The biofuels case as the coming of the third horseman

Stuart Staniford has just posted at http://www.theoildrum.com/node/2431 a remarkable piece of work that covers, at an academic level, an issue I have been raising for some time in TOD comments like
http://www.theoildrum.com/node/3412/286090 and
http://www.theoildrum.com/node/3124/253090 . After making a couple of IMV important observations, I will try to express the concepts involved as a simple business case.

First, although current global annual production of ethanol is much higher than that of biodiesel, due to US corn ethanol, biodiesel (mostly from soybean) will probably play an increasingly larger role because of the following reasons:

1. Soybean biodiesel has a much more robust EROEI than corn ethanol.

2. Soybean has lower fertilizer and pesticide requirements than corn, in absolute terms and even more when taking EROEI into account. "Per unit of energy gained, biodiesel requires just 2 percent of the N and 8 percent of the P needed for corn ethanol. Pesticide use per NEB differs similarly." (Quoted from the National Academy of Sciences recent report titled "Water Implications of Biofuel Production in the United States" at
http://www.nap.edu/catalog.php?record_id=12039 .)

3. Outside the US, and particularly in Europe and in South American major grains and soybean exporters, the liquids fuels usage profile has a much higher share of diesel fuel relative to gasoline, with diesel fuel powering many personal vehicles.

4. Anywhere, diesel fuel's availability is more critical than gasoline's. No gasoline means it will be a pain to get to the supermarket, but no diesel fuel means there will be no goods in the supermarket.

5. Should a shortage of NG develop, most of today's NG-fired power plants can burn diesel fuel as well.

6. Finally, although I don't have a reference at hand to support it, I remember learning that the investment costs for a corn ethanol distillation plant are three times higher than those for a biodiesel plant of similar capacity.

Second, the fact that "the biofuel potential of the entire human food supply is quite a small amount of energy compared to the global oil supply - somewhere between 15-20% on a volumetric basis, so 10-15% on an energy basis -", although conceptually undisputable, is effectively irrelevant. Because the decision about how much agricultural production will be diverted into biofuels will not be made for the whole world by a hypothetical good-willed council that considers the world as one unit and balances the energy and food needs of the world's population. Rather, the decisions will be made by the countries which today are big agricultural exporters taking into account THEIR needs. And the key point here is that the countries with more biofuel production potential (e.g. Brazil, Argentina, Paraguay) have much lower liquid fuel (and energy in general) usage per capita than OECD countries. Therefore if they maximize the allocation of THEIR agricultural potential into biodiesel production (plus sugar cane to ethanol) for THEIR own use, they will be able to keep running the most important parts of THEIR current economies in the face of a future decline of global oil production (and a much harder decline of global oil exports), and it is just not realistic to expect they will forego that possibility.

Since it's essential to understand this issue, I feel it is warranted to emphasize its explanation: even while it's true that, if all vegetable oil in the world were converted to biodiesel, it would only cover 8% of GLOBAL diesel fuel demand, the key point is that Brazilians, Argentinians, etc. will not scale up biodiesel production (from soybean, sunflower or rapeseed, that's not the point) to satisfy GLOBAL diesel fuel demand. They will do it to satisfy THEIR OWN demand. So the relevant analysis that has to be made is, e.g. for Argentina:

- How much land they need to provide wheat, etc. for THEIR OWN population.

- How much biodiesel they would produce if the rest of their arable land were devoted to biodiesel production (pick the oilseed you want).

- How that potential biodiesel production compares to THEIR OWN current diesel fuel consumption.

Basically, if Argentina allocates ALL their current arable land to soybean (currently they allocate 53%), they would generate biodiesel to cover ALL their current diesel fuel consumption. If they used sunflower instead, they would need to allocate only 50% of the current arable land for that (using yield figures from
http://en.wikipedia.org/wiki/Biodiesel). Given that Argentina today is a big grains exporter, it is clear that they can provide food for their current population while at the same time producing enough biodiesel to avoid experiencing a dramatic impact from the coming relentless decline in global crude oil production.

