – 100
Lignocellulose diesel 5 – 120

Source: Carriquiry et al., 2011

Net Present Value (NPV) Model

In addition to our socioeconomic analysis, our full paper contains a net present value (NPV) model that details the economic viability of 1G and 2G biofuels in several national cases.  There are four cases divided among two countries, a representative developed country (United States), and a less developed/developing countries (Brazil). These countries have exhibited potential for biofuel investment in terms of research, land, and crop allocations. The model simulates the rate of return (in dollars), or net benefit, of a conventional investment in 1G generation biofuels and a new investment in 2G generation biofuels over a 15-year time frame. Relevant ratios and metrics given the resulting numbers will also be analyzed in context. We also hope to compare these model figures with that of a coal plant, and if these lands were used to grow regular food crops instead–what is the efficient economic investment? Finally, given this wealth of empirical and quantitative data, we will construct general investment and policy recommendations with applications in policy and economics.

For the purposes of the model, we simulated costs and revenues of Ethanol versus Miscanthus/cellulosic ethanol for the biofuels comparison. We then compare these numbers with the amount of energy per gallon of gasoline and compare this with the price per gallon.

Aggregate Results

Tabulation of Findings:

Description (CASE) (‘000 US$) Developed Nation (2G) CASE A Developing Nation (2G) CASE B Developed Nation (1G) CASE C Developing Nation (1G) CASE D
Operating Profit 209,313 -1,176,017 166,952 -91,300
Net Present Value 100,690 -1,011,217 40,982 39,224
Return on Investment 1.41 0.32 1.17 0.73

 

CASE Table 1: Profit, NPV, and ROI Values

Case A has the highest NPV and Operating Profit. A developed nation with the right amount of investment and the relatively low input costs to produce 2G biofuels can capitalize on the earning potential of 2G biofuels, specifically miscanthus-based cellulosic ethanol. In this case, developed nation plants with well-developed and optimized 2G biofuel plants stand to earn substantial profits.

When choosing between Case A (2G) or Case C (1G) biofuels plant operation for developed nations, Case A 2G biofuels has the highest NPV and should be the preferred choice. We expect this result to hold, especially in the near future when 2G biofuels production becomes more efficient and realizes its cost-savings in inputs as compared to 1G biofuels. While the current capital, chemical, and maintenance costs for 2G biofuels projects are above that of 1G, feedstock costs tend to be lower and projected revenues are higher. Assuming input prices stay the same and innovation and R&D on 2G biofuels leads to lower capital and conversion costs, 2G biofuels could be considered a rewarding investment for developed countries that generates a growing stream of profits.

Case B, or developing nation (2G) plant, should not continue because of a negative NPV value; that is, sustained investment losses. This is because 2G biofuels require large investments initially and revenues would be needed to help cover the cost. In addition, in many developing nations, costs can be high due to corruption, waste and inexperience handling the technology and production processes; furthermore, export or domestic markets can be difficult to find or penetrate.  Another factor is the high relative cost for businesses in developing countries to convert their machinery to biofuel production.

For Case D, we find that while the NPV is positive, indicating that we should push through with the investment, the operating profit is actually negative. Thus, the NPV calculation is deceptive as the project is kept alive by FDI or by financing from investments. The investment in 1G in most developing nations can proceed, but would require some significant public-private investments for the plant and operation survive and produce. Most developing nations are familiar with the production of 1G biofuels, although investment costs may require external support.

Clearly, Case A has the highest ROI of the four cases due to its high potential revenue and low expense of 2G biofuels production.  Although Case D has a positive NPV value, its return to investment is very low and is less than 1, suggesting that in the long-run, 1G biofuels production in a developing country could be unsustainable and unprofitable.

The model findings agree with the empirical evidences presented in Section II. Although the future of biofuels seems secure for most developed countries like the US and developing countries with already robust biofuel industries, such as Brazil, the use of biofuels as a mainstream fuel outside these types of countries is unlikely.

Summary of Recommendations

From the Table, we see that 2G biofuels are generally more profitable than 1G biofuels, although 2G biofuel revenues per gallon in developing countries lag behind those of developed countries. It is possible that the lack of a strong export market and lower domestic demand will reduce the revenue per gallon of a developing nation’s biofuel yield. The lower demand could result from less emphasis on biofuel policy or from the cost of converting machinery to accept biofuels. These developing nations may have to reduce the price of their biofuels to lure buyers away from relatively cheaper gasoline, leading to smaller revenues and risking economic losses in the long run.

Revenues from developing countries for 1G and 2G biofuels can be quite substantial though the profit per barrel is negative due to the high relative cost and inadequate revenue generation to offset these costs. Revenue generation for 2G biofuels is much higher than that of 1G biofuels, suggesting that 2G biofuels could be a lucrative investment for most developing countries in the future, as technology and domestic operations become more inexpensive. For most developing nations, the cost of producing 1G biofuels is cheaper and industry is more familiar with the technology to produce these kinds of biofuels.

The US has the highest production capacity for biofuels and nets the largest NSAR value based on revenues per gallon, while Brazil has the next highest value. Profits per gallon are still generally higher for developed nation 2G biofuels as opposed to 1G biofuels, as reflected in the higher revenue amount for 2G biofuels.

The US and Germany are capable of producing both kinds of biofuels at a profitable rate; however, capacity and total land allocation will ultimately decide the potential of a developed country to produce biofuels.

Anthony Gokianluy,  Matthew Cason,  & Rohit Satishchandra are Green Economics Consultants, The Green Economics Group, University of Chicago. Mr. Gokianluy also serves as a client consultant.  They would like to thank Professor Theodore Steck, M.D. of the University of Chicago and the Center for International Studies for their assistance throughout the writing process.

This article is a commentary on the actual research paper, which can be found here

References