Of course, they will not say as much in their presentations, which can be found at:
http://www.argentine-embassy-uk.org/biofuels/presentaciones/panel1.ppt and
http://www.ars.usda.gov/meetings/Biofuel2007/presentations/IP-B/Almada.pdf .

Therefore the most probable outcome is that, as oil prices go higher, a growing share of agricultural production will be diverted into biodiesel production. Land arbitraging based on profits per acre will drive the allocation of land out of wheat and corn production and into soybean production. Food exports will drop, food prices will rise, and poor people will be priced out of food.

I will try to express the above dynamics as a simple business case. Let's assume a farmer has the option of producing any of the following:

  • Wheat (W)
  • Corn (C)
  • Soybean (S)
  • Soybean Oil (BO) (using a co-owned mill from a local co-op), yielding Soybean Meal (SM) as by-product.
  • Soybean biodiesel (SBD) (further processing BO at a co-owned refinery from a local co-op).

Let's use the suffix "a" to denote "per acre" (non-US folks can use "h" for "per hectare"). Thus, Wa = Wheat yield per acre. Each option yields a different profit per acre. Some key components of profit per acre for W (and C and S) are (the currency is shown as dollar but could be any):

Profit(Wa) =
= $ Wa
- $ fuel (for sowing, harvesting, etc.)
- $ fertilizer, herbicides and pesticides

While the key components of the profit per acre for the full chain of production of soybean biodiesel (SBD) are:

Profit(SBDa) =
= $SBDa
- $ fuel (for sowing, harvesting, etc. the soybean)
- $ fertilizer, herbicides and pesticides
- $ milling operations energy input
+ $SMa by-product
- $ refining operations energy input
- $ methanol
+ $ glycerin by-product

The case for allocating the land to biodiesel production occurs when:

Profit(SBDa) > Max[Profit(Wa), Profit(Ca), Profit(Sa), Profit(BOa)]

Now, since BD (from any oilseed) is functionally equivalent to diesel fuel (DF), except for the fact that the volumetric energy density of BD is about 9 % lower than regular Number 2 petrodiesel (
http://www.biodiesel.org/pdf_files/fuelfactsheets/BTU_Content_Final_Oct2005.pdf) in the absence of any government-induced price distortion (through a difference in taxes/subsidies) the price equivalence condition for any biodiesel to substitute diesel fuel is:

$ BD = 0.9 x $ DF (per gallon/litre)

And, since the prices of most cost items for BD are more or less directly linked to the prices of fossil fuels (including methanol, which is currently made out of coal in China, waste in Germany, and NG elsewhere, according to
http://www.methanol.org/pdf/WorldMethanolPlantsEndOf2006.pdf), which most probably will all rise along with the price of crude oil, though at different speeds, then Profit(BDa) will rise with the crude oil price in, at the very least, a roughly directly proportional fashion. In contrast, for W (and C, etc.) the oil price has an impact only on the cost items. Therefore, the higher the crude oil price, the higher Profit(BDa) and the lower Profit(Wa), Profit(Ca), etc.

At this point, arbitraging starts. As more land is diverted into BD production and less into grains, BD production will increase and its price will stabilize (I wouldn't say fall) while grains production will decrease and their prices will rise, until Profit(Wa) becomes competitive with Profit(BDa) and no further land is diverted into BD. However, since the prospects for world crude oil production is to experience a relentless decline after its near (2012?) peak, if demand for crude oil does not fall correspondingly on its own, crude oil (and diesel fuel) prices will keep rising, having a further diverging impact on Profit(BDa) and Profit(Wa), etc., and driving the land arbitraging mechanism to successive new equilibrium states with more land allocated to BD and less land to grains.

Therefore, in the absence of a worldwide voluntary reduction of crude oil demand in line with the evolution of crude oil production (as proposed by the Oil Depletion Protocol), the prospects for world food production are quite bleak.

A similar analysis as that for soybean biodiesel can be made for corn ethanol, the main difference being that the energy and fertilizer, etc. costs are so much higher for corn ethanol that it wouldn't yield a profit in the absence of huge government subsidies. Similar analyses can also be made for sunflower biodiesel and rapeseed biodiesel. These options have on the one hand the advantage of higher oil and biodiesel yields per acre/hectare, and on the other the disadvantage of lacking a by-product of significant nutritional value as livestock and poultry feed as Soybean Meal.

Now it could be useful to refine a bit the expression of the business case.

As said above, Profit(BD) refers to the profit for the full production chain, because full vertical integration was being assumed (i.e. farmers owned the mill and the refinery through a co-op). Even if there were no such integration, it still makes sense to look at the profit for the full chain because it has to be higher than that for just producing soybeans. But it might be more useful to separate the profits for each stage, e.g. for soybeans:

- Farming - Output: soybeans (S)
- Milling and oil refining - Input: S; Output: Soybean oil (BO) + Soybean Meal (SM)
- Transesterification - Input: BO; Output: SBD

Thus, the profit for the full chain can be expressed as:

Profit(SBD) =
= Profit(S)
+ Profit(BOmill)
+ Profit(SBDref)

For prices, it is necessary to specify whether they are retail or collected by the refiner, the difference being taxes (ignoring gas station margin by assuming that gas station profitability is the same for biodiesel and diesel fuel). Because the price equivalence condition with diesel fuel (DF) holds at the retail level. Therefore, for ANY biodiesel:

$BDretail = 0.9 x $DFretail

$BDref + $BDtax = 0.9 x ($DFref + $DFtax)

$BDref = 0.9 x ($DFref + $DFtax) - $BDtax

For corn ethanol, the price equivalence condition with gasoline (RB) would be:
$CEref = 0.66 x ($RBref + $RBtax) - $CEtax

Clearly, the business case for a biofuel is heavily dependent on both the tax/subsidy on the biofuel itself and the tax/subsidy on the substituted petroleum product (subsidy being a negative tax), so that if the petroleum product has a higher tax/lower subsidy than the biofuel the business case is improved. The level of taxation/subsidising on petroleum products varies wildly across different countries, as shown in the "International Fuel Prices 2007" document available from http://www.gtz.de/en/themen/umwelt-infrastruktur/transport/10285.htm .

It should be noted, however, that the case for biofuel production in a country does not necessarily arise out of the price equivalence condition holding in the producing country, because the biofuel can be produced for exporting to another country where the condition holds. Thus, while in November 2006 retail diesel prices in Argentina ($0.48 per litre) or even Brazil ($0.84) would not make the case for biodiesel production for local use, retail diesel prices for France ($1.33), Germany ($1.38), Italy ($1.49) and the UK($1.73) would paint a different picture for exports. And that was in November 2006, with a WTI price of $60. So it is reasonable to assume that the scaling up of biodiesel production will initially be driven by exports and only later - as domestic crude oil production declines significantly - be diverted to supply the local market. This prospect is supported, at least for Argentina, by an excellent study on their biofuels market available at

Therefore, using the price collected by the biodiesel refiner, the profit for the transesterification stage is, for soybeans:

Profit(SBDref) =
= $BDref
- $BOmill
- $ refining operations energy input
- $ methanol
+ $ glycerin by-product

The profit formula uses $BOmill and not $BOretail because typically the owner of the milling and oil refining facility also owns the biodiesel refinery. So the profit is related to the price they get for BO, which is its cost for the transesterification stage.

It should be noted that the difference in profits for the transesterification stage using different vegetable oils as feedstock depends only on the price of the vegetable oils. However, this should not be expected to lead to instantaneous arbitration between oilseeds. Because, in contrast with transesterification facilities which can equally process any vegetable oil, milling facilities are specific for each oilseed. Therefore, oilseed arbitration would depend on the combination of Profit(*OILmill) + Profit(*BDref).

No comments: